10QSB 1 form10-qsb_sep302005.txt FORM 10-QSB 09-30-05 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO __________ COMMISSION FILE NUMBER 333-07953 DYNECO CORPORATION (Exact name of registrant as specified in its charter) Minnesota 41-1508703 --------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 564 International Place, Rockledge, Florida 32955 ------------------------------------------------- (Address of principal executive offices) (321) 639-0333 -------------- (Registrant's telephone number, including area code) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of November 12, 2005, the registrant had 33,538,533 shares of its $.01 par value per share common stock outstanding. Transitional Small Business Disclosure Format: Yes [ ] No [X] DYNECO CORPORATION INDEX TO QUARTERLY REPORT ON FORM 10-QSB FOR THE FISCAL QUARTER ENDED SEPTEMBER 30, 2005 PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Interim Condensed Consolidated Financial Statements (Unaudited): Condensed Consolidated Balance Sheets as of September 30, 2005........... 1 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2005 and September 30, 2004........... 2 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and September 30, 2004....................... 3 Notes to Interim Condensed Consolidated Financial Statements............. 4 Item 2. Management's Discussion and Analysis or Plan of Operation.......... 10 Item 3. Controls and Procedures............................................ 17 PART II. OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Item 5. Other Information.................................................. 18 Item 6. Exhibits........................................................... 19 Signatures.................................................................. 20 i PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DYNECO CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 2005 (UNAUDITED) ASSETS Current Assets Cash ......................................................... $ 12,689 Other current assets ......................................... - ----------- Total Current Assets ...................................... 12,689 Property and equipment, net ..................................... 38,257 ----------- Other Assets Deposits ..................................................... 566 Debt issue costs, net ........................................ 34,575 ----------- Total Other Assets ........................................ 35,141 Total Assets .............................................. $ 86,087 =========== LIABILITIES AND STOCKHOLDERS' DEFICIT Current Liabilities Convertible promissory notes, net of discount of $232,037 .... $ 77,752 Accounts payable ............................................. 47,932 Accrued compensation ......................................... 283,625 Accrued interest ............................................. 37,784 Other accrued liabilities .................................... 5,946 Loan payable ................................................. 203,503 Loan payable - Bank .......................................... 3,869 Current maturity of notes payable - Shareholders ............. 37,543 Current maturity of capital lease obligations ................ 384 ----------- Total Current Liabilities ................................. 698,338 Long Term Liabilities Loans payable - Bank, net of current portion ................. 17,143 Notes payable - Shareholders, net of current portion ......... 118,891 ----------- Total Long Term Liabilities ............................... 136,034 Total Liabilities ......................................... 834,372 ----------- Commitments and contingencies Stockholders' Deficit Preferred stock, $0.01 par value, 20,000,000 shares authorized, none issued and outstanding ................... - Common stock, $0.01 par value, 80,000,000 shares authorized, 33,538,533 shares issued and outstanding ....... 335,385 Common stock issuable, at par value (1,200,000 shares) ....... 12,000 Additional paid-in capital ................................... 7,534,727 Accumulated deficit .......................................... (8,630,397) ----------- Total Stockholders' Deficit ............................... (748,285) ----------- Total Liabilities and Stockholders' Deficit ............ $ 86,087 =========== 1 DYNECO CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED)
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- -------------------------------- 2005 2004 2005 2004 ---------------- ------------ ---------------- ------------ Revenues - Consulting ....................... $ - $ 75,000 $ - $ 225,000 Compressor prototypes ............ - - - 5,103 ---------------- ------------ ---------------- ------------ Total Revenues ................ - 75,000 - 230,103 Cost of revenues ............................ - 5,776 - 15,811 ---------------- ------------ ---------------- ------------ Gross Profit .......................... - 69,224 - 214,292 Operating Expenses Compensation .......................... 43,946 43,187 132,048 128,207 General and administrative ............ 70,604 92,384 314,041 295,111 Bad debt expense ...................... - - 2,150 - ---------------- ------------ ---------------- ------------ Total Operating Expenses ......... 114,550 135,571 448,239 423,318 ---------------- ------------ ---------------- ------------ Loss from Operations ............. (114,550) (66,347) (448,239) (209,026) Other Income (Expense) Interest income ....................... 177 125 1,236 274 Other income .......................... 80,879 - 80,879 - Interest expense ...................... (56,229) (8,488) (133,596) (25,455) ---------------- ------------ ---------------- ------------ Total Other Expense, net ......... 24,827 (8,363) (51,481) (25,181) ---------------- ------------ ---------------- ------------ Net Loss ......................... $ (89,723) $ (74,710) $ (499,720) $ (234,207) ================ ============ ================ ============ Net Loss Per Share - Basic and Diluted ...... $ (0.00) $ - $ (0.01) $ (0.01) ================ ============ ================ ============ Weighted average number of shares outstanding during the period - basic and diluted . 33,725,780 33,112,978 33,556,486 32,994,000 ================ ============ ================ ============ See accompanying notes to unaudited financial statements 2
DYNECO CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED)
