<PAGE> 1
Filed Pursuant to Rule 424 (b)(4)
Registration No. 333-42682
P R O S P E C T U S
7,000,000 SHARES
[HYDROGENICS CORPORATION LOGO]
COMMON SHARES
$12.00 PER SHARE
------------------
We are selling 7,000,000 common shares. The underwriters named in this
prospectus may purchase up to 1,050,000 additional common shares from us to
cover over-allotments.
This is the initial public offering of our common shares. The offering
price for shares offered in the United States will be payable in U.S. dollars
and will be approximately equivalent to the offering price in Canadian dollars
for shares offered in Canada. Our common shares have been approved for quotation
on the Nasdaq National Market under the symbol "HYGS" and conditionally approved
for listing on The Toronto Stock Exchange under the symbol "HYG."
------------------
INVESTING IN OUR COMMON SHARES INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING
ON PAGE 6.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
---------- ---------------
<S> <C> <C>
Initial Public Offering Price U.S.$12.00 U.S.$84,000,000
Underwriting Commission U.S.$ 0.84 U.S.$ 5,880,000
Proceeds to Hydrogenics Corporation (before expenses) U.S.$11.16 U.S.$78,120,000
</TABLE>
The underwriters are offering the common shares subject to various
conditions. The underwriters expect to deliver the common shares to purchasers
on or about November 1, 2000.
------------------
SALOMON SMITH BARNEY
CIBC WORLD MARKETS
BMO NESBITT BURNS
October 26, 2000
<PAGE> 2
[The front inside cover shows, clockwise from the top left corner, photos
of the HyTEF Power Generator and a 2 kW Portable Power Generator captioned
together as "Fuel Cell Systems in Development"; an illustration of a PEM Fuel
Cell with the caption "Illustration of PEM Fuel Cell"; a FCATS Screener and an
FCATS 12000 test station captioned together as "Fuel Cell Test Stations". In the
center of the page there is the Hydrogenics Corporation logo with the following
text below: "We make fuel cells work".
The back inside cover shows, clock-wise from the top left corner, two
photos of Hydrogenics fuel cell stacks under development with the caption "Fuel
Cell Stacks in Development"; a photo of an AC Impedance FCATS module with the
caption "Fuel Cell Stack Performance Monitor"; a large active area fuel cell on
a test bench with the caption "Large Area Fuel Cell Stack in Development"; and a
FCATS 85 kW test station with the caption "Fuel Cell Test Station". There is a
Hydrogenics logo and the following text in the middle of the page: "Since 1995,
Hydrogenics has been building a technology platform to exploit transportation,
stationary and portable fuel cell markets worldwide.
- Vehicular markets
- Stationary power generation
- Portable power"]
<PAGE> 3
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH ANY DIFFERENT INFORMATION. WE ARE NOT
MAKING AN OFFER OF THESE SECURITIES IN ANY STATE WHERE SUCH AN OFFER IS NOT
PERMITTED. YOU SHOULD NOT ASSUME THAT THE INFORMATION PROVIDED BY THIS
PROSPECTUS IS ACCURATE AS OF ANY DATE OTHER THAN THE DATE ON THE FRONT OF THIS
PROSPECTUS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.......................................... 1
Risk Factors................................................ 6
Forward-Looking Statements.................................. 19
Exchange Rates.............................................. 19
Presentation of Financial and Other Information............. 19
Use of Proceeds............................................. 20
Dividend Policy............................................. 20
Capitalization.............................................. 21
Dilution.................................................... 22
Selected Financial Data..................................... 23
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 25
Business.................................................... 30
Management.................................................. 46
Certain Transactions........................................ 54
Principal Shareholders...................................... 55
Description of Capital Stock................................ 57
Shares Eligible for Future Sale............................. 58
Income Tax Consequences..................................... 60
Underwriting................................................ 65
Legal Matters............................................... 68
Experts..................................................... 68
Where You Can Find More Information......................... 68
Index to Financial Statements............................... F-1
</TABLE>
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UNTIL NOVEMBER 20, 2000, ALL DEALERS THAT BUY, SELL OR TRADE OUR COMMON
SHARES IN THE UNITED STATES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY
BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS'
OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT
TO UNSOLD ALLOTMENTS OR SUBSCRIPTIONS, AND IS IN ADDITION TO THE DELIVERY
OBLIGATIONS OF DEALERS SUBJECT TO CANADIAN SECURITIES LAWS.
------------------------
WE HAVE APPLIED FOR REGISTRATION OF THE TRADEMARKS "HYDROGENICS," "FCATS,"
"FCAVS," "HyTEF," "HyAL," "SCREENER," "POTENZ" AND "MREF" IN CANADA. ALL OTHER
TRADEMARKS OR SERVICE MARKS APPEARING IN THIS PROSPECTUS ARE THE TRADEMARKS OR
SERVICE MARKS OF THEIR RESPECTIVE OWNERS.
------------------------
i
<PAGE> 4
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
Before deciding to invest in our common shares, you should carefully read this
entire prospectus, including the section entitled "Risk Factors."
HYDROGENICS CORPORATION
We design, develop and manufacture proton-exchange membrane, or PEM, fuel
cell automated test stations. Our customers use our test stations to simulate,
monitor and control the effect of power load, temperature, pressure,
humidification, and potential contaminants on a fuel cell and to measure the
effect of changes in these variables on fuel cell performance. The data obtained
through our test stations is used to aid in the design, development and
manufacture of PEM fuel cell systems. We are currently selling our test stations
to automotive companies, fuel cell developers, component suppliers and
government agencies. Our largest customers for test stations in these markets,
based on revenues, include General Motors Corporation, Johnson Matthey plc,
Minnesota Mining and Manufacturing Company (3M), W.L. Gore & Associates, Inc.,
and the United States Army.
A PEM fuel cell system produces electricity without combustion through an
electrochemical reaction of hydrogen and oxygen with the principal by-products
being heat and water. A PEM fuel cell system is comprised of three major sets of
components: a hydrogen fuel processor, which derives hydrogen from fuels such as
propane or natural gas; a fuel cell or stack of fuel cells; and power
conditioning equipment, which regulates the type and level of power transferred
from the fuel cell. Through the development of our proprietary test stations, we
have gained significant expertise in the development and operation of PEM fuel
cell stacks and the integration of subsystems and components that control and
operate PEM fuel cell systems.
OUR PRODUCTS
We are currently generating commercial sales from our PEM fuel cell
automated test stations. We expect to continue to market and sell our test
stations for the foreseeable future.
OUR PRODUCTS IN DEVELOPMENT
We are currently adapting the components and subsystems used in our test
stations to be commercial products for use in third party fuel cell systems. We
have also begun developing our own PEM fuel cell systems designed for use in
situations that require reliable power regardless of the environment, such as in
remote and extreme weather locations or for military applications. For example,
we are developing what we believe is the first fuel cell system designed to
operate at -40C. We are also developing a fuel cell system that will be used to
power a military device that detects chemical and biological agents in the
field. We plan to deliver demonstration units of our fuel cell systems in the
second half of 2000. Over the longer term, we will be targeting our fuel cell
systems toward the broad transportation, stationary and portable commercial
markets. In addition, we are developing for these markets regenerative fuel cell
systems that are designed both to generate electricity and produce hydrogen fuel
from water and store it for later use in powering the fuel cell. We have not yet
begun to manufacture commercial fuel cell systems in significant quantities.
MARKET OPPORTUNITIES FOR OUR FUEL CELL PRODUCTS
Automotive companies, fuel cell developers, component suppliers and others
are currently spending significant amounts of capital developing their own fuel
cell programs, though commercial markets for PEM fuel cell systems and products
are still emerging. We believe that test stations will be essential elements of
many of these development programs and that our subsystems and components will
have broad applications in manufacturing processes if and when commercial
markets develop.
Trends that we expect will influence the penetration of PEM fuel cells into
commercial markets include:
- Increasing demand for higher quality and more reliable power, which is
partially attributable to the proliferation of computers, the Internet,
communication networks and advanced electronics devices;
- Deregulation in the energy industry, which is likely to expand the market
for alternative power technologies;
1
<PAGE> 5
- Operational efficiencies and other advantages of fuel cells over
traditional power technologies;
- Environmental concerns regarding conventional power technologies,
including combustion-based power generation and lead-acid batteries; and
- Rising energy costs causing consumers to seek alternative means of
producing energy.
We are principally targeting our products at the transportation, stationary
and portable power markets:
- TRANSPORTATION: We believe that the opportunities in this market include
the supply of test stations, balance of plant and fuel cell systems for
utility vehicles such as underground mining vehicles and forklift trucks,
and retooling of machinery for vehicle production.
- STATIONARY: We believe that the opportunities in this market include the
supply of test stations and fuel cell systems for commercial markets,
including primary power generators for buildings, factories and hospitals
and backup power generators for computers, Internet service providers,
communications networks and commercial facilities.
- PORTABLE: We believe that the opportunities in this market include the
supply of test stations and fuel cell systems for portable power
generation, scientific and environmental monitoring, remote and extreme
weather power generation, control instrumentation at remote sites,
auxiliary power, portable electronic devices such as laptop computers and
cellular telephones, and other specialty applications.
OUR BUSINESS STRATEGY
We have implemented the following business strategy to further our goal of
becoming a leading designer and provider of commercial test stations and PEM
fuel cell systems.
INITIALLY TARGET NEAR TERM MARKET OPPORTUNITIES. In order to develop early
commercial markets for our test stations and fuel cell system technology, we are
initially focusing on customers that presently have substantial testing and
diagnostic requirements, such as General Motors Corporation, or those that have
a need for remote location or extreme weather power sources.
EXPAND INTO BROADER MARKETS. Over the longer term, our principal strategy
is to develop our proprietary fuel cell technology for the transportation,
stationary and portable markets and to expand our remote location power
technology into broader commercial markets.
ESTABLISH KEY CUSTOMER AND STRATEGIC RELATIONSHIPS. We seek to establish
customer-focused, service-oriented relationships with key customers and
manufacturing, marketing and distribution alliances with potential strategic
partners.
DEVELOP AND EXPLOIT OUR TECHNOLOGY ACROSS OUR TARGET MARKETS. We intend to
continue to develop and exploit our technology, knowledge and expertise across
our three principal target markets.
FOCUS ON OVERALL SYSTEM DESIGN, COMPONENT AND SUBSYSTEM INTEGRATION, FINAL
ASSEMBLY AND QUALITY CONTROL. We believe that our balance of plant expertise
provides us with a significant technological advantage over most of our
competitors in the design, assembly and integration of PEM fuel cell systems.
DEVELOP AND ACQUIRE COMPLEMENTARY TECHNOLOGIES. We believe that developing
and acquiring complementary technologies can accelerate our market penetration.
------------------------
We are incorporated under the laws of Canada. Our principal executive
offices are located at 5985 McLaughlin Road, Mississauga, Ontario, Canada L5R
1B8, and our telephone number is (905) 361-3660.
------------------------
2
<PAGE> 6
THE OFFERING
<TABLE>
<S> <C>
Common shares offered................................ 7,000,000 common shares
Common shares to be outstanding after this
offering........................................... 35,532,000 common shares
Use of proceeds...................................... For research and product development, capital
expenditures, potential acquisitions and
investments and general corporate purposes.
See "Use of Proceeds."
Nasdaq National Market symbol........................ HYGS
Toronto Stock Exchange symbol........................ HYG
</TABLE>
The information set forth above is based on common shares outstanding as of
June 30, 2000 and excludes the following:
- outstanding options as of the date of this prospectus to purchase
3,905,750 common shares under our stock option plan at a weighted average
exercise price of $0.723 per share;
- 724,400 common shares available for future grants under our new stock
option plan; and
- common shares issued upon the exercise of stock options after June 30,
2000.
------------------------
Unless we state otherwise, the information in this prospectus:
- assumes no exercise of the underwriters' over-allotment option;
- gives effect to a 0.9375 for one share consolidation of our common shares
effected on January 21, 2000;
- gives effect to the conversion of 750,000 Series A preferred shares and
510,500 Series B preferred shares into an aggregate of 8,823,500 common
shares, which will occur automatically upon the closing of this offering;
and
- gives effect to a seven-for-one share split of our common shares effected
on September 29, 2000.
3
<PAGE> 7
SUMMARY FINANCIAL DATA
Our financial statements are prepared in accordance with Canadian generally
accepted accounting principles. These principles conform in all material
respects with U.S. generally accepted accounting principles except as disclosed
in note 16 of our financial statements for the years ended December 31, 1999 and
1998 and note 7 of our unaudited interim financial statements for the six month
periods ended June 30, 2000 and 1999. You should read the following summary
financial data together with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our financial statements and notes
appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------- -------------------------
1997 1998 1999 1999 2000
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Canadian GAAP:
Revenues........................ $ 97 $ 665 $ 2,674 $ 774 $ 4,459
Gross profit.................... 25 250 569 196 1,537
Income (loss) from operations... 3 113 (145) (136) 459
Net income (loss)............... $ (1) $ 99 $ (209) $ (148) $ 83
=========== =========== =========== =========== ===========
Basic and fully diluted earnings
(loss) per share.............. $ (0.00) $ 0.01 $ (0.01) $ (0.01) $ 0.00
=========== =========== =========== =========== ===========
Shares used in computing basic
and fully diluted earnings
(loss) per share.............. 19,687,500 19,687,500 19,687,500 19,687,500 19,689,243
Pro forma earnings (loss) per
share......................... $ (0.01) $ 0.00
=========== ===========
U.S. GAAP:
Revenues........................ $ 647 $ 2,598 $ 749 $ 4,459
=========== =========== =========== ===========
Net income (loss)............... $ 96 $ (165) $ (108) $ (1,718)
=========== =========== =========== ===========
Basic and fully diluted earnings
(loss) per share.............. $ 0.00 $ (0.01) $ (0.01) $ (0.09)
=========== =========== =========== ===========
Pro forma earnings (loss) per
share......................... $ (0.01) $ (0.06)
=========== ===========
</TABLE>
Pro forma earnings (loss) per share has been computed assuming the
conversion of 750,000 Series A preferred shares and 510,500 Series B preferred
shares, as of the beginning of the periods presented or at the date of issuance
if later, into an aggregate of 8,823,500 common shares, which will occur
automatically upon the closing of this offering. Although the Canadian dollar is
our functional currency, we have adopted the U.S. dollar as our reporting
currency. See note 2 of our financial statements for the years ended December
31, 1999 and 1998 and note 2 of our unaudited interim financial statements for
the six month periods ended June 30, 2000 and 1999.
4
<PAGE> 8
<TABLE>
<CAPTION>
AS OF JUNE 30, 2000
-----------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
------ --------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Canadian GAAP:
Cash and cash equivalents.................................. $2,192 $2,037 $78,549
Working capital............................................ 4,192 4,192 80,704
Total assets............................................... 6,808 6,653 83,165
Total shareholders' equity................................. 561 4,616 81,128
U.S. GAAP:
Total assets............................................... 6,808 6,653 83,165
Total shareholders' equity (deficiency).................... 70 4,616 81,128
</TABLE>
The pro forma financial information in the table above gives effect as of
June 30, 2000 to the conversion of 750,000 Series A preferred shares and 510,500
Series B preferred shares into 8,823,500 common shares and payment of accrued
dividends, which will occur automatically upon the closing of this offering. The
pro forma as adjusted numbers in the table above are adjusted to give effect to
the conversion of preferred shares into common shares as described in the
previous sentence and in addition, to give effect to our receipt of the net
proceeds from the sale of 7,000,000 common shares offered by us in this offering
at the initial public offering price of $12.00 per share, after deducting the
underwriting commissions and estimated offering expenses of $1.6 million payable
by us. See "Use of Proceeds," "Capitalization" and "Underwriting."
5
<PAGE> 9
RISK FACTORS
This offering involves a high degree of risk. You should carefully consider
the risks described below and the other information contained in this prospectus
before purchasing our common shares. If any of the following risks occur, our
business, operating results and financial condition could be materially
adversely affected, the trading price of our common shares could decline and you
may lose all or part of your investment.
RISK FACTORS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY, SO IT MAY BE DIFFICULT FOR YOU TO ASSESS
OUR BUSINESS AND FUTURE PROSPECTS.
We commenced operations of our fuel cell business in 1995 and since that
time have been engaged principally in research and development relating to fuel
cell systems and the manufacture and sale of fuel cell testing equipment.
Accordingly, there is only a limited basis upon which you can evaluate our
business, performance to date and prospects. Part of our long-term strategy is
to sell fuel cell systems and subsystems primarily into the transportation,
stationary and portable power markets. We have not yet begun to manufacture
commercial fuel cell products for any of these markets in significant
quantities. In light of the foregoing, you should not rely on our historical
results of operations as indications of future performance.
OUR FUEL CELL BUSINESS IS AT THE DEVELOPMENT STAGE AND OUR FUTURE SUCCESS
DEPENDS ON OUR ABILITY TO DESIGN, DEVELOP AND MANUFACTURE NEW PRODUCTS WHICH IS
UNCERTAIN.
We have only been engaged in our fuel cell business for a short period of
time and are still in the developmental stage. You should consider the
challenges, expenses and difficulties that we will face as a developing company
seeking to design, develop and manufacture new products in each of our proposed
markets. The uncertainty of our future performance and the uncertainties of our
operating in new and expanding markets increase the risk that the value of your
investment will decline.
BECAUSE WE EXPECT TO CONTINUE TO INCUR NET LOSSES, WE MAY NOT BE ABLE TO
IMPLEMENT OUR BUSINESS STRATEGY AND THE PRICE OF OUR COMMON SHARES MAY DECLINE.
We have a shareholders' equity of approximately $70,000 as of June 30,
2000, as determined in accordance with U.S. generally accepted accounting
principals, and we may never sustain profitability. Our current business
strategy is to expand significantly our development and manufacture of PEM fuel
cell products and to market these products in the transportation, stationary and
portable markets. In so doing, we will incur significant expenditures for
research and development, expansion of our manufacturing capabilities, general
administrative and sales and marketing expenses. As a result of these increased
costs, we will need to generate significantly higher revenues to achieve and
sustain profitability. Since we began conducting our fuel cell business in 1995,
we have generated approximately $8.0 million in revenues through June 30, 2000.
We anticipate a net loss for the year 2000 and we may continue to incur losses
beyond 2000. Accordingly, our ability to operate our business and implement our
business strategy may be hampered and the value of our common shares may
decline.
WE MAY NEVER COMPLETE THE DEVELOPMENT OF COMMERCIALLY VIABLE FUEL CELL PRODUCTS
AND IF WE FAIL TO DO SO, WE WILL NOT BE ABLE TO MEET OUR BUSINESS AND GROWTH
OBJECTIVES.
We do not know when or whether we will successfully complete research and
development of commercially viable fuel cell products for any of our target
markets. Our future success depends on our ability to develop and sell fuel cell
products. We must develop or acquire access to substantial technological
advances to be incorporated into our products, particularly in the areas of fuel
processing and systems integration, before we will be able to produce
commercially viable products other than fuel cell
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<PAGE> 10
testing stations. We will be unable to meet our business and growth objectives
if we do not produce these other products.
WE MUST LOWER THE COST OF OUR FUEL CELL PRODUCTS AND DEMONSTRATE THEIR
RELIABILITY OR WE WILL NOT GENERATE SUFFICIENT REVENUES TO ACHIEVE OR MAINTAIN
PROFITABILITY.
Fuel cells currently cost significantly more than many established
competing technologies, such as internal combustion engines and batteries. The
price of fuel cell products is dependent largely on material and manufacturing
costs. We cannot guarantee that we will be able to lower these costs to the
level where we will be able to produce a competitive product or that any product
we produce using lower cost materials and manufacturing processes will not
suffer from a reduction in performance, reliability and longevity. If we are
unable to produce fuel cell products that are comparable to competing
technologies in terms of price, reliability and longevity, consumers will be
unlikely to buy our fuel cell products. Accordingly, we would not be able to
generate sufficient revenues to achieve or maintain profitability.
WE CURRENTLY DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR A SIGNIFICANT MAJORITY
OF OUR REVENUES AND A DECREASE IN REVENUE FROM THESE CUSTOMERS COULD MATERIALLY
REDUCE OUR REVENUES AND EARNINGS.
To date, a small number of customers has accounted for a significant
majority of our revenues and will continue to do so for the foreseeable future.
For the year ended December 31, 1999, our three largest customers accounted for
approximately 80% of our revenues. For the year ended December 31, 1998, these
customers accounted for approximately 83% of our revenues. As of August 31,
2000, we had outstanding purchase orders for a total of 14 test stations with
our three largest customers, representing approximately $2.4 million, and these
customers have no obligation to acquire additional units. We expect that all of
these currently outstanding orders will be filled by the end of 2000. If we lose
any of these customers and do not attract additional customers, we may not
generate sufficient revenues to offset this loss of revenues and our financial
results will be materially adversely affected. In addition, if a significant
customer breaches its contractual obligation to pay amounts it owes us under
non-cancelable binding purchase orders because of its inability or refusal to
pay, or does not pay those amounts on time, our revenues and earnings could be
materially adversely affected.
WE MAY BE UNABLE TO RAISE ADDITIONAL CAPITAL TO PURSUE OUR COMMERCIALIZATION
PLANS AND MAY BE FORCED TO DISCONTINUE PRODUCT DEVELOPMENT, REDUCE OUR SALES AND
MARKETING EFFORTS OR FOREGO ATTRACTIVE BUSINESS OPPORTUNITIES.
We may not have sufficient capital to fund our operations and we may not be
able to raise additional capital. Either of these outcomes could adversely
affect our ability to respond to competitive pressures or prevent us from
conducting all or a portion of our planned operations. We expect that the net
proceeds from this offering and cash on hand will be sufficient to meet our
working capital and capital expenditure needs for the next 24 months. After
that, we may need to raise additional funds through financing which may not be
available on acceptable terms, if at all. We may also require additional capital
to acquire or invest in complementary businesses or products or obtain the right
to use complementary technologies. The development and commercialization of our
products could be delayed or discontinued if we are unable to fund our research
and product development activities or the development of our manufacturing
capabilities. In addition, we may be forced to reduce our sales and marketing
efforts or forego attractive business opportunities. If we issue additional
equity securities in order to raise funds, your ownership percentage of our
company will be reduced.
OUR ABILITY TO COMPETE EFFECTIVELY IN THE TRANSPORTATION AND STATIONARY POWER
MARKETS MAY SUFFER BECAUSE WE CURRENTLY DO NOT HAVE A SIGNIFICANT STRATEGIC
PARTNER.
One of our leading competitors in the market for transportation-related
fuel cells has a well-established relationship with two leading automobile
manufacturers, which is a significant competitive advantage because it provides
this competitor with preferred access to broad market opportunities. Similarly,
competitors in the stationary power market have strategic relationships with
leading suppliers of power generation technology and electric utilities. We do
not currently have any similar strategic
7
<PAGE> 11
relationships and, if similar relationships do not develop, we may not have
access to similar broad market opportunities. Furthermore, due to the developing
nature of our industry, forming alliances and gaining membership in industry
consortiums may become important to our success. If we are unable to form such
alliances or gain membership to any industry consortiums of which our
competitors are members, our access to broad market opportunities may be
similarly impeded.
WE CURRENTLY FACE AND WILL CONTINUE TO FACE SIGNIFICANT COMPETITION, AND IF WE
ARE UNABLE TO COMPETE SUCCESSFULLY, WE COULD EXPERIENCE A LOSS OF MARKET SHARE
AND REDUCED GROSS MARGINS FOR OUR EXISTING PRODUCTS AND A FAILURE TO ACHIEVE
ACCEPTANCE OF OUR PROPOSED PRODUCTS.
Our products currently face and will continue to face significant
competition. New developments in technology may negatively affect the
development or sale of some or all of our products or make our products or
proposed products uncompetitive or obsolete. Other companies, many of which have
substantially greater resources than we, are currently engaged in the
development of products and technologies that are similar to, or may be
competitive with, our products and technologies. They also may be better able to
market, promote and advertise their products. To the extent that they already
have name recognition, their products may enjoy greater initial market
acceptance among our potential customers. We also expect that several of these
competitors will be able to deliver competing products to the market before we
will. To the extent that any one of our competitors does so, it could limit our
ability to gain market share or market acceptance for our products, which could
harm our revenues and impair our ability to expand our business. These
competitors may also be better able than we to adapt quickly to customers'
changing demands and to changes in technology.
A number of corporations, national laboratories and universities in the
United States, Canada, Europe, Japan and elsewhere possess fuel cell technology
and are actively engaged in the development and manufacture of fuel cells and
fuel cell products. Each of these competitors has the potential to capture
market share in various markets.
As the fuel cell has the potential to replace existing power sources,
competition for our products will come from current power technologies, from
improvements to current power technologies and from new alternative power
technologies, including other types of fuel cells. Each of our target markets is
currently served by existing manufacturers with existing customers and
suppliers. These manufacturers use proven and widely accepted technologies such
as internal combustion engines and turbines as well as coal, oil and nuclear
powered generators. Additionally, there are competitors working on developing
technologies including other types of fuel cells and other alternative power
technologies, advanced batteries and hybrid battery/internal combustion engines
which may compete for our target customers.
We also face competition in the market for our fuel cell test stations. In
addition to a number of companies that currently manufacture fuel cell test
stations, most large fuel cell developers and original equipment manufacturers
have some degree of internal test station development. Any of these companies
may compete with us for customers.
If we are unable to compete successfully, we could experience a loss of
market share and reduced gross margins for our existing products and a failure
to achieve acceptance of our proposed products.
WE HAVE NO EXPERIENCE MANUFACTURING FUEL CELL PRODUCTS ON A LARGE SCALE BASIS,
AND IF WE DO NOT DEVELOP ADEQUATE MANUFACTURING PROCESSES AND CAPABILITIES, WE
WILL BE UNABLE TO ACHIEVE OUR GROWTH AND PROFITABILITY OBJECTIVES.
To date, we have focused primarily on research and development and have no
experience manufacturing fuel cell products on a large scale basis. In order to
produce fuel cell products at affordable prices we will have to manufacture a
large volume of fuel cell products. We do not know whether or when we will be
able to develop efficient, low-cost manufacturing capabilities and processes
that will enable us to meet the quality, price, engineering, design and
production standards or production volumes required to successfully mass market
our fuel cell products. Even if we are successful in developing our
manufacturing capabilities and processes, we do not know whether we will do so
in time to meet our product
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<PAGE> 12
commercialization schedule or to satisfy the requirements of our customers and
the market. Our failure to develop these manufacturing processes and
capabilities in a timely manner could prevent us from achieving our growth and
profitability objectives.
OUR PRODUCTS MAY NOT MEET PERFORMANCE EXPECTATIONS IN FIELD TESTS WHICH COULD
NEGATIVELY AFFECT OUR CUSTOMER RELATIONSHIPS AND INCREASE OUR MANUFACTURING
COSTS.
We regularly field test our products and we plan to conduct additional
field tests in the future. Any failures or delays in our field tests could harm
our competitive position and impair our ability to sell our products. Our field
tests may encounter problems and delays for a number of reasons, including the
failure of our technology, the failure of the technology of others, the failure
to combine these technologies properly, operator error and the failure to
maintain and service the test prototypes properly. Many of these potential
problems and delays are beyond our control. In addition, field test programs, by
their nature, will involve delays and modifications, as well as third party
involvement. Any problem or perceived problem with our field tests, whether
originating from our technology, from our design, or from third parties, could
hurt our reputation and the reputation of our products and limit our sales. In
the first phase of field testing two of our HyTEF units in Antarctica during the
first quarter of 2000, one of the two units failed after having operated for
some time. We have agreed to pay the costs of replacing this unit. The remote
location of the second unit makes it currently impossible to assess its
functionality. Such failures with our field tests may negatively affect our
relationships with customers, require us to extend field testing longer than
anticipated before undertaking commercial sales, and to develop further our
technology to account for more failures than anticipated prior to the field
tests.
WE ARE DEPENDENT ON THIRD PARTY SUPPLIERS FOR KEY MATERIALS AND COMPONENTS FOR
OUR PRODUCTS. IF THESE SUPPLIERS BECOME UNABLE OR UNWILLING TO PROVIDE US WITH
SUFFICIENT MATERIALS AND COMPONENTS ON A TIMELY AND COST-EFFECTIVE BASIS, WE MAY
BE UNABLE TO MANUFACTURE OUR PRODUCTS COST-EFFECTIVELY OR AT ALL, AND OUR
REVENUES AND GROSS MARGINS WOULD SUFFER.
We rely upon third party suppliers to provide materials and components for
our fuel cell products. A supplier's failure to provide materials or components
in a timely manner, or to provide materials and components that meet our
quality, quantity or cost requirements, or our inability to obtain substitute
sources for these materials and components in a timely manner or on terms
acceptable to us, would harm our ability to manufacture our fuel cell products.
To the extent that we are unable to develop and patent our own technology and
manufacturing processes, and to the extent that the processes which our
suppliers use to manufacture the materials and components are proprietary, we
may be unable to obtain comparable materials or components from alternative
suppliers, and that could adversely affect our ability to produce viable fuel
cell products or could raise our cost of producing fuel cell products to a level
where it would no longer be profitable to produce such products.
IF WE ARE UNABLE TO EXPAND OUR MANUFACTURING CAPACITY IN A TIMELY MANNER, OR IF
WE DO NOT ACCURATELY PROJECT DEMAND, WE WILL HAVE EXCESS CAPACITY OR
INSUFFICIENT CAPACITY, WHICH WILL SERIOUSLY HARM OUR REVENUES OR GROSS MARGINS.
We currently have only limited production facilities that are not capable
of producing fuel cell products on a large-scale basis. We moved to a new
facility in October 2000 in order to meet our production goals. If our business
grows more quickly than we anticipate, our new manufacturing facility will
quickly become inadequate and we may need to seek out new or additional space at
considerable cost to us. If our business does not grow as quickly as we expect,
our new manufacturing facility would in part represent excess capacity for which
we may not recover the cost; in that circumstance, our revenues may be
inadequate to support our committed costs and our planned growth, and our gross
margins and business strategy would suffer. If we encounter delays in moving to
our new manufacturing facility, in obtaining and installing the necessary
equipment or in hiring and training personnel to commence manufacturing on a
large scale basis, we will not be able to fill customer orders or profitably
manufacture our various fuel cell products and as a result, our revenues will be
reduced.
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WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE THE EXPANSION OF OUR OPERATIONS.
The location, equipping and establishment of manufacturing operations at
our new facility will place significant demands on our managerial, technical,
financial and other resources. We will be required to make significant
investments in our engineering and logistics systems and our financial and
management information systems as well as retaining, motivating and effectively
managing our employees. There can be no assurance that our management skills and
systems currently in place will enable us to implement our strategy or enable us
to attract and retain skilled management, engineering and production personnel.
Our failure to manage our growth effectively or to implement our strategy in a
timely manner may significantly harm our ability to achieve profitability.
