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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 20-F**

 

**(MarkOne)**

 

| **o**      | **REGISTRATION STATEMENT PURSUANT  TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934**                                    |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                            |
| **OR**     |
| ** ** | ** **                                                                                                                                            |
| **x**      | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the fiscal year ended December 31, 2008** |
| ** ** | ** **                                                                                                                                            |
| **OR**     |
| ** ** | ** **                                                                                                                                            |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                               |
| ** ** | ** **                                                                                                                                            |
| **OR**     |
| ** ** | ** **                                                                                                                                            |
| **o**      | **SHELL COMPANY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                            |

 

Commissionfile number: 000-31815

 
| **HYDROGENICS CORPORATION -**

**CORPORATION HYDROGÉNIQUE**                                                                                           |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (Exact name of Registrant as specified in its charter)                                                                                                     |
|                                                                                                                                                       |
| **Canada**                                                                                                                                                 |
| (Jurisdiction of incorporation or organization)                                                                                                            |
|                                                                                                                                                       |
| **5985 McLaughlin Road**

**Mississauga, Ontario**

**Canada L5R 1B8**

**(905) 361-3660**                                                                 |
| (Address of principal executive office)                                                                                                                    |
|                                                                                                                                                       |
| **Lawrence Davis, Chief Financial Officer**

**5985 McLaughlin Road**

**Mississauga, Ontario**

**Canada L5R 1B8**

**(905) 361-3660 Fax (905) 361-3626** |
| (Name, Telephone, Email and/or Facsimile number and Address of  Company Contact Person)                                                                    |

 

Securitiesregistered or to be registered pursuant to Section 12(b) of the Act.

 

**None**

 

Securitiesregistered or to be registered pursuant to Section 12(g) of the Act.

 

**Common Shares**

 

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Securitiesfor which there is a reporting obligation pursuant to Section 15(d) ofthe Act.

 

**None**

 

Indicatethe number of outstanding shares of each of the issuer’s classes of capital orcommon stock as of the close of the period covered by the annual report.
| At  December 31, 2008, 92,405,666 common shares were issued and outstanding |   |
|-----------------------------------------------------------------------------|--------|
|                                                                        |   |

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.

o Yes   x No

 

Ifthis report is an annual or transition report, indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934.

o Yes   x No

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

x Yes   o No

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).

x Yes   o No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer x |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicateby check mark which basis of accounting the registrant has used to prepare thefinancial statements included in this filing:

 

| U.S. GAAP o |   | International Financial Reporting Standards as issued  by the International Accounting Standards Board o |   | Other x |
|-------------|--------|----------------------------------------------------------------------------------------------------------|--------|---------|

 

If“Other” has been checked in response to the previous question, indicate bycheck mark which financial statement item the registrant has elected to follow.

o Item 17   x Item 18

 

Ifthis is an annual report, indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes   x No

 

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| **TABLE  OF CONTENTS**                 | ** ** |
|----------------------------------------|------------|
|                                   |       |
| INTRODUCTION AND USE OF  CERTAIN TERMS | 1          |
| FORWARD LOOKING STATEMENTS             | 1          |
| PART I                            |       |   | 2 |
|                                   | ITEM 1.    | IDENTITY OF DIRECTORS,  SENIOR MANAGEMENT AND ADVISERS | 2 |
|                                   | ITEM 2.    | OFFER STATISTICS AND  EXPECTED TIMETABLE | 2 |
|                                   | ITEM 3.    | KEY INFORMATION | 2 |
|                                   | ITEM 4.    | INFORMATION ON THE  COMPANY | 18 |
|                                   | ITEM 4A.   | UNRESOLVED STAFF  COMMENTS | 27 |
|                                   | ITEM 5.    | OPERATING AND  FINANCIAL REVIEW AND PROSPECTS | 27 |
|                                   | ITEM 6.    | DIRECTORS,  SENIOR MANAGEMENT AND EMPLOYEES | 45 |
|                                   | ITEM 7.    | MAJOR  SHAREHOLDERS AND RELATED PARTY TRANSACTIONS | 59 |
|                                   | ITEM 8.    | FINANCIAL INFORMATION | 61 |
|                                   | ITEM 9.    | THE OFFER AND LISTING | 61 |
|                                   | ITEM 10.   | ADDITIONAL  INFORMATION | 62 |
|                                   | ITEM 11.   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 69 |
|                                   | ITEM 12.   | DESCRIPTION OF  SECURITIES OTHER THAN EQUITY SECURITIES | 69 |
| PART II                           |       |   | 70 |
|                                   | ITEM 13.   | DEFAULTS,  DIVIDEND ARREARAGES AND DELINQUENCIES | 70 |
|                                   | ITEM 14.   | MATERIAL  MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 70 |
|                                   | ITEM 15.   | CONTROLS AND  PROCEDURES | 75 |
|                                   | ITEM 16A.  | AUDIT  COMMITTEE FINANCIAL EXPERT | 76 |
|                                   | ITEM 16B.  | CODE OF ETHICS | 76 |
|                                   | ITEM 16C.  | PRINCIPAL  ACCOUNTANT FEES AND SERVICES | 77 |
|                                   | ITEM 16D.  | EXEMPTIONS  FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES | 77 |
|                                   | ITEM 16E.  | PURCHASES OF  EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS | 78 |
|                                   | ITEM 16F.  | CHANGE IN  REGISTRANT’S CERTIFYING ACCOUNTANT | 78 |
|                                   | ITEM 16G.  | CORPORATE GOVERNANCE | 78 |
| PART III                          |       |   | 79 |
|                                   | ITEM 17.   | FINANCIAL STATEMENTS | 79 |
|                                   | ITEM 18.   | FINANCIAL STATEMENTS | 79 |
|                                   | ITEM 19.   | EXHIBITS | 80 |

 

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**Table of Contents**

** **

**INTRODUCTION AND USE OF CERTAINTERMS**

** **

In this Form 20-F,references to the “United States” or to “US” are to the United States ofAmerica. You will find the words “we,” “our,” “us” and similar words or phrasesin this Form 20-F. We use those words to comply with the requirement ofthe US Securities and Exchange Commission to use “plain English” in publicdocuments like this Form 20-F. Each executive identified in this Form 20-Freports directly to other executives of the Company by whom the executive isemployed, or to the Company’s board of directors.

 

References to the“Company” or “Hydrogenics” herein refer to Hydrogenics Corporation, theRegistrant and references to “common shares” or “Shares” refer to common sharesof Hydrogenics.