2005 2004 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ........................................................... $(495,570) $(234,207) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization ................................ 22,202 26,981 Amortization of debt issue costs ............................. 14,151 - Amortization of debt discount ................................ 94,963 - Interest accretion on loan payable ........................... 16,452 14,194 Bad debt expense ............................................. 2,150 - Common stock issued for services ............................. - 24,000 Stock option grant for consultants ........................... 56,925 - Write off of accounts payable ................................ (82,879) (Increase) decrease in current assets: Accounts receivable .......................................... 6,875 (1,878) Other current assets ......................................... 2,993 187 Increase (decrease) in current liabilities: Accounts payable ............................................. 4,571 11,158 Accrued expenses ............................................. 88 1,223 Accrued salaries ............................................. 2,917 - Accrued Interest Payable ..................................... 12,934 - --------- --------- Net Cash Used In Operating Activities ........................ (341,228) (158,342) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of property and equipment .............................. (1,011) - Disbursements relating to patent rights ............................ - (7,201) --------- --------- Net Used In Investing Activities ............................. (1,011) (7,201) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Note repayments ................................................. (1,217) (1,488) Loan repayments ................................................. (3,208) - Proceeds from convertible promissory notes ...................... 300,000 - Repayment of convertible promissory notes ....................... (17,211) Repayment of capital lease obligation ........................... (1,154) (16,213) Debt issue costs ................................................ (21,726) - Issuance of common stock for cash ............................... 85,000 Repurchase of stock with receivable ............................. (2,445) - --------- --------- Net Cash Provided By (Used In) Financing Activities ......... 338,039 (17,701) --------- --------- Net Increase (Decrease) in Cash ....................................... (4,200) (183,244) Cash at Beginning of Period ........................................... 16,889 199,441 --------- --------- Cash at End of Period ................................................. $ 12,689 $ 16,197 ========= ========= Supplemental disclosure of cash flow information Cash paid during the period for interest ........................... $ 9,411 $ 21,518 ========= ========= Supplemental Disclosure of non-cash investing and financing activities: Exchange of employee receivable for stock receivable ............... $ 2,250 $ - ========= ========= Issuance of promissory notes as debt issue cost .................... $ 27,000 $ - ========= ========= Discount on promissory notes ....................................... $ 327,000 $ - ========= ========= See accompanying notes to unaudited financial ststements 3
DYNECO CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (UNAUDITED) NOTE 1 BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of DynEco, Inc. and Subsidiaries ("DynEco", "the Company", "we", "us", "our") have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the United States of America Securities and Exchange Commission for interim condensed consolidated financial information. Accordingly, they do not include all the information and footnotes necessary for a comprehensive presentation of consolidated financial position and results of operations. It is management's opinion, however, that all material adjustments (consisting of normal recurring adjustments) have been made which are necessary for a fair condensed consolidated financial statement presentation. The results for the interim period are not necessarily indicative of the results to be expected for the year. For further information, refer to the audited consolidated financial statements and footnotes of the Company for the year ending December 31, 2004 included in the Company's Form 10-KSB. NOTE 2 NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES STOCK-BASED COMPENSATION The Company has three stock-based compensation plans. The Company accounts for stock options issued to employees in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation cost is measured on the date of grant as the excess of the current market price of the underlying stock over the exercise price. Such compensation amounts are amortized over the respective vesting periods of the option grant. The Company adopted the disclosure provisions of SFAS No. 123 "Accounting for Stock-Based Compensation," and SFAS No. 148 "Accounting for Stock Based Compensation - Transition and Disclosure," which permits entities to provide pro forma net income (loss) and pro forma earnings (loss) per share disclosures for employee stock option grants as if the fair-valued based method defined in SFAS No. 123 had been applied. The Company accounts for stock options or warrants issued to non-employees for goods or services in accordance with the fair value method of SFAS 123. Under this method, the Company records an expense equal to the fair value of the options or warrants issued. The fair value is computed using an options pricing model. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation as of September 30: 4 2005 2004 ---------- ---------- Net loss, as reported $ (495,570) $ (234,207) Add: Stock-based employee compensation expense included in reported net income, net of related tax effects - - ---------- ---------- Deduct: Total stock-based compensation expense, determined under fair value based method for all awards, net of related tax effects - - ---------- ---------- Proforma net loss $ (495,570) $ (234,207) ========== ========== Basic and diluted per share information: Net loss per share, as reported $ (.01) $ (.01) ========== ========== Net loss per share, pro forma $ (.01) $ (.01) ========== ========== NOTE 3 GOING CONCERN AND MANAGEMENT'S PLAN The Company has a net loss of $495,570 and net cash used in operations of $343,673 for the nine months ended September 30, 2005, a working capital deficiency of $607,897, accumulated deficit of $8,630,397, and a stockholders' deficiency of $748,285 at September 30, 2005. Additionally, the Company was in default of the repayment terms on notes payable aggregating $35,000 and the Convertible Promissory Notes at September 30, 2005. The Company's developmental contracts generate insufficient operating capital and given the above financial results along with the Company's expected cash requirements in 2005 and 2006, additional capital investment will be necessary to develop and sustain the Company's operations. These matters raise substantial doubt about the Company's ability to continue as a going concern. As of September 30, 2005 and the date of this report, we have limited resources with which to pay our operating expenses and we are currently in default of our debt service obligations to holders of our secured promissory notes in the aggregate principal amount of $327,000. In addition, we have been unsuccessful in raising additional capital to fund operations and service our debt. While the note holders have not commenced legal proceedings against us or sought to foreclose on the security interest collateralizing the promissory