WE COULD BE LIABLE FOR ENVIRONMENTAL COSTS AND DAMAGES RESULTING FROM OUR
RESEARCH, DEVELOPMENT AND FUTURE MANUFACTURING OPERATIONS, AND THESE COSTS AND
DAMAGES WOULD REDUCE OUR NET INCOME.
Our business is subject to numerous U.S. and Canadian laws, regulations and
policies relating to the protection of the environment. These requirements, and
enforcement of these requirements, may become more stringent in the future. As
we have not performed any environmental audits on our current facilities, we
cannot assure you that we have been, or will be at all times, in compliance with
these requirements, and we may be required to make significant unanticipated
capital and operating expenditures in connection with these requirements.
Non-compliance could subject us to material liabilities, such as government
fines and penalties, revocation of operating permits, third party lawsuits or
the suspension of operations. Our business, which includes the use and storage
of hazardous substances, exposes us to the risk of harmful substances escaping
into the environment, which may result in personal injury or loss of life,
damage to or contamination of the environment, and natural resource damages. In
addition, our current insurance policies may not adequately reimburse us for
costs incurred in settling environmental liabilities, and in some instances, we
may not be reimbursed at all.
OUR PRODUCT REVENUES WILL NOT GROW WITHOUT SUCCESSFUL MARKETING AND SALES
EFFORTS OF THIRD PARTIES THAT WE DO NOT CONTROL.
To be commercially useful, some of our fuel cell products must be
integrated into products manufactured by other manufacturers. Our success in
growing our revenues and achieving profitability is therefore dependent in part
upon the successful marketing and sales efforts of third parties and upon their
designing and engineering their products to be compatible with our own. Our
success also depends upon our ability to make our products compatible with the
products of these manufacturers. We cannot assure you that these manufacturers
will manufacture appropriate products or, if they do, that they will choose to
use our fuel cell products. Any integration, design, manufacturing or marketing
problems encountered by these manufacturers could adversely affect our future
revenues.
OUR QUARTERLY OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY AND MAY
FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS AND INVESTORS, WHICH MAY
CAUSE OUR SHARE PRICE TO DECLINE.
We expect our revenues and operating results to vary significantly from
quarter to quarter. These quarterly fluctuations in our operating performance
result from the length of time between our first contact with a business
customer and the first receipt of revenue from sales to that customer. Our
products are highly-engineered and expensive to produce and many are still in
development stages; therefore, the length of time between approaching a customer
and delivering our products to that customer can span quarterly periods.
Further, we generally recognize revenues on a percentage-of-completion basis.
Under this accounting method, revenues are recognized on a pro rata basis in
relation to contract costs incurred. As costs may vary significantly from
quarter to quarter depending on the stage of development of the project, quarter
to quarter comparisons of our revenues and operating results may not be
meaningful.
In addition, due to our early stage of development, we cannot predict our
future revenues or results of operations accurately. Our management does not
have experience running a public company, and in one or
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more future quarters our operating results could fall below the expectations of
securities analysts and investors. If this happens, the trading price of our
common shares could be materially adversely affected.
EXCHANGE RATE FLUCTUATIONS COULD ADVERSELY AFFECT OUR GROSS MARGINS.
Exchange rate fluctuations may cause fluctuations in our quarterly results.
We transact business internationally in multiple currencies. In particular, a
significant portion of our cost of revenues consists of materials purchased in
U.S. dollars, which is only partially offset by revenues generated in U.S.
dollars. We do not currently engage in any hedging transactions related to our
exchange rate risk. Accordingly, gains and losses on the conversion of foreign
payments may contribute to fluctuations in our results of operations and
fluctuating exchange rates could cause reduced revenue and gross margins from
our international sales.
WE MAY ACQUIRE TECHNOLOGIES OR COMPANIES IN THE FUTURE AND THESE ACQUISITIONS
COULD DISRUPT OUR BUSINESS AND DILUTE YOUR HOLDINGS IN US.
We may acquire technologies or companies in the future. Entering into an
acquisition entails many risks, any of which could materially harm our business,
including:
- diversion of management's attention from other business concerns;
- failure to effectively assimilate the acquired technology, employees or
other assets of the company into our business;
- the loss of key employees from either our current business or the
acquired business; and
- assumption of significant liabilities of the acquired company.
To date, we have not completed any acquisitions, and we may not be able to
do so in an effective manner. In addition, your holdings in our company will be
diluted if we issue equity securities in connection with an acquisition.
WE WILL NEED TO RECRUIT, TRAIN AND RETAIN KEY MANAGEMENT AND OTHER QUALIFIED
PERSONNEL TO SUCCESSFULLY EXPAND OUR BUSINESS.
Our future success will depend in large part on our ability to recruit and
retain experienced research and development, engineering, manufacturing,
operating, sales and marketing, customer service and management personnel. If we
do not attract and retain such personnel, we may not be able to expand our
business. Competition for qualified personnel is intense in our industry. In the
past we have experienced difficulty in recruiting qualified personnel that meet
our standards, and we expect to experience continued difficulties in recruiting
similar personnel. We are in a new market and there are a limited number of
people with the appropriate combination of skills needed to provide the services
that our customers demand. We expect competition for qualified personnel to
remain intense, and we may not succeed in attracting or retaining sufficient
personnel. In addition, new employees generally require substantial training,
which requires significant resources and management attention. Even if we invest
significant resources to recruit, train and retain qualified personnel, we may
not be successful in our efforts.
Our success also depends upon the continuing contribution of our key
management, research, product development, engineering, marketing and
manufacturing personnel, many of whom would be difficult to replace. We do not
currently have employment agreements with some key employees.
In addition, a significant element in our plan to attract and retain
qualified personnel is the issuance to such persons of options to purchase our
common shares. Accordingly, to the extent that we are required to issue
significant numbers of options to our employees, and such options are exercised,
you could experience substantial dilution.
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WE DEPEND ON INTELLECTUAL PROPERTY AND OUR FAILURE TO PROTECT THAT INTELLECTUAL
PROPERTY COULD ADVERSELY AFFECT OUR FUTURE GROWTH AND SUCCESS.
Failure to protect our existing intellectual property rights may reduce our
ability to prevent others from using our technology. We rely on a combination of
patent, trade secret, trademark and copyright laws to protect our intellectual
property. Most of our intellectual property is currently not covered by any
patent or patent application, and some of our most important products, including
our FCATS products, are currently not protected by any patents or patent
applications. Our patent protection is subject to complex factual and legal
issues that may give rise to uncertainty as to the validity, scope and
enforceability of a particular patent. Accordingly, we cannot assure you that:
- any of the U.S., Canadian or other patents owned by us or third party
patents that are licensed to us will not be invalidated, circumvented,
challenged, rendered unenforceable, or licensed to others; or
- any of our pending or future patent applications will be issued with the
breadth of protection sought by us, if issued at all.
In addition, effective patent, trademark, copyright and trade secret
protection may be unavailable, limited, not applied for or unenforceable in
foreign countries.
We also seek to protect our proprietary intellectual property through
contracts, including, when possible, confidentiality agreements and inventors'
rights agreements with our customers and employees. We cannot assure you that
the parties that enter into such agreements with us will not breach them, that
we will have adequate remedies for any breach or that such persons or
institutions will not assert rights to intellectual property arising out of
these relationships. If necessary or desirable, we may seek licenses under the
patents or other intellectual property rights of others. However, we can give no
assurances that we will obtain such licenses or that the terms of any offered
licenses will be acceptable to us. The failure to obtain a license from a third
party for intellectual property we use in the future could cause us to incur
substantial liabilities and to suspend the manufacture, shipment of products or
our use of processes which exploit such intellectual property.
OUR POTENTIAL INVOLVEMENT IN INTELLECTUAL PROPERTY LITIGATION COULD NEGATIVELY
AFFECT OUR BUSINESS.
Our future success and competitive position depends in part upon our
ability to obtain or maintain the proprietary intellectual property used in our
principal products. Our ability to establish and maintain such a competitive
position may be achieved in part by prosecuting claims against others who we
believe are infringing our rights and by defending claims brought by others who
believe we are infringing their rights. Our involvement in intellectual property
litigation could result in significant expense to us, adversely affect the sales
of any products involved or the use or licensing of related intellectual
property, and divert the efforts of our valuable technical and management
personnel from their principal responsibilities, whether or not such litigation
is resolved in our favor. If we are found to infringe the intellectual property
rights of others in such litigation, we may, among other things, be required to:
- pay substantial damages;
- cease the development, manufacture, use, sale or importation of products
that infringe upon other patented intellectual property;
- expend significant resources to develop or acquire non-infringing
intellectual property;
- discontinue processes incorporating infringing technology; or
- obtain licenses to the intellectual property which we are found to be
infringing.
We cannot assure you that we would be successful in such development or
acquisition or that such licenses would be available upon reasonable terms. Any
such development, acquisition or license could require the expenditure of
substantial time and other resources and could have a material adverse effect on
our business and financial results.
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THE COMPONENTS OF OUR FUEL CELL PRODUCTS MAY CONTAIN DEFECTS OR ERRORS WHICH
COULD NEGATIVELY AFFECT OUR CUSTOMER RELATIONSHIPS AND INCREASE OUR
MANUFACTURING COSTS.
Our fuel cell products are complex and must meet the stringent technical
requirements of our customers. The software and other components used in our
fuel cell products may contain undetected errors or defects, especially when
first introduced. Furthermore, these components may contain errors or defects
after delivery to customers has begun, which could result in the failure of our
fuel cell products to perform, damage to our reputation, delayed or lost
revenue, diverted development resources and increased development, service and
warranty costs.
OUR EARNINGS AS DETERMINED IN ACCORDANCE WITH U.S. GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES, OR GAAP, WILL BE REDUCED, OR OUR LOSSES WILL BE INCREASED, BY
CHARGES ASSOCIATED WITH OUR ISSUANCES OF OPTIONS. THESE CHARGES MAY INCREASE IN
THE FUTURE AND COULD DEPRESS THE MARKET PRICE FOR OUR COMMON SHARES.
As of June 30, 2000, we had outstanding options to purchase 3,770,550 of
our common shares which were granted to our employees and non-employee
directors, including options to purchase 1,394,533 shares which were granted
during 1999. Some of these options were granted with exercise prices lower than
the deemed fair value, for U.S. financial reporting purposes, of our common
shares at the dates of grant. Our financial statements are prepared in
accordance with Canadian GAAP and as such include no expense for stock-based
compensation. If our financial statements were prepared in accordance with U.S.
GAAP, in connection with the granting of these options, we would be required to
record stock-based compensation over the vesting period of the applicable
options, generally four years in the case of options granted to employees and
non-employee directors. These types of charges may increase in the future and
could depress the market price for our common shares.
RISK FACTORS RELATED TO THE FUEL CELL INDUSTRY
SIGNIFICANT MARKETS FOR FUEL CELL PRODUCTS MAY NEVER DEVELOP OR MAY TAKE LONGER
TO DEVELOP THAN WE ANTICIPATE, WHICH WOULD ADVERSELY AFFECT OUR REVENUE GROWTH.
Significant markets may never develop for fuel cell products, or may
develop more slowly than we anticipate. If significant markets fail to develop
or develop more slowly than we anticipate, we may be unable to recover the
losses we expect to incur in the development of our products and we may never
achieve profitability. Any delay in, or failure of, the development of
significant markets for fuel cell products would significantly harm our revenues
and could cause our business to fail, in which case you could lose all or part
of your investment in us. Fuel cell products represent an emerging market, and
we do not know whether end-users will want to use them. The development of a
significant market for fuel cell products may be affected by many factors, some
of which are out of our control, including:
- the emergence of newer, more competitive technologies and products;
- the future cost of hydrogen and other fuels used by our systems;
- the future cost of membrane electrode assemblies used in our fuel cell
systems;
- the future cost of platinum, a key component of our fuel cell systems;
- regulatory requirements;
- manufacturing and supply costs for fuel cell components and systems;
- consumer perceptions of the safety of our products;
- consumer reluctance to try a new product; and
- the continued development and improvement of existing power technologies.
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THE FUELS ON WHICH OUR FUEL CELL PRODUCTS RELY MAY NOT BE READILY AVAILABLE ON A
COST-EFFECTIVE BASIS.
If our customers are not able to obtain the fuels they will need to run our
products on a cost-effective basis, we may be unable to compete with traditional
power sources and our revenues and results of operations would be materially
adversely affected. Our fuel cell products require oxygen and hydrogen to
operate. While ambient air typically can supply the necessary oxygen, our fuel
cells derive hydrogen from fuels such as natural gas, propane, methanol and
other petroleum products. Even if these fuels are available to us, if their
prices are such that electricity produced by our systems would cost more than
electricity provided through other means, we will be unable to compete
successfully.
OUR PRODUCTS USE FLAMMABLE FUELS WHICH ARE INHERENTLY DANGEROUS SUBSTANCES AND
COULD SUBJECT US TO PRODUCT LIABILITIES.
Fuel cell products use dangerous substances. Our results of operations
could be materially harmed by any accidents involving either our products or
those of other fuel cell manufacturers, either because we could face claims for
damages or because demand for fuel cells and fuel cell products could suffer and
our sales could decline. Our fuel cell products use hydrogen which is typically
generated from gaseous and liquid fuels, such as propane, natural gas or
methanol in a process known as reforming. While our fuel cell products do not
use these fuels in a combustion process, natural gas, propane and other
hydrocarbons are flammable fuels that could leak and then combust if ignited by
another source. Since our products have not yet gained widespread market
acceptance, any accidents involving our systems or those of other fuel cell
products could materially impede acceptance of our products. In addition,
although our management believes that our liability coverage is adequate to
cover these risks, we may be held responsible for damages beyond the scope of
our insurance coverage.
CHANGES IN GOVERNMENT POLICIES AND REGULATIONS COULD HURT THE MARKET FOR OUR
PRODUCTS.
The fuel cell industry is in its development phase and is not currently
subject to industry-specific government regulations in Canada or the United
States relating to matters such as design, storage, transportation and
installation of fuel cell systems. However, given that the production of
electrical energy has typically been an area of significant government
regulation, we expect that we will encounter industry-specific government
regulations in the future in the jurisdictions and markets in which we operate.
For example, regulatory approvals or permits may be required for the design,
installation and possibly operation of stationary fuel cell systems under
federal, state and provincial regulations governing electric utilities, and
mobile fuel cell systems under federal, state and provincial emissions
regulations affecting automobile manufacturers. To the extent that there are
delays in gaining regulatory approval, our development and growth may be
constrained. Furthermore, the inability of our potential customers to obtain a
permit, or the inconvenience often associated with the permit process, could
harm demand for fuel cell products and, therefore, harm our business.
Our principal target markets for our fuel cell products are the
transportation, stationary and portable markets, and our business will suffer if
environmental policies change and no longer encourage the development and growth
of these markets. The interest by automobile manufacturers in fuel cell
technology has been driven in large part by environmental laws and regulations
mainly in California and, to a lesser extent, in New York, Massachusetts and
Maine. There can be no guarantee that these laws and regulations will not
change. For example, California delayed implementation of its zero emission
vehicle mandate from 1998 to 2003 after a study determined that existing battery
technology provided inadequate performance to meet consumer needs. Changes in
these laws and regulations could result in automobile manufacturers abandoning
their interest in fuel cell powered vehicles. In addition, if current laws and
regulations in these states are not kept in force or if further environmental
laws and regulations are not adopted in these jurisdictions as well as in other
jurisdictions, demand for vehicular fuel cells may be limited.
The market for stationary and portable energy-related products is
influenced by federal and state governmental regulations and policies concerning
the electric utility industry. Changes in regulatory
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standards or public policy could deter further investment in the research and
development of alternative energy sources, including fuel cells and fuel cell
products, and could result in a significant reduction in the potential market
demand for our products. We cannot predict how the deregulation and
restructuring of the industry will affect the market for stationary and portable
fuel cell systems.
Although the development of alternative energy sources, and in particular
fuel cells, has been identified as a significant priority by many governments,
we cannot assure you that governments will not change their priorities or that
any such change would not materially affect our revenues and business. If
governments change their laws and regulations such that the development of
alternative energy sources is no longer required or encouraged, the demand for
alternative energy sources such as our fuel cell products may be significantly
reduced or delayed and our sales would decline.
ZERO EMISSION VEHICLE REQUIREMENTS CAN BE MET WITHOUT USING FUEL CELLS.
It is possible to meet the zero emission vehicle requirements imposed by
California, New York, Massachusetts and Maine by using technologies other than
fuel cells. For example, vehicles powered by batteries can receive full credit
and vehicles powered by low emission internal combustion engines and hybrid
internal combustion/battery engines can receive partial credit toward the zero
emission vehicle requirement. We can offer no assurance that automobile
manufacturers will use fuel cells in their vehicles to meet regulatory
requirements. Their failure to do so could have a material adverse effect on our
business and financial results and would significantly impair our ability to
expand our business.
RISK FACTORS RELATED TO THIS OFFERING
YOUR TAX LIABILITY MAY INCREASE IF WE ARE TREATED AS A PASSIVE FOREIGN
INVESTMENT COMPANY AND UNITED STATES HOLDERS OF OUR COMMON SHARES WILL BE
RESPONSIBLE FOR DETERMINING WHETHER WE ARE A PASSIVE FOREIGN INVESTMENT COMPANY.
If at any time we qualify as a passive foreign investment company under
U.S. tax laws, you may be subject to adverse tax consequences. We could be a
passive foreign investment company if 75% or more of our gross income in any
year is considered passive income for U.S. tax purposes. For this purpose,
passive income generally includes interest, dividends, some types of rents and
royalties, and gains from the sale of assets that produce these types of income.
In addition, we could be classified as a passive foreign investment company if
the average percentage of our assets during any year that produced passive
income, or that were held to produce passive income, is at least 50%. If we are
classified as a passive foreign investment company, and if you sell any of our
common shares or receive some types of distributions from us, you may have to
pay taxes that are higher than if we were not considered a passive foreign
investment company. It is impossible to predict how much your taxes would
increase, if at all, because these taxes depend upon the number of common shares
sold by you and the price at which they are sold, or the amount of a
distribution from us, as well as upon the marginal rate at which you would be
taxed for the sale or distribution.
Based on our current and projected income, and our estimates as to the
market value of the common shares when issued, we do not expect to be a passive
foreign investment company for U.S. federal income tax purposes. However, since
the determination of whether we are a passive foreign investment company is
based on the composition of our income and assets from time to time, and since
the market value of our common shares is likely to fluctuate after the offering,
there can be no assurance that we will not be considered a passive foreign
investment company for any fiscal year. If you are a U.S. investor and we are a
passive foreign investment company at the time that you own common shares, you
will be subject to special U.S. federal income tax rules that may have negative
consequences and will require annual reporting. United States holders will be
responsible for determining whether we are a passive foreign investment company
each year for purposes of applying the passive foreign investment company act
rules. See "Income Tax Consequences -- U.S. Federal Income Tax
Considerations -- Passive Foreign Investment Companies."
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A LIMITED NUMBER OF SHAREHOLDERS WILL COLLECTIVELY CONTINUE TO OWN A MAJORITY OF
OUR COMMON SHARES AFTER THIS OFFERING AND MAY ACT, OR PREVENT CORPORATE ACTIONS,
TO THE DETRIMENT OF OTHER SHAREHOLDERS.
Immediately after this offering, our principal shareholders, including
entities affiliated with members of our management team, will own more than 78%
of our outstanding common shares. Accordingly, these shareholders may, if they
act together, exercise significant influence over all matters requiring
shareholder approval, including the election of a majority of the directors and
the determination of significant corporate actions after this offering. This
concentration could also have the effect of delaying or preventing a change in
control that could be otherwise beneficial to our shareholders.
OUR ARTICLES OF INCORPORATION AUTHORIZE US TO ISSUE AN UNLIMITED NUMBER OF
COMMON AND PREFERRED SHARES AND SIGNIFICANT ISSUANCES OF COMMON OR PREFERRED
SHARES COULD DILUTE YOUR SHARE OWNERSHIP, DETER OR DELAY A TAKEOVER OF US THAT
YOU MAY CONSIDER BENEFICIAL OR DEPRESS THE TRADING PRICE OF OUR COMMON SHARES.
Our articles of incorporation permit us to issue an unlimited number of
common and preferred shares. If we were to issue a significant number of common
shares, it would reduce the relative voting power of previously outstanding
shares. Such future issuances could be at prices less than you paid for your
common shares. If we were to issue a significant number of common or preferred
shares, these issuances could also deter or delay an attempted acquisition of us
that you may consider beneficial, particularly in the event that we issue
preferred shares with special voting or dividend rights. While the rules of The
Nasdaq Stock Market and The Toronto Stock Exchange may require us to obtain
shareholder approval of significant issuances, we would not be subject to these
requirements if we ceased, voluntarily or otherwise, to be listed on The Nasdaq
Stock Market and The Toronto Stock Exchange. Significant issuances of our common
or preferred shares, or the perception that such issuances may occur, could
cause the trading price of our common shares to drop.
U.S. INVESTORS MAY NOT BE ABLE TO ENFORCE THEIR CIVIL LIABILITIES AGAINST US OR
OUR DIRECTORS, CONTROLLING PERSONS AND OFFICERS.
We are organized under the laws of Canada. All of our directors,
controlling persons and officers, as well as some of the experts named in this
prospectus, are residents of Canada and all or a substantial portion of their
assets and substantially all of our assets are located outside of the United
States. As a result, it may be difficult for U.S. holders of our common shares
to effect service of process on these persons within the United States or to
realize in the United States upon judgments rendered against them. In addition,
you should not assume that the courts of Canada (i) would enforce judgments of
U.S. courts obtained in actions against us or such persons predicated upon the
civil liability provisions of the U.S. federal securities laws or other laws of
the United States, or (ii) would enforce, in original actions, liabilities
against us or such persons predicated upon the U.S. federal securities laws or
other laws of the United States.
However, U.S. laws would generally be enforced by a Canadian court provided
that those laws are not contrary to Canadian public policy, are not foreign
penal laws or laws that deal with taxation or the taking of property by a
foreign government and provided they are in compliance with applicable Canadian
legislation regarding the limitation of actions. Also, a judgment obtained in a
U.S. court would generally be recognized by a Canadian court except, for
example:
- where the U.S. court where the judgment was rendered had no jurisdiction
according to applicable Canadian law;
- the judgment was subject to ordinary remedy (appeal, judicial review and
any other judicial proceeding which renders the judgment not final,
conclusive or enforceable under the laws of the applicable state) or not
final, conclusive or enforceable under the laws of the applicable state;
- the judgment was obtained by fraud or in any manner contrary to natural
justice or rendered in contravention of fundamental principles of
procedure;
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- a dispute between the same parties, based on the same subject matter has
given rise to a judgment rendered in a Canadian court or has been decided
in a third country and the judgment meets the necessary conditions for
recognition in a Canadian court;
- the outcome of the judgment of the U.S. court was inconsistent with
Canadian public policy;
- the judgment enforces obligations arising from foreign penal laws or laws
that deal with taxation or the taking of property by a foreign
government; or
- there has not been compliance with applicable Canadian law dealing with
the limitation of actions.
FUTURE SALES OF COMMON SHARES BY OUR EXISTING SHAREHOLDERS COULD CAUSE OUR SHARE
PRICE TO FALL AND REDUCE THE VALUE OF YOUR INVESTMENT.
If our shareholders sell substantial amounts of our common shares in the
public market, the market price of our common shares could fall. The perception
among investors that these sales will occur could also produce this effect.
After this offering, based upon the number of common shares outstanding as of
June 30, 2000 and giving effect to the conversion of all of our preferred shares
into common shares, we will have 35,532,000 common shares outstanding. All of
the common shares we will issue in this offering will generally be immediately
available for resale in the public markets, other than shares purchased by our
affiliates. In accordance with applicable U.S. securities laws and after giving
effect to lock-up agreements executed by our directors and executive officers
and existing principal shareholders, the common shares held by any such persons
who are U.S. residents will be available for sale in the public market beginning
180 days after the date of this prospectus.
Under applicable Canadian securities laws, all common shares, or common
shares issuable upon the exercise of options to purchase common shares, held by
residents of Canada, other than those acquired in this offering, may not be sold
or otherwise disposed of for value except pursuant to a prospectus, a
discretionary exemption or a statutory exemption available only in specific
limited circumstances, until we have been a reporting issuer in good standing
for at least 12 months. We will become a reporting issuer when we file this
prospectus with the applicable Canadian securities regulatory authorities and
when those authorities issue receipts for the prospectus. See "Shares Eligible
for Future Sale."
THERE HAS BEEN NO PRIOR PUBLIC MARKET FOR OUR SECURITIES AND OUR SHARE PRICE MAY
DECLINE AFTER THE OFFERING.
Before this offering, there has been no public market for our common
shares, and an active public market for our common shares may not develop or be
sustained after this offering. If an active public market for our common shares
does not develop, the liquidity of your investment may be limited, and our share
price may decline below its initial public offering price. The initial public
offering price has been determined by negotiations between us and the
representative of the underwriters and may bear no relationship to the price
that will prevail in the public market. The market price of our common shares
could be subject to wide fluctuations in response to many risk factors discussed
in this section.
In recent years, the stock markets have experienced significant price and
volume fluctuations, especially in the technology sector. Our common shares may
also experience that volatility for reasons unrelated to our own operating
performance, including:
- performance of other companies in the fuel cell or alternative power
businesses;
- news announcements, securities analysts' reports and recommendations and
other developments with respect to our industry or our competitors; and
- changes in general economic conditions.
17
<PAGE> 21
YOU WILL PAY MORE FOR OUR COMMON SHARES THAN YOUR PRO RATA PORTION OF OUR ASSETS
IS WORTH; AS A RESULT, YOU WOULD LIKELY RECEIVE MUCH LESS THAN YOU PAID FOR YOUR
SHARES IF WE LIQUIDATE OUR ASSETS AND DISTRIBUTE THE PROCEEDS.
The initial public offering price of our common shares will significantly
exceed the net tangible book value per share of our common shares. Accordingly,
if you purchase common shares in this offering, you will incur immediate and
substantial dilution of your investment. If the outstanding options to purchase
our common shares are exercised, you will incur additional dilution. As a
result, you would likely receive much less than you paid for your shares if we
liquidate our assets and distribute the proceeds.
WE WILL HAVE BROAD DISCRETION REGARDING THE USE OF PROCEEDS FROM THIS OFFERING.
IF WE DO NOT USE THE PROCEEDS EFFECTIVELY TO DEVELOP AND EXPAND OUR BUSINESS,
THE VALUE OF YOUR INVESTMENT COULD BE REDUCED.
We have not identified specific uses for the proceeds from this offering.
As a result, our management will have broad discretion in how we use the net
proceeds from this offering. You will not have the opportunity to evaluate the
economic, financial or other information on which we base our decisions
regarding the use of the net proceeds from this offering and we may use these
proceeds in ways that do not increase our operating results or market value.
18
<PAGE> 22
FORWARD-LOOKING STATEMENTS
Statements under "Prospectus Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business" and elsewhere in this prospectus about our future results, levels of
activity, performance, goals or achievements or other future events may
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause actual results or
events to differ materially from those anticipated in our forward-looking
statements. These factors include, among others, those listed under "Risk
Factors" or described elsewhere in this prospectus.
In some cases, you can identify forward-looking statements by our use of
words such as "may," "will," "should," "could," "expects," "plans," "intends,"
"anticipates," "believes," "estimates," "predicts," "seeks," "strategy,"
"potential" or "continue" or the negative or other variations of these words, or
other comparable words or phrases.
Although we believe that the expectations reflected in our forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements or other future events. We are under no
duty to update any of our forward-looking statements after the date of this
prospectus, other than as required by law. You should not place undue reliance
on forward-looking statements.
EXCHANGE RATES
As of October 26, 2000, the noon buying rate in New York City for cable
transfers in Canadian dollars was Cdn.$1.00 equals U.S. $0.6585. The following
table sets forth, for each period presented, the high and low exchange rates,
the average of the exchange rates on the last day of each month during the
period indicated, and the exchange rates at the end of the period indicated for
one Canadian dollar expressed in U.S. dollars, based on the inverse of the noon
buying rate for cable transfers payable in Canadian dollars as certified for
customs purposes by the Federal Reserve Bank of New York.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
--------------------------------------------------- ENDED JUNE 30,
1995 1996 1997 1998 1999 2000
------- ------- ------- ------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
End of period.............. $0.7323 $0.7301 $0.6999 $0.6504 $0.6925 $0.6758
Average for period......... $0.7306 $0.7329 $0.7198 $0.6714 $0.6744 $0.6816
High for period............ $0.7527 $0.7513 $0.7467 $0.7105 $0.6925 $0.6969
Low for period............. $0.7023 $0.7235 $0.6945 $0.6341 $0.6535 $0.6629
</TABLE>
All references to "$" or "U.S.$" in this prospectus refer to United States
dollars and all references to "Cdn.$" refer to Canadian dollars.
PRESENTATION OF FINANCIAL AND OTHER INFORMATION
Unless we indicate otherwise, financial information in this prospectus has
been prepared in accordance with Canadian generally accepted accounting
principles, or GAAP. Canadian GAAP differs in some significant respects from
U.S. GAAP and thus our financial statements may not be comparable to the
financial statements of U.S. companies. The principal differences as they apply
to us are summarized in note 16 of our financial statements for the years ended
December 31, 1999 and 1998 and note 7 of our unaudited interim financial
statements for the six month periods ended June 30, 2000 and 1999, included
elsewhere in this prospectus.
Our functional currency is the Canadian dollar. Effective December 31,
1999, we adopted the U.S. dollar as our reporting currency and the financial
information included in this prospectus for 1999 and prior years has been
presented in U.S. dollars in accordance with a translation of convenience method
using the exchange rate at December 31, 1999, as set forth in note 2 of our
financial statements for the years ended December 31, 1999 and 1998 and note 2
of our unaudited interim financial statements for the six month periods ended
June 30, 2000 and 1999. For periods subsequent to December 31, 1999, Canadian
dollar amounts have been translated into U.S. dollars using the current rate
method, as set forth in note 2 of our financial statements for the years ended
December 31, 1999 and 1998 and note 2 of our unaudited interim financial
statements for the six month periods ended June 30, 2000 and 1999.
19
<PAGE> 23
USE OF PROCEEDS
We expect to receive approximately $76.5 million in net proceeds from the
sale of 7,000,000 common shares being offered by us in this offering, based on
the initial public offering price of $12.00 per common share. We expect that the
net proceeds will be approximately $88.2 million if the underwriters' over-
allotment option is exercised in full.