 

**FORWARD LOOKING STATEMENTS**

** **

This Form 20-Fcontains certain “forward looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), which can beidentified by the use of forward-looking terminology such as  “anticipates,” “believes,” “continue,”“could,” “estimates,” “expects,” “intends,” “seeks,” “may,” “plans,”“potential,” “predicts,” “should,” “strategy” or “will,” or the negative orother variations of these words, or other comparable words or phrases. Webelieve the expectations reflected in our forward-looking statements arereasonable, although we cannot guarantee future results, levels of activity,performance, goals or achievements or other future events.  Our ability to successfully execute ourbusiness plan, which includes an increase in revenue, obtaining additionalfunding from potential investors or through non-traditional sources offinancing and actively managing our liquidity, will have a direct impact on ourbusiness, results of operations and financial condition, and if we are notsuccessful will exacerbate other risks and uncertainties. In addition, thefailure to maintain the listing requirements of the Nasdaq Global Market couldadversely affect our common share price and ability to raise additional funds.Forward-looking statements are subject to many risks and uncertainties thatcould cause actual results or events to differ materially from those anticipatedin our forward-looking statements.  Theserisks and uncertainties include, but are not limited to: our inability toincrease our revenues or raise additional funding to continue operations,execute our business plan, or to grow our business; our inability to address asustained or broad economic recession, and its impact on our business, resultsof operations and financial condition; our limited operating history; ourinability to implement our business strategy; fluctuations in our quarterly results;our failure to maintain our customer base that generates the majority of ourrevenues; currency fluctuations; our failure to maintain sufficient insurancecoverage; changes in value of our identifiable intangible assets; the failureof a significant market to develop for our products; the failure of hydrogenbeing readily available on a cost-effective basis; changes in governmentpolicies and regulations; the failure of uniform codes and standards forhydrogen-fuelled vehicles and related infrastructure to develop; our failure tocompete with other developers and manufacturers of products in our industry;our failure to compete with developers and manufacturers of traditional andalternative technologies; our failure to develop partnerships with originalequipment manufacturers, governments, systems integrators and other thirdparties; our inability to obtain sufficient materials and components for ourproducts from suppliers; our failure to manage expansion of our operations; ourfailure to manage foreign sales and operations; our failure to recruit, trainand retain key management personnel; our inability to integrate acquisitions;our failure to develop adequate manufacturing processes and capabilities; ourfailure to complete the development of commercially viable products; ourfailure to produce cost-competitive products; failure or delay in field testingof our products; our failure to produce products free of defects or errors; ourinability to adapt to technological advances or new codes and standards; ourfailure to protect our intellectual property; our involvement in intellectualproperty litigation; our exposure to product liability claims; our failure tomeet the listing requirements of the Nasdaq Global Market; the implementationof a share consolidation of our common shares; our failure to meet rules regardingpassive foreign investment companies; the actions of our significant andprincipal shareholders; dilution as a result of significant issuances of ourcommon shares and preferred shares; inability of U.S. investors to enforce U.S.civil liability judgments against us; the volatility of our common share price;and dilution as a result of the exercise of options.  Some of these factors are discussed in moredetail herein, including under “Item 3. Key Information — Risk Factors,”“Item 4. Information on the Company,” “Item 5. Operating andFinancial Review and Prospects, and “Item 14. Material Modifications to theRights of Security Holders and Use of Proceeds.”  Should one or more of these risks oruncertainties materialize, or should underlying assumptions prove incorrect,actual results may vary materially from those described in this Form 20-Fas anticipated, believed, estimated or expected. We provide the information inthis 20-F as of the date of its filing. We do not intend, and do not assume anyobligation, to update any information or forward looking statements set out inthis Form 20-F.

 

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** **

**PART I**

** **

**ITEM1.  IDENTITY OF DIRECTORS, SENIORMANAGEMENT AND ADVISERS**

** **

Not applicable.

 

**ITEM2.  OFFER STATISTICS AND EXPECTEDTIMETABLE**

** **

Not applicable.

 

**ITEM3.  KEY INFORMATION**

** **

**SELECTED FINANCIAL DATA**

** **

All financial datapresented in this Form 20-F with respect to the years ended December 31,2008, 2007 and 2006 are qualified in their entirety by reference to therelevant information in the consolidated financial statements and their notes.

 

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**HYDROGENICS CORPORATION****BALANCESHEETS****DATA**

 
| **(in thousands of US dollars,  except for share amounts)**  | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **ASSETS**                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Current Assets**                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                    |       | $          | 21,601     |       | $          | 15,460     |       | $          | 5,937      |       | $          | 5,394 |   | $ | 26,209 |   |
| Restricted cash                                              |       | 1,130      |       | —     |       | —     |       | —     |       | —     |       |
| Short-term investments                                       |       | —     |       | 15,032     |       | 54,350     |       | 80,396     |       | 62,853     |       |
| Accounts receivable (note 7*)                                |       | 3,974      |       | 12,713     |       | 9,740      |       | 7,733      |       | 5,223      |       |
| Grants receivable                                            |       | 505        |       | 850        |       | 1,901      |       | 1,909      |       | 2,437      |       |
| Inventories (note 8*)                                        |       | 10,101     |       | 12,659     |       | 12,718     |       | 8,685      |       | 4,324      |       |
| Prepaid expenses                                             |       | 1,161      |       | 1,077      |       | 1,539      |       | 2,353      |       | 1,400      |       |
|                                                         |       | 38,472     |       | 57,791     |       | 86,185     |       | 106,470    |       | 102,446    |       |
| **Deferred Charges****                                       |       | —     |       | —     |       | —     |       | —     |       | 1,030      |       |
| **Property, plant and equipment**(note 9*)                   |       | 4,082      |       | 4,847      |       | 5,435      |       | 5,682      |       | 5,286      |       |
| **Intangible assets**(note 10*)                              |       | —     |       | 249        |       | 500        |       | 33,972     |       | 3,878      |       |
| **Goodwill**(note 6*)                                        |       | 5,025      |       | 5,025      |       | 5,025      |       | 68,505     |       | 5,113      |       |
| **Other non-current assets**                                 |       | —     |       | 28         |       | 28         |       | 28         |       | 108        |       |
|                                                         | ** ** | **$**      | **47,579** | ** ** | **$**      | **67,940** |       | $          | 97,173     |       | $          | 214,657 |   | $ | 117,861 |   |
| **LIABILITIES**                                              |       |       |       |       |       |       |       |       |       |       |       |
| **Current Liabilities**                                      |       |       |       |       |       |       |       |       |       |       |       |
| Accounts payable and accrued liabilities (notes 11  and 18*) |       | $          | 17,298     |       | $          | 18,166     |       | $          | 21,380     |       | $          | 14,918 |   | $ | 6,635 |   |
| Unearned revenue                                             |       | 4,785      |       | 9,042      |       | 8,809      |       | 3,772      |       | 1,537      |       |
|                                                         |       | 22,083     |       | 27,208     |       | 30,189     |       | 18,690     |       | 8,172      |       |
| **Long-term debt**(note 12*)                                 |       | —     |       | 11         |       | 94         |       | 325        |       | 302        |       |
| **Deferred research and  development grants**                |       | 13         |       | 337        |       | 133        |       | 135        |       | 174        |       |
|                                                         |       | 22,096     |       | 27,556     |       | 30,416     |       | 19,150     |       | 8,648      |       |
| **Shareholders’ Equity**                                |       |       |       |       |       |       |       |       |       |       |       |
| Common Shares                                                |       | 307,000    |       | 306,872    |       | 307,376    |       | 306,957    |       | 187,282    |       |
| Warrants                                                     |       | —     |       | —     |       | —     |       | —     |       | 4,722      |       |
| Contributed surplus                                          |       | 16,300     |       | 15,606     |       | 13,718     |       | 11,847     |       | 2,155      |       |
| Deficit                                                      |       | (291,420   | )          | (277,101   | )          | (249,033   | )          | (118,274   | )          | (80,900    | )          |
| Accumulated other comprehensive loss                         |       | (6,397     | )          | (4,993     | )          | (5,304     | )          | (5,023     | )          | (4,046     | )          |
| Total deficit and accumulated other comprehensive  loss      |       | (297,817   | )          | (282,094   | )          | (254,337   | )          | (123,297   | )          | (84,946    | )          |
|                                                         |       | 25,483     |       | 40,384     |       | 66,757     |       | 195,507    |       | 109,213    |       |
|                                                         | ** ** | **$**      | **47,579** | ** ** | **$**      | **67,940** |       | $          | 97,173     |       | $          | 214,657 |   | $ | 117,861 |   |
| Weighted average number of shares                            |       | 92,080,656 |       | 91,797,911 |       | 91,816,049 |       | 91,226,912 |       | 63,542,811 |       |