notes, there is no assurance that they will not do so, and the prospect of their doing so has made it more difficult for us to raise additional capital. In light of the delays encountered by Parker-Hannifin in commercializing UniVane products, and the resulting delays in our receipt of royalty income from anticipated product sales by Parker-Hannifin, we will be unable to sustain our operations unless we are able to restructure our existing debt obligations and secure additional funding. While we have been engaged in ongoing discussions with our debt holders, we have no commitments to restructure our debt, and, as of the date of this report, we have no commitments or understandings that will result in our receipt of additional funding. In addition to discussions with our debt holders, we are reviewing other possible transactions to enable us to remain in existence, including the sale or license of our assets and business combinations with third parties. There is no assurance that we will be successful in our efforts to restructure our debt or raise additional funding. 5 NOTE 4 LOANS PAYABLE During the nine months ended September 30, 2005, the Company recognized $16,452 of interest accretion on a loan payable. The Company also repaid $3,208 on a loan payable to a Bank for the nine months ended September 30, 2005. The loan was used to refinance a capital lease obligation in December 2004. NOTE 5 NOTES PAYABLE - SHAREHOLDERS During the nine months ended September 30, 2005, the Company repaid $1,217 of notes payable - shareholders. Total notes payable - shareholders at September 30, 2005 aggregated $156,434. NOTE 6 CONVERTIBLE PROMISSORY NOTES & WARRANTS On March 2, 2005, the Company completed a $300,000 financing consisting of secured convertible promissory notes and common stock purchase warrants. The notes mature on March 2, 2007. The notes are convertible at the option of the two holders into shares of our common stock, at a price of $.10 per share, subject to adjustment. The notes are payable with interest at the rate of 5% per annum. Principal amortization payments, each in the amount of $15,789 plus accrued interest, are to be paid in 19 equal monthly installments, commencing July 2, 2005. Amortization payments may be made in cash (accompanied by a 10% premium) or, at our option, in registered common stock, at a 20% discount to market. Amortization payments in stock are subject to (a) a limitation based upon the weighted average trading volume of the common stock for the 20 trading days preceding the payment date and (b) a 4.99% cap on the beneficial ownership that each investor may have at any point in time while the notes and warrants are outstanding. We also issued the investors immediately exercisable common stock purchase warrants to purchase an aggregate of 7,500,000 shares of common stock, consisting of (a) five-year warrants to purchase 3,000,000 shares at an exercise price of $.14375 per share, subject to adjustment, (b) five-year warrants to purchase 1,500,000 shares at an exercise price of $.25 per share, subject to adjustment and (c) five-year warrants to purchase 3,000,000 shares at $.10 per share, subject to adjustment. We may require the investors to exercise the warrants described in (c) if the closing price for our common stock is $.15 or more for 30 consecutive trading days, and average daily volume during such period is at least 250,000 shares. The exercise of warrants is also subject to the 4.99% cap on the beneficial ownership that each investor may have at any point in time while the notes and warrants are outstanding. If certain registration statement requirements as discussed below are not met, the warrants holders may exercise the warrants on a cashless basis. The exercise price of the warrants described in subparagraph (b) was reduced to $.18 per share. We agreed to file a registration statement covering the shares issuable upon conversion or payment of the notes and exercise of the warrants. The registration statement must be filed by and effective within 90 days from the filing date or we will incur liquidated damages equal to 2% of the promissory note principal balance per 30 days of non-compliance. Repayment of the notes is collateralized by a general security interest in all of our assets. The registration statement was timely filed and is currently available to permit resales by the note and warrant holders. If the Company does not issue unlegended shares under the provisions of the agreements, the Company may be liable for damages, including liquidated damages of $100 per day for each $10,000 of purchase price per 30 days of non-compliance. 6 We paid unaffiliated finders a total $27,000, by the issuance of promissory notes payable in the same manner as the investor notes, and issued the finders five-year warrants to purchase a total of 270,000 shares of common stock, excercisable at $.14375 per share, subject to adjustment. The warrants are valued at $27,000 and a debt discount of $27,000 was recorded (see valuation method and assumptions below). The total debt issue costs of $48,726 is amortized over the debt term. The value of the 7,500,000 warrants issued with the convertible promissory notes exceeded the $300,000 promissory note value and accordingly, the full amount of the note $300,000 was allocated to the warrant value by recording a debt discount of $300,000 and a credit to additional paid-in capital. The debt discount will be amortized to interest expense over the debt term. The warrants were valued using the Black-Scholes option pricing method with a common stock price of $.10 based on recent offering by the Company, five-year expected term, zero expected dividends, volatility of 294% and a discount rate of 3.99%. As there was no value allocated to the debt, there was no beneficial conversion amount to record. In addition, the promissory notes that were issued to the finders were identical to the aforementioned promissory notes equal to 9% of the promissory notes, and were for $27,000. The value was accounted for in the same manner as the $300,000 promissory notes. Convertible debentures $ 327,000 Debt discount (232,037) Repayments (17,211) ----------- Convertible debentures, net of discount $ 77,752 =========== Debt issue costs $ 48,726 Amortization of costs thru September 30, 2005 14,151 ----------- Debt issue costs, net of amortization $ 34,575 =========== On July 1, 2005, the Company failed to make the required installment payments under the secured convertible promissory notes. The delinquent payments to the five note holders aggregated $17,211 of principal plus accrued interest. On August 3, 2005, the note holders waived the Company's default in making the July 1, 2005 payments and agreed not to assert any remedies they have under the notes and related loan agreements. As consideration for the waivers and agreements on the part of the note holders, the Company: o Agreed to pay in August two note holders a total of $18,333 representing the July 1, 2005 installment of principal and agreed upon accrued interest under their