The primary purposes of this offering are to obtain additional equity
capital, create a public market for our common shares and facilitate future
access to public markets. As of the date of this prospectus, we have not made
any specific expenditure plans with respect to the net proceeds of this
offering, except as described below. We expect to use the net proceeds of this
offering for general corporate purposes and capital expenditures. Our projected
budget for 2001 and 2002 includes capital expenditures of approximately $7
million and $10 million, respectively, to purchase equipment and make leasehold
improvements to expand our production capacity and research and development
programs. Also, we believe that there will be significant opportunities to make
acquisitions of, or investments in, businesses, products or technologies that
expand, complement or are otherwise related to our current business and we may
also use net proceeds from this offering for these purposes. However, we
currently have no specific acquisitions planned. Pending these uses, we expect
to invest the net proceeds in short-term, interest bearing investment grade
securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common shares. We
currently intend to retain any future earnings to fund the development and
growth of our business and we do not anticipate paying any cash dividends in the
foreseeable future.
20
<PAGE> 24
CAPITALIZATION
The table below describes our capitalization as of June 30, 2000:
- on an actual basis;
- on a pro forma basis to give effect to the conversion of 750,000 Series A
preferred shares and 510,500 Series B preferred shares into an aggregate
of 8,823,500 common shares and payment of accrued dividends, which will
occur automatically upon the closing of this offering; and
- on a pro forma as adjusted basis to give effect to the pro forma
adjustments described above and to the sale of 7,000,000 common shares
offered by us at the initial public offering price of $12.00 per common
share, after deducting the underwriting commission and estimated offering
expenses of $1.6 million payable by us.
<TABLE>
<CAPTION>
AS OF JUNE 30, 2000
----------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
------ -------------- ------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents............................... $2,192 $2,037 $78,549
====== ====== =======
Debt:
Loan payable.......................................... 94 94 94
Dividends payable on preferred shares................. 155 -- --
Unlimited number of preferred shares authorized;
8,823,500 shares issued and outstanding (actual);
no shares issued and outstanding (pro forma); no
shares issued and outstanding (pro forma as
adjusted).......................................... $4,055 $ -- $ --
------ ------ -------
4,304 94 94
Shareholders' equity (deficit):
Unlimited number of common shares authorized;
19,687,500 shares issued and outstanding (actual);
28,532,000 shares issued and outstanding (pro
forma); 35,532,000 shares issued and outstanding
(pro forma as adjusted)............................ 25 4,646 81,158
Other equity.......................................... 566 -- --
Currency translation adjustment....................... (6) (6) (6)
Deficit............................................... (24) (24) (24)
------ ------ -------
Total shareholders' equity (deficit)............... 561 4,616 81,128
------ ------ -------
Total capitalization.......................... $4,865 $4,710 $81,222
====== ====== =======
</TABLE>
The number of common shares outstanding as of June 30, 2000 in the table
above excludes the following:
- common shares issuable upon the exercise of outstanding options as of the
date of this prospectus to purchase 3,905,750 common shares under our
stock option plan at a weighted average exercise price of $0.723 per
share; and
- common shares issuable upon the exercise of options granted after June
30, 2000.
Although the Canadian dollar is our functional currency, we have adopted
the U.S. dollar as our reporting currency. See note 2 of our financial
statements for the years ended December 31, 1999 and 1998 and note 2 of our
unaudited interim financial statements for the six month periods ended June 30,
2000 and 1999.
21
<PAGE> 25
DILUTION
Our pro forma net tangible book value as of June 30, 2000 was $4.6 million,
or $0.16 per common share. Our pro forma net tangible book value reflects (a)
the issuance of preferred shares during the first quarter of 2000 in
consideration for net cash proceeds of approximately $3.7 million and (b) the
automatic conversion of all outstanding preferred shares into 8,823,500 common
shares upon the closing of this offering. Pro forma net tangible book value per
share is determined by dividing the amount of our pro forma total tangible
assets less total liabilities by the pro forma number of common shares
outstanding at that date. Dilution in net tangible book value per common share
represents the difference between the initial public offering price and the pro
forma net tangible book value per common share immediately after the completion
of this offering.
After giving effect to the sale of the 7,000,000 common shares offered at
the initial public offering price of $12.00 per share and after deducting the
estimated underwriting commissions and estimated offering expenses payable by
us, our pro forma net tangible book value as of June 30, 2000, would have been
$81.1 million, or $2.28 per common share. This represents an immediate increase
in pro forma net tangible book value of $2.12 per common share to existing
shareholders and an immediate dilution in net tangible book value of $9.72 per
common share to new investors in common shares who purchased such common shares
in this offering. This amount is equal to 81% of the initial public offering
price of $12.00 per share. The following table illustrates this dilution on a
per share basis:
<TABLE>
<S> <C> <C>
Initial public offering price per common share.............. $12.00
Pro forma net tangible book value per common share as of
June 30, 2000.......................................... $0.16
Increase in pro forma net tangible book value per common
share attributable to new investors.................... 2.12
-----
Pro forma net tangible book value per common share after
this offering............................................. 2.28
------
Dilution in pro forma net tangible book value per common
share to new investors.................................... $ 9.72
======
</TABLE>
The following table sets forth, as of June 30, 2000, the difference between
the number of common shares purchased, the total consideration paid and the
average price per common share paid by the existing holders of our common shares
and by the new investors, before deducting underwriting commissions and
estimated offering expenses payable by us at the initial public offering price
of $12.00 per share.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
---------------------- ------------------------ AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- -------- ------------ -------- -------------
(IN THOUSANDS, EXCEPT SHARE AMOUNT)
<S> <C> <C> <C> <C> <C>
Existing shareholders.............. 28,532,000 80.3% $ 4,615,000 5.2% $ 0.16
New investors...................... 7,000,000 19.7 84,000,000 94.8 12.00
---------- ----- ----------- -----
Total.............................. 35,532,000 100.0% $88,615,000 100.0%
========== ===== =========== =====
</TABLE>
The table above excludes the following:
- outstanding options as of the date of this prospectus to purchase
3,905,750 common shares under our stock option plan at a weighted average
exercise price of $0.723 per share; and
- common shares issued upon the exercise of stock options after June 30,
2000.
To the extent that any common shares are issued upon the exercise of
options that were outstanding as of June 30, 2000 or granted after that date, or
reserved for future issuance under our stock option plan, there will be further
dilution to new investors. For a more detailed discussion of our stock option
plan and outstanding options to purchase common shares see "Management -- Stock
Options," "Management New Stock Option Plan," "Description of Share Capital,"
note 8 of our financial statements for the years ended December 31, 1999 and
1998 and note 3 of our unaudited interim financial statements for the six month
periods ended June 30, 2000 and 1999.
22
<PAGE> 26
SELECTED FINANCIAL DATA
Our financial statements are prepared in accordance with Canadian generally
accepted accounting principles. These principles conform in all material
respects with U.S. generally accepted accounting principles except as disclosed
in note 16 to our financial statements for the years ended December 31, 1999 and
1998, and note 7 to our unaudited interim financial statements for the six month
periods ended June 30, 2000 and 1999. You should read the following selected
financial data with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and notes appearing
elsewhere in this prospectus. The statements of operations data for the years
ended December 31, 1997, 1998, and 1999, and the balance sheet data as of
December 31, 1998 and 1999 are derived from our financial statements that have
been audited by PricewaterhouseCoopers LLP, our independent auditors, which are
included elsewhere in this prospectus. The statement of operations data for the
years ended December 31, 1995 and 1996 and the balance sheet data as of December
31, 1995, 1996 and 1997 are derived from our financial statements that have been
audited by PricewaterhouseCoopers LLP that are not included in this prospectus.
The selected financial data as of June 30, 2000 and for the six month periods
ended June 30, 1999 and 2000 are derived from the unaudited interim financial
statements, which, in the opinion of management, include all adjustments
(consisting solely of normal recurring adjustments) necessary to present fairly
the financial information for such periods. Results for any interim period are
not necessarily indicative of the results that may be expected for any other
interim period or for a full year.
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 31,
TO SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED DECEMBER 31, JUNE 30,
--------------- ------------------------------------------------- -----------------------
1995 1996 1997 1998 1999 1999 2000
--------------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Canadian GAAP:
Revenues................ $ 2 $ 116 $ 97 $ 665 $ 2,674 $ 774 $ 4,459
Cost of revenues........ -- 52 72 415 2,105 578 2,922
---------- ---------- ---------- ---------- ---------- ---------- ----------
Gross profit............ 2 64 25 250 569 196 1,537
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating expenses:
Selling and
marketing........... 1 4 11 38 125 31 81
General and
administrative...... 1 13 17 51 409 235 670
Research and
development......... -- 41 (8) 45 162 62 304
Depreciation of
capital assets...... -- 1 2 3 18 5 23
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total operating
expenses.......... 2 59 22 137 714 333 1,078
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
operations............ -- 5 3 113 (145) (136) 459
Other expenses.......... -- -- 1 2 64 27 107
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes.......... -- 5 2 111 (209) (163) 352
Income tax expense
(benefit)............. -- 2 3 12 -- (15) 268
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)....... (0) 3 (1) 99 (209) (148) 84
========== ========== ========== ========== ========== ========== ==========
Basic and fully diluted
earnings (loss)
per share............. $ (0.00) $ (0.00) $ (0.00) $ 0.01 $ (0.01) $ (0.01) $ 0.00
========== ========== ========== ========== ========== ========== ==========
</TABLE>
23
<PAGE> 27
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 31,
TO SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED DECEMBER 31, JUNE 30,
--------------- ------------------------------------------------- -----------------------
1995 1996 1997 1998 1999 1999 2000
--------------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Shares used in computing
basic and fully
diluted earnings
(loss)
per share............. 19,687,500 19,687,500 19,687,500 19,687,500 19,687,500 19,687,500 19,689,243
========== ========== ========== ========== ========== ========== ==========
Pro forma earnings
(loss) per share...... $ (0.01) $ 0.00
========== ==========
U.S. GAAP:
Revenues................ 647 2,598 749 4,459
========== ========== ========== ==========
Net income (loss)....... $ 96 $ (165) $ (108) $ (1,718)
========== ========== ========== ==========
Basic and fully diluted
earnings (loss)
per share............. $ 0.00 $ (0.01) $ (0.01) $ (0.09)
========== ========== ========== ==========
Pro forma earnings
(loss) per share...... $ (0.01) $ (0.06)
========== ==========
</TABLE>
Pro forma earnings (loss) per share has been computed assuming the
conversion as at the beginning of the periods presented, or at the date of
issuance if later, of 750,000 Series A preferred shares and 510,500 Series B
preferred shares to 8,823,500 common shares which will occur automatically upon
the closing of this offering.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------- AS OF JUNE 30,
1995 1996 1997 1998 1999 2000
---- ---- ---- ------ ------ --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Canadian GAAP:
Cash and cash equivalents.............. $19 $16 $-- $ 819 $ 453 $2,192
Working capital........................ 19 22 15 1,123 700 4,192
Total assets........................... 23 58 80 1,249 1,964 6,808
Total shareholders' equity............. 20 24 23 247 38 561
U.S. GAAP:
Total assets........................... 1,176 1,964 6,808
Total shareholders' equity
(deficiency)......................... 115 (66) 70
</TABLE>
Although the Canadian dollar is our functional currency, we have adopted
the U.S. dollar as our reporting currency. See note 2 of our financial
statements for the years ended December 31, 1999 and 1998 and note 2 of our
unaudited interim financial statements for the six month periods ended June 30,
2000 and 1999.
24
<PAGE> 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with the financial statements and the
notes to those statements included elsewhere in this prospectus which have been
prepared in accordance with generally accepted accounting principles, or GAAP,
in Canada. Differences between Canadian GAAP and GAAP in the United States are
discussed in note 16 to our financial statements for the years ended December
31, 1999 and 1998 and note 7 to our unaudited interim financial statements for
the six month periods ended June 30, 2000 and 1999. This discussion contains
forward-looking statements that involve risks and uncertainties. Please see
"Forward Looking Statements."
OVERVIEW
We design, develop and manufacture proton-exchange membrane, or PEM, fuel
cell automated test stations. We are currently selling test stations to
automotive companies, fuel cell developers, component suppliers and government
agencies.
Our goal is to become a leading designer and provider of commercial PEM
fuel cell automated test stations and PEM fuel cell systems. However, given the
current high costs of PEM fuel cells, we do not currently expect to generate
material revenues from sales of products, other than fuel cell automated test
stations until there are significant reductions in the costs associated with PEM
fuel cell materials. We cannot currently predict if and when such cost
reductions or sales will occur. We expect to incur substantial additional
research and development expenditures in developing products suitable for our
targeted commercial markets.
Revenues
We currently derive revenues primarily from the sale of fuel cell automated
test stations, marketed under the trade name FCATS, to a limited number of
commercial customers who use our test stations to aid in their fuel cell system
and materials development efforts. However, in the future we expect to derive
revenues from sales of fuel cell systems for the stationary and portable power
markets for use in situations that require reliable power regardless of the
environment such as in remote and extreme weather locations or for military
applications. These products include a PEM fuel cell power generator for use in
extreme weather conditions and a 2kW fuel cell power generator currently being
developed as a power source for a military device that detects chemical and
biological agents in the field. To date, we have recognized a small amount of
revenue from the pre-commercial sale of these systems. Sales of pre-commercial
products in our target markets are intended to test system performance, market
conditions and customer preferences. This data is intended to assist our
continuing product design and also to speed commercialization and acceptance of
our products in our target markets.
Our current commercial products represent a large capital investment for
our customers, typically require significant direct sales and custom engineering
support, and generally have long sales cycles. Due to these long sales cycles,
typically at least three to four months, our revenues during any particular
period are not directly comparable to revenues during other periods. We
generally recognize revenues using the "percentage-of-completion" method of
accounting, under which revenues are recognized on a pro rata basis in relation
to contract costs incurred. As a result, the revenues we recognize in any given
period depend to a significant extent on our estimate of total remaining costs
to complete individual contracts.
To date, a small number of customers has accounted for a significant
majority of our revenues and will continue to do so for the foreseeable future.
Our principal source of revenues from these customers has evolved from the sale
of engineering services to the sale of our fuel cell automated test stations.
Aggregate sales to our three largest customers accounted for approximately 80%
and 83% of our revenues for the years ended December 31, 1999 and 1998,
respectively.
25
<PAGE> 29
Cost of revenues
Our cost of revenues consists primarily of the cost of compensation and
benefits for manufacturing staff and related engineering and support staff, and
materials and supplies used in the manufacturing process. We expect our cost of
revenues to increase following our move to a new facility during the fourth
quarter of 2000.
Operating expenses
Our operating expenses are primarily comprised of expenses relating to
sales and marketing, general and administrative, and research and development.
We expect our operating expenses to increase significantly as we continue to
grow.
Our sales and marketing expenses consist primarily of compensation and
benefits for our sales and marketing personnel and related business development
expenses. Due to the limited size of our market to date, our historical sales
and marketing expenses have not been material.
Our general and administrative expenses consist primarily of compensation
and benefits related to our corporate staff, professional fees, and travel and
facilities costs, including lease payments.
Research and development expenses consist primarily of salaries and
benefits for research and development personnel and costs of research and
development equipment and materials.
We also receive financial assistance payments from various governmental and
educational entities for specific research and development projects. To the
extent that we reasonably expect to commercialize products developed as a result
of these payments, we will be required to accrue expenses for royalties at rates
ranging from 1.3% to 4% to repay these payments. Research and development
arrangements that obligate us to repay the financial assistance payments
regardless of the outcome or commercialization of the research and development
are recognized as liabilities. We receive tax credits in Canada in respect of
qualifying research and development expenditures.
Other expenses
Our non-operating expenses include accrued dividends and amortization of
discount on preferred shares. Upon the closing of this offering, our preferred
shares will be automatically converted into an aggregate of 8,823,500 common
shares and the holders of the preferred shares will be paid accrued dividends in
cash. As a result of the conversion, we will cease to incur expenses associated
with the preferred shares following the completion of this offering.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Revenues
Revenues for the six months ended June 30, 2000 were approximately
$4,459,000, compared to approximately $774,000 for the six months ended June 30,
1999. This increase of $3,685,000 is the result of revenues recognized from an
increase in the sales of FCATS. We recognized revenue on a percentage of
completion basis relating to 47 FCATS units completed or partially completed
during the six month period ending June 30, 2000 compared to revenue recognized
on a percentage of completion basis relating to four FCATS units completed or
partially completed during the six month period ending June 30, 1999. FCATS
units are assembled to varying specifications, and prices vary widely depending
on model and customer requirements. The increase in sales of FCATS was
attributable to the increase in development activity in the field of PEM fuel
cells and the increased recognition of the superiority and stage of development
of our FCATS products compared to competing products. Although we launched our
FCAVS series during this period, we have not recognized any revenue from FCAVS
sales during the period.
26
<PAGE> 30
Cost of revenues
Cost of revenues for the six months ended June 30, 2000 was approximately
$2,922,000, compared to approximately $578,000 for the six months ended June 30,
1999. This increase of $2,344,000 primarily reflects costs associated with
increased production of FCATS units.
Selling and marketing expenses
Selling and marketing expenses for the six months ended June 30, 2000 were
approximately $81,000, compared to approximately $31,000 for the six months
ended June 30, 1999. This increase of $50,000 reflects costs relating to our
expanded sales and marketing efforts.
General and administrative expenses
General and administrative expenses for the six months ended June 30, 2000
were approximately $670,000, compared to approximately $235,000 for the six
months ended June 30, 1999. Contributing to this increase of $435,000 were a
significant increase in our number of employees resulting in an increase of
approximately $200,000 in employee expenses and increased professional advisory
expenses of approximately $70,000 resulting from a private placement financing
which was completed in January 2000. The remaining $165,000 represents expenses
incurred in continuing to build our operating infrastructure.
Research and development expenses
Research and development expenses for the six months ended June 30, 2000
were approximately $409,000, compared to approximately $193,000 for the six
months ended June 30, 1999. This increase of $216,000 is a result of increased
research and development related to our FCATS and HyTEF products. For the six
month period ending June 30, 2000 we received research and development grants of
approximately $105,000 to fund specified research and development projects.
During the six month period ending June 30, 1999 we received research and
development grants of approximately $131,000.
COMPARISON OF YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Revenues
Revenues increased to approximately $2,674,000 in 1999, compared to
approximately $665,000 in 1998 and approximately $97,000 in 1997. These
increases of $2,009,000 from 1998 to 1999 and $568,000 from 1997 to 1998,
respectively, are attributable primarily to increasing unit sales of FCATS. We
recognized revenue on a percentage completion basis in 1997, 1998 and 1999
relating to two, four and 26 FCATS units, respectively, which were completed or
partially completed in those years. FCATS units are assembled to varying
specifications, and prices vary widely depending on model and customer
requirements.
Cost of revenues
Cost of revenues increased to approximately $2,105,000 in 1999, compared to
approximately $415,000 in 1998 and approximately $71,000 in 1997. These
increases of $1,690,000 from 1998 to 1999 and $344,000 from 1997 to 1998,
respectively, primarily reflect costs associated with increased production of
FCATS units. Approximately $87,000 of these costs in 1999 is attributable to the
establishment of a product warranty reserve charge. 1999 was the first year we
accrued a warranty reserve charge. Our policy is to accrue a warranty reserve
charge as revenue is recognized. The amount of the warranty reserve charge for
1999 was based on an estimate of future claims and was not based on historical
or actual claims presented to us. We expect that increased FCATS production in
2000 will provide us with greater economies of scale, resulting in a decline in
FCATS per-unit component costs, which we believe will reduce the production cost
of each FCATS unit.
27
<PAGE> 31
Selling and marketing expenses
Selling and marketing expenses in 1999 were approximately $125,000,
compared to approximately $38,000 for 1998 and approximately $11,000 in 1997.
Increases over the periods reflect the expansion of our infrastructure to
support sales growth and the commercialization of our products, primarily in the
United States, Europe and, during 1999, Asia. Specific expenses include salaries
for additional marketing personnel and increased travel costs, which accounted
for the increase.
General and administrative expenses
General and administrative expenses in 1999 were approximately $409,000,
compared to approximately $51,000 in 1998 and approximately $17,000 in 1997. The
increase of $358,000 from 1998 to 1999 includes expenses incurred in moving to
larger premises in 1999 of approximately $64,000, the hiring of 19 additional
employees of approximately $226,000 and professional advisory expenses of
approximately $26,000. The remaining $42,000 represents expenses incurred in
continuing to build our infrastructure. The increase of $34,000 from 1997 to
1998 reflects initial expenses incurred in connection with building our
operating infrastructure.
Research and development expenses
Research and development expenses excluding research and development grants
in 1999 were approximately $424,000, compared to approximately $94,000 in 1998
and approximately $124,000 in 1997. The increase in our research and development
expenses from 1998 to 1999 of approximately $330,000 is attributable to higher
personnel and materials expenditures incurred in the expansion of our existing
research programs and lower investment tax credits. The decrease in our research
and development expenses from 1997 to 1998 of approximately $30,000 was
attributable principally to Canadian investment tax credits earned in 1998 of
$107,000. Canadian investment tax credits are earned when we make research and
development expenditures that meet the criteria for specified government
programs designed to promote research and development in Canada.
In 1999, we received approximately $262,000 in research and development
grants from various governmental and educational entities for specific research
and development projects. In 1998, we received approximately $50,000 in research
and development grants from various governmental and educational entities for
specific research and development projects. In 1997, we received approximately
$131,000 of research and development grants from various governmental and
educational entities.
LIQUIDITY AND CAPITAL RESOURCES
Our cash requirements depend on many factors, including our research and
development activities, expansion of our manufacturing facilities and our
efforts to commercialize our products. In 2000, we expect to spend a total of
approximately $1.75 million on selling and marketing expenses and general and
administrative expenses. Part of these expenses will be used to continue to
develop our sales and marketing programs and hire additional production staff.
We also expect to spend a total of approximately $660,000 on research and
development expenses, net of grants, to continue and expand our research and
development program and a total of $500,000 to relocate our operations to our
new manufacturing facility and fund tenant improvements. In 2000 we expect each
of the expenses described above to be funded from cash on hand and cash from
operations. From January 1, 2000 through September 15, 2000, we have already
spent approximately $1.1 million on selling and marketing and general
administrative expenses, approximately $490,000 on research and development
expenses, and approximately $56,000 on expenses relating to relocating our
operations to our new facility. We believe that our current cash balances, cash
from operations and the net proceeds from this offering will provide us with
sufficient capital to fund our operations through the next 24 months.
We have experienced significant increases in accounts receivable,
inventory, accounts payable and accrued liabilities in 1999 and for the period
ended June 30, 2000. These increases are the result of the increase in
production volumes and trading activity experienced during these periods or
specific events
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<PAGE> 32
previously described, such as the increase in professional fees in the six-month
period ended June 30, 2000 or the warranty reserve charge in 1999.
Historically, we have financed our operations primarily through cash from
operations and private equity offerings. We raised approximately $1.0 million in
December 1998 and approximately $3.7 million in January 2000 through the sale of
our preferred shares. Our primary cash requirements have been to fund research
and development, capital expenditures and production costs. Net cash used in
operating activities was approximately $86,000, $152,000 and $42,000 for 1999,
1998 and 1997, respectively. Proceeds remaining from the sales of preferred
shares are currently held in short-term, interest-bearing investment-grade
securities to provide liquidity for operations. In addition, we have established
a line of credit with a Canadian chartered bank in the amount of approximately
$173,000. As of June 30, 2000, we have no outstanding borrowings under this line
of credit.
Our capital requirements will be affected by many factors, including the
success of current product offerings, the ability to enhance our current
products and our ability to develop and introduce new products that keep pace
with technological developments in the marketplace. We intend to use the
proceeds of this offering for general corporate purposes including continued
research and product development, capital expenditures and sales and marketing
expenses. Additionally, we may use a portion of the net proceeds to fund
acquisitions of, or investments in, businesses, products or technologies that
expand, complement or are otherwise related to our current business. Pending our
use of proceeds as described above, we intend to invest the proceeds of this
offering in short-term, interest-bearing investment grade securities.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS NOT YET IMPLEMENTED
For United States GAAP reporting purposes we will be required to adopt SFAS
133 "Accounting for Derivative Instruments and Hedging Activities" for the 2001
fiscal year. We do not use derivative financial instruments for trading purposes
and do not have any current intention to enter into any hedging transactions,
and therefore we expect that any such impact on our financial reporting will not
be material.
DISCLOSURE ABOUT MARKET RISK
Our functional currency is the Canadian dollar. Effective December 31,
1999, we adopted the U.S. dollar as our reporting currency and the financial
information included in this prospectus for 1999 and prior years has been
presented in U.S. dollars in accordance with a translation of convenience method
using the exchange rate at December 31, 1999, as set forth in note 2 of our
financial statements for the years ended December 31, 1999 and 1998 and note 2
of our unaudited interim financial statements for the six month periods ended
June 30, 2000 and 1999. For periods subsequent to December 31, 1999, Canadian
dollar amounts have been translated into U.S. dollars using the current rate
method, as set forth in note 2 of our financial statements for the years ended
December 31, 1999 and 1998 and note 2 of our unaudited interim financial
statements for the six month periods ended June 30, 2000 and 1999.
A significant proportion of our cost of revenues consists of materials
purchased in U.S. dollars. This may expose us to some currency rate risk
associated with our exchange of Canadian dollars for U.S. dollars. We believe
that this risk is mitigated to a significant extent by the fact that a large
proportion of our revenues are received in U.S. dollars. We do not currently
engage in any hedging transactions relating to our exchange rate risk.
Our cash equivalents and investments, all of which have maturities of less
than one year, may expose us to market risk. We maintain a non-trading
investment portfolio of short-term, interest-bearing investment grade, liquid
debt securities. The fair value of these securities approximates their cost.
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<PAGE> 33
BUSINESS
OUR COMMERCIAL BUSINESS TODAY
We design, develop and manufacture proton-exchange membrane, or PEM, fuel
cell automated test stations. Our test stations are used to aid in the design,
development and manufacture of PEM fuel cell systems. A PEM fuel cell system is
a power generator that produces electricity through an electrochemical reaction
of hydrogen and oxygen with the principal by-products being heat and water. A
PEM fuel cell system is comprised of three major sets of components: a hydrogen
fuel processor, which derives hydrogen from fuels such as propane or natural
gas; a fuel cell or stack of fuel cells; and power conditioning equipment, which
regulates the type and level of power transferred from the fuel cell. The other
components and subsystems of a fuel cell system are known in our industry as the
"balance of plant" of a fuel cell system.
In order to perform testing and diagnostic functions, our test stations
provide balance of plant components and subsystems that simulate, monitor and
control key parameters of a fuel cell such as power load, temperature, pressure,
humidification and potential contaminants. This data enables our customers to
measure the effect of these variables on fuel cell performance.
We are currently selling our test stations to automotive companies, fuel
cell developers, component suppliers and government agencies. Our largest
customers in these markets, based on revenues, include General Motors
Corporation, Johnson Matthey plc, Minnesota Mining and Manufacturing Company
(3M), W.L. Gore & Associates, Inc., and the United States Army. Through the
development of our proprietary test stations, we have gained significant
expertise in the development and operation of PEM fuel cell stacks and the
balance of plant subsystems and components of a fuel cell system.
OUR PRODUCTS
We are currently generating commercial sales from our PEM fuel cell
automated test stations. We expect to continue to market and sell our test
stations for the foreseeable future.
OUR PRODUCTS IN DEVELOPMENT
In addition to generating commercial sales from test stations, we are
adapting the balance of plant components and subsystems used in our test
stations as commercial products for fuel cell systems. We are also developing
PEM fuel cell systems designed for use in situations that require high quality,
reliable power regardless of the environment, such as in remote and extreme
weather locations or for military applications. For example, we are developing
what we believe is the first fuel cell system designed to operate at -40
degreesC. We are also developing a fuel cell system that will be used to power a
military device that detects chemical and biological agents in the field. We
plan to deliver demonstration units of these fuel cell systems for use in
marketing to customers in the second half of 2000. Over the longer term, we will
be targeting our fuel cell systems toward the transportation, stationary and
portable commercial markets. In addition, we are developing regenerative fuel
cell systems for these markets that can both generate electricity and produce
hydrogen fuel from water and store it for later use in powering the fuel cell.
We have not begun to manufacture commercial fuel cell systems in significant
quantities.
MARKET OPPORTUNITIES FOR OUR FUEL CELL PRODUCTS
We believe that a number of trends are focusing attention on the use of PEM
fuel cells as an attractive alternative method of power generation. As a result,
automotive companies, fuel cell developers, component suppliers and others are
currently spending significant amounts of capital developing their own fuel cell
programs. We believe that test stations, such as our FCATS and FCAVS products,
and our balance of plant components and subsystems will be important elements of
many of these programs in both the development stages and the manufacturing
process as broad commercial markets for fuel cells develop.
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<PAGE> 34
Trends that will influence the penetration of PEM fuel cells into broad
commercial markets include:
- Increasing demand for continuous and reliable power;
- Deregulation in the energy industry;
- Operational efficiencies and other advantages of fuel cells over
traditional power technologies;
- Environmental concerns regarding conventional power technologies; and
- Rising energy costs causing consumers to seek alternative means of
producing energy.
Although we are encouraged by these trends, there remain numerous technical
and logistical disadvantages that represent obstacles to the broad commercial
application of fuel cell technology. For example:
- current fuel cell technology does not have the proven dependability that
many of the existing alternative technologies have in our target markets;
- the high manufacturing costs currently associated with fuel cell
production make many commercial applications in our target markets
prohibitively expensive;
- appropriate integration of current fuel cell systems into existing
conventional technology may be difficult;
- fuels such as hydrogen are not as readily available as fuels such as
gasoline and methanol used in some of the alternative technologies in our
target markets; and
- the costs of hydrocarbon fuels currently used to produce hydrogen in fuel
cells are rising, which may impede the growth of hydrocarbon-powered fuel
cells as a cost-efficient alternative means of producing energy.
We believe that these trends will contribute to the penetration of PEM fuel
cells into each of our target markets described below:
Transportation Market
The United States federal government and several states, principally
California and, to a lesser extent, New York, Massachusetts and Maine, have
adopted laws and regulations establishing vehicle emission standards and
requirements for the sale of low and, in the case of California, New York,
Massachusetts and Maine, zero emission vehicles. Some of the regulations adopted
by these states require that 10% of new vehicles sold in these states meet zero
emission guidelines by 2003. We believe that PEM fuel cell powered vehicles will
meet the performance requirements of consumers and the regulatory requirements
for zero emission vehicles. However, these guidelines can also be satisfied in
whole by other forms of zero emission vehicles, such as battery powered
vehicles, or in part by the sale of a large number of ultra low-emission
vehicles, such as vehicles powered by improved internal combustion engines or
hybrid battery/internal combustion engines.
While environmental considerations provided the initial impetus for
automobile manufacturers to seek alternatives to the internal combustion engine,
we believe that these manufacturers are beginning to recognize that PEM fuel
cells offer an opportunity to deliver products that are more attractive to
consumers than the current internal combustion engine. A fuel cell system
converts fuel into power through an electrochemical reaction that is
approximately twice as efficient as that of an internal combustion engine.