 

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Note:

 

*                 With respect to the financial information for the years ended December 31,2008 and 2007, please see the relevant notes under the Notes to ConsolidatedFinancial Statements, which can be found on page F-10 of this form.

 

**          Direct andincremental transaction costs incurred in connection with the acquisition ofStuart Energy Systems Corporation incurred during 2004 were deferred as anon-current asset on the consolidated balance sheets until the completion ofthe transaction in 2005, at which time the costs were added to the purchaseprice.

 

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*** ***

**HYDROGENICS CORPORATION****STATEMENTSOF INCOME****DATA**

 
| **(in thousands of US dollars, except for share and per share  amounts)** | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **Revenues**                                                              |       | $          | 39,340     |       | $          | 37,990     |       | $          | 30,059     |       | $          | 37,191 |   | $ | 16,656 |   |
| **Cost of revenues**                                                      |       | 31,446     |       | 33,601     |       | 29,360     |       | 33,881     |       | 12,396     |       |
|                                                                      |       | 7,894      |       | 4,389      |       | 699        |       | 3,310      |       | 4,260      |       |
| **Operating expenses**                                                    |       |       |       |       |       |       |       |       |       |       |       |
| Selling, general and administrative                                       |       | 15,022     |       | 24,006     |       | 27,891     |       | 24,616     |       | 14,305     |       |
| Research and product development (note 14*)                               |       | 7,296      |       | 9,690      |       | 9,379      |       | 7,745      |       | 9,069      |       |
| Windup of test equipment business (note 5*)                               |       | —     |       | 2,016      |       | —     |       | —     |       | —     |       |
| Amortization of property, plant and equipment                             |       | 855        |       | 903        |       | 1,285      |       | 1,365      |       | 2,517      |       |
| Amortization of intangible assets                                         |       | 249        |       | 251        |       | 7,139      |       | 8,429      |       | 8,510      |       |
| Integration costs                                                         |       | —     |       | —     |       | —     |       | 1,123      |       | (77        | )          |
| Impairment of intangible assets and goodwill (notes  6 and 10*)           |       | —     |       | —     |       | 90,834     |       | —     |       | 3,693      |       |
|                                                                      |       | 23,422     |       | 36,866     |       | 136,528    |       | 43,278     |       | 38,017     |       |
|                                                                      |       |       |       |       |       |       |       |       |       |       |       |
| **Loss from operations**/ Loss from  continuing operations                |       | (15,528    | )          | (32,477    | )          | (135,829   | )          | (39,968    | )          | (33,757    | )          |
| **Other income** (expenses)                                               |       |       |       |       |       |       |       |       |       |       |       |
| Gain on sale of assets                                                    |       | 44         |       | —     |       | 477        |       | —     |       | —     |       |
| Loss on disposal of property, plant and equipment  (note 5*)              |       | —     |       | (308       | )          | —     |       | —     |       | —     |       |
| Provincial capital tax                                                    |       | 170        |       | (127       | )          | (42        | )          | (91        | )          | (260       | )          |
| Interest, net                                                             |       | 923        |       | 2,249      |       | 3,551      |       | 2,936      |       | 895        |       |
| Foreign currency gains (losses)                                           |       | 188        |       | 2,617      |       | 904        |       | (251       | )          | (333       | )          |
|                                                                      |       | 1,325      |       | 4,431      |       | 4,890      |       | 2,594      |       | 302        |       |
| **Loss before income taxes**                                              |       | (14,203    | )          | (28,046    | )          | (130,939   | )          | (37,374    | )          | (33,456    | )          |
| **Current income tax expense**(recovery)  (note 19*)                      |       | 116        |       | 22         |       | (180       | )          | —     |       | 84         |       |
| **Net loss for the year**                                                 |       | $          | (14,319    | )          | $          | (28,068    | )          | $          | (130,759   | )          | (37,374    | ) | (33,539 | ) |
| ** **                                                                |       |       |       |       |       |       |       |       |       |       |       |
| **Net loss per share**/ Net loss  from continuing operations per share    |       |       |       |       |       |       |       |       |       |       |       |
| Basic and diluted (note 20*)                                              |       | $          | (0.16      | )          | $          | (0.31      | )          | $          | (1.42      | )          | $          | (0.41 | ) | $ | (0.53 | ) |
| Shares used in calculating basic and diluted net  loss per share          |       | 92,080,656 |       | 91,797,911 |       | 91,816,049 |       | 91,226,912 |       | 63,542,811 |       |

 

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Note:

 

*      With respect to the financial information for theyears ended December 31, 2008, 2007 and 2006, please see therelevant notes under the Notes to Consolidated Financial Statements, which canbe found on page F-10 of this form.

 

We have never declared orpaid any cash dividends on our common shares.