notes, o Reduced the exercise price of warrants to purchase a total of 1,500,000 shares of the Company's common stock issued to the two note holders, from $.25 per share to $.18 per share; and o Agreed with the other three note holders to defer repayment of the unpaid principal installment of $1,421 plus accrued interest on their notes until the March 2, 2007 maturity date of the notes, and agreed that those note holders could convert the deferred payments into shares of our common stock at the lesser of $.06704 per share or the then applicable conversion price of the note. Notwithstanding the waivers and settlement agreement, we failed to make the installment payments, plus interest, and we have failed to make required installment payments to the note holders in September, October and November 2005. On September 1st, October 1st, and November 1st, the Company failed to make the required installment payments under the secured convertible promissory notes. The delinquent payments to the five note holders aggregated $17,211 per month of principal, plus accrued interest. As a result of the default, the loan is now considered a current liability. While the note holders have not commenced legal proceedings against us or sought to foreclose on the security interest collateralizing the promissory notes, there is no assurance that they will not do so. 7 NOTE 7 CAPITAL LEASES During the nine months ended September 30, 2005, the Company repaid $1,154 of capital leases. Total leases payable at September 30, 2005 aggregated $384. NOTE 8 RELATED PARTY TRANSACTIONS Edwards Employment Agreement On January 1, 2004, the Company entered into an employment agreement with an individual acting as the Company's Chief Technical Officer and Chief Executive Officer. Under the terms of the agreement, the individual will receive a salary as follows: Year ended December 31, ----------------------- 2005 $ 70,000 2006 $ 80,000 2007 $ 90,000 2008 $100,000 Edwards Technology License Agreement: During February 2004, under an amendment to a 1992 license agreement, the Company was granted an exclusive license to utilize certain compressor technology, which includes the current UniVanetm technology, developed by a current officer/director in exchange for future royalty payments based on the underlying technology-producing income. The Company is obligated to pay the officer/director quarterly royalties equal to one percent of sales of related products and sublicensed products and ten percent of any royalty income received from sublicense agreements. The agreement expires in December 2009, or upon six months written notice by the Company. As of September 30, 2005, no royalty payments were incurred or due as no related sales have yet occurred. NOTE 9 STOCKHOLDERS' DEFICIENCY During January 2005, the Company sold 250,000 common shares and 125,000 warrants exercisable at $.15 per share for two years in exchange for $25,000 cash. On March 9, 2005, the transfer agent issued the above certificates and the certificates for the stock that was issuable from December 15, 2004. Accordingly, the shares have been reclassified from issuable to issued. During August 2005, the Company sold 200,000 common shares and 100,000 warrants exercisable at $.10 per share for four years in exchange for $10,000 cash. Also during August 2005, the Company received the former bookkeeper's stock certificate that collaterized her loan payable. 24,445 shares were cancelled at $.18 per share in settlement of her loan payable for $4,400. (See Note 10) During September 2005, the Company sold 1,000,000 common shares and 500,000 warrants exercisable at $.10 per share for four years in exchange for $50,000 cash. 8 The shares of stock for the sales of stock in August and September have not yet been issued and were therefore reflected as Common Stock Issuable at September 30, 2005. NOTE 10 STOCK RECEIVABLE The Company elected to write off a portion of an employee receivable, due from a former employee, that has been deemed uncollectible as of June 30, 2005. The receivable was collateralized by 25,000 shares of the Company's common stock owned by the employee. The Company recorded a common stock receivable, a deferred component of equity in the amount of $2,250. This figure was computed by multiplying the number of shares to be cancelled upon return of the collateral by the fair value of the Company's common stock as of June 30, 2005. The remaining $2,150 was charged to bad debt expense. (See Note 9) NOTE 11 STOCK OPTIONS AND WARRANTS On April 7, 2005 the Company issued stock options to the Company's employees, directors, counsel and consultants that expire three years from the grant date. The options were issued as follows: 1993 Corporate Stock Option Plan Directors 300,000 Consultants 75,000 Employees 131,667 Chief Executive Officer (CEO) 100,000 2001 Equity Incentive Plan Consultant 500,000 Employees 168,333 All of the options were granted at Fair Market Value ($.10) on the grant date and thus under APB 25 there is no expense for the options issued to the directors, employees and the CEO. Had the Company used the Fair Value Method under SFAS 123 method for directors, employees and the CEO, the expense would have been $69,300. The options granted to Consultants were valued under the Fair Value Method of SFAS 123 using the Black-Scholes option pricing method with a common stock price of $.10 based on price for April 7, 2005 (grant date), 3 year expected term, zero expected dividends, volatility of 294% and a discount rate of 3.90%. Therefore, the Company has recorded an expense of $56,925. On April 7, 2005, the Company's board extended the expiration date of 4,000,000 warrants owned by two holders from November 2005 to November 2006. In addition, the board extended the expiration date of 33,333 options owned by an employee from June 2005 to June 2007. There was no financial effect of these transactions. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Certain disclosures in this Quarterly Report on Form 10-QSB include certain forward-looking statements within the meaning of the safe harbor protections of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Statements that include words such as "believe," "expect," "should," intend," "may," "anticipate," "likely," "contingent," "could," "may," "estimate," or other future-oriented statements, are forward-looking statements. Such forward-looking statements include, but are not limited to, statements regarding our business plans, strategies and objectives, and, in particular, statements referring to our expectations regarding our ability to continue as a going concern, realize improved gross margins, and timely obtain required financing. These forward-looking statements involve risks and uncertainties that could cause actual results to differ from anticipated results. The forward-looking statements are based on our current expectations and what we believe are reasonable assumptions given our knowledge of the markets; however, our actual performance, results and achievements could differ materially