Furthermore, it does so quietly, with low vibration and little or no pollution,
depending on the fuel used. As a result, compared to an internal-combustion
engine, fuel cells provide quieter, cleaner and more energy-efficient power for
vehicles, with equivalent range and performance. According to industry sources,
fuel cells approach 40% efficiency, while internal combustion engines are only
15% to 20% efficient. In the stationary market described below, the efficiency
of a fuel cell can increase to as much as 60% to 90% with co-generation
capabilities. Energy efficiency is the measure, expressed as a percentage, at
which a given energy producing system converts fuel to electricity.
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Stationary Market
Worldwide demand for electricity, particularly high quality, reliable
power, has been increasing rapidly in recent years, which is partially
attributable to the proliferation of computers, the Internet, communications
networks and advanced electronics. According to The Huber-Mills Digital Power
Report, electricity accounted for 25% of U.S. energy consumption 25 years ago,
accounts for 37% today, and will account for more than half of U.S. energy
consumption early in this century. In addition, grid power worldwide is
regularly unreliable or inadequate. The Electric Power Research Institute
estimated that electric power problems cost U.S. industry more than $50 billion
annually. In addition, industry sources estimate that in 1999, businesses spent
approximately $12 billion globally on power quality and reliability equipment.
Lead-acid batteries currently provide back-up energy for most power
applications in which a high degree of reliability is required, including those
in communications, and are viewed as the weakest component of conventional power
quality due to low reliability, high cost, and environmental issues. We believe
that PEM fuel cell technology can provide significant advantages over existing
stationary power sources, such as higher reliability, longer life, lower
life-cycle cost, continuous operation as long as fuel and oxidant supplies are
provided, reduced maintenance, more reliable monitoring, and no environmental
pollution. Also, unlike traditional large-scale power generation facilities,
which are very capital intensive, PEM fuel cell systems have the potential to be
implemented at smaller, less capital-intensive generating facilities, reducing
the cost to power generators of maintaining or incrementally increasing their
generating capacity.
In addition, environmental concerns and inefficiencies in delivering power
through the grid have resulted in a desire for the development of alternative
power generation technologies. We believe that potential customers in the
stationary power market are exploring the use of new power sources due to the
increasing demand for power generating capacity and the need to replace aging
power generators in a cost-effective manner. We also believe that continued
deregulation in the electric power industry in North America and elsewhere is
creating potential demand for new alternative stationary power generators. Power
producers and other energy distributors are looking to implement decentralized
or distributed power generating solutions. Generators and suppliers of electric
power are also exploring alternative power generation methods that are less
capital intensive than current technologies.
Portable Market
There is a growing demand for quiet, clean and efficient portable
generators, especially in densely populated areas where noise pollution is a
significant concern or in other areas where noxious emissions of more
conventional technologies pose significant problems. We expect a growing demand
for standby power generators for homes and businesses due to the increasing use
of computers and the Internet. In addition, we believe that power generation for
rural, remote and extreme weather locations, scientific instrumentation and
remote control instrumentation will provide significant portable power
opportunities. We believe that portable power generators powered by PEM fuel
cells enjoy substantial advantages over existing portable generators and
batteries, such as higher reliability, longer life, lower life-cycle cost,
continuous operation as long as fuel and oxidant supplies are provided, reduced
maintenance, more reliable monitoring, and no environmental pollution. We
believe that portable generators powered by PEM fuel cells can provide consumers
with the power they need in a package that is small and durable.
OUR BUSINESS STRATEGY
We have implemented the following business strategy to further our goal of
becoming a leading designer and provider of PEM fuel cell test stations and
commercial fuel cell systems:
Initially target near term market opportunities. In order to develop early
commercial markets for our test stations and fuel cell system technology, we are
initially focusing on customers that presently have substantial testing and
diagnostic requirements, such as General Motors Corporation, or those that have
a need for power in remote locations.
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<PAGE> 36
Expand into broader markets. Over the longer term, our principal strategy
is to develop our proprietary fuel cell technology for the transportation,
stationary and portable commercial markets and to expand our remote location
power technology into broader commercial markets. As part of our fuel cell
program, we will be developing regenerative fuel cells which we believe will
potentially offer customers a preferred renewable, sustainable energy solution.
Establish key customer and strategic relationships. We seek to establish
customer-focused, service-oriented relationships with key existing customers
such as General Motors Corporation, Johnson Matthey plc, Minnesota Mining and
Manufacturing Company (3M), W.L. Gore & Associates, Inc., and the United States
Army. We will also pursue cooperative arrangements with selected manufacturers
and distributors to help us design and manufacture new products, expand our
distribution channels and achieve early commercialization of our products.
Develop and exploit our technology across our target markets. We intend to
continue to develop and exploit our technology, knowledge and expertise across
our three principal target markets. By using the knowledge and expertise gained
from the development of testing stations and fuel cell technology, we believe
that we can develop PEM fuel cell products quickly and efficiently for our
specific targeted markets.
Focus on overall system design, component and subsystem integration, final
assembly and quality control. We believe that our test station and balance of
plant expertise provides us with a significant technological advantage over most
of our competitors in the design, assembly and integration of PEM fuel cell
systems. In order to capitalize on our balance of plant expertise, we intend to
focus our research, development and manufacturing activities on high value-added
systems and subsystems design, integration and assembly.
Develop and acquire complementary technologies. We believe that developing
and acquiring complementary technologies can accelerate our market penetration.
For example, we have developed and sold a number of unique test measurement
capabilities which enhance the performance of our PEM fuel cell automated test
stations. In addition, we regularly consider the acquisition of complementary
technologies that we believe will assist in the development of our products.
OUR COMPETITIVE ADVANTAGES
We believe that the following competitive advantages have aided us in the
design, development, manufacture and sale of PEM fuel cell testing and
diagnostic equipment and will enable us to become a leader in the design,
development and manufacture of PEM fuel cell test stations and systems and
subsystems:
Commercial sales to premier customer base. We are currently generating
commercial sales of our testing and diagnostic equipment from industry leaders
such as General Motors Corporation, Johnson Matthey plc, Minnesota Mining and
Manufacturing Company (3M), and W.L. Gore & Associates, Inc. We believe that
having an existing and expanding commercial sales base for our test stations
distinguishes us from many of our competitors and that our commercial sales will
provide us with significant early advantages in the development and manufacture
of our fuel cell products and with alliance opportunities as significant markets
emerge. However, as we currently face, and will continue to face, significant
competition, we could experience a loss of market share and reduced gross
margins for our existing products and a failure to achieve acceptance of our
proposed products.
Well-positioned for broader market opportunities. We currently provide
industrial-grade fuel cell testing and diagnostic equipment to many of the
world's leading fuel cell developers and component suppliers. Our current
customer relationships will help us capitalize on the opportunities expected to
develop in the industry, including increased demand for fuel cell test stations,
retooling of manufacturing facilities to accommodate fuel cell technology,
providing balance of plant and manufacturing fuel cell systems for broad
commercial markets. We have no experience manufacturing fuel cell products on a
large
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<PAGE> 37
scale basis, and if we do not develop adequate manufacturing processes and
capabilities, we may be unable to take advantage of these broad commercial
markets.
Key customer relationships in target markets. Our customer base for test
stations includes General Motors Corporation, Johnson Matthey plc and other
prominent manufacturers and suppliers of fuel cell technology. Some of these
customers are undertaking research and development on products which may compete
with our products or products in development. However, we believe that only a
minority of them have the potential to become competitors of ours and that,
despite any competition, we can maintain good customer relationships with them
in connection with the sale of testing and diagnostic equipment, which is
currently our principal business. We will seek to develop other relationships
with potential partners in the transportation, stationary and portable markets.
We are targeting these customer relationships because we believe that they will
have the potential to provide us with access to some of the largest distribution
channels for fuel cell technology. However, our ability to compete effectively
in the transportation and stationary power markets may suffer because we
currently do not have a significant strategic partner.
Superior proprietary fuel cell automated test stations. We offer a full
range of automated fuel-cell testing equipment, from single-cell testing
equipment to large, multi-kW test stations. Our FCATS products feature key
capabilities to assist with fuel cell development, including proprietary
software for data acquisition and control. In addition, FCATS are built with
advanced safety features which permits unattended, automated operation. FCATS
enable real-time monitoring and control of a fuel cell system from remote
locations by displaying instrumentation on a computer which is electronically
linked to the FCATS unit. In addition, FCATS offer versatility and cost savings
to customers by allowing the rapid customization of the unit through software
rather than hardware upgrades. However, there are other companies that offer
fuel cell automated test stations. As we do not have exclusive agreements with
our customers, they could purchase test stations from these competitors.
Balance of Plant expertise. Through the development of our FCATS products,
we have gained significant PEM fuel cell system balance of plant expertise and
fuel cell operating and response experience. We are currently applying our
balance of plant expertise to develop fuel cell systems for remote locations and
for broad commercial markets. We believe that our balance of plant expertise
will have strong market applications in the transportation, stationary and
portable markets.
Superior power technology for remote locations. We are developing our
premium power technology, which we believe is the first PEM fuel cell system
designed to operate at -40(degrees)C. Once we are able to establish this
technology's power redundancy, reliability and efficiency, we believe that this
technology will provide competitive advantages in the remote location and
extreme weather segments of the portable power market. In addition, we are
developing a fuel cell system that can power portable devices, such as a device
for the Canadian military that detects chemical and biological agents in the
field. We are currently field testing our HyTEF product and expect to deliver
demonstration units to customers in the second half of 2000. Our demonstration
units are units we provide to our customers to use without charge to facilitate
the customer's purchasing decision. The customer can then place an order for the
product according to the customer's particular specifications. However, our
demonstration models may not meet performance expectations, which could
negatively affect our customer relationships and increase our manufacturing
costs.
PEM regenerative fuel cell technology. We believe that we are among a
small number of companies around the world to have developed regenerative fuel
cell technology. A regenerative fuel cell system can both generate electricity
and produce hydrogen fuel from water and store it for later use. We believe that
this technology, when coupled with appropriate hydrogen storage, has the
potential to achieve higher kilowatt hours per kilogram than advanced battery
systems. We believe that this technology has potential market applications in
the transportation, stationary and portable markets. However, we must lower the
cost of this technology and demonstrate its reliability, or we will not generate
revenues from it.
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OUR COMMERCIAL PRODUCTS
Our products are described in more detail on the following pages.
References in the tables and elsewhere in this prospectus to "amps" and "watts"
are to the applicable measurement units for electric current and power,
respectively, established under the International System of Units, which is the
modern metric system of measurement. One thousand watts of power is referred to
as a "kilo-watt" or "kW" as abbreviated. The references to these units of
measurement in the tables below are to the electrical limits that a particular
test station can test. For example, one of our 85kW FCATS would be able to test
a fuel cell stack that can generate up to 85kW of electric power and our
FCATS-LAA, which is designed to test a single fuel cell, can test single fuel
cells that generate no more than 2000 amps of electric current.
The testing requirements of our customers are dictated by the power
requirements of the applications for which they are developing fuel cells and
fuel cells stacks. Our customers typically first test single fuel cells. Testing
of a single fuel cell typically measures the current, in amps, generated by the
fuel cell. A customer may begin to develop fuel cells with low currents of up to
300 amps and then increase to development of fuel cells with higher currents of
up to 2000 amps, if developing fuel cell systems for applications with higher
power requirements. Single fuel cells are not usually used as power generators
for products or buildings, such as automobiles or houses, but are combined with
other fuel cells to make up a fuel cell stack. Testing of a fuel cell stack
typically measures the power, or kW level, generated by the stack. Generally,
fuel cell stacks consisting of fuel cells with high electric current levels,
such as 2000 amps, will generate more electric power than stacks consisting of
the same number of fuel cells but with lower electric current levels, such as
300 amps, and a greater number of fuel cells in a fuel cell stack will typically
produce a fuel cell stack that can generate a greater amount of electric power.
The amount of power produced by a fuel cell stack will determine the commercial
markets for its use. For example, a 4kW fuel cell stack could produce enough
electricity to power a small house, whereas an 85kW fuel cell stack could
produce enough electricity to power an automobile.
The following table sets forth our commercial products and describes their
respective applications, target markets and development status:
FUEL CELL AUTOMATED TEST STATIONS
<TABLE>
<CAPTION>
PRODUCT APPLICATION TARGET MARKET STATUS
<S> <C> <C> <C>
-------------------------------------------------------------------------------------------------
FCATS Automated control and monitoring of Transportation, - 4kW, 12kW, 24kW and
fuel cell stacks ranging from 2kW Stationary 85kW systems in
to 85kW as part of the product commercial production
development process
-------------------------------------------------------------------------------------------------
FCATS-LAA Automated control & monitoring of a Transportation, - Commercial production
single fuel cell for a large active Stationary
area (up to 1000cm(2)) with current
up to 2000 amps as part of the
product development process
-------------------------------------------------------------------------------------------------
FCATS Screener Automated control and monitoring of Transportation, - Commercial production
a single fuel cell with total Stationary,
current output of 300 amps as part Portable
of the product development process
-------------------------------------------------------------------------------------------------
FCAVS Residential Automated performance and quality Stationary - Commercial production
verification of fuel cell stacks
for residential fuel cell systems
of 12kW and under as part of the
manufacturing process
-------------------------------------------------------------------------------------------------
FCAVS Automated inspection station that Transportation, - In development
verifies performance and quality of Stationary
fuel cell stacks of 2kW to 85kW as
part of the manufacturing process
</TABLE>
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Fuel Cell Automated Test Stations
Our fuel cell automated test stations represent complete turnkey units that
evaluate fuel cell design and performance by simulating, monitoring and
controlling key parameters such as power load, temperature, pressure,
humidification and potential contaminants in the system. Our test stations are
built with advanced safety features which permit unattended automated operation,
and proprietary software. The software controls, alters and monitors:
- Gas flow rates -- higher gas flow rates result in higher power output;
- Pressure -- increasing pressure achieves higher power output;
- Individual cells -- the testing and monitoring of individual cells within
a stack to validate each cell and quickly locate problems in stack
performance;
- Temperature -- a temperature that is too high threatens to evaporate
water in the fuel cell, creating "dry" or sub-optimal operating
conditions; and
- Humidity -- fuel cells operate best when they are humidified or moist;
however, over- or under-humidification can impair performance;
humidification testing helps to identify the optimal operating humidity
and therefore optimizes the fuel cell's performance.
FCATS. Our fuel cell automated test stations, marketed under the trade
name FCATS, are industrial-grade test stations capable of operating multi-cell,
large surface area stacks. Our FCATS product line consists of four models that
cover fuel cell stack testing from 2kW to 85kW, which we believe covers the
power range for most PEM fuel cell stacks currently in development. We believe
that few of our competitors have developed test equipment capable of measuring
PEM fuel cell stacks above 5kW. We also manufacture a smaller, more economical
FCATS Screener model, which is an industrial-grade test station with a variety
of features for testing single cells. In addition, we provide custom design and
fabrication of test stations to meet specific customer needs. FCATS test
stations are designed to keep pace with current manufacturing requirements as
fuel cell commercialization progresses from the research and development stage
to prototype production, and eventually to mass production.
Our existing and potential customers for FCATS are primarily automotive
manufacturers and suppliers of fuel cell components. These customers use our
FCATS products to simulate, monitor, and control the effect of power load,
temperature, pressure, humidification and potential contaminants on a fuel cell
and to measure the effect of changes in these variables on fuel cell
performance. The data obtained through our test stations is used by our
customers to aid in the design, development, and manufacture of PEM fuel cell
systems.
FCATS units are manufactured to order. We are continuing to improve the
FCATS product line based on customer feedback and on new requirements identified
in the market. In 2000, we plan to expand our line of FCATS products. We believe
that continuing to improve product design, manufacturing processes and supplier
relationships will enable us to simplify the production process.
FCAVS. We have developed a fuel cell automated verification station based
on our FCATS platform which we market under the trade name FCAVS. We believe
that FCAVS will meet the demand for a single-point testing station required to
verify fuel cell power generators for inspection as a part of the manufacturing
process. We launched our FCAVS series in the first quarter of 2000.
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OUR PRODUCTS IN DEVELOPMENT
The following tables set forth our products in development and describes
their respective applications, target markets and development status:
BALANCE OF PLANT COMPONENTS AND SUBSYSTEMS
<TABLE>
<CAPTION>
PRODUCT APPLICATION TARGET MARKET STATUS
<S> <C> <C> <C>
-------------------------------------------------------------------------------------------------
Balance of Plant Control and operation of PEM fuel Transportation, - In development
Components and cell systems Stationary,
Subsystems Portable
</TABLE>
FUEL CELL SYSTEMS FOR REMOTE LOCATIONS
<TABLE>
<CAPTION>
PRODUCT APPLICATION TARGET MARKET STATUS
<S> <C> <C> <C>
-------------------------------------------------------------------------------------------------
HyTEF Automated remote power source of up Stationary, - In field tests; expect
to 500W where climate conditions Portable to deliver first
may reach -40(degrees)C demonstration units
for use in marketing
to customers in second
half of 2000
- Currently designing
for multi-kW power
outputs for larger
range of applications
-------------------------------------------------------------------------------------------------
2kW portable Premium applications to power Portable - Expect to deliver
power generator portable devices, such as chemical first demonstration
agent detectors and remote power units for use in
applications marketing to customers
in second half of 2000
- Developing future
generations for other
applications
</TABLE>
FUEL CELL SYSTEMS FOR BROAD COMMERCIAL MARKETS
<TABLE>
<CAPTION>
PRODUCT APPLICATION TARGET MARKET STATUS
<S> <C> <C> <C>
-------------------------------------------------------------------------------------------------
Fuel Cell Systems - Fuel cell systems for utility Transportation, - In development
vehicles such as underground Stationary,
mining vehicles and forklift Portable
trucks
- Fuel cell systems for commercial
markets, including primary power
generators for buildings,
factories, hospitals and backup
power generators for computers,
Internet service providers,
communications networks and
commercial facilities
- Fuel cell systems for portable
power generation, scientific and
environmental monitoring, remote
and extreme weather power
generation, control
instrumentation at remote sites,
auxiliary power and other
specialty applications
- Portable electronic devices
- Regenerative fuel cell systems
for the applications described
above
</TABLE>
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Balance of Plant Components and Subsystems
The components and subsystems of our test stations evaluate fuel cell
design and optimize performance by simulating, monitoring and controlling key
parameters such as power load, temperature, pressure, humidification and
potential contaminants in the system. These components and subsystems also
provide balance of plant to a fuel cell system. We are currently applying our
balance of plant expertise and operational experience to develop fuel cell
systems. We believe that our balance of plant components and subsystems will
have broad market applications in all of our target markets, as they are
integrated into the control and operation of fuel cell systems.
Fuel Cell Systems For Remote Locations
Extreme Weather Applications. Our HyTEF system, which we began developing
in 1996, is a PEM fuel cell generator and incorporates a fuel cell system
designed to generate 50W and to operate between -40(degrees)C to +40(degrees)C,
from 0% to 100% relative humidity, and from 0 meters to 10,000 meters elevation.
To achieve these operating results, the system combines a fuel cell, a burner
which can be used for the delivery of hydrogen and the co-generation of heat, a
controller and other components to maintain performance under all operating
conditions.
We have also developed a line of power generators for remote location
applications which emphasize efficiency over reliability in all operating
conditions. We are currently commencing the manufacture of pre-commercial units
under the HyTEF name. We are extending our range of outputs up to 10kW in this
product line.
We believe that our technology for remote locations can be applied to power
sources for various commercial applications such as road and highway controls,
refrigeration, remote cellular towers, remote lighting applications, remote data
collection, remote cameras and solar panel replacement.
2kW Portable Power Generator. We are developing, with support from Natural
Resources Canada and the Canadian Department of National Defence, a 2kW portable
fuel cell system that powers a device for detecting chemical and biological
agents. We expect to deliver our first prototype unit in the second half of
2000. We believe that this system will have other commercial and military
applications, such as man-portable battery chargers, powering of remote sensors,
communication equipment, micro-cogeneration, micro-climate conditioning, robots,
automated vehicles, navigation, personal electronics, weapon subsystems, silent
watch and disseminated hydrogen production.
Fuel Cell Systems for Broad Commercial Markets
Fuel Cell Systems. We are developing integrated fuel cell systems for
broad commercial markets. We are currently expanding the kilowatt range of our
proprietary pre-commercial fuel cell systems such that they can be used in
stationary products, particularly to address power quality demands. We believe
that we will be able to develop our current systems to eventually reach a 3kW to
30kW power range for these products.
We have identified the mining industry as an early, commercially-viable
adopter of fuel cell technology. We are a member of the Fuel Cell Propulsion
Institute and are contributing our expertise to the integration of a 14kW fuel
cell system into an underground mining locomotive. This Institute is planning
two additional demonstration projects in larger kilowatt ranges and it is our
intention to expand our involvement in these projects as they proceed.
Regenerative Fuel Cell Systems. We are developing a regenerative fuel cell
system, which can both generate electricity and produce hydrogen fuel from water
and store it for later use. We believe that the system has the potential to
achieve higher kilowatt hours per kilogram than advanced battery systems.
When electricity from an external power source is available, the
regenerative system applies electricity to water to produce both oxygen and
hydrogen to be stored until required. Operating as a fuel cell, the stored
hydrogen and oxygen are consumed at the surfaces of the regenerative fuel cell
to generate
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<PAGE> 42
electricity. We are currently in the development phase of a 500W regenerative
fuel cell system and are in the research and development phases of a 10kW
regenerative fuel cell system.
Our regenerative fuel cell systems will be designed to enable our customers
to invest in a single system that can be applied to both refueling and
electricity generation. We believe the single system characteristic to have
significant economic benefits in markets where electricity costs can vary widely
and where electricity can be generated from renewable sources such as solar and
wind energy. Where electricity can be generated from renewable sources, a
regenerative fuel cell system creates a sustainable energy solution.
We believe that our regenerative fuel cell technology will have
applications in each of the transportation, stationary and portable markets.
Compact Fuel Cell System. We are developing a compact fuel cell system
designed to provide portable fuel cell power. We expect that this compact fuel
cell will enjoy substantial advantages over conventional batteries, such as
higher reliability, longer life, lower life-cycle cost, continuous operation as
long as fuel and oxidant supplies are provided, reduced maintenance, more
reliable monitoring and no environmental pollution. In the long term, this
compact fuel cell could potentially be used for powering personal electronic
devices such as laptop computers and cameras.
Other Products and Services
In addition to our products described above, we design and manufacture
stand-alone PEM fuel cell stacks that can be integrated into other fuel cell
developers' systems. We also design and manufacture catalytic burners, a key
component of our extreme weather power products, that can be used for clean,
cost-effective and efficient delivery of hydrogen and the co-generation of heat.
39
<PAGE> 43
OUR MILESTONES
The following tables illustrate the major milestones which we have achieved
since 1996 relating to our products in each of the transportation, stationary
and portable power markets:
Transportation Market
<TABLE>
<CAPTION>
DATE MILESTONE
<S> <C>
------------------------------------------------------------------
1996 Initiated FCATS research and development contract with the
Canadian federal government
------------------------------------------------------------
Sold first FCATS to a U.S. aerospace manufacturer in
connection with a NASA-sponsored project
------------------------------------------------------------------
1997 Developed and sold four 5kW FCATS to U.S., Canadian and
European research institutions
------------------------------------------------------------------
1998 Sales of FCATS to commercial fuel cell manufacturers
------------------------------------------------------------------
1999 First repeat sale of a FCATS
------------------------------------------------------------------
2000 First sale of a FCATS to a major U.S. auto manufacturer
------------------------------------------------------------
Initiated research and development for a multi-kW stack
</TABLE>
Stationary Market
<TABLE>
<CAPTION>
DATE MILESTONE
<S> <C>
------------------------------------------------------------------
1996 Initiated a fuel cell development contract with the Canadian
federal government
------------------------------------------------------------------
1997 Demonstrated our first 1kW fuel cell operable without forced
air circulation
------------------------------------------------------------------
1998 Demonstrated our first PEM technology to convert water into
hydrogen
------------------------------------------------------------------
1999 Demonstrated our first regenerative fuel cell prototype
technology
------------------------------------------------------------------
2000 Received funding from the Canadian federal government for
development of our regenerative fuel cell technology
------------------------------------------------------------
Developed a multi-kW fuel cell stack for distributed power
</TABLE>
Portable Market
<TABLE>
<CAPTION>
DATE MILESTONE
<S> <C>
------------------------------------------------------------------
1996 Initiated the development of an extreme cold-weather fuel
cell system under sponsorship of the Canadian federal
government
------------------------------------------------------------------
1997 Demonstrated a fuel cell system designed to operate
continuously at a temperature of -40(degrees)C
------------------------------------------------------------------
1998 Secured U.S. and Canadian patents for our extreme
cold-weather fuel cell system. Initiated 2kW field
deployable fuel cell generator contract with the Canadian
federal government
------------------------------------------------------------------
1999 Developed a compact portable fuel cell product with
integrated heat transfer channels
------------------------------------------------------------
Received pre-commercial orders for two of our extreme
weather premium power fuel cell systems
------------------------------------------------------------------
2000 Delivered an integrated 2kW fuel cell generator with
low-pressure metal hydride fuel storage capabilities
------------------------------------------------------------
Received funding from the Canadian federal government for
the development of a chemical hydride reactor
</TABLE>
HOW FUEL CELLS WORK
The core of a fuel cell consists of two electrodes, the anode and cathode,
separated by a solid polymer membrane electrolyte, which, in the case of our
fuel cells, is a proton-exchange membrane known in our
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<PAGE> 44
industry as a PEM. Each of the electrodes is coated on one side with a thin
catalyst layer. Hydrogen fuel separates into free electrons and protons in the
presence of the catalyst at the anode. The free electrons are conducted in the
form of usable electric current though an external circuit. The protons migrate
through the PEM to the cathode. At the cathode, oxygen from air, electrons from
the circuit and protons combine to form water and heat. To obtain the desired
amount of electrical power, individual fuel cells are combined into a fuel cell
stack. Increasing the number of cells in the stack increases the voltage while
increasing the surface area of the cells increases the current. A diagram of a
fuel cell is shown below:
[Fuel Cell Graphic]
To generate usable electrical power, a complete fuel cell power system,
like a complete automobile engine or power generator, requires a fuel supply
subsystem, an air supply subsystem, a cooling subsystem and a control subsystem.
In addition, a fuel cell system may require an inverter and a power conditioner
to convert the direct current produced by the fuel cell into the alternating
current required by some electrical equipment and transmission systems.
RESEARCH AND DEVELOPMENT
We are targeting our research and development efforts to integrate fuel
cells into specific commercial applications while enhancing the performance and
life span of fuel cell systems. Developmental research in the areas of hydrogen
generation and regenerative fuel cell systems is also a focus of our research
and development program. We also undertake projects with our customers for
developing prototype and pre-commercial products.
MANUFACTURING AND FACILITIES
We manufacture our products at our registered and head office at 5985
McLaughlin Road, Mississauga, Ontario, Canada L5R 1B8. This facility is
approximately 95,000 square feet. We moved to this facility in October 2000, and
our lease for this facility expires in August 2005. Our main activities at this
facility involve the manufacture of our test station products and research and
development of our fuel cell products.
On occasion, we outsource some of the manufacturing that we require to
local operators who produce prototype components to our specifications. We also
outsource to third party manufacturers the production of components, for
example, steel frames and enclosures used in FCATS production. We believe that
this practice allows us to manage our capital costs and to focus on our core
business.
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<PAGE> 45
We also continue to maintain our former registered and head office of
approximately 13,600 square feet at 100 Caster Avenue, Woodbridge, Ontario,
Canada L4L 5Y9. Our lease for this facility expires in July 2002.
SALES & MARKETING
Our first commercial product was our FCATS fuel cell test station. FCATS
are marketed and sold by our direct sales and marketing staff to advanced fuel
cell developers such as automotive companies, fuel cell component developers and
research institutions. Our marketing efforts are global in scope and we have
current plans to establish sales and service offices in strategic locations
around the world. We recently hired a sales representative who is based in Tokyo
and who will cover Japan and other parts of Asia. The sales force is currently
organized by customer account for our test station line of products, and by
product line for our fuel cell system products. We currently plan to expand our
sales staff to cover our growing markets.
Our sales and marketing strategies for our three principal markets are as
follows:
Transportation Market. To date, our sales efforts with our principal
customer in the transportation market, General Motors Corporation, have focused
on supplying automotive fuel cell test stations. Fuel cell test stations
delivered range from 2kW to 85kW, and include most aspects of the balance of
plant required to control and operate large fuel cell stacks. We intend to
develop fuel cell systems for emerging power applications in this market, such
as underground mining vehicles and forklift trucks.
Over the longer term, we hope to build sales in the automotive fuel cell
market with automotive original equipment manufacturers, or OEMs, who are
actively expanding their own market opportunities through the adoption of fuel
cell technology. We intend to seek opportunities to manufacture fuel cell
subsystems for direct sale to or for distribution through OEMs, to license
designs to automotive manufacturers and to participate in the retooling of
machinery for the production of vehicles which use fuel cell technology.
Stationary Market. We intend to focus our sales and marketing efforts in
the stationary power market on the sale of our industrial-grade test stations
and fuel cell systems that can be applied directly to the stationary power
market. We believe that as we improve the efficiencies of our systems and
production costs decrease, an increase in the demand for clean, high quality
uninterruptible electric power will lead to broader market opportunities for our
products.
We also intend to develop strategic distribution partnerships in the
distributed power generation market to distribute our stationary power products.
We do not intend to market our stationary power products directly to end users,
except for military and power applications for remote locations. Targeted
strategic distribution partners include electric and gas utilities, energy
merchants, propane companies, independent heating, ventilation and
air-conditioning dealers/contractors, as well as energy service providers and
distributors of reciprocating engines and microturbines.
Portable Market. Our primary near-term customer for portable fuel cell
systems will continue to be the Canadian Department of National Defence.
However, we believe that there is an expanding market for portable power
generation for applications such as scientific and environmental monitoring,
remote and extreme weather power generation, control instrumentation at remote
sites, auxiliary power and other specialty applications. Portable power
generators also can fulfill back-up power requirements, especially as high power
demands on the power grid cause an increase in random electrical black-outs and
brown-outs. We believe that fuel cell systems can be marketed by highlighting
the significant advantages such systems enjoy over existing technologies for
these applications. Our intention is to establish non-exclusive supplier
relationships with large volume major retailers and with existing OEMs who wish
to expand into a fuel cell line. In either case, our current intentions are to
supply fuel cell systems to these customers to be built into an end product. As
we develop portable fuel cell systems and as our manufacturing costs decline,
our long-term objectives are to form non-exclusive strategic relationships or
joint ventures with leading industry partners.
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<PAGE> 46
In the long term, as manufacturing costs decline, we also hope to enter the
area of sub-kW electronic devices, such as cell phones and laptop computers. Our
marketing goal will be to promote the longevity of the fuel cell system and its
ease of recharging, compared to the capabilities of battery technology. Our
objectives are to form non-exclusive relationships or joint ventures with
leading industry partners.