 

The financial informationin this Form 20-F has been prepared in accordance with Canadian generallyaccepted accounting practices (“GAAP”).  Certainfinancial information under US GAAP are as follows:

 

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| **(in thousands of US dollars, except for share and per share  amounts)**           | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Revenues                                                                            |       | $          | 39,340     |       | $          | 37,990     |       | $          | 30,059     |       | $          | 37,191 |   | $ | 16,656 |   |
| Loss from operations                                                                |       | $          | (15,440    | )          | $          | (32,477    | )          | $          | (120,058   | )          | $          | (55,739 | ) | $ | (33,780 | ) |
| Loss from continuing operations                                                     |       | $          | (15,440    | )          | $          | (32,477    | )          | $          | (120,058   | )          | $          | (55,739 | ) | $ | (33,780 | ) |
| Net loss for the year                                                               |       | $          | (14,231    | )          | $          | (28,068    | )          | $          | (114,988   | )          | $          | (53,145 | ) | $ | (33,562 | ) |
| Total assets                                                                        |       | $          | 47,579     |       | $          | 67,940     |       | $          | 97,173     |       | $          | 198,881 |   | $ | 117,861 |   |
| Net assets                                                                          |       | $          | 25,571     |       | $          | 40,384     |       | $          | 66,757     |       | $          | 179,736 |   | $ | 109,213 |   |
| Shareholders’ Equity                                                           |       | $          | 25,571     |       | $          | 40,384     |       | $          | 66,757     |       | $          | 179,736 |   | $ | 109,213 |   |
|                                                                                |       |       |       |       |       |       |       |       |       |       |       |
| Basic and fully diluted comprehensive net loss per  share                           |       | $          | (0.15      | )          | $          | (0.31      | )          | $          | (1.26      | )          | $          | (0.59 | ) | $ | (0.53 | ) |
| Weighted average number of shares used in  calculating comprehensive loss per share |       | 92,080,656 |       | 91,797,911 |       | 91,816,049 |       | 91,226,912 |       | 63,542,811 |       |

 

For a reconciliation ofcertain additional financial information, see “Note  23 — Differences Between Canadian and UnitedStates Accounting Principles” under the Notes to Consolidated FinancialStatements, which can be found on page F-30 of this form, and is incorporated byreference herein.

 

**CAPITALIZATION AND INDEBTEDNESS**

** **

Not applicable.

 

**REASONS FOR THE OFFER AND USE OF PROCEEDS**

** **

Not applicable.

 

**RISK FACTORS**

** **

**Risk Factors Related toOur Financial Condition**

** **

***If we areunsuccessful in increasing our revenues or raising additional funding, we maypossibly cease to continue as we currently do.***

*** ***

Although our consolidatedfinancial statements for the year ended December 31, 2008 have beenprepared on a going concern basis, which contemplates the realization of assetsand liquidation of liabilities during the normal course of operations, ourability to continue as a going concern is dependent on the successful executionof the Company’s business plan, which includes an increase in revenue andadditional funding to be provided by potential investors as well asnon-traditional sources of financing.

 

We have sustained lossesand negative cash flows from operations since our inception. We expect thatthis will continue throughout 2009. If we do not raise additional capitalbefore 2010, we do not expect our operations to generate sufficient cash flowto fund our obligations as they come due. On June 12, 2009, we announced that we ***enteredinto an agreement with the trustees (the “Algonquin Board”) of Algonquin PowerIncome Fund (“Algonquin Power”) to implement a non-dilutive financingtransaction that will provide us with working capital, and which is describedin more detail below under***“Item 4.  Information of the Company — History andDevelopment of Hydrogenics Corporation.” The transaction is subject to variousconditions, including the receipt of regulatory approvals, such as the approvalof The Toronto Stock Exchange (the “TSX”) and Nasdaq Global Select Market (“Nasdaq”),  approval by the Ontario Superior Court ofJustice and by shareholders of Hydrogenics. The transaction is also subject toapproval by unitholders of Algonquin Power with respect to certain amendmentsto Algonquin Power’s declaration of trust in connection with the transaction,and Algonquin Power unitholders tendering the requisite number of units to thetake-over bid to be made by Hydrogenics in connection with the transaction.

 

Additional funding may bein the form of debt or equity or a hybrid instrument depending on the needs ofthe investor. Given the prevailing global economic and credit marketconditions, we may not be able to raise additional cash resources through thesetraditional sources of financing. Although we are also investigating non-traditionalsources of financing, the global credit market crisis has also adverselyaffected the ability of potential parties to pursue such transactions. We donot believe that the ability to access 

 

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capital markets orthese adverse conditions are likely to improve significantly in the nearfuture. Accordingly, we may have to pursue a combination of operating andrelated initiatives, such as further restructurings and/or asset sales.

 

There can be noassurances that we will achieve profitability or positive cash flows or be ableto obtain additional funding or that, if obtained, they will be sufficient, orwhether any other initiatives will be successful, such that we may continue asa going concern. There are material uncertainties related to certain adverseconditions and events that cast significant doubt on the validity of thisassumption.

 

***Our inability togenerate sufficient cash flows, raise additional capital and actively manageour liquidity may impair our ability to execute the Company’s business plan,and result in our reducing or eliminating product development andcommercialization efforts, reduce our sales and marketing efforts, and havingto forego attractive business opportunities.***

*** ***

At December 31,2008, we had approximately $22.7 million of cash and cash equivalents andrestricted cash (March 31, 2009 - $15.7 million). There are uncertaintiesrelated to the timing and use of our cash resources and working capitalrequirements. These uncertainties include, among other things, the timing andvolume of commercial sales and associated gross margins of our existingproducts and the development of markets for, and customer acceptance of newproducts. Due to these and other factors, many of which are outside of ourcontrol, we may not be able to accurately predict our necessary cashexpenditures or obtain financing in a timely manner to cover any shortfalls.

 

If we are unable togenerate sufficient cash flows or obtain adequate additional financing, whichgiven the current global economy and credit markets is challenging, we may beunable to respond to the actions of our competitors or we may be prevented fromexecuting the Company’s business plan, or conducting all or a portion of ourplanned operations. In particular, the development and commercialization of ourproducts could be delayed or discontinued if we are unable to fund our researchand product development activities or the development of our manufacturingcapabilities. In addition, we may be forced to reduce our sales and marketingefforts or forego attractive business opportunities.

 

***A sustained andbroad economic recession could continue to have a negative impact on ourbusiness, results of operations and financial condition, or our ability toaccurately forecast our results, and it may cause a number of the risks that wecurrently face to increase in likelihood, magnitude and duration.***

*** ***

Macro-level changes inthe global economy began to affect our business in the fourth quarter of 2008.Operationally, we experienced a delay in closing orders and, in one case, adelay in a shipment as a result of a customer not being able to pay for thebalance of an order. Financially, we experienced more challenging conditions asa result of weaker capital markets worldwide and anticipate this may adverselyalter our ability to raise capital on favourable terms and could change theterms of our credit facility.