from those expressed in, or implied by, these forward-looking statements. Factors, within and beyond our control, that could cause or contribute to such differences include, among others, the following: the success of our capital-raising and cost-cutting efforts, developing and marketing new technology devices, including technological advancements and innovations; consumer receptivity, preferences and availability and affordability; whether a third-party can successfully develop, manufacture and market products that incorporate our technology; political and regulatory environments and general economic and business conditions; the effects of our competition; the success of our operating, marketing and growth initiatives; development and operating costs; the amount and effectiveness of our advertising and promotional efforts; brand awareness; the existence of adverse publicity; changes in business strategies or development plans; quality and experience of our management; availability, terms and deployment of capital; labor and employee benefit costs, as well as those factors in our filings with the Securities and Exchange Commission, particularly the discussions under "Risk Factors" in our final prospectus dated May 6, 2005 (as supplemented on August 4, 2005), filed pursuant to Rule 424(b)(3) of the Securities Act of 1933, as amended. Readers are urged to carefully review and consider the various disclosures made by us in this report and those detailed from time to time in our reports and filings with the SEC. Our fiscal year ends on December 31. References to a fiscal year refer to the calendar year in which such fiscal year ends. The following analysis of our consolidated financial condition and results of operations for the nine months ended September 30, 2005 and 2004, should be read in conjunction with the Consolidated Financial Statements and other information presented elsewhere in this prospectus. GENERAL We are engaged primarily in developing and commercializing patented high efficiency low-pressure non-lubricated air compressors and hydrogen circulators, known collectively as UniVane(R) devices. The basic UniVane compressor technology development has been carried out by DynEco and is based upon the concepts, innovations and embodiments of the patents Dr. Edwards has exclusively licensed to us. That license agreement was entered into in January 2004, which replaced a license agreement entered into in 1992. Under the license agreement, we are required to pay Dr. Edwards one percent of revenues we receive from sales of products incorporating the licensed technology, and ten percent of gross royalty fees in excess of $500,000 per calendar year received by us from sublicenses of the licensed technology. The underlying UniVane patent #6,623,261, filed July 21, 2001 has a term of twenty years and expires on July 21, 2021. During May 2003, we granted an exclusive, world-wide patent license to Parker-Hannifin Corporation to further develop, enhance, manufacture and market our UniVane devices for all product applications into which the UniVane is incorporated. 10 Under the license agreement, Parker-Hannifin is responsible for generating production UniVane compressor engineering designs and producing and marketing them. As a result, our technical efforts have been re-directed to generating potentially improved UniVane manufacturing designs, decreasing costs, increasing UniVane operational speeds and capacities and creating initial engineering conceptual layouts for different size UniVanes. In addition to engineering efforts to improve UniVane machines, we are also identifying non-fuel cell markets for UniVane compressors and designing systems that would employ the machines in those markets. Presently, we are designing and testing aeration systems that could be applied to pond water reclamation and the aquaculture industry. We have historically incurred losses primarily resulting from expenditures related to the research, development, testing and preliminary marketing of our proprietary technology. To date, no products incorporating our UniVane technology have been commercially manufactured and we have not yet generated revenues, including royalty income, from the sale of products incorporating our UniVane technology. Until we established our relationship with Parker-Hannifin, we were unable to identify manufacturers who were willing to aid in the commercialization of products incorporating our UniVane technology. However, we expect that operating losses will continue until such time as either our future royalty income generates sufficient revenues to fund continuing operations or a combination of royalties and profits that may be generated from the sale of systems, such as aerators, that use UniVane air compressors. In September 2005, we were advised by Parker-Hannifin that they have encountered delays in commercializing UniVane products due to the limited lifespan of the compressors and that they continue to achieve improvements in the estimated lifespan of the compressors. Parker-Hannifin also continues to develop UniVane hydrogen circulators, but have not as yet completed development of commercial products. It is currently uncertain when commercial product development will be completed or when we can expect product sales to commence. We have limited resources with which to pay our operating expenses and we are currently in default of our debt service obligations to holders of our secured promissory notes in the aggregate principal amount of $327,000. In addition, we have been unsuccessful in raising additional capital to fund operations and service our debt. While the note holders have not commenced legal proceedings against us or sought to foreclose on the security interest collateralizing the promissory notes, there is no assurance that they will not do so, and the prospect of their doing so has made it more difficult for us to raise additional capital. In light of the delays encountered by Parker-Hannifin in commercializing UniVane products, and the resulting delays in our receipt of royalty income from anticipated product sales by Parker-Hannifin, we will be unable to sustain our operations unless we are able to restructure our existing debt obligations and secure additional funding. While we have been engaged in ongoing discussions with our debt holders, we have no commitments to restructure our debt, and, as of the date of this report, we have no commitments or understandings that will result in our receipt of additional funding. In addition to discussions with our debt holders, we are reviewing other possible transactions to enable us to remain in existence, including the sale or license of our assets and business combinations with third parties. There is no assurance that we will be successful in our efforts to restructure our debt or raise additional funding, in the absence of which we will likely be forced to cease operations. CRITICAL ACCOUNTING ESTIMATES Valuation of Patent Rights The valuation of patent rights has a material impact on our reported financial condition and operating performance. Patent rights consist of the costs incurred to obtain patent rights associated with compressor technology. Patent rights are amortized using the straight-line method over their seventeen to twenty year lives commencing upon patent issuance and the generation of revenues utilizing the underlying technology. Future revenues, if any, generated by these patents will be in the form of royalties from Parker-Hannifin. There is no assurance that commercial applications will be developed. 