INTELLECTUAL PROPERTY
We believe that an active policy of protecting intellectual property is an
important component of our strategy of becoming a technology leader in PEM fuel
cell test stations and systems and subsystems. We have recently initiated a
comprehensive program to review our inventions in order to protect our key
intellectual property through a variety of methods.
We rely on a combination of patent, copyright, trademark, trade secret and
contract laws, as well as international treaties, to protect our proprietary
rights to our intellectual property which includes technical know-how, designs,
special materials, manufacturing techniques, test equipment and procedures for
fuel cells, fuel cell components, and fuel cell systems. We have recently
initiated a comprehensive invention disclosure program under which our employees
prepare and submit invention reports for review and evaluation. Most of our
products have been delivered to customers pursuant to confidentiality
agreements, which restrict the recipient from opening or reverse engineering
such products.
Our strategy is to develop and secure intellectual property in areas of
underdeveloped technologies within our core business or areas not widely pursued
by our competitors, in which a cohesive block of patents can be secured as an
important competitive advantage. This strategy has led us to focus on the
development of fuel cell stacks functioning with unpressurized air, no or
limited humidification, no fuel conditioning and simple cooling techniques.
We currently have been granted patents on our HyTEF technology in the
United States and Canada. Corresponding applications have been filed in Europe
covering seven of the European Union nations, and in Iceland, Japan, Norway,
Russia and Chile. More recently, six new patent applications have been filed in
Canada and the United States, primarily directed to water management aspects of
fuel cell operation. Other patent applications are in preparation. Subject to
the payment of maintenance fees, our U.S. and Canadian patents relating to our
HyTEF technology will expire in 2016 and 2017, respectively.
TECHNOLOGY DEVELOPMENT FUNDING ARRANGEMENTS
We typically retain sole ownership of the intellectual property we develop.
However, we have agreed to pay royalties to some of our funding partners as
follows:
Natural Resources Canada and Canadian Department of National
Defence. Since 1996, we have entered into a number of agreements with Natural
Resources Canada, or NRCan, under which NRCan has provided us with varying
levels of funding to aid in the development of prototype power generators and
PEM fuel cell systems. Under each agreement, NRCan receives a royalty equal to
2% of all revenue we receive for the licensing and sale of the intellectual
property related to the particular project. These royalty rights expire upon the
earlier of NRCan recouping the amount of the funding given to us or, in most
cases, 15 years and in one case, 10 years. The aggregate funding amount to be
recouped by NRCan is approximately $641,000. We retain all intellectual property
rights in the projects, provided that we pursue the commercialization of the
intellectual property, subject to a non-exclusive royalty-free licenses granted
to NRCan in perpetuity to use or sublicense the intellectual property rights,
should we decide not to commercialize the technology. One of these agreements
was amended in early 2000 to add the Canadian Department of National Defence as
a contributor of funds.
National Research Council Canada. In 1998, we entered into an agreement
with the National Research Council Canada, or the NRC, under which the NRC
agreed to contribute up to approximately $27,000 toward the development of an
advanced modular client/server fuel cell automated test station mainframe and
satellite. The NRC has no right to receive royalties under the agreement. In
1999, we entered into another agreement with the NRC pursuant to which the NRC
agreed to contribute up to
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<PAGE> 47
approximately $329,000 toward the development of fuel cell automated test
stations for residential fuel cells. Under this agreement, from April 1, 2005 to
January 1, 2008, the NRC has the right to receive a quarterly royalty of 1.3% of
our gross revenue, up to a total of approximately $494,500. If the NRC's
contribution to the project is not recouped by 2008, we will be obligated to pay
royalties until the earlier of full repayment or April 1, 2015.
Universite du Quebec a Trois-Rivieres. In 1996, we entered into an
agreement with the Universite du Quebec a Trois-Rivieres, or UQTR, pursuant to
which we contributed approximately $21,000 to UQTR to aid in the development of
the HyTEF system. Under this agreement, UQTR has a right to receive a royalty of
4% of the total sales generated by the technology developed under that project
until September 2006. We retain rights to all intellectual property developed in
connection with the project. Amounts payable to UQTR are not capped under this
agreement.
COMPETITION
We expect to compete against current conventional technologies, other fuel
cell developers and other alternative power sources in all of our targeted
markets. In the fuel cell industry, we expect to compete in both the fuel cell
system and the fuel cell automated test station areas.
Fuel Cell Automated Test Stations. In the fuel cell automated test station
area, we compete primarily on the basis of product features, performance,
reliability and price. A number of companies currently manufacture fuel cell
automated test stations. These companies include Emprise Corporation,
ElectroChem, Inc. and Lynntech Inc.
In addition to the companies which currently manufacture test stations,
most large fuel cell developers and original equipment manufacturers have some
degree of internal test station development. These companies include Ballard
Power Systems Inc., Plug Power Inc., International Fuel Cells Corporation, H
Power Corporation and Delphi Automotive Systems Corporation.
Fuel Cell Systems. When we begin commercial production of fuel cell
systems and subsystems, we expect to compete with companies who currently have
fuel cell and fuel cell system development programs. Companies involved in fuel
cell development programs include Ballard Power Systems Inc., United
Technologies Corporation, Analytic Power Corporation, DeNora spa, Energy
Partners, Inc., General Motors Corporation, Honda Motor Co. Ltd., H Power Corp.,
International Fuel Cells Corporation, Northwest Power Systems, LLC, Plug Power
Inc., Toshiba Corporation, the Toyota Motor Corporation, Giner, Inc. and Proton
Energy Systems Inc. Companies with programs for fuel cells other than PEM fuel
cells include Fuel Cell Energy Inc., Fuji Electric Co., Ltd., Global
Thermoelectric Inc., Hitachi, Ltd. and International Fuel Cells Corporation.
A number of corporations, national laboratories and universities in the
United States, Canada, Europe, Japan and elsewhere also possess fuel cell
technology. Many of our competitors have financial, technological and personnel
resources far greater than ours and represent significant competition.
GOVERNMENT REGULATION
Currently, the only regulations we encounter are the regulations that are
common to all businesses, such as employment legislation, implied warranty laws,
and environmental, health and safety standards. The principal environmental
legislation regulating our operations is the Ontario Environmental Protection
Act. We maintain a policy of operating our business in compliance with all
government regulations.
It is likely that we will encounter industry-specific government
regulations in the future in many of the jurisdictions in which we operate. It
may become the case that regulatory approvals will be required for the design,
installation and possibly operation of stationary and mobile fuel cell systems.
To the extent that there are delays in gaining regulatory approval, our
development and growth may be constrained. We intend to comply with any
industry-specific regulations governments put in place.
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<PAGE> 48
EMPLOYEES
As of October 20, 2000, we employed 71 persons, all of whom are full-time
employees. Approximately 27 of our employees are professional staff, including
engineers, scientists, and other professionals. Our employees are not
represented by a labor union. We believe that our relationship with our
employees is good.
LEGAL PROCEEDINGS
We are not currently subject to any material legal proceedings; however, we
may from time to time become a party to various legal proceedings arising in the
ordinary course of business.
CORPORATE HISTORY
We were incorporated under the Canada Business Corporations Act on August
1, 1988 as Traduction Militech Translation Inc. Initially, Traduction Militech
Translation Inc. was engaged in providing translation services. By articles of
amendment dated August 20, 1990, we changed our name to Societe Hydrogenique
Incorporee -- Hydrogenics Corporation Incorporated. From 1990 to August 1995,
Societe Hydrogenique Incorporee -- Hydrogenics Corporation Incorporated did not
actively carry on business. In August 1995, we commenced our fuel cell
technology development business. By articles of amendment dated December 11,
1995, we changed the location of our registered office and added restrictions to
our articles concerning subscription for shares by the public. By articles of
amendment dated December 21, 1998, we changed our authorized capital by creating
a class of preferred shares. We also divided our 300 common shares then
outstanding into 3,000,000 common shares. By articles of amendment dated January
21, 2000, we changed the location of our registered office and created a new
class of preferred shares issuable in series. Pursuant to the same amendment, we
re-designated the original class of preferred shares as Series A preferred
shares, converted the 750,000 preferred shares of the original class into
750,000 Series A preferred shares, changed the rights and conditions attaching
to such shares, and created a new series of preferred shares, the Series B
preferred shares. We also consolidated our 3,000,000 common shares then
outstanding into 2,812,500 common shares. By articles of amendment dated January
24, 2000, we changed our name to Hydrogenics Corporation -- Corporation
Hydrogenique. By articles of amendment dated September 29, 2000, we effected a
seven-for-one share split of our common shares and deleted the restrictions in
our articles concerning transfer and subscription for shares by the public. We
have no subsidiaries.
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<PAGE> 49
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information with respect to our executive
officers and directors as of the date of this prospectus:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Pierre Rivard........................ 44 President, Chief Executive Officer and Director
Norman M. Seagram.................... 66 Chairman of the Board of Directors
Boyd J. Taylor....................... 40 Vice President Sales and Marketing and Director
Joseph Cargnelli..................... 31 Vice President Technology and Director
Robert Edwards....................... 42 Vice President Finance, Treasurer and Secretary
Dr. Ravi B. Gopal.................... 39 Vice President Engineering, Electronics and Controls
Don J. Morrison...................... 40 Director
Donald J. Lowry...................... 48 Director
Dr. Robert Lee....................... 76 Director
Charley Pappas....................... 43 Vice President of Operations
</TABLE>
PIERRE RIVARD is one of our founders and has served as our President and a
director since the inception of our fuel cell related business in August 1995.
Mr. Rivard has served as our Chief Executive Officer since July 2000. From June
1994 to July 1995, Mr. Rivard served as a research engineer at the University of
Toronto with the Department of Mechanical Engineering. Mr. Rivard earned a
Master's degree in Mechanical Engineering from the University of Toronto, a
Master's degree in Business Administration from the University of Western
Ontario, and a Bachelor's degree in Mechanical Engineering from the Royal
Military College of Canada. Mr. Rivard resides in Toronto, Ontario.
NORMAN M. SEAGRAM was elected Chairman of our board of directors in July
2000. From September 1996 to May 1997, Mr. Seagram was President and Chief
Executive Officer of Molson Inc., a brewery and entertainment company. From
October 1992 to August 1996, Mr. Seagram was Chairman and Chief Executive
Officer of Air Liquide Canada, Inc., a producer of industrial gases. Mr. Seagram
is currently Vice-Chairman of Tennis Canada and serves as a director on the
boards of VitalAire Company, the AR Plus Group, the Toronto Symphony Orchestra,
Trinity College School and the Canadian Foundation of International Management.
Mr. Seagram also serves on the International Advisory Council of INSEAD, France,
and on the advisory boards of Exclamation International Inc., the Business Fund
for Canadian Studies in the United States, and the Faculty of Applied Science
and Engineering, University of Toronto. Mr. Seagram resides in Toronto, Ontario.
BOYD J. TAYLOR is one of our founders and has served as a director since
January 1996. Mr. Taylor served as our Secretary from January 1996 until July
1999 and was appointed as our Vice President Sales and Marketing in July 2000.
From January 1993 to September 1995, Mr. Taylor was Manager of Sales and
Marketing of Aquatic Telemetry Systems at Lotek Engineering Inc., a manufacturer
of terrestrial and aquatic telemetry systems. Mr. Taylor earned a Bachelor's
degree in Electrical Engineering from Memorial University. Mr. Taylor resides in
Aurora, Ontario.
JOSEPH CARGNELLI is one of our founders and has served as a director since
January 1996. Mr. Cargnelli served as our Treasurer from January 1996 until July
2000. Mr. Cargnelli was appointed as our Vice President Technology in July 2000.
Mr. Cargnelli earned both a Master of Applied Science degree in Mechanical
Engineering and a Bachelor of Applied Science degree in Mechanical Engineering
from the University of Toronto. From April 1992 to April 1993, Mr. Cargnelli
served as a Research Engineer with the Laboratory of Advanced Concepts in Energy
Conversion Inc., a laboratory engaged in the research, development and
demonstration of alkaline fuel cells and hydrogen storage methods. Mr. Cargnelli
resides in Toronto, Ontario.
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<PAGE> 50
ROBERT EDWARDS joined us in July 1999 as our Vice President Finance. Mr.
Edwards has served as our Secretary since July 1999 and as Treasurer since July
2000. From January 1999 to July 1999, Mr. Edwards served as one of our directors
as a nominee of Working Ventures Canadian Fund Inc. From November 1996 to July
1999, Mr. Edwards was employed by Working Ventures Canadian Fund Inc. as a
Portfolio Manager and Vice President of Investments. Mr. Edwards earned a
Masters degree in Business Administration from the University of Western Ontario
and a Bachelor of Applied Science degree from the University of British
Columbia. Mr. Edwards resides in Oakville, Ontario.
DR. RAVI B. GOPAL joined us in May 1998 and was appointed Vice President of
Engineering, Electronics and Controls in June 1999. Dr. Gopal was employed by
the University of Quebec, Trois-Rivieres as a Post-Doctoral Fellow from October
1991 to May 1994, a Research Associate from June 1994 to May 1998 and as a
member of the teaching faculty from January to May 1998. Dr. Gopal received his
Ph.D. from the Indian Institute of Science. Dr. Gopal resides in Toronto,
Ontario.
DON J. MORRISON joined our board of directors in September 2000. Mr.
Morrison is Vice President of Investments with Working Ventures Canadian Fund
Inc., a Canadian venture capital fund. Prior to joining Working Ventures in July
1995, Mr. Morrison was a principal in the Financial Advisory Services Group of
PricewaterhouseCoopers LLP. Mr. Morrison represents Working Ventures on our
Board of Directors and on a number of private and public companies with a focus
on manufacturing, transportation and technology sectors. Mr. Morrison is a
chartered accountant. Mr. Morrison resides in Toronto, Ontario.
DONALD J. LOWRY joined our board of directors in July 2000. Since February
1998, Mr. Lowry has been President and Chief Executive Officer of EPCOR
Utilities Inc., an essential services utility. From May 1997 to January 1998,
Mr. Lowry served as Chairman of Alta Telecom Inc., a telecommunications company.
From March 1993 to May 1997, Mr. Lowry served as President and Chief Operating
Officer of Telus Communications Inc., a telecommunications company. Mr. Lowry
currently serves as a director on the board of the Canadian Electrical
Association, Sasktel International, Imperial Rubber Co. Ltd., Total Telecom Inc.
and Encore Energy. Mr. Lowry earned both a Master's degree in Business
Administration and a Bachelor of Commerce degree from the University of
Manitoba. Mr. Lowry resides in Edmonton, Alberta.
DR. ROBERT LEE joined our board of directors in January 1999 and served as
Chairman until July 2000. Prior to January 1999, Dr. Lee was a member of our
Advisory Board. Dr. Lee has worked for Air Liquide Canada since 1947. Since
1990, Dr. Lee has been an independent technical advisor to Air Liquide Canada
and several of its subsidiaries, as well as to various other institutions,
including the University of British Columbia-Center for Metallurgical Processing
and the American Iron and Steel Institute/Department of Energy. Since 1985, Dr.
Lee has served as a director and the Vice President of Technology of Q.S. Oxygen
Process Inc. Dr. Lee has been involved in the development of more than 25
inventions, securing over 200 patents. In 1998, Dr. Lee received an honorary
Doctorate of Science from McGill University for innovative contributions to the
metallurgical industry. Dr. Lee resides in Calgary, Alberta.
CHARLEY PAPPAS joined us in April 2000 as our Director of Engineering
Operations and was appointed Vice President of Operations in September 2000.
From October 1992 to April 2000, Mr. Pappas was employed with The Electrolyser
Corporation Limited, a manufacturer of hydrogen generators, where he served as
Senior Design Engineer from 1992 to 1994, and Vice-President of Engineering from
1994 to 1999. From 1991 to 1992, Mr. Pappas was President and Project Manager
with Phalanx Engineering Inc., an engineering consultant to the industrial gas
business. From 1981 to 1991, Mr. Pappas was employed by Union Carbide Canada
Limited in a number of positions. Mr. Pappas resides in Scarborough, Ontario,
and is a Member of the Professional Engineers of Ontario.
COMPOSITION OF THE BOARD OF DIRECTORS
Our board of directors currently consists of seven members, four of whom
are non-management directors. Our articles provide that we may have between
three and nine directors on our board. Each of our directors holds office until
the next annual meeting of shareholders and until the director's successor is
elected and qualified, or until the director's earlier death, resignation or
removal.
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<PAGE> 51
COMMITTEES OF THE BOARD OF DIRECTORS
Our board of directors has a Management Development and Compensation
Committee, an Audit Committee and a Nomination and Corporate Governance
Committee.
Management Development and Compensation Committee. The Management
Development and Compensation Committee reviews and makes recommendations to our
board concerning the terms of the compensation packages provided to our
employees, including our executive officers, the terms of any bonus or other
awards provided to our employees, including our executive officers, and makes
recommendations to our board regarding new executive officer appointees. Our
Management Development and Compensation Committee also administers our current
stock option arrangements. See "Stock Options" and "New Stock Option Plan." The
members of our Management Development and Compensation Committee are Norman
Seagram, Donald Lowry and Pierre Rivard.
Audit Committee. The Audit Committee oversees the retention, performance
and compensation of our independent auditors, and oversees and establishes
procedures concerning our systems of internal accounting and auditing control.
The members of our Audit Committee are Norman Seagram, Donald Lowry and Robert
Lee. We may modify the composition of our Audit Committee after the completion
of this offering to ensure compliance with the rules promulgated by the
Securities and Exchange Commission, The Nasdaq Stock Market, Inc. and The
Toronto Stock Exchange.
Nomination and Corporate Governance Committee. The Nomination and
Corporate Governance Committee evaluates and assesses the effectiveness of our
board, our individual directors and our board committees, establishes procedures
for identifying new nominees to the board, recruits and recommends new nominees
to the board and develops and monitors our approach to corporate governance
issues. The members of our Nomination and Corporate Governance Committee are
Norman Seagram, Donald Lowry and Pierre Rivard.
EXECUTIVE COMPENSATION
Summary Compensation
For the year ended December 31, 1999, our aggregate cash compensation
payments to our executive officers and directors for services rendered in these
capacities was approximately $223,000.
The following table sets forth all compensation we paid to our Chief
Executive Officer and our four other most highly compensated executive officers,
to whom we refer hereafter as our senior executive officers, in the years
indicated.
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<PAGE> 52
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------------------ ---------------------
OTHER ANNUAL SECURITIES UNDERLYING
YEAR SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS/SARS (#)
---- ---------- --------- ---------------- ---------------------
<S> <C> <C> <C> <C> <C>
Pierre Rivard.................... 1999 $51,964 -- $ 69 --
President, Chief Executive 1998 $47,946 -- -- --
Officer and Director 1997 $23,413 -- -- --
Boyd J. Taylor................... 1999 $51,964 -- -- --
Vice President Sales 1998 $47,946 -- -- --
and Marketing and Director 1997 $23,413 -- -- --
Joseph Cargnelli................. 1999 $51,964 -- -- --
Vice President of Technology 1998 $47,946 -- -- --
and Director 1997 $23,413 -- -- --
Robert Edwards................... 1999 $21,652(1) -- $ 69 1,394,533
Vice President Finance, 1998 -- -- -- --
Treasurer and Secretary 1997 -- -- -- --
Dr. Ravi B. Gopal................ 1999 $45,483 -- $ 104 --
Vice President Engineering, 1998 $28,407(2) -- $1,386 --
Electronics and Controls 1997 -- -- -- --
</TABLE>
---------------
(1) Mr. Edwards joined us in July 1999.
(2) Dr. Gopal joined us in May 1998.
Option Grants During Fiscal 1999
We granted options under our stock option plan to our senior executive
officers during the year ended December 31, 1999 as follows:
<TABLE>
<CAPTION>
NUMBER OF MARKET VALUE OF
COMMON SHARES % OF TOTAL COMMON SHARES
UNDERLYING OPTIONS/SARS TO UNDERLYING
OPTIONS/SARS EMPLOYEES IN EXERCISE PRICE OPTIONS/SARS ON
NAME GRANTED FISCAL 1999 (%) (CDN.$/SHARE) DATE OF GRANT(1) EXPIRATION DATE
---- ------------- --------------- -------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
Robert Edwards....... 984,375 71 Cdn.$ 0.29 Cdn.$285,469 January 24, 2010
410,158 29 Cdn.$0.046 Cdn.$117,305 January 24, 2010
</TABLE>
---------------
(1) There was no public market for our common shares for the year ended December
31, 1999. Therefore, the amounts set forth in this column represent the fair
market value of each of our common shares on the date of grant, as
determined by our board of directors.
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<PAGE> 53
Options Exercised in Fiscal Year 1999
None of our senior executive officers exercised any options during the year
ended December 31, 1999. The following table sets forth the estimated value as
of December 31, 1999 of the exercisable and unexercisable options held by these
officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING
UNEXERCISED OPTIONS AT VALUE OF UNEXERCISED IN-THE-MONEY
YEAR END (#) OPTIONS AT YEAR END (#)
--------------------------- ----------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- -------------- ----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Robert Edwards............................. 123,046 861,329 Cdn.$ 0 Cdn.$ 0
205,079 205,079 Cdn.$50,039 Cdn.$50,039
</TABLE>
---------------
(1) The value of an "in-the-money" option represents the difference between the
aggregate estimated fair market value of the common shares issuable upon
exercise of the option and the aggregate exercise price of the option. There
was no public market for our common shares as of December 31, 1999.
Therefore, the amounts set forth in this column represent the fair market
value of our common shares as of December 31, 1999, approximately Cdn.$0.29
per share, as determined by our board of directors.
Director, Employee and Consultant Stock Options
As of June 30, 2000, our executive officers, directors, employees and
consultants held options to purchase an aggregate of 3,770,550 of our common
shares. Our executive officers held options to acquire 2,345,000 of these common
shares, exercisable at prices ranging from Cdn.$0.046 to Cdn.$0.29, expiring
January 24, 2010. Our directors who are not executive officers held options to
acquire 117,600 common shares, exercisable at prices ranging from Cdn.$0.29 to
Cdn.$5.07, expiring between January 24, 2010 and June 30, 2010. Our employees,
excluding our executive officers, held options to acquire 1,306,200 common
shares, exercisable at prices ranging from Cdn.$0.29 to Cdn.$5.07, expiring at
dates ranging from January 24, 2010 to October 24, 2010.
In 2000, as of the date of this prospectus, the options granted to
officers, directors and various employees have been at the exercise prices
indicated below:
- on January 24, 2000 we granted (i) Dr. Robert Lee, one of our directors
who was also the Chairman of our Board on the date of the grant, 84,000
options at Cdn.$0.29 and 24,500 options at Cdn.$1.05, (ii) Dr. Ravi Gopal
our Vice President Engineering, Electronics and Controls 420,000 options
at Cdn.$0.29 and 437,500 options at Cdn.$0.05, and (iii) various
employees (other than officers and directors) an aggregate of 437,500
options at Cdn.$0.05, 280,000 options at Cdn.$0.29 and 147,000 options at
Cdn.$1.05;
- on April 19, 2000 we granted various employees (other than officers and
directors) an aggregate of 168,000 options at Cdn.$1.05;
- on June 16, 2000 we granted (i) Charley Pappas our Vice President of
Operations 35,000 options at Cdn.$4.64, and (ii) various other employees
(other than officers and directors) an aggregate of 80,500 options at
Cdn.$1.05, 32,900 options at Cdn.$1.50, 21,000 options at Cdn.$2.11,
10,500 options at Cdn.$2.23, 1,400 options at Cdn.$3.01, 7,000 options at
Cdn.$3.38, 3,500 options at Cdn.$3.80 and 14,000 options at Cdn.$5.07;
- on June 30, 2000 we granted (i) Donald Lowry, one of our directors, 4,200
options at Cdn.$5.00, (ii) Norman Seagram, one of our directors and the
current Chairman of our Board, 4,900 options at Cdn.$5.00, and (iii)
various employees (other than officers and directors) an aggregate of
65,450 options at Cdn.$5.00 and 4,200 options at Cdn.$4.29;
50
<PAGE> 54
- on September 11 we granted various employees (other than officers and
directors) an aggregate of 10,500 options at Cdn.$6.43, 7,000 options at
Cdn.$9.29, 3,150 options at Cdn.$10.00, and 13,650 options at Cdn.$10.71;
and
- on October 6, 2000 we granted various employees (other than officers and
directors) an aggregate of 3,500 options at Cdn.$10.71, 80,500 options at
Cdn.$11.43 and 16,900 options at Cdn.$12.14.
COMPENSATION OF DIRECTORS
We do not currently pay any cash compensation to directors for serving on
our board, but we do reimburse directors for out-of-pocket expenses for
attending board and committee meetings. Two of our non-management directors,
Donald Lowry and Norman Seagram, were granted options to purchase 4,200 and
4,900 of our common shares, respectively, in connection with their agreements to
serve on our board. Dr. Robert Lee, another of our non-management directors, was
granted options to purchase 108,500 of our common shares in connection with his
service as our Chairman from January 1999 to July 2000.
EMPLOYMENT AGREEMENTS AND INSURANCE POLICY
Each of Mr. Rivard, Mr. Taylor and Mr. Cargnelli is currently negotiating
an employment agreement with us.
Mr. Edwards' employment is currently subject to the terms and conditions of
a letter agreement dated July 16, 1999. Under the terms of the letter agreement,
we offered Mr. Edwards an annual salary of $51,964, options to purchase 984,375
common shares at an exercise price of Cdn.$0.29 per share vesting over four
years, and various other customary benefits. Pursuant to the letter agreement,
all of Mr. Edwards' unvested options will immediately vest upon his termination
without cause in connection with a change of control of our company. Pursuant to
a letter agreement dated July 15, 1999, we also offered Mr. Edwards options to
purchase an additional 410,158 common shares at an exercise price of Cdn.$0.046
per share. These additional options have no such automatic accelerated vesting
provisions.
Dr. Gopal's employment is currently subject to the terms and conditions of
a letter agreement dated March 16, 1998. Under the terms of the letter
agreement, we offered Dr. Gopal an annual salary of $51,964, life insurance
coverage and other customary benefits.
We have purchased a key-man employee insurance policy with respect to
Pierre Rivard, Joseph Cargnelli and Boyd J. Taylor, providing coverage of
approximately $350,000 per person.
STOCK OPTIONS
Since 1999, we have granted options to purchase our common shares to
various employees, officers, directors and consultants. We formalized these
grants in January 2000 by entering into stock option agreements with these
individuals. These agreements generally provide that the options have a maximum
term of ten years and vest over four years. In the event that an optionee's
employment is terminated, the vested portion of any grant will remain
exercisable for a period of 60 days after the date of termination. In the event
of the death or incapacity of the optionee, the vested portion of any grant will
remain exercisable for a period of 120 days following the date of death or
incapacity. Unvested options expire upon the termination, death or incapacity of
the optionee. If a change of control of our company occurs, the company through
our board of directors has the power to amend the terms of each option to allow
for the exercise of the unvested portion of each option prior to the completion
of the change of control. Our stock option agreement with Mr. Edwards covering
options to purchase 1,487,500 of our common shares at a weighted average
exercise price of Cdn.$0.22 per share provides that all of Mr. Edwards' then
unvested options subject to such agreement will immediately vest upon his
termination without cause in connection with a change of control of our company.
51
<PAGE> 55
NEW STOCK OPTION PLAN
Our board has approved a new stock option plan to be implemented by our
Management Development and Compensation Committee prior to the completion of
this offering. This plan grants to our board of directors or a committee of our
board the discretion to grant options to purchase common shares to our
employees, directors and consultants. The new plan provides that options will
have a maximum term of ten years, unless a shorter term is specified by our
board, and will have an exercise price per share of not less than the fair
market value of our common shares on the day immediately prior to the date of
grant. Unless otherwise specified in the particular optionee's option agreement,
options granted under the plan will vest over a period of four years with 25% of
the particular option grant vesting each year. Options granted under the plan
may not be transferred or assigned by the optionee and upon any such transfer or
assignment or attempted transfer or assignment, such options will terminate and
be of no further force and effect. The total number of options approved for
issuance under the new plan and all other established or proposed share
compensation arrangements is 4,641,000.
If an optionee's employment or term as a director or consultant with us is
terminated without cause or the optionee voluntarily resigns, any vested options
then held by the optionee may be exercised by the optionee for a period of 90
days from the applicable date of termination or resignation provided that the
option does not expire prior to the end of the 90 day period. If an optionee's
employment or term as a director or consultant with us is terminated for cause,
all options then held by the optionee, whether vested or unvested, immediately
expire and are cancelled on the applicable termination date. If an optionee that
is an employee, director or consultant dies or becomes disabled or an optionee
that is an employee or director retires, any vested options then held by the
optionee may be exercised for a period of 180 days from the applicable date of
death, disablement or retirement, provided that the option does not expire prior
to the end of the 180 day period.
If there is an amalgamation, combination, merger or other reorganization
involving our company, the plan will allow the board to replace or modify any
issued option in order to preserve proportionately the rights and obligations of
all optionees. The board may also permit the vesting and exercise of any
outstanding unvested option not otherwise exercisable upon the occurrence of
events, for example, a change of control involving our company.
In addition, no one person will be permitted to receive more than 5% of the
common shares reserved for issuance pursuant to options granted under the plan.
DIRECTORS' AND OFFICERS' INDEMNIFICATION
Under the Canada Business Corporations Act and our By-Laws, we are
permitted to indemnify out of our own funds our directors and officers, former
directors and officers and their respective heirs and legal representatives
against costs, charges and expenses, including amounts paid to settle an action
or satisfy a judgment reasonably incurred by them in a civil, criminal or
administrative action or proceeding to which they are made parties because of
their position as our directors or officers, including an action by or on behalf
of us to procure a judgment in our favor. In order to be entitled to
indemnification under this Act and our By-Laws, the director or officer must act
honestly and in good faith with a view to our best interests, and in the case of
a criminal or administrative action or proceeding that is enforced by a monetary
penalty, the director or officer must have reasonable grounds for believing that
his or her conduct was lawful. In addition, in respect of an action by or on
behalf of us to procure a judgment in our favor, a court must approve of the
indemnification.
We have indemnified our directors and their heirs and legal representatives
against all costs, charges and expenses, including amounts paid to settle
actions or satisfy judgments reasonably incurred by them in respect of any
civil, criminal or administrative proceeding to which they are made parties
because of being or having been one of our directors, provided that they acted
honestly and in good faith with a view to our
52
<PAGE> 56
best interests and, in the case of a criminal or administrative proceeding that
is enforced by a monetary penalty, they had reasonable grounds to believe that
their conduct was lawful.
Currently, there is no pending litigation or proceeding where a current or
past director, officer or employee is seeking indemnification, nor are we aware
of any threatened litigation that may result in claims for indemnification. We
have purchased a liability insurance policy covering our directors and officers.