 

The condition of thecurrent global economy and credit markets affect our outlook in two primaryways. First, our products depend, to some degree, on general world economicconditions and activity. If the current condition of the economy results in asustained broad economic recession, demand for our products is likely todecline. Secondly, the current economic and credit climate could adverselyaffect our ability to conduct normal day-to-day selling activities which dependon the granting of short-term credit to a wide variety of purchasers andparticularly the corresponding need of those purchasers to finance purchases byaccessing credit. Our business is dependent on purchasers of our productshaving access to adequate levels of credit. If the current condition of theeconomy is not resolved in a manner that will provide access to credit topotential purchasers of our products, our business will likely suffer as a result.

 

With a sustained orexpanding economic downturn, we expect that we will continue to experiencesignificant difficulties on a number of fronts, depending upon the duration andseverity of these events. As a result, we may face new risks as yet unidentified,and a number of risks that we ordinarily face and that are further describedherein may increase in likelihood, magnitude and duration. These risks includebut are not limited to deferrals or reductions of customer orders, potentialdeterioration of our customers’ ability to finance purchases, reduced revenue,further deterioration in our cash balances and liquidity due to foreignexchange impacts, and an inability to access capital markets. The financialcrisis and economic downturn will also reduce our ability to accuratelyforecast our performance, results or cash position.

 

***We have a limitedoperating history, and because our mix of revenues in the recent past does notreflect our current business strategy, it may be difficult to assess our businessand future prospects.***

*** ***

We commenced operationsof our fuel cell test business in 1996 and since that time we have been engagedprincipally in the manufacture and sale of fuel cell test and diagnosticequipment, the provision of related engineering and testing services, andresearch and product development relating to fuel cell systems and subsystems.For the year ended December 31, 2008, we derived $31.2 million, or 79%, ofrevenues from our sales of hydrogen generation products and services, $5.6 million,or 15%, of our revenues from sales of power products and services, and $2.5million, or 6%, of our revenues from sales of fuel cell test equipment andservices. For the year ended December 31, 2007, we derived $19.6 million,or 52%, of revenues from our sales of hydrogen generation products andservices, $6.1 million, or 16%, of our revenues from sales of power productsand services, and $12.3 million, or 32%, of our revenues from sales of fuelcell test equipment and services. For the year ended December 31, 2006, wederived $12.0 million, or 40%, of our revenues from sales of hydrogengeneration products and services, $7 million, or 23%, of our revenues fromsales of power products 

 

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and services, and$11.1 million, or 37%, of our revenues from sales of fuel cell test equipmentand services. On November 7, 2007, we announced our decision to commencean orderly windup of our fuel cell test products design, development andmanufacturing business, which is anticipated to take up to two years tocomplete. Our current business strategy is to develop, manufacture and sellfuel cell power products in larger quantities. In addition, following ouracquisition of Stuart Energy Systems Corporation (“Stuart Energy”) in January 2005,a significant part of our business now relates to hydrogen generation products.Because we have made limited sales of fuel cell power products to date and haveadded a new revenue stream with our hydrogen generation business, ourhistorical operating data may be of limited value in evaluating our futureprospects.

 

***Because we expectto continue to incur net losses, we may not be able to implement our businessstrategy, and the price of our common shares may decline.***

*** ***

We have not generatedpositive net income since our inception. Our current business strategy is todevelop a portfolio of hydrogen and fuel cell products with market leadershippositions for each product. In so doing, we will continue to incur significantexpenditures for general administrative activities, including sales andmarketing and research and development. As a result of these costs, we willneed to generate and sustain significantly higher revenues and positive grossmargins to achieve and sustain profitability. We incurred a net loss of $14.2million for the year ended December 31, 2008, a net loss of $28.1 millionfor the year ended December 31, 2007, and a net loss of $130.8 million forthe year ended December 31, 2006. Our accumulated deficit as of December 31,2008 was $291.4 million, as of December 31, 2007 was $277.1 million and asof December 31, 2006 was $249 million.

 

We expect to incursignificant operating expenses over the next several years. As a result, weexpect to incur further losses in 2009 and 2010, and we may never achieveprofitability. Accordingly, we may not be able to implement our businessstrategy, and the price of our common shares may decline.

 

***Our quarterlyoperating results are likely to fluctuate significantly and may fail to meetthe expectations of securities analysts and investors, and cause the price ofour common shares to decline.***

*** ***

Our quarterly revenuesand operating results have varied significantly in the past and are likely tovary in the future.  These quarterlyfluctuations in our operating performance result from the length of timebetween our first contact with a customer and the recognition of revenue fromsales to that customer.  Our products arehighly engineered and many are still in development stages; therefore, thelength of time between approaching a customer and delivering our products tothat customer can span many quarterly periods. In many cases a customer’s decision to buy our products and services mayrequire the customer to change its established business practices and toconduct its business in new ways.  As aresult, we must educate customers on the use and benefits of our products andservices. This can require us to commit significant time and resources withoutnecessarily generating any revenues. Many potential customers may wish to enter into test arrangements withus in order to use our products and services on a trial basis.  The success of these trials may determinewhether or not the potential customer purchases our products or services on acommercial basis.  Potential customersmay also need to obtain approval at a number of management levels and one ormore regulatory approvals. This may delay a decision to purchase our products.

 

The length andvariability of the sales cycles for our products make it difficult to forecastaccurately the timing and amount of specific sales and corresponding revenuerecognition.  The delay or failure tocomplete one or more large sales transactions could significantly reduce ourrevenues for a particular quarter. We may expend substantial funds andmanagement effort during our sales cycle with no assurance that we willsuccessfully sell our products.  As aresult, our quarterly operating results are likely to fluctuate significantlyand we may fail to meet expectations of securities analysts and investors, andthe price of our common shares may decline.

 

***We currentlydepend upon a relatively limited number of customers for a majority of ourrevenues and a decrease in revenue from these customers could materiallyadversely affect our business, financial condition and results of operations.***

*** ***

To date, a relativelylimited number of customers have accounted for a majority of our revenues andwe expect they will continue to do so for the foreseeable future. Our fourlargest customers accounted for 35% of our revenues for the year ended December 31,2008, 26% of our revenues for the year ended December 31, 2007 and 31% ofour revenues for the year ended December 31, 2006. The identities of someof our largest customers have changed from year to year. Our arrangements withthese customers are generally non-exclusive, have no volume commitments and areoften on a purchase-order basis. We cannot be certain that customers that haveaccounted for significant revenue in past periods will continue to purchase ourproducts and generate revenues. Accordingly, our revenue and results ofoperations may vary from period to period. We are also subject to credit riskassociated with the concentration of our accounts receivable from thesesignificant customers. If one or more of these significant customers were tocease doing business with us, significantly reduce or delay purchases from us,or fail to pay on a timely basis, our business, financial condition and resultsof operations could be materially adversely affected.