11 Due to: (a) uncertainties in the developing fuel cell industry, (b) inherent risk of competing future technologies, and (c) our reliance on Parker-Hannifin, we recognized an impairment loss of the entire net carrying value of patent rights of $144,603 in 2004. This loss is reflected as an operating expense and an increased the stockholders' deficit to $719,196 at December 31, 2004. We recorded and charged to operations impairment losses of $144,603 and $0, relating to patent rights, for the years ended December 31, 2004 and 2003, respectively. Stock Based Compensation Plans We have two stock based compensation plans. The board of directors administers these plans and may grant options to key individuals at their discretion. Terms and prices are to be determined by the compensation committee or the board. These plans have an aggregate of 2,500,000 shares of common stock reserved for issuance. Total options outstanding were 3,736,167 at June 30, 2005. In April of 2005, the Company granted 1,275,000 options under the plans. All of the options were granted at Fair Market Value on the grant date. Therefore there was no compensation expense for the 700,000 options granted to the employees, directors and chief executive officer in accordance with the provisions of Accounting Principles Board Opinion No. 25 and no pro forma disclosures required under the provisions of SFAS No. 123. The 575,000 options granted to counsel and consultants were valued under the Fair Value Method of SFAS 123 using the Black-Scholes option pricing method with a common stock price of $.10 based on a price for April 7, 2005 (grant date), 3 year expected term, zero expected dividends, volatility of 294% and a discount rate of 3.9%. Therefore, the Company recorded an operating expense of $56,925. On April 7, 2005, the Company's board extended the expiration date of 4,000,000 warrants owned by 2 holders from November 2005 to November 2006. In addition, the board extended the expiration date of 33,333 options owned by an employee. There was no financial effect of these transactions. RESULTS OF OPERATIONS Our historical results of operations prior to 2003 are not indicative of our current operations due to a shift in business operations, commencing with the licensing of our UniVane patent rights to the Parker-Hannifin Corporation along with the associated consulting agreement. Revenues for the near term will depend upon our receipt of royalty payments, if any, related to the sale of systems that employ our UniVane technology. In May 2003, we licensed our UniVane patent rights to the Parker-Hannifin Corporation. At the same time we commenced providing services under an associated product consulting agreement with Parker-Hannifin. The product development and marketing and distribution resources of Parker-Hannifin are, of course, far greater than those of DynEco, and, in the long-term we anticipate that these resources will enable us to realize a greater level of revenues without the related costs that we would incur if we were to undertake these activities on our own. Moreover, our limited resources do not enable us to undertake performance of these activities. Our revenues for 2004 and 2003 were primarily derived from consulting fees under the agreement with Parker-Hannifin. Our consulting fees terminated in December of 2004. 12 To date, there have been no sales of UniVane products that generated any royalty fees. In general, our license agreement with Parker-Hannifin does not expire until the later to occur of the last licensed UniVane patent expiration (i.e., July 21, 2021), or the final use of UniVane-related technology by Parker-Hannifin. NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2004. We had no revenues in the first nine months of 2005 as compared to $225,000 in consulting revenues in the first nine months of 2004. The 2004 revenues related to the Parker-Hannifin consulting agreement. We also had no prototype sales in the first nine months of 2005 as compared to $5,103 in the first nine months of 2004. Operating expenses increased 5.89% to $448,239 for the first nine months of 2005 from $423,318 for the first nine months of 2004. Legal and professional fees for the first nine months decreased to $72,991 for 2005 from $122,477 in 2004 primarily because the Company classified $21,726 of legal fees as debt issue costs. Research and development costs for the first nine months decreased to $40,698 in 2005 from $66,462 in 2004. Interest expense increased for the first nine months to $133,596 for 2005 from $25,455 for 2004, primarily because of the amortization of the debt discount on the convertible debentures. Our net loss increased $263,513 for the first nine months of 2005 to $497,720 from $234,207 for the first nine months of 2004. FINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES DynEco Corporation is a developmental stage company. Our financial condition relies on continuing equity investment until, if ever, Parker-Hannifin is successful in commercializing the UniVane technology. During 2004 and 2003 equity funding was augmented by prototype sales and consulting fees. From time-to-time, we issue stock, options and warrants to satisfy operating expenses, which provides us with a form of liquidity. For example, during February 2004, the Company settled an outstanding legal services agreement from August 1, 2001, in which the holder was owed $10,000 payable with 100,000 shares of issuable common stock, which had been reflected in the Company's records as common stock issuable. In February 2004, the Company granted a stock option in lieu of issuing shares. In April 2004, the Company issued 200,000 shares of common stock to a director for services rendered. Due, in part, to our lack of earnings, our success in attracting additional funding has been limited to transactions in which our equity is used as currency. In light of the availability of this type of financing, and the lack of alternative proposals, our board of directors has determined that the continued use of our equity for these purposes may be necessary if we are to sustain operations. Equity financings of the type we have been required to pursue are dilutive to our stockholders and may adversely impact the market price for our shares. In November 2002, we entered into an agreement with the Technological Research and Development Authority that provided $150,000 in funding for the development and commercialization of DynEco's UniVane compressors and hydrogen circulators for fuel cell applications. In