53
<PAGE> 57
CERTAIN TRANSACTIONS
AMENDED AND RESTATED UNANIMOUS SHAREHOLDERS' AGREEMENT
We are a party to an Amended and Restated Unanimous Shareholders' Agreement
with all of our existing shareholders, some of whom are presently officers and
directors of our company. Pursuant to this agreement, the parties agreed to
restrictions and reciprocal rights in connection with sales of their shares in a
number of specified circumstances, including tag-along rights, drag-along rights
and rights of first refusal. In addition, the agreement places restrictions upon
loans to us from shareholders and allows participation by the shareholders in
future debt and equity financings. The agreement was amended in July 2000 to
change the composition of the board of directors and to adjust the composition
of its various committees in preparation for this offering. All shareholders
have consented to the offering and have waived their right to participate in the
offering. This agreement will terminate automatically upon the closing of this
offering. Don J. Morrison, one of our directors, was appointed to our board as a
nominee of Working Ventures Canadian Fund Inc. in accordance with the terms of
this agreement.
RELATIONSHIP BETWEEN CIBC WORLD MARKETS INC. AND CIBC CAPITAL PARTNERS
CIBC Capital Partners, which presently holds preferred shares convertible
into 2,758,000 common shares, representing approximately 9.7% of our common
equity, is a division of a Canadian chartered bank. CIBC World Markets Inc., one
of the underwriters in this offering, is a wholly-owned subsidiary of the same
Canadian chartered bank. Accordingly, CIBC World Markets Inc. may be considered
a related and connected issuer of ours for the purposes of applicable Canadian
securities laws. The decision of CIBC World Markets Inc. to underwrite this
offering was made independently of CIBC Capital Partners. The decision to
distribute our common shares was made by us independently of CIBC Capital
Partners, although the terms of the offering were established through
negotiations between us and the underwriters. CIBC World Markets Inc. will not
receive any benefit from this offering other than its portion of the commissions
payable by us to the underwriters.
RELATED PARTY TRANSACTION
We subcontract some manufacturing in the normal course of our operations to
a company owned by the father and uncle of Joseph Cargnelli, one of our
directors and a principal shareholder. From January 1, 1997 to December 31,
1999, this company billed us a total of $177,734. At December 31, 1999, we had
an accounts payable balance due to this company of $69,430. We believe that the
rates this company has charged us for its services are comparable to rates we
could have obtained from an unrelated third party.
54
<PAGE> 58
PRINCIPAL SHAREHOLDERS
The following table provides information regarding the beneficial ownership
of our common shares as of June 30, 2000, and as adjusted to reflect the sale of
7,000,000 common shares in this offering, as to:
- each person or entity who beneficially owns more than 5% of our
outstanding common shares;
- each of our senior executive officers; and
- all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power with
respect to the securities. Except as otherwise indicated, the persons named in
the table have sole voting and investment power with respect to all common
shares held by them. The number of common shares outstanding used in calculating
the percentage for each listed person includes the common shares underlying
options held by such person that are exercisable within sixty (60) days of June
30, 2000, but excludes common shares underlying options held by any other
person. Percentage ownership is calculated by reference to the 28,532,000 common
shares deemed outstanding as of June 30, 2000, and 7,000,000 additional common
shares to be issued in this offering. All of our shareholders are currently
party to a shareholder's agreement. Upon completion of this offering, the
shareholder's agreement shall terminate in accordance with its terms.
<TABLE>
<CAPTION>
NUMBER OF COMMON NUMBER OF COMMON
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER
THIS OFFERING THIS OFFERING
--------------------- ---------------------
BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
---------------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Pierre Rivard(1)................................. 6,562,500 23% 6,562,500 18.5%
Boyd Taylor...................................... 6,562,500 23 6,562,500 18.5
Joseph Cargnelli................................. 6,562,500 23 6,562,500 18.5
Robert Edwards(2)................................ 481,250 1.7 481,250 1.35
Dr. Ravi B. Gopal(3)............................. 481,250 1.7 481,250 1.35
Micro-Generation Technology Fund, L.L.C.(4)...... 2,758,000 9.7 2,758,000 7.76
Working Ventures Canadian Fund Inc.(5)........... 2,583,000 9.1 2,583,000 7.27
CIBC Capital Partners(6)......................... 2,758,000 9.7 2,758,000 7.76
All directors and executive officers as a group
(9 persons).................................... 20,758,500 72.8 20,758,500 58.4
</TABLE>
---------------
(1) The address of Mr. Rivard and all of the other senior executive officers
listed in this table is Hydrogenics Corporation, 5985 McLaughlin Road,
Mississauga, Ontario, Canada L5R 1B8.
(2) Consists of 481,250 common shares issuable pursuant to presently exercisable
stock options.
(3) Consists of 481,250 common shares issuable pursuant to presently exercisable
stock options.
(4) Consists of 2,758,000 common shares issuable upon the conversion of
outstanding preferred shares, which will occur automatically upon the
completion of this offering. Micro-Generation Technology Fund, L.L.C. is a
private venture capital fund managed on behalf of investors by Arete
Corporation. The address of Micro-Generation Technology Fund, L.L.C. is c/o
Arete Corporation, Manager, P.O. Box 1299, Center Harbor, New Hampshire
03226.
(5) Consists of 2,583,000 common shares issuable upon the conversion of
outstanding preferred shares, which will occur automatically upon the
completion of this offering. Don J. Morrison, one of our directors, was
appointed to our board as a nominee of Working Ventures Canadian Fund Inc.
in accordance with the terms of our shareholders agreement. Working Ventures
Canadian Fund Inc. is a widely held Canadian mutual fund. The address of
Working Ventures Canadian Fund Inc. is 250 Bloor Street East, Suite 1600,
Toronto, Ontario, Canada M4W 1E6.
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<PAGE> 59
(6) Consists of 2,758,000 common shares issuable upon the conversion of
outstanding preferred shares, which will occur automatically upon the
completion of this offering. CIBC Capital Partners is a division of a
Canadian chartered bank and carries on merchant banking operations under
that registered business name. The address of CIBC Capital Partners is BCE
Place, P.O. Box 500, 8th Floor, 161 Bay Street, Toronto, Ontario, Canada M5J
2S8.
56
<PAGE> 60
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED AND ISSUED SHARE CAPITAL
Our authorized capital consists of an unlimited number of common shares and
an unlimited number of preferred shares issuable in series, of which 19,708,500
common shares, 750,000 Series A preferred shares and 510,500 Series B preferred
shares were issued and outstanding as of June 30, 2000. Upon closing of this
offering, all of the issued and outstanding Series A and Series B preferred
shares described above will be automatically converted at a ratio of seven to
one, into an aggregate of 8,823,500 common shares and we will have no preferred
shares outstanding.
Each common share carries one vote on all matters to be voted on by our
shareholders. Holders of common shares are entitled to receive dividends as and
when declared by our board of directors and to share ratably in our remaining
assets available for distribution, after payment of liabilities, upon our
liquidation, dissolution or winding up. Our common shares do not carry
pre-emptive rights or rights of conversion into any other securities. All
outstanding common shares are fully paid and non-assessable, and the common
shares to be issued in this offering will also be fully paid and non-assessable.
There are no limitations on the rights of non-resident or foreign owners of our
common shares to hold or vote their shares.
Our board of directors has the authority, without further action by the
shareholders, to issue an unlimited number of preferred shares in one or more
series and in the event that preferred shares are issued, the board also has the
authority to fix the designations, powers, preferences, privileges and relative,
participating, optional or special rights of any preferred shares including any
qualifications, limitations or restrictions. Special rights which may be granted
to a series of preferred shares may include dividend rights, conversion rights,
voting rights, terms of redemption and liquidation preferences, any or all of
which may be superior to the rights of the common shares. Preferred share
issuances could decrease the market price of the common shares and may adversely
affect the voting and other rights of the holders of common shares. The issuance
of preferred shares could also have the effect of delaying or preventing a
change in control of our company.
Prior to this offering we had 17 shareholders, two of whom reside in the
United States and hold an aggregate of approximately 11.36% of our securities.
SHARE SPLIT
On September 29, 2000, we amended our articles to split all of our
outstanding and reserve common shares on a basis of seven common shares for each
outstanding common share.
PRIOR SALES
In January 2000, we issued 510,500 Series B preferred shares for an
aggregate subscription price of $3.7 million. This was the only transaction
involving the sale of shares in the 12 months prior to the date of this
prospectus, other than in connection with the granting and exercise of stock
options by our officers, directors, and employees.
REGISTRAR AND TRANSFER AGENT
The registrar and transfer agent for our common shares in Canada is CIBC
Mellon Trust Company at its principal offices in Toronto, Ontario, and the
co-transfer agent and co-registrar for our common shares in the United States is
ChaseMellon Shareholders Services, L.L.C. at its offices in New York, New York.
57
<PAGE> 61
SHARES ELIGIBLE FOR FUTURE SALE
The sale of substantial numbers of common shares in the public market, or
the possibility of this sale, could adversely affect prevailing market prices
for our common shares.
Upon completion of the offering based on the information as of June 30,
2000:
- a total of 35,532,000 of our common shares will be outstanding; and
- options to purchase a total of 3,770,550 common shares will be
outstanding.
All of the 7,000,000 common shares sold in the offering in the United
States and Canada will be freely tradable without restriction under either the
Securities Act of 1933 or applicable Canadian securities laws, except by
"affiliates" as defined in Rule 144 under the Securities Act of 1933, or by
"control persons" as defined under applicable Canadian securities laws.
For the reasons given below, and subject to the restrictions set forth
below in "Canadian Resale Restrictions" and "Other Resale Restrictions," we
believe that the following restricted common shares will be eligible for resale
in the public market at the following times:
<TABLE>
<CAPTION>
RESTRICTED SHARES ELIGIBLE FOR SALE IN THE
PUBLIC MARKET
------------------------------------------
<S> <C>
On the date of this prospectus.............................. 0
181 days after the date of this prospectus.................. 3,241,000
12 months after the date of this prospectus, following
applicable hold periods under Canadian securities laws.... 5,603,500
18 months after the date of this prospectus, following
applicable hold periods under Canadian securities laws.... 19,687,500
</TABLE>
Each of our officers and directors and major shareholders have agreed with
Salomon Smith Barney Inc. that they will not offer or sell any of our common
shares for 180 days following the date of this prospectus without the prior
written consent of Salomon Smith Barney Inc., subject to limited exceptions.
CANADIAN RESALE RESTRICTIONS
Excluding any common shares purchased in this offering and including
conversion of Series A and Series B preferred shares, as of June 30, 2000,
Canadian residents held 25,291,000 common shares and options to purchase
3,770,550 common shares. Under applicable Canadian securities laws in effect on
the date of this prospectus, all such previously issued common shares or common
shares issuable upon exercise of previously issued options may not be sold or
otherwise disposed of for value, except pursuant to a prospectus, a
discretionary exemption or a statutory exemption available only in specific
limited circumstances, until we have been a reporting issuer in good standing
for at least 12 months. Sales of our common shares by shareholders that are
control persons, as that term is defined under Canadian securities law, are also
restricted for a period of at least 18 months. We will become a reporting issuer
when we file this prospectus with the applicable Canadian securities regulatory
authorities and when those authorities issue receipts for the prospectus. We
expect that the receipts will be issued on or about the date of this prospectus.
OTHER RESALE RESTRICTIONS
As a result of the lock-up agreements and the provisions of Rule 144 under
the Securities Act of 1933, common shares and common shares issuable upon
exercise of options held by non-Canadian residents will be available for sale in
the public market in the United States, subject in some cases to Rule 144 volume
limitations.
In general, under Rule 144, as in effect on the date of this prospectus,
any person (including an affiliate of ours) who has beneficially owned common
shares for at least one year will be entitled to sell, in
58
<PAGE> 62
any three-month period, a number of shares that (together with common shares
with which the person's shares must be aggregated) does not exceed the greater
of:
- 1% of the then outstanding common shares (approximately 355,320 shares
immediately after the offering); and
- the average weekly trading volume of the common shares on the Nasdaq
National Market during the four calendar weeks immediately preceding the
date on which the sale is made.
Sales of restricted securities under Rule 144 must also satisfy requirements
relating to manner of sale, notice and availability of current public
information about us. Affiliates of ours must also comply with the restrictions
and requirements of Rule 144, other than the one-year holding period
requirement, in order to sell common shares which are not restricted securities.
Upon the closing of this offering, we intend to file a registration
statement for the resale of the common shares that are authorized for issuance
under our stock option plan. We expect this registration statement to become
effective immediately upon filing. Shares issued pursuant to our stock option
plan to U.S. residents after the effective date of that registration statement,
other than shares issued to our affiliates and our employees subject to lock-up
agreements, generally will be freely tradable without restriction or further
registration under the Securities Act of 1933.
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INCOME TAX CONSEQUENCES
Because Canadian and United States tax consequences may differ from one
holder to the next, the discussion set out below does not purport to describe
all of the tax considerations that may be relevant to you and your particular
situation. Accordingly, you are advised to consult your own tax advisor as to
the United States and Canadian federal, provincial, state and other tax
consequences of investing in our common shares. The statements of United States
and Canadian tax law set out below are based on the laws and interpretations in
force as of the date of this prospectus, and are subject to changes occurring
after that date.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS FOR UNITED STATES INVESTORS
In this summary, a "U.S. holder" means a person who, for the purposes of
the Canada-United States Income Tax Convention (1980), is a resident of the
United States and not of Canada and who, for the purposes of the Income Tax Act
(Canada):
- deals at arm's length with us;
- is the beneficial owner of our common shares;
- holds our common shares as capital property;
- does not use or hold and is not deemed to use or hold our common shares
in the course of carrying on a business in Canada; and
- is not an insurer for whom our common shares constitute designated
insurance property.
Our common shares will be capital property to a U.S. holder unless it is
held in the course of carrying on a business or in an adventure in the nature of
trade. This summary does not apply to a U.S. holder that is a "financial
institution" for purposes of the rules contained in the Income Tax Act (Canada).
There are no Canadian federal estate taxes applicable to the purchase or
ownership of our common shares. Under the Income Tax Act (Canada), on death, a
U.S. holder would be deemed to dispose of all of his or her assets, including
our common shares.
This summary is based on the current provisions of the Income Tax Act
(Canada) and the regulations in force under the Income Tax Act (Canada) on the
date of this prospectus, the Convention, current published administrative and
assessing practices of the Canada Customs and Revenue Agency, formerly Revenue
Canada, all specific proposals to amend the Income Tax Act (Canada) and the
regulations announced by the Minister of Finance (Canada) prior to the date of
this prospectus and all judicial decisions currently in effect.
This summary is not exhaustive and, except for the proposed amendments to
the Income Tax Act, does not take into account or anticipate prospective or
retrospective changes in the law or the administrative or assessing practices of
the Canada Customs and Revenue Agency, whether these changes are effected by
judicial, governmental or legislative action or interpretation. This summary
does not take into account tax legislation or considerations of any province or
territory of Canada. None of the tax consequences described herein depend or
rely on any of the proposed amendments to the Income Tax Act passing into law.
Because Canadian tax consequences may differ from one holder to the next, this
summary does not purport to describe all of the tax considerations that may be
relevant to you and your particular situation. In unusual cases, the Canadian
tax treatment to a U.S. holder may differ from the treatment described herein.
You are advised to consult your own tax advisor.
DIVIDENDS
Dividends paid, credited or deemed to have been paid or credited on our
common shares are subject to nonrefundable Canadian withholding tax under the
Income Tax Act at the rate of 25%, although this rate may be reduced by the
provisions of an applicable income tax treaty. Subject to the exceptions noted
immediately below, under the Convention, U.S. holders who beneficially own the
dividends will be subject
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to a 15% withholding tax on the gross amount of such dividends. In the case of a
U.S. holder that is a corporation which beneficially owns at least 10% of our
voting shares, the applicable rate of withholding tax on dividends will be
reduced to 5%. In the case of dividends paid, credited or deemed to be credited
to a U.S. holder that is a tax exempt organization as described in Article XXI
of the Convention, no withholding tax will be payable.
DISPOSITIONS
Under the Income Tax Act, assuming you are a U.S. holder and provided our
common shares are listed on a prescribed stock exchange, which includes the
Toronto Stock Exchange and the Nasdaq National Market, you will be exempt from
Canadian tax on a capital gain realized on an actual or deemed disposition of
the common shares unless you, persons with whom you did not deal at arm's length
or you together with such persons owned or had rights to acquire 25% or more of
our issued shares of any class at any time during the five-year period before
the actual or deemed disposition.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material United States federal income tax
considerations arising from the acquisition, ownership and disposition of our
common shares by a United States holder. A United States holder is:
- an individual citizen or resident of the United States;
- a corporation created or organized in or under the laws of the United
States or any of its political subdivisions; or
- an estate or trust the income of which is subject to United States
federal income taxation regardless of its source.
This summary deals only with common shares that are held as a capital asset
by a United States holder, and does not address tax considerations applicable to
United States holders that may be subject to special tax rules, such as:
- dealers or traders in securities or currencies;
- financial institutions or other United States holders that treat income
in respect of our common shares as financial services income;
- life insurance companies;
- tax-exempt entities;
- United States holders that hold our common shares as a part of a straddle
or conversion transaction or other arrangement involving more than one
position or that hedge against currency risks in respect of our common
shares;
- United States holders that own, or are deemed for United States tax
purposes to own, 10% or more of the total combined voting power of all
classes of our voting shares;
- United States holders that have a principal place of business or "tax
home" outside the United States; or
- United States holders whose "functional currency" is not the United
States dollar.
The discussion below is based upon the provisions of the United States
Internal Revenue Code of 1986, as amended, or Code, and regulations, rulings and
judicial decisions as of the date of this prospectus; any authority may be
repealed, revoked or modified, perhaps with retroactive effect, so as to result
in federal income tax consequences different from those discussed below. The
following discussion describes the general application of the U.S. federal
income tax laws. The discussion does not purport to describe all
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of the tax considerations that may be relevant to you specifically. We advise
you to consult your own tax advisor.
DISTRIBUTIONS
Distributions that we make with respect to our common shares, other than
distributions in liquidation and distributions in redemption of shares that are
treated as exchanges, will be taxed to United States holders as ordinary
dividend income to the extent that the distributions do not exceed the current
and accumulated earnings and profits of the Company, as determined for United
States federal income tax purposes. The amount treated as a dividend will
include any Canadian withholding tax deducted from the distribution.
Distributions, if any, in excess of the current and accumulated earnings and
profits of the Company, as determined for United State federal income tax
purposes, will constitute a nontaxable return of capital to a United States
holder and will be applied against and reduce the United States holder's tax
basis in our common shares. To the extent that these distributions exceed the
tax basis of the United States holder in its shares of our common shares, the
excess will be treated as capital gain.
In the case of distributions in Canadian dollars, the amount of the
distributions will equal the United States dollar value of the Canadian dollars
distributed, determined by reference to the spot currency exchange rate on the
date of receipt of the distribution by the United States holder, and the United
States holder will realize separate foreign currency gain or loss only to the
extent that gain or loss arises as a result of foreign currency fluctuations
from the date the distribution is received (or deemed received) to the date such
distribution is converted into United States dollars. Any foreign currency gain
or loss will be treated as ordinary income or loss.
Dividends that we pay will not be eligible for the dividends-received
deduction allowed to United States corporations under Section 243 of the Code.
SALE OR EXCHANGE
Upon a sale or exchange of our common shares to a person other than
Hydrogenics Corporation, a United States holder will recognize gain or loss in
an amount equal to the difference between the amount realized on the sale or
exchange and the United States holder's adjusted tax basis in the common shares
(determined in U.S. dollars). Any gain or loss recognized will be capital gain
or loss and will be long-term capital gain or loss if the United States holder
has held our common shares for more than one year.
FOREIGN TAX CREDIT
In computing its United States federal income tax liability, a United
States holder may elect for each taxable year to claim a deduction or, subject
to the limitations with respect to foreign tax credits, a credit for foreign
income taxes paid or accrued by it, including any non-United States taxes
withheld from distributions, if any, that we pay on our common shares. For
foreign tax credit purposes, under Section 904(g) of the Internal Revenue Code,
in the event that at least 50 percent of our shares (determined by vote or
value) is owned, directly, indirectly or by attribution, by United States
persons, and subject to the limitations described below, a portion of the
dividends that we pay in each taxable year will be treated as United
States-source income, depending upon the ratio for that taxable year of our
United States-source earnings and profits to our total earnings and profits. The
remaining portion of our dividends will be treated as foreign-source income and
will be treated as passive income, subject to the separate foreign tax credit
limitation for passive income. The application of Section 904(g) is subject to
two limitations. First, if in any taxable year we have earnings and profits, and
less than 10 percent of those earnings and profits are from United States
sources, then dividends that we pay from our earnings and profits for that year
will be treated entirely as foreign-source income. Second, because dividends
that we pay are treated entirely as foreign-source income under the Convention,
a United States holder that qualifies for the benefits of the Convention may
elect to have the portion of those dividends that would be treated as United
States-source income under Section 904(g) instead treated as foreign-source
income that is subject to a separate foreign tax credit limitation.
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Gain or loss realized by a United States holder on the sale or exchange of
our common shares will be treated as United States source gain or loss for
United States foreign tax credit purposes.
If we were to be a passive foreign investment company (see "-- Passive
Foreign Investment Companies" below), special rules would apply to the
calculation of foreign tax credits.
BACKUP WITHHOLDING TAX
Backup withholding tax at a rate of 31% may apply to payments of dividends
and to payments of proceeds of the sale or other disposition of our common
shares within the United States by a non-corporate United States holder, if the
holder fails to furnish a correct taxpayer identification number or otherwise
fails to comply with applicable requirements of the backup withholding tax
rules. Backup withholding tax is not an additional tax and may be credited
against a United States holder's United States federal income tax liability,
provided that correct information is provided to the Internal Revenue Service.
PASSIVE FOREIGN INVESTMENT COMPANIES
In general, a foreign corporation is a passive foreign investment company
for any taxable year in which (i) 75% or more of its gross income consists of
passive income (such as dividends, interest, rents and royalties, other than
rents and royalties derived in the active conduct of a trade or business) or
(ii) 50% or more of the average of the quarterly values of its assets consists
of assets that produce, or are held for the production of, passive income. We
will determine the fair market value of our assets based on the market price of
our common shares, less total liabilities. As a result, fluctuations in the
market price of our common shares would affect the determination of whether we
would be considered a passive foreign investment company.
Based on our current and projected income, and our estimates as to the
market value of our assets as determined by reference to the expected market
value of our common shares when issued, we do not expect to be considered to be
a passive foreign investment company. However, because the determination of
whether we are a passive foreign investment company is based on the composition
of our income and assets from time to time and because the market price of our
shares is likely to fluctuate after the offering, there can be no assurance that
we will not be considered a passive foreign investment company for any fiscal
year. If we are a passive foreign investment company at any time that you own
common shares, you will likely be subject to the rules described below, even if
we subsequently cease to be a passive foreign investment company. United States
holders will be responsible for determining whether we are a passive foreign
investment company each year for purposes of applying the rules described below.
Except as described below, if we are considered to be a passive foreign
investment company, the following special rules will apply to:
- any gain realized on the sale or other disposition (including a pledge as
security for a loan) of our common shares, and
- any "excess distribution" on the common shares, that is any distribution
received by you on the common shares in a taxable year other than the
first year in which you hold the common shares that are greater than 125%
of the average annual distributions received by you in the preceding
three taxable years, or, if shorter, your holding period for the common
shares).
Under these rules:
- the gain or excess distribution would be allocated ratably over your
holding period for the common shares;
- the amount allocated to the current taxable year and to taxable years
before the first day in which we became a passive foreign investment
company would be taxed as ordinary income; and
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- the amount allocated to each of the prior taxable years in which we were
a passive foreign investment company would be subject to tax at the
highest rate of tax in effect for a corporate or individual taxpayer, as
applicable, that year, and an interest charge for the deemed deferral
benefit would be imposed on the resulting tax attributable to such prior
year.
Alternatively, as long as the common shares are regularly traded on the
Nasdaq National Market (or another qualifying market), you will be able to make
an election with respect to the common shares upon acquisition of the common
shares to include in income as ordinary income each year the excess of the fair
market value of the common shares over your adjusted basis in the common shares,
and you will be entitled to deduct as an ordinary loss each year the lesser of
(a) the excess of your original or, if applicable, adjusted basis in the common
shares over their fair market value, and (b) the excess of the total amount of
income included in prior years over the total amount of deductions allowed in
prior years under these rules. Your adjusted basis in the common shares will be
increased by the amount of any income inclusions and will be decreased by the
amount of any deductions. If you dispose of the common shares for an amount in
excess of your adjusted basis, the gain will be taxed at ordinary income tax
rates.
A U.S. investor who owns common shares during any year that we are a
passive foreign investment company must file Internal Revenue Service Form 8621,
describing any distributions received from the ownership of common shares and
any gain realized on the sale or other disposition of common shares.
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UNDERWRITING
Subject to the terms and conditions stated in the underwriting agreement
dated the date hereof, each underwriter named below has severally agreed to
purchase, and we have agreed to sell to each underwriter, the number of common
shares set forth opposite the name of that underwriter.
<TABLE>
<CAPTION>
NUMBER OF SHARES
----------------
<S> <C>
Salomon Smith Barney Inc.................................... 3,500,000
CIBC World Markets Inc...................................... 2,100,000
BMO Nesbitt Burns Inc....................................... 1,400,000
----------
Total............................................. 7,000,000
==========
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase the shares included in this offering are subject to
approval of particular legal matters by the underwriters' counsel and to other
conditions. The obligations of the underwriters under the underwriting agreement
are several and may be terminated at their discretion on the basis of their
assessment of the state of the financial markets and upon the occurrence of
other stated events. The underwriters are obligated to purchase all of the
common shares, other than those covered by their over-allotment option described
below, if they purchase any of the common shares.
This offering is being made concurrently in the United States and in all of
the provinces of Canada. Subject to applicable law, the underwriters may also
offer the common shares outside of the United States and Canada. Broker-dealer
affiliates of the underwriters named above may sell common shares in the United
States, Canada or elsewhere, as the case may be, in each case pursuant to
applicable law.
Neither BMO Nesbitt Burns Inc. nor CIBC World Markets Inc. is registered
with the Securities and Exchange Commission. Accordingly, these members of the
underwriting syndicate will only make offers or sales of the common shares in
the United States through their respective affiliates, BMO Nesbitt Burns
Corporation Limited and CIBC World Markets Corp., each of which is registered
with the Securities and Exchange Commission.
The underwriters, for whom Salomon Smith Barney Inc., CIBC World Markets
Inc. and BMO Nesbitt Burns Inc. are acting as representatives, propose to offer
some of the common shares directly to the public at the public offering price
set forth on the cover page of this prospectus and some of the common shares to
particular dealers at the public offering price less a concession not in excess
of $0.50 per common share. The underwriters may allow, and such dealers may
reallow, a concession not in excess of $0.10 per common share on sales to other
dealers. If all of the common shares are not sold at the initial offering price,
the underwriters may change the public offering price and other selling terms.
The representatives have advised us that the underwriters do not intend to
confirm any sales to any accounts over which they exercise discretionary
authority.
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to 1,050,000 additional common
shares at the public offering price less the underwriting commission. The
underwriters may exercise this option solely for the purpose of covering
over-allotments, if any, in connection with this offering. To the extent this
option is exercised, each underwriter will be obligated, subject to some
conditions, to purchase a number of additional common shares approximately
proportionate to that underwriter's initial purchase commitment.
We and our officers, directors and major shareholders have agreed that, for
a period of 180 days from the date of this prospectus, we will not, without the
prior written consent of Salomon Smith Barney Inc., dispose of or hedge any
shares of our common shares or any securities convertible into, or exercisable
or exchangeable for, our common shares. Salomon Smith Barney Inc., in its sole
discretion, may release any of the securities subject to these lock-up
agreements at any time without notice.
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Prior to this offering, there has been no public market for our common
shares. Consequently, the initial public offering price for the common shares
was determined by negotiation among us and the representatives. Among the
factors considered in determining the initial public offering price were:
- our record of operations;
- our current financial conditions;
- our future prospects;
- our markets;
- the economic conditions in and future prospects for the industry in which
we operate;
- our management; and
- currently prevailing general conditions in the equity securities markets,
including current market valuations of publicly traded companies
considered comparable to us.
The prices at which common shares will sell in the public market after this
offering may, however, be lower than the price at which they are sold by the
underwriters. Additionally, an active trading market in our common shares may
not develop and continue after this offering.
Our common shares have been approved for quotation on the Nasdaq National
Market under the symbol "HYGS" and have been conditionally approved for listing
on The Toronto Stock Exchange under the symbol "HYG."
The following table shows the underwriting commissions that we will pay to
the underwriters in connection with this offering. These amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional common shares.
<TABLE>
<CAPTION>
NO EXERCISE FULL EXERCISE
----------- -------------
<S> <C> <C>
Per Common Share.................................... $ 0.84 $ 0.84
Total............................................... $5,880,000 $6,762,000
</TABLE>
At our request, the underwriters will reserve up to 5 percent of the common
shares to be sold, at the initial public offering price, to our directors,
officers and employees, and other persons having business relationships with us.
This directed share program will be administered by Salomon Smith Barney Inc. in
the United States and by CIBC World Markets Inc. in Canada. The number of common
shares available for sale to the general public will be reduced to the extent
that these individuals purchase any such common shares reserved for issuance
under the directed share program. Any reserved common shares that are not
purchased through this directed share program will be offered by the
underwriters to the general public on the same basis as the other common shares
offered by this prospectus. We have agreed to indemnify the underwriters against
liabilities and expenses, including liabilities under the Securities Act of
1933, in connection with the sales of the reserved shares.
In connection with this offering, Salomon Smith Barney Inc., on behalf of
the underwriters, may purchase and sell our common shares in the open market.
These transactions may include short sales, syndicate covering transactions and
stabilizing transactions. Short sales involve syndicate sales of common stock in
excess of the number of shares to be purchased by the underwriters in the
offering, which creates a syndicate short position. "Covered" short sales are
sales of shares made in an amount up to the number of shares represented by the
underwriters' over-allotment option. In determining the source of shares to
close out the covered syndicate short position, the underwriters will consider,
among other things, the price of shares available for purchase in the open
market as compared to the price at which they may purchase shares through the
over-allotment option. Transactions to close out the covered syndicate short
involve either purchases of the common stock in the open market after the
distribution has been completed or the exercise of the over-allotment option.
The underwriters may also make "naked" short sales of shares in excess of the
over-allotment option. The underwriters must close out any naked short position
by purchasing common shares in the open market. A naked short position is more
likely to be created if the
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underwriters are concerned that there may be downward pressure on the price of
the shares in the open market after pricing that could adversely affect
investors who purchase in the offering. Stabilizing transactions consist of bids
for or purchases of shares in the open market while the offering is in progress.