 

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***Our operatingresults may be subject to currency fluctuation.***

*** ***

Our monetary assets andliabilities denominated in currencies other than the functional currency willgive rise to a foreign currency gain or loss reflected in earnings.  To the extent that the Canadian dollar or theeuro strengthen against the U.S. dollar, we may incur net foreign exchangeslosses on our net monetary asset balance which is denominated in thosecurrencies.  Such losses would be includedin our financial results and, consequently, may have an adverse effect on ourshare price.

 

As we currently haveoperations based in Canada and Europe, a significant portion of our expensesare in Canadian dollars and euros. However, a significant part of our revenues are currently generated inU.S. dollars and euros, and we expect that this will continue for theforeseeable future.  In addition, we maybe required to finance our European operations by exchanging Canadian dollarsor U.S. dollars into euros.  The exchangerates between the Canadian dollar, the U.S. dollar and the euro are subject todaily fluctuations in the currency markets and these fluctuations in marketexchange rates are expected to continue in the future.  Such fluctuations affect both ourconsolidated revenues as well as our consolidated costs.  If the value of the US dollar weakens againstthe Canadian dollar or the euro, the profit margin on our products may bereduced.  Also, changes in foreignexchange rates may affect the relative costs of operations and prices at whichwe and our foreign competitors sell products in the same market.  We currently have limited currency hedgingthrough financial instruments.  We carrya portion of our short-term investments in Canadian dollars and euros.

 

***Our insurance maynot be sufficient.***

*** ***

We carry insurance thatwe consider adequate having regard to the nature of the risks and costs ofcoverage.  We may not, however, be ableto obtain insurance against certain risks or for certain products or other resourceslocated from time to time in certain areas of the world.  We are not fully insured against all possiblerisks, nor are all such risks insurable. Thus, although we maintain insurance coverage, such coverage may not beadequate.

 

***Certain externalfactors may affect the value of goodwill, which may require us to recognize animpairment charge.***

*** ***

Goodwill arising from ouracquisition of Stuart Energy in 2005 comprise approximately 10.6% of our totalassets as at December 31, 2008 and 8% of our total assets as at December 31,2007.  Economic, market, legal,regulatory, competitive, customer, contractual and other factors may affect thevalue of identifiable intangible assets and goodwill.  If any of these factors impair the value ofthese assets, accounting rules require us to reduce their carrying valueand recognize an impairment charge. This would reduce our reported assets andearnings in the year the impairment charge is recognized.

** **

**Risk Factors Related toOur Business and Industry**

** **

***Significantmarkets for fuel cell and other hydrogen energy products may never develop ormay develop more slowly than we anticipate, which would significantly harm ourrevenues and may cause us to be unable to recover the losses we have incurredand expect to incur in the development of our products.***

*** ***

Significant markets maynever develop for fuel cell and other hydrogen energy products or they maydevelop more slowly than we anticipate. Any such delay or failure would significantly harm our revenues and wemay be unable to recover the losses we have incurred and expect to continue toincur in the development of our products. If this were to occur, we may never achieve profitability and ourbusiness could fail.  Fuel cell and otherhydrogen energy products represent an emerging market, and whether or notend-users will want to use them may be affected by many factors, some of whichare beyond our control, including:

 

·                  the emergence of more competitivetechnologies and products, including other environmentally clean technologiesand products that could render our products obsolete;

 

·                  the future cost of hydrogen and otherfuels used by our fuel cell systems;

 

·                  the future cost of membrane electrodeassembly used in our fuel cell systems;

 

·                  the future cost of platinum group metals,a key catalyst used in our fuel cell and hydrogen generation systems;

 

·                  the regulatory requirements of agencies,including the development of uniform codes and standards for fuel cellproducts, hydrogen refueling infrastructure and other hydrogen energy products;

 

·                  government support by way of legislation,tax incentives, policies or otherwise, of fuel cell technology, hydrogenstorage technology and hydrogen refueling technology;

 

·                  the manufacturing and supply costs forfuel cell components and systems;

 

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·                  the perceptions of consumers regardingthe safety of our products;

 

·                  the willingness of consumers to try newtechnologies;

 

·                  the continued development and improvementof existing power technologies; and

 

·                  the future cost of fuels used in existingtechnologies.

 

***Hydrogen may notbe readily available on a cost-effective basis, in which case our fuel cellproducts ma***y be***unable to compete with existing power sources, and ourrevenues and results of operations would be materially adversely affected.***

*** ***

If our fuel cell productcustomers are not able to obtain hydrogen on a cost-effective basis, we may beunable to compete with existing power sources, and our revenues and results ofoperations would be materially adversely affected.  Our fuel cell products require oxygen andhydrogen to operate.  While ambient aircan typically supply the necessary oxygen, our fuel cells rely on hydrogenderived from water or from fuels such as natural gas, propane, methanol and otherpetroleum products.  We manufacture anddevelop hydrogen generation systems called electrolyzers that use electricityto separate water into its constituent parts of hydrogen and oxygen.  In addition, third parties are developingsystems to extract, or reform, hydrogen from fossil fuels.  Significant growth in the use ofhydrogen-powered devices, particularly in the mobile market, may require thedevelopment of an infrastructure to deliver the hydrogen.  There is no guarantee that such aninfrastructure will be developed on a timely basis or at all.  Even if hydrogen is available for ourproducts, if its price is such that electricity or power produced by oursystems would cost more than electricity provided through other means, we maybe unable to compete successfully.

 

***Changes ingovernment policies and regulations could hurt the market for our products.***

*** ***

The fuel cell andhydrogen industry is in its development phase and is not currently subject toindustry-specific government regulations in Canada, the European Union and theUnited States as well as other jurisdictions, relating to matters such asdesign, storage, transportation and installation of fuel cell systems andhydrogen infrastructure products. However, given that the production of electrical energy has typicallybeen an area of significant government regulation, we expect that we willencounter industry-specific government regulations in the future in thejurisdictions and markets in which we operate. For example, regulatory approvals or permits may be required for thedesign, installation and operation of stationary fuel cell systems underfederal, state and provincial regulations governing electric utilities andmobile fuel cell systems under federal, state and provincial emissionsregulations affecting automobile manufacturers. To the extent that there are delays in gaining such regulatory approval,our development and growth may be constrained. Furthermore, the inability of our potential customers to obtain apermit, or the inconvenience often associated with the permit process, couldharm demand for fuel cell and other hydrogen products and, therefore, harm ourbusiness.

 

Our business will sufferif environmental policies change and no longer encourage the development andgrowth of clean power technologies.  Theinterest by automobile manufacturers in fuel cell technology has been driven inpart by environmental laws and regulations. There is no guarantee that theselaws and regulations will not change and any such changes could result inautomobile manufacturers abandoning their interest in fuel cell poweredvehicles.  In addition, if current lawsand regulations are not kept in force or if further environmental laws andregulations are not adopted, demand for vehicular fuel cells may be limited.