consideration of the funding, we are obligated to make royalty payments to the Authority equal to five percent of future UniVane-related sales up to an amount equal to three times the amount DynEco receives from the Authority. During 2003, the entire $150,000 funding commitment was received. The agreement expires in November 2012. We do not anticipate any additional funding from the Technological Research and Development Authority. As of September 30, 2005, our primary source of liquidity was $12,689 of cash. The working capital deficit was $(685,649). We had total assets of $86,087, of which long-term assets consisted of other assets of $34,575 of debt issue costs and $566 of deposits, and $38,257 of property and equipment, net. Our liabilities totaling $834,372 included $47,932 of accounts payable, $327,355 of accrued liabilities, $207,372 of loan payables and $37,927 of current maturities of long-term debt and convertible promissory notes, net of discount of $77,752. Total shareholders' deficit was $(748,285). At September 30, 2005, we had an accumulated deficit of $(8,630,397). 13 We are in default of the repayment terms on notes payable aggregating $35,000 at June 30, 2005, and no extension has been granted by the two non-affiliated debt holders. The proceeds of the loans were used for general working capital purposes. As of the date of this report, the debt holders have not sought to enforce their rights to repayment of the unsecured notes. On July 1, 2005, the Company failed to make the required installment payments under its secured promissory notes in the aggregate principal amount of $327,000. The delinquent payments to the five note holders aggregated $17,211 of principal plus accrued interest. On August 3, 2005, the note holders waived the Company's default in failing to make the July 1, 2005 payments and agreed no to assert any remedies they have under the notes and related loan agreements. As consideration for the waivers and agreements on the part of the note holders, the Company: o Agreed to pay in August two note holders a total of $18,333 representing the July 1, 2005 installment of principal and agreed upon accrued interest under their notes; o Reduced the exercise price of warrants to purchase a total of 1,500,000 shares of the Company's common stock issued to the two note holders, from $.25 per share to $.18 per share; and o Agreed with the other three note holders to defer repayment of the unpaid principal installment of $1,421 plus accrued interest on their notes until the March 2, 2007 maturity date of the notes, and agreed that those note holders could convert the deferred payments into shares of our common stock at the lesser of $.06704 per share or the then applicable conversion price of the note. Notwithstanding the waivers and settlement agreement, we failed to make the installment payments, plus interest, and we have failed to make the required payments to the note holders in September, October and November 2005. Net cash used in operating activities was $341,228 for nine months ended September 30, 2005 compared to $158,342 for 2004. The cash provided by financing activities in first nine months of 2005 of $338,039 was due to the proceeds from secured convertible promissory notes and the sale of common stock, less repayments of shareholder loans and capital lease obligations and the debt issue costs that were incurred. Historically, we have relied upon limited revenues from consulting fees and equity financing in order to fund operations. While these activities have provided limited resources, they have never resulted in cash flow in excess of immediately needed funding. Our inability to generate cash flow in excess of immediately needed funds was, in large part responsible for our decision to enter into the strategic relationship with Parker-Hannifin as a means to develop commercially viable products and a potential source of revenue generation. In January 2005, the Company issued 250,000 common shares and 125,000 warrants exercisable for two years in exchange for $25,000 cash. In March 2005, the Company completed a $300,000 financing consisting of secured convertible promissory notes and common stock purchase warrants. In August and September 2005, the Company agreed to issue 1,200,000 common shares and 600,000 warrants exercisable for four years in exchange for $60,000 cash. It is not expected that the internal sources of liquidity will improve until net cash is provided from operating activities, and until such time, we will rely upon external sources of liquidity, including additional private placements of our common stock and exercise of various outstanding stock warrants and stock options. 14 We project our current monthly cash flow requirement to be approximately $35,000. Our cash is insufficient to satisfy our monthly costs and anticipated costs associated with new product development. There can be no assurance, however, that we will be able to generate sufficient cash from operations, if any, in future periods beyond this period to satisfy our capital requirements. Therefore, we will have to continue to rely on external financing activities, including the sale of our equity securities, to satisfy our capital requirements for the foreseeable future. Due, in part, to our lack of earnings, our success in attracting additional funding has been limited to transactions in which our equity is used as currency. In light of the availability of this type of financing, and the lack of alternative proposals, our board of directors has determined that the continued use of our equity for these purposes may be necessary if we are to sustain operations. Equity financings of the type we have been required to pursue are dilutive to our stockholders and may adversely impact the market price for our shares. However, we have no commitments for borrowings or additional sales of equity, the precise terms upon which we may be able to attract additional funding is not known at this time, and there can be no assurance that we will be successful in consummating any such future financing transactions on terms satisfactory to us, or at all. As of September 30, 2005 and the date of this report, we have limited resources with which to pay our operating expenses and we are currently in default of our debt service obligations to holders of our secured promissory notes in the aggregate principal amount of $327,000. In addition, we have been unsuccessful in raising additional capital to fund operations and service our debt. While the note holders have not commenced legal proceedings against us or sought to foreclose on the security interest collateralizing the promissory notes, there is no assurance that they will not do so, and the prospect of their doing so has made it more difficult for us to raise additional capital. In light of the delays encountered by Parker-Hannifin in commercializing UniVane products, and the resulting delays in our receipt of royalty income from anticipated product sales by Parker-Hannifin, we will be unable to sustain our operations