Any of these activities may have the effect of preventing or retarding a
decline in the market price of the common shares. They may also cause the price
of the common shares to be higher than the price that would otherwise exist in
the open market in the absence of these transactions. The underwriters may
conduct these transactions on the Nasdaq National Market or in the
over-the-counter market, or otherwise. If the underwriters commence any of these
transactions, they may discontinue them at any time.
The underwriters may also impose a penalty bid. Penalty bids permit the
underwriters to reclaim a selling concession from a syndicate member when
Salomon Smith Barney Inc., in covering syndicate short positions or making
stabilizing purchases, repurchases shares originally sold by that syndicate
member.
A prospectus in electronic format may be made available on the websites
maintained by one or more of the underwriters. The underwriters may agree to
allocate a number of shares to underwriters for sale to their online brokerage
account holders. The representatives will allocate shares to underwriters that
may make Internet distributions on the same basis as other allocations.
In accordance with the applicable policies of several Canadian provinces,
the underwriters may not, throughout the period of distribution, bid for or
purchase common shares. Exceptions, however, exist where the bid or purchase is
not made to create the appearance of active trading in, or raising prices of,
the common shares. These exceptions include a bid or purchase permitted under
the by-laws and rules of The Toronto Stock Exchange relating to market
stabilization and passive market making activities and a bid or purchase made
for and on behalf of a customer where the order was not solicited during the
period of distribution. We have been advised that in connection with the
offering and pursuant to the first exception mentioned above, the underwriters
may over-allot or effect transactions which stabilize or maintain the market
price of the common shares at levels other than those which might otherwise
prevail on the open market.
Because the parent of CIBC World Markets Inc. beneficially owns more than
10% of the preferred stock outstanding prior to the closing of this offering, it
may be deemed to have a "conflict of interest" with us under Rule 2720 of the
National Association of Securities Dealers, Inc. When a NASD member with a
conflict of interest participates as an underwriter in a public offering, that
rule requires that the initial public offering price may be no higher than that
recommended by a "qualified independent underwriter," as defined by the NASD. In
accordance with this rule, Salomon Smith Barney Inc. has assumed the
responsibilities of acting as a qualified independent underwriter. In its role
as a qualified independent underwriter, Salomon Smith Barney Inc. has performed
a due diligence investigation and participated in the preparation of this
prospectus and the registration statement of which this prospectus is a part.
Salomon Smith Barney Inc. will not receive any additional fees for serving as a
qualified independent underwriter in connection with this offering. We have
agreed to indemnify Salomon Smith Barney Inc. against liabilities incurred in
connection with acting as a qualified independent underwriter, including
liabilities under the Securities Act.
CIBC Capital Partners, which presently holds preferred shares convertible
into 2,758,000 common shares, representing approximately 9.7% of our common
equity, is a division of a Canadian chartered bank. CIBC World Markets Inc., one
of the underwriters in this offering, is a wholly-owned subsidiary of the same
Canadian chartered bank. Accordingly, CIBC World Markets Inc. may be considered
a related and connected issuer of the company for the purposes of applicable
Canadian securities laws. The decision of CIBC World Markets Inc. to underwrite
this offering was made independently of CIBC Capital Partners. The decision to
distribute our common shares was made by us independently of CIBC Capital
Partners, although the terms of the offering were established through
negotiations between us and the underwriters. CIBC World Markets Inc. will not
receive any benefit from this offering other than its portion of the commissions
payable by us to the underwriters.
We estimate that our total expenses for this offering will be $1.6 million.
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We have agreed to indemnify the underwriters against specified liabilities,
including liabilities under the Securities Act of 1933 or under applicable
Canadian securities laws, or to contribute to payments the underwriters may be
required to make in respect of any of those liabilities.
LEGAL MATTERS
Osler, Hoskin & Harcourt LLP, Toronto, Ontario is acting as our Canadian
legal counsel with respect to this offering and will pass upon the legality of
the common shares offered by this prospectus. Brobeck, Phleger & Harrison LLP,
New York, New York, is acting as our U.S. legal counsel with respect to the
offering. Certain U.S. legal matters will be passed upon for the underwriters by
Cravath, Swaine & Moore, New York, New York.
In connection with this offering, several lawyers of Osler, Hoskin &
Harcourt LLP and Brobeck, Phelger & Harrison LLP are expected to purchase up to
16,000 and 11,455 respectively, of the common shares offered by the
underwriters.
EXPERTS
The financial statements as of December 31, 1998 and 1999 and for each of
the three years in the period ended December 31, 1999 included in this
prospectus have been so included in reliance upon the report of
PricewaterhouseCoopers LLP, independent accountants, given upon the authority of
said firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form F-1 covering the common shares being sold in this offering. We
have not included in this prospectus all of the information contained in the
registration statement, and you should refer to the registration statement and
its exhibits for further information. Any statement regarding any of the
contracts or other documents referred to in this prospectus is not necessarily
complete. If the contract or document is filed as an exhibit to the registration
statement, the contract or document is deemed to modify the description
contained in this prospectus. You must review the exhibits themselves for a
complete description of the contract or document. You may review a copy of the
registration statement, including exhibits and schedules filed with it, at the
Commission's public reference facilities in Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C., 20549, and at the regional offices of the
Commission located at 7 World Trade Center, 13th Floor, New York, New York 10048
and at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. You may also obtain copies of such materials from the
Public Reference Section of the Commission, Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C., 20549, at prescribed rates. You may call
the Commission at 1-800-SEC-0330 for further information on the public reference
rooms. These Commission filings are also available to the public from commercial
document retrieval services.
Prior to this offering, we have not been required to file reports with the
Commission. Following consummation of the offering, we will be required to file
reports and other information with the Commission under the U.S. Securities
Exchange Act of 1934 and with the securities regulators in each of the provinces
of Canada under applicable provincial securities legislation. You are invited to
read and copy any reports, statements or other information, other than
confidential filings, that we file with the Commission at its public reference
room. These materials can also be inspected on the Securities and Exchange
Commission's Website at http://www.sec.gov, and at the website of the Canadian
System for Electronic Document Analysis and Retrieval (SEDAR) at
http://www.sedar.com.
We intend to file with the Commission annual reports on Form 20-F. In
addition, in order to comply with the rules of The Nasdaq Stock Market, Inc., we
intend to furnish to our shareholders an annual report and a proxy statement
prior to each of our annual meetings of shareholders. Our annual reports will
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include financial statements prepared in accordance with accounting principles
generally accepted in Canada which, except as will be disclosed therein, will
conform in all material respects with accounting principles generally accepted
in the U.S. These annual financial statements will be examined by our
independent auditors. We also intend to make available quarterly reports
containing condensed unaudited financial information for each of the first three
quarters of each fiscal year, prepared in accordance with accounting principles
generally accepted in Canada.
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HYDROGENICS CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
UNAUDITED INTERIM FINANCIAL STATEMENTS FOR THE SIX MONTH
PERIOD ENDED JUNE 30, 2000
Balance Sheets as at June 30, 2000 and December 31, 1999.... F-2
Statements of Operations and Deficit for the six-month
periods ended June 30, 2000 and 1999...................... F-3
Statements of Cash Flows for the six-month periods ended
June 30, 2000 and 1999.................................... F-4
Notes to Financial Statements............................... F-5
AUDITED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER
31, 1999 AND 1998
Balance Sheets as at December 31, 1999 and 1998............. F-13
Statements of Operations and Retained Earnings (Deficit) for
the years ended December 31, 1999, 1998 and 1997.......... F-14
Statements of Cash Flows for the years ended December 31,
1999, 1998 and 1997....................................... F-15
Notes to Financial Statements............................... F-16
</TABLE>
F-1
<PAGE> 74
HYDROGENICS CORPORATION
BALANCE SHEETS
AS AT JUNE 30, 2000 AND DECEMBER 31, 1999
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
$ $
------------ ---------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................... 453,380 2,192,467
Accounts receivable and unbilled revenues................... 992,930 3,282,449
Grants receivable........................................... 142,530 82,956
Inventories................................................. 117,210 398,069
Prepaid expenses............................................ 8,067 334,910
--------- ---------
1,714,117 6,290,851
CAPITAL ASSETS.............................................. 249,755 517,740
--------- ---------
1,963,872 6,808,591
========= =========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities.................... 952,849 1,228,246
Income taxes payable........................................ 8,869 268,700
Dividends payable on preferred shares....................... 51,964 154,884
Customer deposits........................................... -- 446,878
--------- ---------
1,013,682 2,098,708
LOAN PAYABLE................................................ -- 94,405
PREFERRED SHARES (NOTE 3)................................... 912,423 4,054,722
--------- ---------
1,926,105 6,247,835
--------- ---------
SHAREHOLDERS' EQUITY
SHARE CAPITAL (NOTE 3)...................................... 145,273 591,513
DEFICIT..................................................... (107,506) (24,453)
CURRENCY TRANSLATION ADJUSTMENT............................. -- (6,304)
--------- ---------
37,767 560,756
--------- ---------
1,963,872 6,808,591
========= =========
</TABLE>
<TABLE>
<S> <C>
/s/ BOYD TAYLOR /s/ JOSEPH CARGNELLI
--------------------------------------------------- ---------------------------------------------------
Director Director
</TABLE>
F-2
<PAGE> 75
HYDROGENICS CORPORATION
STATEMENTS OF OPERATIONS AND DEFICIT
FOR THE THREE-MONTH PERIODS AND SIX-MONTH PERIODS ENDED JUNE 30, 2000 AND 1999
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------- -------------------------
1999 2000 1999 2000
$ $ $ $
-------- --------- ---------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES....................................... 498,472 2,809,472 774,241 4,459,086
COST OF REVENUES............................... 353,848 1,686,607 577,826 2,922,468
-------- --------- -------- ---------
144,624 1,122,865 196,415 1,536,618
-------- --------- -------- ---------
OPERATING EXPENSES
Selling and marketing.......................... 24,400 49,838 30,727 80,589
General and administrative..................... 148,793 326,713 235,248 670,478
Research and development....................... 117,198 216,250 192,997 409,460
Research and development grants................ (131,444) (45,600) (131,444) (105,441)
Depreciation of capital assets................. 3,170 12,851 5,167 22,588
-------- --------- -------- ---------
162,117 560,052 332,695 1,077,674
-------- --------- -------- ---------
INCOME (LOSS) FROM OPERATIONS.................. (17,493) 562,813 (136,280) 458,944
-------- --------- -------- ---------
OTHER (INCOME) EXPENSES
Accrued dividends and amortization of discount
on preferred shares.......................... 18,768 81,965 36,592 148,772
Other interest and bank charges................ (3,952) (22,558) (9,947) (41,279)
-------- --------- -------- ---------
14,816 59,407 26,645 107,493
-------- --------- -------- ---------
INCOME (LOSS) BEFORE INCOME TAXES.............. (32,309) 503,406 (162,925) 351,451
-------- --------- -------- ---------
INCOME TAX EXPENSE (BENEFIT)
Current........................................ (5,751) 273,494 (5,751) 268,398
Future......................................... -- -- (9,334) --
-------- --------- -------- ---------
(5,751) 273,494 (15,105) 268,398
-------- --------- -------- ---------
NET INCOME (LOSS) FOR THE PERIOD............... (26,558) 229,912 (147,820) 83,053
RETAINED EARNINGS (DEFICIT) -- BEGINNING OF
PERIOD....................................... (20,034) (254,365) 101,228 (107,506)
-------- --------- -------- ---------
DEFICIT -- END OF PERIOD....................... (46,592) (24,453) (46,592) (24,453)
-------- --------- -------- ---------
EARNINGS (LOSS) PER SHARE (NOTE 5)............. 0.00 0.01 (0.01) 0.00
</TABLE>
F-3
<PAGE> 76
HYDROGENICS CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2000 AND 1999
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
1999 2000
$ $
-------- ----------
(UNAUDITED)
<S> <C> <C>
CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Net income (loss) for the period............................ (147,820) 83,053
Items not affecting cash
Depreciation of capital assets............................ 5,167 45,265
Amortization of discount on preferred shares.............. 10,610 43,730
Future income taxes....................................... (9,353) --
Net change in non-cash working capital (note 4)............. (276,809) (1,752,621)
-------- ----------
(418,205) (1,580,573)
INVESTING ACTIVITIES
Purchase of capital assets.................................. (175,421) (321,855)
-------- ----------
FINANCING ACTIVITIES
Preferred shares issued -- net of issuance costs............ -- 3,623,348
Common shares issued........................................ -- 4,052
Increase in loan payable.................................... -- 94,405
-------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS DURING THE
PERIOD.................................................... (593,626) 1,819,377
EFFECT OF EXCHANGE RATE ADJUSTMENTS......................... -- (80,290)
CASH AND CASH EQUIVALENTS -- BEGINNING OF PERIOD............ 818,617 453,380
-------- ----------
CASH AND CASH EQUIVALENTS -- END OF PERIOD.................. 224,991 2,192,467
======== ==========
SUPPLEMENTAL DISCLOSURE
Interest paid............................................... -- --
Income taxes paid........................................... -- --
</TABLE>
F-4
<PAGE> 77
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
1 DESCRIPTION OF BUSINESS
Hydrogenics Corporation designs, develops and manufactures proton-exchange
membrane, or PEM, fuel cell automated test stations. The company's principal
customers include automotive companies, fuel cell developers and component
suppliers principally located in Canada, the United States and United Kingdom.
2 UNAUDITED INTERIM FINANCIAL STATEMENTS
The unaudited balance sheet as at June 30, 2000 and the unaudited
statements of operations and deficit and cash flows for the six months ended
June 30, 2000, in the opinion of management, have been prepared on the same
basis as the audited financial statements and include all adjustments necessary
for the fair statement of the results of the interim periods. All adjustments
reflected in the financial statements are of a normal recurring nature. The data
disclosed in the notes to the financial statements for this period is also
unaudited. Results for the six months ended June 30, 2000 are not necessarily
indicative of the results to be expected for the full year.
The functional currency of the company is the Canadian dollar. Effective
December 31, 1999, the U.S. dollar was adopted as the reporting currency and the
financial information for 1999 and prior years has been presented in U.S.
dollars in accordance with a translation of convenience method using the
exchange rate at December 31, 1999 of U.S.$ 1.00 -- Cdn.$ 1.4433, being the Bank
of Canada noon buying rate at December 31, 1999. For periods subsequent to
December 31, 1999, the Canadian dollar amounts are translated into the reporting
currency using the current rate method, whereby assets and liabilities are
translated at the period-end exchange rate, and revenues and expenses are
translated at the average exchange rate for the period. Gains or losses from
translation into the reporting currency are included in the cumulative
translation adjustment in shareholders' equity.
3 SHARE CAPITAL AND PREFERRED SHARES
The authorized capital stock of the company consists of an unlimited number
of common shares and an unlimited number of preferred shares issuable in series.
On January 21, 2000, the 3,000,000 issued and outstanding common shares were
reduced to 2,812,500 common shares through a reverse share split. Subsequent to
June 30, 2000, the number of outstanding common shares will be increased to
19,708,500 through a share split. The effects of the share splits have been
recognized retroactively in all share and per share data in the accompanying
financial statements and notes.
The 750,000 Series A (Cdn.$1,500,000) and 510,500 Series B (Cdn.$5,360,250)
preferred shares are cumulative, voting, convertible and redeemable. The
preferred shares are redeemable upon demand by the holder at face value plus a
5% annual dividend payable in cash, on the earlier of December 31, 2003 for
Series A and January 24, 2005 for Series B, or in the event of non-compliance
under the shareholders' agreement. The total amount payable, should redemption
of the Series A preferred shares occur on December 31, 2003, and Series B occur
on January 24, 2005, will be $1,299,106 (Cdn.$1,875,000) and $4,642,356
(Cdn.$6,700,312), respectively. At June 30, 2000, dividends payable amounted to
$154,884 (Cdn.$229,197). Conversion for each preferred share may occur at the
option of the holder for no consideration into seven common shares. The number
of common shares issuable on conversion will be adjusted in the event that an
anti-dilution event occurs pursuant to the operation of the anti-dilution
provisions. At conversion, the preferred shareholders are entitled to receive
cumulative dividends accrued to the date of conversion. Automatic conversion
will occur upon completion of a public underwriting whereby the common shares
are listed on a North American stock exchange, the offering price is not less
than Cdn.$2.14 per share, and the net proceeds to the company are not less than
Cdn.$15 million. The
F-5
<PAGE> 78
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
holders of the preferred shares are entitled to vote with the holders of the
common shares as if conversion had occurred.
The preferred shares have a liability and equity component. The liability
component is $4,054,722 based on the discounted future cash flows to the holders
of the preferred shares. The remaining $566,675 is included in other equity
within share capital.
ISSUED AND OUTSTANDING
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
$ $
------------ ---------
<S> <C> <C>
19,708,500 (December 31, 1999 -- 19,687,500) common
shares............................................. 20,786 24,838
Other equity......................................... 124,487 566,675
-------- --------
145,273 591,513
======== ========
</TABLE>
On January 24, 2000, the company issued 510,500 Series B preferred shares
for $7.23 (Cdn.$10.50) each in a private placement. The total proceeds received
were $3,623,348 (Cdn.$5,261,142), net of share issuance costs of $67,567.
During 2000, the company adopted a broad-based employee share option plan.
This plan replaces previous employee share purchase arrangements. The number of
common shares that may be made subject to option under the share option plan is
limited to 4,641,000. All options are for a term of ten years from the date of
grant and vest over four years unless otherwise determined by the board of
directors. As of June 30, 2000, 1,474,746 options are fully vested and the
remainder vest over periods ranging from two to four years from the date of
grant. Options were granted to employees and directors in the six months ended
June 30, 2000.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
OPTIONS FOR COMMON EXERCISE PRICE
SHARES CDN.$
------------------ ----------------
<S> <C> <C>
Balance -- December 31, 1999............................... 1,394,533 0.22
Options granted............................................ 1,944,467 0.24
--------- ----
Balance -- March 31, 2000.................................. 3,339,000 0.23
Options granted............................................ 450,800 2.30
Options exercised.......................................... (21,000) 0.29
--------- ----
Balance -- June 30, 2000................................... 3,768,800 0.48
--------- ----
</TABLE>
The following table summarizes information about the company's share
options outstanding as at June 30, 2000.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE PRICE NUMBER OUTSTANDING REMAINING NUMBER EXERCISABLE
CDN.$ AT JUNE 30, 2000 CONTRACTUAL LIFE AT JUNE 30, 2000
-------------- ------------------ ---------------- ------------------
<S> <C> <C> <C>
0.05 1,312,500 9.4 years 656,250
0.29 1,834,000 9.3 years 674,625
1.05 420,000 9.7 years 143,871
1.50 32,900 10.0 years --
</TABLE>
F-6
<PAGE> 79
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE PRICE NUMBER OUTSTANDING REMAINING NUMBER EXERCISABLE
CDN.$ AT JUNE 30, 2000 CONTRACTUAL LIFE AT JUNE 30, 2000
-------------- ------------------ ---------------- ------------------
<S> <C> <C> <C>
2.11 21,000 10.0 years --
2.23 10,500 10.0 years --
3.01 1,400 10.0 years --
3.38 7,000 10.0 years --
3.80 3,500 10.0 years --
4.29 4,200 10.0 years --
4.64 35,000 10.0 years --
5.00 74,550 10.0 years --
5.07 14,000 10.0 years --
--------- ---------
3,770,550 1,474,746
========= =========
</TABLE>
4 STATEMENT OF CASH FLOWS
Net change in non-cash operating working capital is as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
--------------------------
1999 2000
$ $
---------- ------------
<S> <C> <C>
Decrease (increase) in current assets
Accounts receivable and unbilled revenues................. (439,599) (2,289,519)
Grants receivable......................................... (74,263) 59,574
Inventories............................................... (3,364) (280,859)
Prepaid expenses.......................................... (9,094) (326,843)
Income taxes recoverable.................................. (5,751) --
Increase in current liabilities
Accounts payable and accrued liabilities.................. 229,280 275,397
Income taxes payable...................................... -- 259,831
Dividends payable......................................... 25,982 102,920
Customer deposits......................................... -- 446,878
-------- ----------
(276,809) (1,752,621)
======== ==========
</TABLE>
5 EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is calculated using the weighted average number
of common shares outstanding for the period, which amounted to 19,689,243 shares
in 2000 (1999 -- 19,687,500 shares). No effect has been given to the potential
exercise of stock options and conversion of preferred shares in the calculation
of fully diluted earnings (loss) per share in 2000 and 1999 as the effect would
be anti-dilutive.
F-7
<PAGE> 80
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
6 SUBSEQUENT EVENT
a) SHARE SPLIT
Subsequent to June 30, 2000, the number of outstanding common shares was
increased to 19,708,500 through a share split. The effect of the share split has
been recognized retroactively in all share and per share data in the financial
statements and notes.
b) SHARE OPTIONS
The shareholders of the company approved the grant of 46,900 additional
employee and director options to purchase common shares on September 11, 2000.
These options have a ten year term from the date of grant, vest over a four year
period, and allow the holder to acquire common shares for prices ranging from
Cdn.$6.43 to Cdn.$10.71.
c) NEW LEASE
In August 2000, the company signed a lease for a new facility. The lease is
for a term of 5 years commencing September 1, 2000, requires monthly lease
payments of $37,755 (Cdn.$55,587) for the first 2 years and $40,471
(Cdn.$59,586) per month thereafter, and requires a deposit at signing of the
lease of $72,665 (Cdn.$106,986). The company has provided the landlord with a
letter of credit of $441,480 (Cdn.$650,000) as security for lease payments. This
letter of credit is secured by cash of $441,480 (Cdn.$650,000).
7 DIFFERENCES BETWEEN CANADIAN AND UNITED STATES ACCOUNTING PRINCIPLES AND
PRACTICES
The financial statements have been prepared in accordance with Canadian
generally accepted accounting practices (Canadian GAAP), which differ in certain
respects from those principles and practices that the company would have
followed had its financial statements been prepared in accordance with
accounting principles and practices generally accepted in the United States
(U.S. GAAP).
F-8
<PAGE> 81
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
The reconciliation of net income (loss) for the three-month and six-month
periods ended June 30 based on Canadian GAAP to conform to U.S. GAAP is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1999 2000 1999 2000
$ $ $ $
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Net income (loss) for the period
based on Canadian GAAP........ (26,558) 229,912 (147,820) 83,053
Accrued dividends and
amortization of discount on
preferred shares (i).......... 18,768 81,965 36,592 148,772
Change in reporting currency
(iv).......................... (1,541) -- 3,637 --
Stock-based compensation (ii)... -- (937,509) -- (1,950,152)
---------- ----------- ---------- -----------
Net loss for the period based on
U.S. GAAP..................... (9,361) (625,632) (107,591) (1,718,327)
Other comprehensive income --
foreign currency translation
adjustment.................... (717) (3,581) (2,879) (4,297)
---------- ----------- ---------- -----------
Comprehensive loss for the
period based on U.S. GAAP..... (10,078) (629,213) (110,470) (1,722,624)
========== =========== ========== ===========
Basic and diluted loss per share
based on U.S. GAAP............ (0.00) (0.03) (0.01) (0.09)
Pro forma loss per share (vi)... (0.02) (0.06)
Weighted average number of
shares used in calculating
basic and fully diluted
earnings (loss)
per share..................... 19,687,500 19,690,965 19,687,500 19,689,243
</TABLE>
The effect of these adjustments on the shareholders' equity (deficiency) of
the company is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
$ $
------------ --------
<S> <C> <C>
Shareholders' equity based on Canadian GAAP................. 37,767 560,756
Equity component of preferred shares (i).................... (124,487) (566,675)
Cumulative amortization of discount on preferred shares
(i)....................................................... 21,220 64,951
Currency translation adjustment related to preferred shares
(i)....................................................... -- 10,503
-------- --------
Shareholders' equity (deficiency) based on U.S. GAAP........ (65,500) 69,535
======== ========
</TABLE>
---------------
(i) Preferred shares
Under Canadian GAAP, convertible redeemable preferred shares are presented
as debt and equity components on the balance sheet. The statement of
operations includes a charge for interest on the debt component and
dividends. However, under U.S. GAAP, these preferred shares meet the
definition of mandatorily redeemable shares, which are considered a
component of temporary equity outside of shareholders' equity. They are
recorded at face value and no accretion of a discount is necessary.
Dividends are accrued each period and are charged directly to equity. In
addition, a
F-9
<PAGE> 82
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
shareholders' equity reconciliation adjustment is required to reflect the
different foreign exchange translation treatment between U.S. and Canadian
GAAP. At June 30, 2000, the balance of temporary equity for U.S. GAAP
purposes, representing principal and accrued dividends on mandatorily
redeemable shares, is $4,701,000 (December 31, 1999 -- $1,068,000).
(ii) Stock-based compensation
Under Canadian GAAP, no compensation expense has been recognized with
respect to employee stock options. For U.S. GAAP reporting, the company
uses the intrinsic value method of APB Opinion No. 25 and options issued
under the plan are deemed to be compensatory to the extent that the fair
value of the stock exceeds the exercise price at the date of grant. The
compensation cost is recognized over the vesting period. For U.S. GAAP,
the compensation cost not yet recognized is presented as a deferred
stock-based compensation charge, with a corresponding amount included in
stock options outstanding, both of which form part of shareholders'
equity. As at June 30, 2000, equity balances for deferred stock-based
compensation expense and stock options outstanding are $3,408,610 and
$5,392,866 respectively.
(iii) New accounting standards
For United States GAAP reporting purposes, the company will be required to
adopt FAS 133 "Accounting for Derivative Instruments and Hedging
Activities" for the 2001 fiscal year. The company does not use derivative
financial instruments for trading purposes and, at present, does not enter
into hedging transactions and therefore the impact of FAS 133 on financial
reporting will not be material.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation -- an interpretation of APB Opinion No. 25" ("FIN 44").
FIN 44 clarifies the application of APB Opinion No. 25 and among other
issues clarifies the definition of an employee for purposes of applying
APB Opinion No. 25, the criteria for determining whether a plan qualifies
as a non-compensatory plan, and the accounting consequence of various
modifications to the terms of previously fixed stock options or awards.
FIN 44 is effective July 1, 2000, but certain conclusions in FIN 44 cover
specific events that occurred after either December 15, 1998 or January
12, 2000. The company does not expect the application of FIN 44 to have a
material impact on the company's financial position or results of
operations.
In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") No.
101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101,
as amended by SAB No. 101A, provides guidance on the measurement and
timing of revenue recognition in financial statements of public companies.
The company does not expect the provisions of SAB 101 to have a material
impact on its financial statements.
(iv) Change in reporting currency
The functional currency of the company is the Canadian dollar. Effective
December 31, 1999, the company adopted the U.S. dollar as its reporting
currency. Under U.S. GAAP, the financial statements, including prior
periods, are translated according to the current rate method whereby
revenues and expenses are translated at exchange rates prevailing at the
respective transaction dates and assets and liabilities are translated at
period-end rates. Under Canadian GAAP, at the time of change in reporting
currency, the historical financial statements are presented using a
translation of convenience whereby all amounts for the current year and
comparative figures are translated at the exchange rate prevailing at
December 31, 1999. For periods subsequent to December 31, 1999, the
Canadian GAAP treatment is consistent with U.S. GAAP.
F-10
<PAGE> 83
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 2000 AND 1999
(UNAUDITED)
(EXPRESSED IN U.S. DOLLARS)
(v) Comprehensive income
U.S. GAAP requires disclosure of comprehensive income, which comprises
income (loss) and other comprehensive income. The only item of other
comprehensive income for the company is the changes to the currency
translation adjustment account. As at June 30, 2000, accumulated other
comprehensive income (loss) is ($755) (December 31, 1999-($4,953)). Under
Canadian GAAP, there is no standard for reporting comprehensive income.
(vi) Pro forma earnings (loss) per share
If the company completes a public underwriting for net proceeds of not
less than Cdn.$15 million, all of the preferred shares will automatically
convert into 8,823,500 common shares. Unaudited pro forma basic and
diluted earnings (loss) per share, computed assuming the conversion of all
outstanding preferred shares at the beginning of the periods presented, or
at the date of issuance if later, is ($0.06) for the six months ended June
30, 2000.
F-11
<PAGE> 84
AUDITORS' REPORT
TO THE SHAREHOLDERS OF
HYDROGENICS CORPORATION
We have audited the balance sheets of HYDROGENICS CORPORATION as at
December 31, 1999 and 1998 and the statements of operations and retained
earnings (deficit) and cash flows for the years ended December 31, 1999, 1998
and 1997. These financial statements are the responsibility of the company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted
auditing standards. Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at December 31, 1999 and 1998
and the results of its operations and its cash flows for the years ended
December 31, 1999, 1998 and 1997 in accordance with Canadian generally accepted
accounting principles.
/s/ PricewaterhouseCoopers
Chartered Accountants
Toronto, Canada
February 25, 2000 (except for
note 15, dated October 25, 2000)
F-12
<PAGE> 85
HYDROGENICS CORPORATION
BALANCE SHEETS
AS AT DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
1998 1999
$ $
--------- ---------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................... 818,617 453,380
Accounts receivable and unbilled revenues (note 5).......... 353,725 992,930
Grants receivable........................................... 33,489 142,530
Inventories................................................. 28,277 117,210
Prepaid expenses............................................ -- 8,067
--------- ---------
1,234,108 1,714,117
CAPITAL ASSETS (NOTE 3)..................................... 14,964 249,755
--------- ---------
1,249,072 1,963,872
========= =========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 6)........... 102,014 952,849
Income taxes payable........................................ -- 8,869
Future income taxes (note 9)................................ 9,354 --
Dividends payable on preferred shares (note 8).............. -- 51,964
--------- ---------
111,368 1,013,682
PREFERRED SHARES (NOTE 8)................................... 891,203 912,423
--------- ---------
1,002,571 1,926,105
--------- ---------
SHAREHOLDERS' EQUITY
SHARE CAPITAL (NOTE 8)...................................... 145,273 145,273
RETAINED EARNINGS (DEFICIT)................................. 101,228 (107,506)
--------- ---------
246,501 37,767
--------- ---------
1,249,072 1,963,872
========= =========
COMMITMENTS AND CONTINGENCIES (NOTE 7)
</TABLE>
<TABLE>
<S> <C>
/s/ PIERRE RIVARD /s/ NORMAN M. SEAGRAM
--------------------------------------------------- ---------------------------------------------------
Director Director
</TABLE>
The accompanying notes form an integral part of these financial statements.