 

The market for stationaryand portable energy-related products is influenced by federal, state andprovincial governmental regulations and policies concerning the electricutility industry.  Changes in regulatorystandards or public policy could deter further investment in the research anddevelopment of alternative energy sources, including fuel cells and fuel cellproducts, and could result in a significant reduction in the potential marketdemand for our products.  We cannotpredict how changing government regulation and policies regarding the electricutility industry will affect the market for stationary and portable fuel cellsystems.

 

Although the developmentof alternative energy sources, and in particular fuel cells, has beenidentified as a significant priority by many governments, we cannot be assuredthat governments will not change their priorities or that any such change wouldnot materially affect our revenues and our business.  If governments change their laws andregulations such that the development of alternative energy sources is nolonger required or encouraged, the demand for alternative energy sources suchas our fuel cell products may be significantly reduced or delayed and our saleswould decline.

 

***The development ofuniform codes and standards for hydrogen powered vehicles and related hydrogenrefueling infrastructure may not develop in a timely fashion, if at all.***

*** ***

Uniform codes andstandards do not currently exist for fuel cell systems, fuel cell components,hydrogen internal combustion engines or for the use of hydrogen as a vehiclefuel.  Establishment of appropriate codesand standards is a critical element to allow fuel cell system developers, fuelcell component developers, hydrogen internal combustion engine developers,hydrogen infrastructure companies and hydrogen storage and handling companiesto develop products that will be accepted in the marketplace.

 

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The development ofhydrogen standards is being undertaken by numerous organizations.  Given the number of organizations pursuinghydrogen codes and standards, it is not clear whether universally acceptedcodes and standards will result in a timely fashion, if at all.

 

***We currently faceand will continue to face significant competition from other developers andmanufacturers of fuel cell power products and hydrogen generation systems.  If we are unable to compete successfully, wecould experience a loss of market share, reduced gross margins for our existingproducts and a failure to achieve acceptance of our proposed products.***

*** ***

In our markets forhydrogen generation systems, we compete with a number of companies that developand manufacture hydrogen generation products based on on-site waterelectrolysis and/or reforming technologies. We also compete with suppliers of hydrogen gas that deliver hydrogen tothe customer’s site in tube trailers or bottles or by pipeline.  In many cases, these suppliers haveestablished delivery infrastructure and customer relationships.

 

In the commercialproduction of fuel cell power products, we compete with a number of companiesthat currently have fuel cell and fuel cell system development programs.  We expect that several of these competitorswill be able to deliver competing products to certain markets before we do.  While our strategy is the development of fuelcell and hydrogen generation technologies for sale to end users, originalequipment manufacturers (“OEMs”), systems integrators, governments and marketchannel partners, many of our competitors are developing products specificallyfor use in particular markets.  Thesecompetitors may be more successful in penetrating their specific markets thanwe are.  In addition, an increase in thepopularity of fuel cell power in particular market channels may cause certainof our customers to develop and produce some or all of the fuel celltechnologies that we are developing.

 

Competition in themarkets for fuel cell power modules and hydrogen generation equipment issignificant and will likely persist and intensify over time.  We compete directly and indirectly with anumber of companies that provide products and services that are competitivewith all, some or part of our products and related services.  Many of our existing and potentialcompetitors have greater brand name recognition and their products may enjoygreater initial market acceptance among our potential customers.  In addition, many of these competitors havesignificantly greater financial, technical, sales, marketing, distribution,service and other resources than we have and may also be better able to adaptquickly to customers’ changing demands and to changes in technology.

 

If we are unable tocontinuously improve our products and if we cannot generate effective responsesto our competitors’ brand power, product innovations, pricing strategies,marketing campaigns, partnerships, distribution channels, service networks andother initiatives, our ability to gain market share or market acceptance forour products could be limited, our revenues and our profit margins may suffer,and we may never become profitable.

 

***We face competitionfor fuel cell power products from developers and manufacturers of traditionaltechnologies and other alternative technologies.***

*** ***

Each of our targetmarkets is currently served by existing manufacturers with existing customersand suppliers.  These manufacturers useproven and widely accepted traditional technologies such as internal combustionengines and turbines, as well as coal, oil, gas and nuclear powered generators.Additionally, there are competitors working on developing technologies that useother types of fuel cells and other alternative power technologies, advancedbatteries and hybrid battery/internal combustion engines, which may compete forour target customers.  Given that protonexchange membrane (“PEM”) fuel cells have the potential to replace theseexisting power sources, competition in our target markets will also come fromthese traditional power technologies, from improvements to traditional powertechnologies and from new alternative power technologies, including other typesof fuel cells.

 

If we are unable tocontinuously improve our products and if we cannot generate effective responsesto incumbent and/or alternative energy competitors’ brand power, productinnovations, pricing strategies, marketing campaigns, partnerships, distributionchannels, service networks and other initiatives, our ability to gain marketshare or market acceptance for our products could be limited, our revenues andour profit margins may suffer, and we may never become profitable.

 

***Our strategy forthe sale of fuel cell power products depends upon developing partnerships withOEMs and governments, systems integrators, suppliers and other market channelpartners who will incorporate our products into theirs.***

*** ***

Other than in a fewspecific markets, our strategy is to develop and manufacture products andsystems for sale to OEMs and governments, systems integrators,  suppliers and other market channel partnersthat have mature sales and distribution networks for their products.  Our success may be heavily dependent upon ourability to establish and maintain relationships with these partners who willintegrate our fuel cell products into their products and on our ability to findpartners who are willing to assume some of the research and development costsand risks associated with our technologies and products.  Our performance may, as a result, depend onthe success of other companies, and there are no assurances of theirsuccess.  We can offer no guarantee thatOEMs and governments, systems integrators, suppliers and other market channelpartners will manufacture appropriate products or, if they do manufacture suchproducts, that they will choose to use our products as components.  The end products into which our fuel cell technologywill be 

 

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incorporated willbe complex appliances comprising many components and any problems encounteredby such third parties in designing, manufacturing or marketing their products,whether or not related to the incorporation of our fuel cell products, coulddelay sales of our products and adversely affect our financial results.  Our ability to sell our products to the OEMmarkets depends to a significant extent upon our partners’ worldwide sales anddistribution networks and service capabilities. In addition, some of our agreements with customers and partners requireus to provide shared intellectual property rights in certain situations, andthere can be no assurance that any future relationships that we enter into willnot require us to share some of our intellectual property.  Any change in the fuel cell, hydrogen oralternative fuel strategies of one of our partners could have a materialadverse effect on our business and our future prospects.