unless we are able to restructure our existing debt obligations and secure additional funding. While we have been engaged in ongoing discussions with our debt holders, we have no commitments to restructure our debt, and, as of the date of this report, we have no commitments or understandings that will result in our receipt of additional funding. In addition to discussions with our debt holders, we are reviewing other possible transactions to enable us to remain in existence, including the sale or license of our assets and business combinations with third parties. There is no assurance that we will be successful in our efforts to restructure our debt or raise additional funding, in the absence of which we will likely be forced to cease operations. OFF BALANCE SHEET ARRANGEMENTS Under SEC regulations, we are required to disclose our off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. An off-balance sheet arrangement means a transaction, agreement or contractual arrangement to which any entity that is not consolidated with us is a party, under which we have: o Any obligation under certain guarantee contracts; o Any retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; 15 o Any obligation under a contract that would be accounted for as a derivative instrument, except that it is both indexed to our stock and classified in stockholder's equity in our statement of financial position; and o Any obligation arising out of a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or engages in leasing, hedging or research and development services with us. As of the date of this Report, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. SEASONALITY AND INFLATION Our business is not seasonal in nature, and management does not believe that our operations have been materially affected by inflationary forces. If the recent increase in oil prices proves to be long lasting, we believe the interest in fuel cell development will only increase. As previously stated, our future success is dependent upon the successful development and market acceptance of fuel cell systems. 16 ITEM 3. CONTROLS AND PROCEDURES The Company's management has concluded its evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Company's management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. As of the evaluation date, the Company's Chief Executive Officer and its Chief Financial Officer concluded that the Company maintains disclosure controls and procedures that are effective in providing reasonable assurance that information required to be disclosed in the Company's reports under the Exchange Act is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There has been no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 17 PART II. OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS On August 26, 2005, we sold 200,000 shares of common stock and common stock purchase warrants to purchase 100,000 shares to one investor for an aggregate purchase price of $10,000. The warrants are exercisable for a period of four years, at an exercise price of $.10 per share. The investor had access to business and financial information about us and had such knowledge and experience in business and financial matters that he was able to evaluate the risks and merits of an investment in the Company. The shares and warrants contain a legend restricting transferability of the shares, warrants and shares issuable upon exercise of the warrants unless the shares are registered under the Securities Act of 1933, as amended. No placement agent was involved, no commissions were paid and no general solicitation or advertising was used in connection with this transaction. The sale of the notes and warrants was exempt from the registration requirements of the Securities Act of 1933, as amended, by reason of Section 4(2) thereof and the rules and regulations thereunder. On September 22, 2005, we sold 1,000,000 shares of common stock and common stock purchase warrants to purchase 500,000 shares to one investor for an aggregate purchase price of $50,000. The warrants are exercisable for a period of four years, at an exercise price of $.10 per share. The investor had access to business and financial information about us and had such knowledge and experience in business and financial matters that he was able to evaluate the risks and merits of an investment in the Company. The shares and warrants contain a legend restricting transferability of the shares, warrants and shares issuable upon exercise of the warrants unless the shares are registered under the Securities Act of 1933, as amended. No placement agent was involved, no commissions were paid and no general solicitation or advertising was used in connection with this transaction. The sale of the notes and warrants was exempt from the registration requirements of the Securities Act of 1933, ad amended, by reason of Section 4(2) thereof and the rules and regulations thereunder. ITEM 5. OTHER INFORMATION On July 1, 2005, we failed to make required installment payments under our promissory notes in the aggregate principal amount of $327,000 issued to five persons. The aggregate principal amount of the monthly installments that were not paid was $17,210.53 plus accrued interest. As consideration for the note holders' waiver of our default, we (a) agreed to pay a total of $18,333.33 including agreed upon accrued interest, to two of the note holders, (b) reduced the exercise price of warrants to purchase a total of 1,500,000 shares of our common stock issued to those two note holders, from $.25 per share to $.18 per share and (c) agreed with the other note holders to defer repayment of the unpaid $1,479.76 installments of principal and accrued interest on their notes until the March 2, 2007 maturity date of the notes, and agreed that those note holders could convert the deferred payments into shares of our common stock at the lesser of $.06704 per share or the then applicable conversion price of the note. To date, we have failed to make the payment described in (a), above. In addition, the Company has failed to make the required September 1st, October 1st, and November 1st, installment payments under the secured convertible promissory notes. The delinquent payments to the five note holders aggregated $17,211 per month of principal (a total of $51,633), plus accrued interest. As a result of the default, the loan is now considered a current liability. While the note holders have not commenced legal proceedings against us or sought to foreclose on the security interest collateralizing the promissory notes, there is no assurance that they will not do so. 18 ITEM 6. EXHIBITS 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ------------------------ 19 SIGNATURES In accordance with the requirements of the Exchange Act the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: November 14, 2005 DYNECO CORPORATION By: /s/ Thomas C. Edwards --------------------- Thomas C. Edwards Chief Financial and Accounting Officer 20 EXHIBIT INDEX 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 21