F-13
<PAGE> 86
HYDROGENICS CORPORATION
STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
1997 1998 1999
$ $ $
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES............................................... 96,598 664,917 2,674,255
COST OF REVENUES....................................... 71,255 414,565 2,105,130
---------- ---------- ----------
25,343 250,352 569,125
---------- ---------- ----------
OPERATING EXPENSES
Selling and marketing.................................. 11,139 37,643 125,402
General and administrative............................. 16,957 51,185 408,513
Research and development (note 4)...................... 123,612 94,239 423,776
Research and development grants (note 7)............... (131,131) (49,690) (261,988)
Depreciation of capital assets......................... 1,492 3,678 18,510
---------- ---------- ----------
22,069 137,055 714,213
---------- ---------- ----------
INCOME (LOSS) FROM OPERATIONS.......................... 3,274 113,297 (145,088)
---------- ---------- ----------
OTHER (INCOME) EXPENSES
Accrued dividends and amortization of discount on
preferred shares..................................... -- -- 73,184
Other interest and bank charges........................ 671 1,677 (9,053)
---------- ---------- ----------
671 1,677 64,131
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES...................... 2,603 111,620 (209,219)
---------- ---------- ----------
INCOME TAX EXPENSE (BENEFIT) (NOTE 9)
Current................................................ 3,834 4,693 8,869
Future................................................. (450) 7,795 (9,354)
---------- ---------- ----------
3,384 12,488 (485)
---------- ---------- ----------
NET INCOME (LOSS) FOR THE YEAR......................... (781) 99,132 (208,734)
RETAINED EARNINGS -- BEGINNING OF YEAR................. 2,877 2,096 101,228
---------- ---------- ----------
RETAINED EARNINGS (DEFICIT) -- END OF YEAR............. 2,096 101,228 (107,506)
========== ========== ==========
BASIC AND FULLY DILUTED EARNINGS (LOSS) PER SHARE (NOTE
12).................................................. (0.00) 0.01 (0.01)
SHARES USED IN COMPUTING BASIC AND FULLY DILUTED
EARNINGS (LOSS) PER SHARE............................ 19,687,500 19,687,500 19,687,500
</TABLE>
The accompanying notes form an integral part of these financial statements.
F-14
<PAGE> 87
HYDROGENICS CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
1997 1998 1999
$ $ $
------- --------- --------
<S> <C> <C> <C>
CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Net income (loss) for the year.............................. (781) 99,132 (208,734)
Items not affecting cash
Depreciation of capital assets............................ 1,492 3,678 44,910
Amortization of discount on preferred shares.............. -- -- 21,220
Future income taxes....................................... (450) 7,795 (9,354)
Net change in non-cash working capital (note 13)............ (41,921) (262,428) 66,422
------- --------- --------
(41,660) (151,823) (85,536)
------- --------- --------
INVESTING ACTIVITIES
Purchase of capital assets.................................. (7,386) (11,218) (279,701)
------- --------- --------
FINANCING ACTIVITIES
Increase in shareholders' advances.......................... 19,290 11,670 --
Repayment of Shareholders' advances......................... -- (32,075) --
Issuance of preferred shares (note 8)....................... -- 1,015,690 --
Increase (decrease) in bank indebtedness.................... 13,627 (13,627) --
------- --------- --------
32,917 981,658 --
------- --------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS DURING THE
YEAR...................................................... (16,129) 818,617 (365,237)
CASH AND CASH EQUIVALENTS -- BEGINNING OF YEAR.............. 16,129 -- 818,617
------- --------- --------
CASH AND CASH EQUIVALENTS -- END OF YEAR.................... -- 818,617 453,380
======= ========= ========
SUPPLEMENTAL DISCLOSURE
Interest paid............................................... 600 1,748 --
Income taxes paid........................................... -- -- 3,813
</TABLE>
The accompanying notes form an integral part of these financial statements.
F-15
<PAGE> 88
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
1 DESCRIPTION OF BUSINESS
Hydrogenics Corporation designs, develops and manufactures proton exchange
membrane, or PEM, fuel cell automated test stations. The company's principal
customers include automotive companies, fuel cell developers and component
suppliers principally located in Canada, the United States and the United
Kingdom.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The financial statements of the company have been prepared in accordance
with Canadian generally accepted accounting principles.
The functional currency of the company is the Canadian dollar. Effective
December 31, 1999, the U.S. dollar was adopted as the reporting currency and the
financial information for 1999 and prior years has been presented in U.S.
dollars in accordance with a translation of convenience method using the
exchange rate at December 31, 1999 of U.S.$1.00 -- Cdn.$1.4433, being the Bank
of Canada noon buying rate at December 31, 1999. For periods subsequent to
December 31, 1999, Canadian dollar amounts are translated into the reporting
currency using the current rate method, whereby assets and liabilities are
translated at the period-end exchange rate, and revenues and expenses are
translated at the average exchange rate for the period. Gains or losses from
translation into the reporting currency are included in the cumulative
translation adjustment in shareholder's equity.
Revenue recognition
Revenues from long-term contracts are determined under the
percentage-of-completion method where revenues are recognized on a pro rata
basis in relation to contract costs incurred. The company may provide
installation services under long-term contracts. These costs are included in
determining the percentage of completion and timing of revenue recognition.
Unbilled revenues (included in accounts receivable) represent revenues earned in
excess of amounts billed on uncompleted contracts. Revenues, other than revenues
for long-term contracts, are recorded when products are delivered.
Product Warranty
The company typically provides a warranty for parts and labour for one year
and provides for future warranty costs based on management's best estimates of
such costs, taking into account the nature of the contracts.
Grants and investment tax credits
Grants to fund various research activities are received from government and
other institutions. These grants are recorded as either a liability, a reduction
of the cost of the applicable capital assets, or a credit in the statement of
operations and retained earnings (deficit) when earned based on the terms and
conditions of the agreements under which the assistance is provided to the
company. A liability is recorded when repayment of the obligation is probable.
Investment tax credits related to qualifying research and development
expenditures are recorded as either a reduction of the cost of applicable
capital assets or credited in the statement of operations and retained earnings
(deficit) depending on the nature of the expenditures which gave rise to the
credits.
F-16
<PAGE> 89
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
Investment tax credits are recognized in the year in which the credits are
earned and realization is reasonably assured.
Cash and cash equivalents
Cash and cash equivalents consist of cash on deposit and highly liquid
short-term interest bearing securities with terms of 90 days or less.
Inventories
Inventories are primarily raw materials and are valued at the lower of
cost, determined on a first-in first-out basis, or market. Market is defined as
replacement cost.
Capital assets
Capital assets are recorded at the cost less accumulated depreciation.
Capital assets are depreciated from the date of acquisition or, in respect of
internally constructed research and development equipment, from the time an
asset is substantially completed and held ready for use.
The company evaluates capital assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. Recoverability of assets held and used is measured by a
comparison of the carrying amount of any asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the net recoverable amount.
Depreciation is computed using the declining balance method as follows:
<TABLE>
<S> <C>
Computer equipment........................................ 30% per annum
Office furniture and equipment............................ 20% per annum
Research and development equipment........................ 30% per annum
</TABLE>
Research and development costs
Research and product development costs are expensed as incurred until
technological feasibility is reached, there is intention to produce or market
the developed product and the future market is clearly defined. Costs for
research and development equipment that has alternative uses are capitalized.
Costs incurred in establishing and acquiring patents and licence agreements
are expensed in the year incurred or acquired, unless benefits are reasonably
assured.
Foreign currency translation
Monetary assets and liabilities denominated in currencies other than the
Canadian dollar, the company's functional currency, are translated at the rate
of exchange in effect at the end of the year. Revenue and expense items are
translated into Canadian dollars at the rate of exchange in effect on the dates
transactions occur. Exchange gains or losses are reflected in operations. See
note 2 "basis of presentation" regarding the company's reporting currency.
Fair values of financial instruments
At December 31, 1999 and 1998, the fair values of cash and cash
equivalents, accounts receivable, grants receivable, accounts payable and
accrued liabilities approximate carrying value because of the short-
F-17
<PAGE> 90
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
term nature of these instruments. Preferred shares are at market terms and
accordingly, fair value approximates carrying value.
Concentration of credit risk
A substantial portion of the company's accounts receivable are with a
limited number of customers. See note 14.
Use of estimates
The preparation of these financial statements in conformity with Canadian
generally accepted accounting principles 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 revenues and expenses during the period.
Actual results could differ from those estimates.
Stock-based compensation
No compensation expense is recognized when stock options are granted to
employees. Any consideration paid by employees on exercise of stock options or
purchase of stock is credited to share capital.
Income taxes
Income taxes are provided based on the liability method. Future income
taxes arise due to the temporary differences in the assets and liabilities
between their accounting and income tax bases. Deferred tax assets are
recognized to the extent that realization of such benefits is more likely than
not.
3 CAPITAL ASSETS
<TABLE>
<CAPTION>
1998 1999
$ $
------ -------
<S> <C> <C>
Cost
Computer equipment........................................ 17,311 64,738
Office furniture and equipment............................ 3,447 59,724
Research and development equipment........................ -- 175,998
------ -------
20,758 300,460
------ -------
Accumulated depreciation
Computer equipment........................................ 5,178 15,903
Office furniture and equipment............................ 616 8,403
Research and development equipment........................ -- 26,399
------ -------
5,794 50,705
------ -------
Net
Computer equipment........................................ 12,133 48,835
Office furniture and equipment............................ 2,831 51,321
Research and development equipment........................ -- 149,599
------ -------
14,964 249,755
====== =======
</TABLE>
F-18
<PAGE> 91
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
4 RESEARCH AND DEVELOPMENT
Research and development expenses consist of the following:
<TABLE>
<CAPTION>
1997 1998 1999
$ $ $
------- -------- -------
<S> <C> <C> <C>
Materials............................................ 51,016 58,676 184,113
Labour............................................... 55,889 127,313 188,787
Subcontracts......................................... 26,459 10,010 5,670
Patent costs......................................... 5,457 4,745 18,806
Depreciation of research and development assets...... -- -- 26,400
Investment tax credits............................... (15,209) (106,505) --
------- -------- -------
123,612 94,239 423,776
======= ======== =======
</TABLE>
The company develops products and related technology using its own
resources and through product development and demonstration contracts with
various government and public sector agencies. The company owns or is entitled
to use the products and technology developed under these contracts.
The company obtains protection of the intellectual property, which it
develops, by filing for patents in Canada, the United States and other
countries. Legal expenditures related to such filings in the year are included
above.
5 ACCOUNTS RECEIVABLE AND UNBILLED REVENUES
Accounts receivable and unbilled revenues consist of the following amounts:
<TABLE>
<CAPTION>
1998 1999
$ $
------- ---------
<S> <C> <C>
Accounts receivable.................................... 353,725 327,329
Less: Allowance for doubtful accounts.................. -- (13,059)
Unbilled revenues on contracts-in-progress............. -- 1,390,099
Less: Progress payments................................ -- (711,439)
------- ---------
353,725 992,930
======= =========
</TABLE>
Progress payments relate to two contracts in progress at year end with
unbilled revenues. There are no holdbacks or receivables with extended payment
terms.
6 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities include the following accounts:
<TABLE>
<CAPTION>
1998 1999
$ $
------- -------
<S> <C> <C>
Trade accounts payable................................... 41,638 801,302
Accrued liabilities...................................... 12,367 30,874
Accrued payroll costs.................................... 48,010 34,066
Warranty accrual......................................... -- 86,607
------- -------
102,015 952,849
======= =======
</TABLE>
F-19
<PAGE> 92
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
7 COMMITMENTS AND CONTINGENCIES
The company incurred rental expenses under operating leases of $30,309 in
1999 (1998 -- $17,460, 1997 -- $17,460).
The company has future minimum lease payments under operating leases
relating to premises at December 31, 1999 as follows:
<TABLE>
<CAPTION>
$
-------
<S> <C>
2000............................................. 56,066
2001............................................. 56,066
2002............................................. 32,705
-------
144,837
=======
</TABLE>
The company has entered into repayable contribution and other research and
development arrangements with the Department of Natural Resources (DNR), the
National Research Council, Canada (NRC), and the University of Quebec at Trois
Riviere (UQTR). Under these arrangements, the company will receive up to a
cumulative amount of Cdn.$1,417,950 (1998 -- Cdn.$312,000; 1997 -- Cdn.$237,450)
towards agreed upon research and development project costs. The utilized amount
of the advances at December 31, 1999 was Cdn.$682,091 (1998 -- Cdn.$303,965 and
1997 -- Cdn.$232,247). The amount of costs incurred and funding recognized in
the year ended December 31, 1999 was $261,988 (1998 -- $49,690,
1997 -- $131,131). In return for this funding, DNR, NRC and UQTR have a right to
receive as repayments, 1.3% to 4% of gross revenue received by the company as a
result of the commercial exploitation of the associated technology. These
arrangements will expire in stages between September 30, 2006 and March 31,
2016, or when total payments paid reach the utilized amount of the advance,
depending on the terms of the individual contracts. Research and development
arrangements that obligate the company to repay the funds regardless of the
outcome or commercialization of the research and development are recognized as
liabilities.
8 SHARE CAPITAL AND PREFERRED SHARES
The authorized capital stock of the company consists of an unlimited number
of common shares and an unlimited number of preferred shares issuable in series.
<TABLE>
<CAPTION>
1998 1999
$ $
------- -------
<S> <C> <C>
ISSUED AND OUTSTANDING
19,687,500 common shares................................. 20,786 20,786
Other equity............................................. 124,487 124,487
------- -------
145,273 145,273
======= =======
</TABLE>
During 1998, the company divided the 300 issued and outstanding common
shares into 3,000,000 issued common shares, and issued 750,000 Series A
preferred shares for $1,039,285 (Cdn.$1,500,000) less issue costs of $23,595.
Subsequent to year-end, on January 21, 2000, the number of outstanding common
shares was reduced to 2,812,500 through a reverse share split (note 15(c)). The
shares were then split prior the initial public offering on a seven to one basis
(note 15(e)). The effect of the reverse share split and share split has been
recognized retroactively in all share and per share data in the financial
statements and notes.
F-20
<PAGE> 93
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
The Series A preferred shares have a liability and equity component. The
liability component is $912,423 (1998 -- $891,203) based on discounted future
cash flows to the holders of the preferred shares and are recorded as preferred
shares on the balance sheet. The remaining $124,487 (1998 -- $124,487) is
included in other equity within share capital. Accrued dividends and
amortization of discount on the liability component is charged to the statement
of operations in the period.
The 5% cumulative Series A preferred shares are voting, convertible and
redeemable. The preferred shares are redeemable upon demand by the holder at
face value plus a 5% annual dividend payable in cash on the earlier of December
31, 2003 or in the event of non-compliance under the shareholders' agreement.
The total amount payable should redemption occur on December 31, 2003 will be
$1,299,106 (Cdn.$1,875,000). At December 31, 1999, dividends payable amounted to
$51,964 (Cdn.$75,000) (1998 -- $nil). Conversion may occur at the option of the
holder for no consideration, into seven common shares. The number of common
shares issuable on conversion will be adjusted in the event that an anti-
dilution event occurs pursuant to the operation of the anti-dilution provisions.
At conversion, the preferred shareholders are entitled to receive cumulative
dividends accrued to the date of conversion. Automatic conversion will occur
upon completion of a public underwriting whereby the common shares are listed on
a North American stock exchange, the offering price is not less than Cdn.$2.14
per share, and the net proceeds to the company are not less than Cdn.$ 15
million. The holders of the preferred shares are entitled to vote with the
holders of the common shares as if conversion had occurred.
In July 1999, the company issued 1,394,533 options to purchase common
shares to an employee. 410,158 of these options have an exercise price of
Cdn.$0.046 and the remainder have an exercise price of Cdn.$0.29. These options
vest over four years and expire in July 2009. At December 31, 1999, options for
266,602 shares at a weighted-average exercise price of Cdn.$0.10 were
exercisable. Under Canadian generally accepted accounting principles, no
compensation expense has been recorded in respect of these options.
9 INCOME TAXES
Significant components of the company's future income tax asset (liability)
are as follows:
<TABLE>
<CAPTION>
1998 1999
$ $
------ -------
<S> <C> <C>
Investment tax credits.................................... (9,354) --
Warranty accrual.......................................... -- 18,724
Capital assets............................................ -- 2,380
Valuation allowance....................................... -- (21,104)
------ -------
(9,354) --
====== =======
</TABLE>
F-21
<PAGE> 94
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
The company's computation of income tax expense (benefit) is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
$ $ $
------ ------- --------
<S> <C> <C> <C>
Income (loss) before income taxes..................... 2,603 111,620 (209,219)
Statutory small business rate......................... 22.62% 22.12% 21.62%
====== ======= ========
Income tax at statutory rate.......................... 589 24,691 (45,233)
Non-deductible interest............................. -- -- 15,823
Other permanent differences......................... 2,795 (12,203) 7,821
Unrecognized benefit of temporary differences....... -- -- 21,104
------ ------- --------
Income tax expense (benefit).......................... 3,384 12,488 (485)
====== ======= ========
</TABLE>
10 RELATED PARTY TRANSACTIONS
In the normal course of operations, the company subcontracts certain
manufacturing functions to a company owned by a relative of one of the principal
shareholders of Hydrogenics. Billings by this related company for manufacturing
functions totalled $177,734 (1998 -- $66,751; 1997 -- $34,303). There were sales
to the related company in relation to project work it was involved with
totalling $2,769 (1998 -- $35,786; 1997 -- $nil). At December 31, 1999, the
company has an accounts payable balance due to this company of $69,430 (1998
$6,072).
11 LINE OF CREDIT
The company has an operating line of credit available up to $173,214
(Cdn.$250,000). As of December 31, 1999, the company had not drawn on this line
(1998 -- $nil; 1997 -- $13,627). The operating facility bears interest at Royal
Bank of Canada prime rate plus 1.75%, is due on demand, and includes a general
security agreement over all assets.
12 NET EARNINGS (LOSS) PER SHARE
Net earnings (loss) per share is calculated using the weighted average
number of common shares outstanding for the year, adjusted for stock splits, of
19,687,500 shares in 1999 (1998 -- 19,687,500; 1997 -- 19,687,500). No effect
has been given to the potential exercise of stock options and conversion of
preferred shares in the calculation of fully diluted earnings (loss) per share
as the effect would be antidilutive.
F-22
<PAGE> 95
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
13 STATEMENT OF CASH FLOWS
Net change in non-cash operating working capital is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
$ $ $
------- -------- --------
<S> <C> <C> <C>
Decrease (increase) in current assets
Accounts receivable and unbilled revenues......... (15,208) (314,198) (639,245)
Grants receivable................................. (20,681) 2,754 (109,041)
Inventories....................................... -- (28,277) (88,893)
Prepaid expenses.................................. (272) 1,016 (8,067)
Increase (decrease) in current liabilities
Accounts payable and accrued liabilities.......... (9,594) 80,110 850,835
Income taxes payable.............................. 3,834 (3,833) 8,869
Dividends payable................................. -- -- 51,964
------- -------- --------
(41,921) (262,428) 66,422
======= ======== ========
</TABLE>
14 SEGMENTED FINANCIAL INFORMATION
The company currently operates in a single operating segment being the
design, development and manufacture of PEM fuel cell automated test stations.
All the company's operations including capital assets are located in Canada. The
distribution of revenue determined by location of customer is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
$ $ $
------ ------- ---------
<S> <C> <C> <C>
Canada................................................ 1,676 159,825 76,735
United States......................................... 94,922 505,092 1,753,213
United Kingdom........................................ -- -- 794,777
Rest of world......................................... -- -- 49,530
------ ------- ---------
96,598 664,917 2,674,255
====== ======= =========
</TABLE>
The company's largest customers comprise the following percentages of total
sales:
<TABLE>
<CAPTION>
1997 1998 1999
% % %
---- ---- ----
<S> <C> <C> <C>
First....................................................... 70 45 36
Second...................................................... 29 23 30
Third....................................................... -- 15 14
Fourth...................................................... -- 11 9
Others...................................................... 1 6 11
--- --- ---
100 100 100
=== === ===
</TABLE>
F-23
<PAGE> 96
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
15 SUBSEQUENT EVENTS
a) SHARE OPTION PLAN
On January 24, 2000, the company adopted a broad-based employee share
option plan. The number of common shares that may be made subject to option
under the share option plan is limited to 4,641,000, of which 3,339,000
have been granted as at January 24, 2000. All options will be for a term of
10 years from the date of grant unless otherwise determined by the Board of
Directors. The share options allow the holder to acquire common shares for
prices ranging from Cdn.$0.046 to Cdn.$1.05 per share and vest over periods
up to four years.
b) SHARE ISSUANCE
On January 24, 2000, the company issued 510,500 5%, Series B preferred
shares at $7.27 (Cdn.$10.50) per share for total proceeds of $3,722,396
(Cdn.$5,360,250). The preferred shares are redeemable upon demand by the
holder at face value plus a 5% annual dividend on the earlier of January
24, 2005 or in the event of non-compliance under the shareholders'
agreement. These shares are cumulative, voting, convertible and redeemable.
Conversion may occur at the option of the holder into seven common shares
and there are anti-dilution and automatic conversion provisions similar to
the Series A preferred shares.
c) REVERSE SHARE SPLIT
On January 21, 2000, the 3,000,000 issued and outstanding common
shares were reduced to 2,812,500 common shares through a reverse share
split. The effect of the reverse share split has been recognized
retroactively in all share and per share data in the accompanying financial
statements and notes.
d) SHARE OPTIONS
Unaudited -- The shareholders of the company approved the grant of
168,000, 205,800, 78,750, 34,300 and 100,900 additional employee and
director options to purchase common shares on April 19, 2000, June 15,
2000, June 29, 2000, September 11, 2000 and October 5, 2000 respectively,
under the company's amended and restated stock option plan dated April 19,
2000. These options have a ten year term from the date of grant, vest over
a four year period, and allow the holder to acquire common shares for
prices ranging from Cdn.$1.05 to Cdn.$12.14. As well, 21,000 options were
exercised at Cdn.$0.286 per share in April 2000.
e) SHARE SPLIT
Unaudited -- On September 29, 2000, the company increased the number
of common shares outstanding through a seven-to-one share split. The effect
of this share split has been recognized retroactively in all share and per
share data in the accompanying financial statements and notes.
16 DIFFERENCES BETWEEN CANADIAN AND UNITED STATES ACCOUNTING PRINCIPLES AND
PRACTICES
The financial statements have been prepared in accordance with Canadian
generally accepted accounting practices (Canadian GAAP), which differ in certain
respects from those principles and practices that the company would have
followed had its financial statements been prepared in accordance with
accounting principles and practices generally accepted in the United States
(U.S. GAAP).
F-24
<PAGE> 97
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
The reconciliation of net income (loss) based on Canadian GAAP to conform
to U.S. GAAP is as follows:
<TABLE>
<CAPTION>
1998 1999
$ $
---------- ----------
<S> <C> <C>
Net income (loss) for the year based on Canadian GAAP....... 99,132 (208,734)
Accrued dividends and amortization of discount on preferred
shares (i)................................................ -- 73,184
Change in reporting currency (iv)........................... (2,660) 4,851
Stock-based compensation (ii)............................... -- (34,104)
---------- ----------
Net (income) loss for the year based on U.S. GAAP........... 96,472 (164,803)
Other comprehensive income -- foreign currency
translation............................................... (39,042) 821
---------- ----------
Comprehensive income (loss) based on U.S. GAAP.............. 57,430 (163,982)
========== ==========
Basic and diluted earnings (loss) per share based on U.S.
GAAP (vi)................................................. 0.00 (0.01)
Pro forma earnings (loss) per share (vii)................... (0.01)
Weighted average number of shares used in calculating
earnings (loss) per share................................. 19,687,500 19,687,500
</TABLE>
The effect of these adjustments on the shareholders' equity of the company
is as follows:
<TABLE>
<CAPTION>
1998 1999
$ $
-------- --------
<S> <C> <C>
Shareholders' equity based on Canadian GAAP................. 246,501 37,767
Equity component of preferred shares (i).................... (124,487) (124,487)
Cumulative amortization of discount on preferred shares
(i)....................................................... -- 21,220
Change in reporting currency (iv)........................... (7,162) --
-------- --------
Shareholders' equity (deficiency) based on U.S. GAAP........ 114,852 (65,500)
======== ========
</TABLE>
---------------
(i) Preferred shares
Under Canadian GAAP, convertible redeemable preferred shares are presented
as debt and equity components on the balance sheet. The statement of
operations includes a charge for interest on the debt component and
dividends. However, under U.S. GAAP, these preferred shares meet the
definition of mandatorily redeemable shares, which are considered a
component of temporary equity outside of shareholders' equity, are
recorded at face value and no accretion of a discount is necessary.
Dividends are accrued each period and are charged directly to equity. At
December 31, 1999, the balance of temporary equity for U.S. GAAP purposes,
representing principal and accrued dividends on manditorily redeemable
shares, is $1,068,000 (1998 - $956,000).
(ii) Stock-based compensation
Under Canadian GAAP, no compensation expense has been recognized with
respect to employee stock options. For U.S. GAAP reporting, the company
uses the intrinsic value method of APB Opinion No. 25 and options issued
under the plan are deemed to be compensatory to the extent that the fair
value of the stock exceeds the exercise price at the date of grant. The
compensation cost is recognized over the vesting period. For U.S. GAAP,
the compensation cost not yet recognized is presented as a deferred
stock-based compensation charge, with a corresponding amount included in
stock options outstanding, both of which form part of shareholders'
equity. As at December 31,
F-25
<PAGE> 98
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
1999, equity balances for deferred stock-based compensation and stock
options outstanding are $34,104 and $68,208, respectively.
Had the company determined compensation cost based on the fair value
method as prescribed in Statement of Financial Accounting Standards No.
123, "Accounting for Stock-based Compensation," the fair market value of
the stock options granted in 1999 would be $108,000 and the pro forma net
(loss) income would be $(185,000) ($(0.01) loss per share) and $96,472
($0.00 earnings per share) for the years ended December 31, 1999 and 1998,
respectively. The weighted average grant date fair value of options with
an exercise price below market value and at market value at the grant date
would be approximately $0.18 and $0.04, respectively. Stock options are
valued using the Black Scholes option pricing model with the following
weighted average assumptions: risk free interest rate of 6.25%, expected
life of four years and expected volatility of 100%.
(iii) New accounting standards
For United States GAAP reporting purposes, the company will be required to
adopt FAS 133 "Accounting for Derivative Instruments and Hedging
Activities" for the 2001 fiscal year. The company does not use derivative
financial instruments for trading purposes and, at present, does not enter
into hedging transactions, and therefore the impact of adopting FAS 133 on
financial reporting will not be material.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation -- an interpretation of APB Opinion No. 25" ("FIN 44").
FIN 44 clarifies the application of APB Opinion No. 25 and among other
issues clarifies the definition of an employee for purposes of applying
APB Opinion No. 25, the criteria for determining whether a plan qualifies
as a non-compensatory plan, and the accounting consequence of various
modifications to the terms of previously fixed stock options or awards.
FIN 44 is effective July 1, 2000, but certain conclusions in FIN 44 cover
specific events that occurred after either December 15, 1998 or January
12, 2000. The company does not expect the application of FIN 44 to have a
material impact on the company's financial position or results of
operations.
In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") No.
101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101,
as amended by SAB No. 101A, provides guidance on the measurement and
timing of revenue recognition in financial statements of public companies.
The company does not expect the provisions of SAB 101 to have a material
impact on its financial statements.
(iv) Change in reporting currency
As discussed in note 2, effective December 31, 1999, the company adopted
the U.S. dollar as its reporting currency. Under U.S. GAAP, the financial
statements, including prior years, are translated according to the current
rate method whereby revenues and expenses are translated at exchange rates
prevailing at the respective transaction dates and assets and liabilities
are translated at the exchange rate at the end of each period. Under
Canadian GAAP, at the time of change in reporting currency, the historical
financial statements are presented using a translation of convenience
whereby all amounts for the current year and comparative figures were
translated at the exchange rate prevailing at December 31, 1999.
F-26
<PAGE> 99
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
The condensed balance sheets as at December 31, 1999 and 1998, and
statements of operations and cash flows for the years ended December 31,
1999 and 1998, after giving effect to the change in reporting currency
under U.S. GAAP, are as follows:
<TABLE>
<CAPTION>
1998 1999
$ $
--------- ---------
<S> <C> <C>
Current assets........................................ 1,161,670 1,714,117
Total assets.......................................... 1,175,756 1,963,872
Current liabilities................................... 104,831 961,718
Mandatorily redeemable preferred shares............... 956,073 1,067,654
Shareholders' equity (deficiency)..................... 114,852 (65,500)
</TABLE>
<TABLE>
<CAPTION>
1998 1999
$ $
------- ---------
<S> <C> <C>
Revenues............................................... 647,074 2,597,760
Cost of revenues....................................... 403,439 2,044,915
Operating expenses..................................... 133,377 726,909
Income (loss) from operations.......................... 110,257 (174,064)
Income (loss) for the period........................... 96,472 (164,803)
</TABLE>
<TABLE>
<CAPTION>
1998 1999
$ $
-------- --------
<S> <C> <C>
Cash used in operating activities...................... (147,750) (83,091)
Cash used in investing activities...................... (10,917) (271,699)
Cash provided by financing activities.................. 955,316 --
</TABLE>
(v) Comprehensive income
U.S. GAAP requires disclosure of comprehensive income which comprises
income (loss) and other comprehensive income. The only item of other
comprehensive income for the company is the changes to the currency
translation adjustment account. As at December 31, 1999, accumulated other
comprehensive income (loss) was ($4,953) (1998 -- ($5,774)). Under
Canadian GAAP, there is no standard for reporting comprehensive income.
(vi) Earnings per share
The numerator for purposes of calculating earnings (loss) per share has
been calculated as follows:
<TABLE>
<CAPTION>
1998 1999
$ $
------ --------
<S> <C> <C>
Net income (loss)........................................ 96,472 (164,803)
Less: dividends on preferred shares...................... -- 50,475
------ --------
Income (loss) available to common shares................. 96,472 (215,278)
====== ========
</TABLE>
(vii) Pro forma earnings (loss) per share
If the company undertakes a public underwriting on a North American
exchange for an offering price not less than Cdn.$2.14 per share and for
net proceeds of not less than Cdn.$15 million, all of the Series A
preferred shares will automatically convert into 5,250,000 common shares.
Unaudited pro forma earnings (loss) per share, computed assuming the
conversion of all outstanding preferred shares at the beginning of the
periods presented, or at the date of issuance if later, is ($0.01) for
the year ended December 31, 1999.
F-27
<PAGE> 100
HYDROGENICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1999 AND 1998
(EXPRESSED IN U.S. DOLLARS)
(viii) Additional cash flow disclosures
Dividends on preferred shares of $50,475 were accrued and charged to
equity but not paid for the year ended December 31, 1999 (1998-nil).
Accordingly, these transactions are not reflected in the statement of
cash flows.
F-28
<PAGE> 101
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7,000,000 SHARES
HYDROGENICS CORPORATION
COMMON SHARES
[HYDROGENICS CORPORATION LOGO]
------------
P R O S P E C T U S
OCTOBER 26, 2000
------------
SALOMON SMITH BARNEY
CIBC WORLD MARKETS
BMO NESBITT BURNS
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