 

In addition, in somecases, our relationships are governed by a non-binding memorandum ofunderstanding or a letter of intent.  Wecannot assure you that we will be able to successfully negotiate and executedefinitive agreements with any of these partners, and failure to do so mayeffectively terminate the relevant relationship.  We also have relationships with third partydistributors who also indirectly compete with us.  For example, we have targeted industrial gassuppliers as distributors of our hydrogen generators.  Because industrial gas suppliers currentlysell hydrogen in delivered form, adoption by their customers of our hydrogengeneration products could cause them to experience declining demand fordelivered hydrogen.  For this reason,industrial gas suppliers may be reluctant to purchase our hydrogengenerators.  In addition, our third partydistributors may require us to provide volume price discounts and otherallowances, or customize our products, either of which could reduce thepotential profitability of these relationships.

 

***We are dependentupon third party suppliers for key materials and components for ourproducts.  If these suppliers becomeunable or unwilling to provide us with sufficient materials and components on atimely and cost-effective basis, we may be unable to manufacture our productscost-effectively or at all, and our revenues and gross margins would suffer.***

*** ***

We rely upon third partysuppliers to provide key materials and components for our fuel cell power products, hydrogen generation products andfuel cell test equipment.  A supplier’sfailure to provide materials or components in a timely manner, or to providematerials and components that meet our quality, quantity or cost requirements,or our inability to obtain substitute sources for these materials andcomponents in a timely manner or on terms acceptable to us, may harm ourability to manufacture our products cost-effectively or at all, and ourrevenues and gross margins might suffer. To the extent that we are unable to develop and patent our owntechnology and manufacturing processes, and to the extent that the processesthat our suppliers use to manufacture materials and components are proprietary,we may be unable to obtain comparable materials or components from alternativesuppliers, and that could adversely affect our ability to produce commerciallyviable products.

 

***We may not be ableto manage successfully the expansion of our operations.***

*** ***

The uneven pace of ourexpansion in facilities, staff and operations has placed serious demands on ourmanagerial, technical, financial and other resources.  We may be required to make seriousinvestments in our engineering and logistics systems and our financial andmanagement information systems, as well as retaining, motivating andeffectively managing our employees.  Ourmanagement skills and systems currently in place may not enable us to implementour strategy or to attract and retain skilled management, engineering andproduction personnel.  Our failure tomanage our growth effectively or to implement our strategy in a timely mannermay significantly harm our ability to achieve profitability.

 

***If we do notproperly manage foreign sales and operations, our business could suffer.***

*** ***

We expect that asubstantial portion of our future revenues will continue to be derived fromforeign sales.  Our internationalactivities may be subject to inherent risks, including regulatory limitationsrestricting or prohibiting the provision of our products and services,unexpected changes in regulatory requirements, tariffs, customs, duties andother trade barriers, difficulties in staffing and managing foreign operations,longer payment cycles, problems in collecting accounts receivable, fluctuationsin currency exchange rates, foreign exchange controls that restrict or prohibitrepatriation of funds, technology export and import restrictions orprohibitions, delays from customs brokers or government agencies, seasonalreductions in business activity and potentially adverse tax consequencesresulting from operating in multiple jurisdictions.  As a result, if we do not properly manageforeign sales and operations, our business could suffer.

 

***We will need torecruit, train and retain key management and other qualified personnel tosuccessfully expand our business.***

*** ***

Our future success willdepend in large part upon our ability to recruit and retain experiencedresearch and development, engineering, manufacturing, operating, sales andmarketing, customer service and management personnel.  We compete in young markets and there are alimited number of people with the appropriate combination of skills needed toprovide the services that our customers require.  In the past, we have experienced difficultyin recruiting qualified personnel and we expect to experience continueddifficulties in personnel recruiting.  Ifwe do not attract such personnel, we may not be able to expand our business. Inaddition, new employees generally require substantial training, which requiressignificant resources and management attention. Our success also 

 

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depends upon retainingour key management, research, product development, engineering, marketing andmanufacturing personnel. Even if we invest significant resources to recruit,train and retain qualified personnel, we may not be successful in our efforts.

 

***We may acquiretechnologies or companies in the future, and these acquisitions could disruptour business and dilute our shareholders’ interests.***

*** ***

We may acquire additionaltechnologies or other companies in the future and we cannot provide assurancesthat we will be able to successfully integrate their operations or that thecost savings we anticipate will be fully realized.  Entering into an acquisition or investmententails many risks, any of which could materially harm our business, including:

 

·                  diversionof management’s attention from other business concerns;

 

·                  failureto effectively assimilate our acquired technology, employees or other assetsinto our business;

 

·                  theloss of key employees from either our current business or the acquired business;and

 

·                  assumptionof significant liabilities of the acquired company.

 

If we complete additionalacquisitions, we may dilute the ownership of current shareholders.  In addition, achieving the expected returnsand cost savings from our past and future acquisitions will depend in part uponour ability to integrate the products and services, technologies, research anddevelopment programs, operations, sales and marketing functions, finance,accounting and administrative functions, and other personnel of thesebusinesses into our business in an efficient and effective manner.  We cannot ensure that we will be able to doso or that the acquired businesses will perform at anticipated levels.  If we are unable to successfully integrateacquired businesses, our anticipated revenues may be lower and our operationalcosts may be higher.

 

***We have noexperience manufacturing our products on a large scale basis, and if we do notdevelop adequate manufacturing processes and capabilities to do so in a timelymanner, we will be unable to achieve our growth and profitability objectives.***

*** ***

We have manufactured mostof our products for prototypes and initial sales, and we have limitedexperience manufacturing products on a larger scale.  In order to produce certain of our productsat affordable prices we will have to manufacture a large volume of suchproducts.  We do not know when or whetherwe will be able to develop efficient, low-cost manufacturing capabilities andprocesses that will enable us to meet the quality, price, engineering, designand production standards or production volumes required to successfully massmarket such products.  Even if we aresuccessful in developing our manufacturing capabilities and processes, we do notknow whether we will do so in time to meet our product commercializationschedule or to satisfy the requirements of our customers and the market.  Our failure to develop these manufacturingprocesses and capabilities in a timely manner could prevent us from achievingour growth and profitability objectives.

 

**Risk Factors Related toOur Products and Technology**

** **

***We may nevercomplete the development of commerci***allyviable fuel cell power products and/or commercially viable hydrogen generationsystems for new hydrogen energy applications, and if we fail to do so, we willnot be able to meet our business and growth objectives.******

*** ***

We have made commercialsales of hydrogen generation, fuel cell test and diagnostic equipment, fuelcell power modules, integrated fuel cell systems and hydrogen refueling stationsfor a relatively short period of time. Because both our business and industry are still in the developmentalstage, we do not know when or whether we will successfully complete researchand development of commercially viable fuel cell power products andcommercially viable hydrogen generation equipment for new hydrogen energyapplications.  If we do not complete thedevelopment of such commercially viable products, we will be unable to meet ourbusiness and growth objectives.  Weexpect to face unforeseen challenges, expenses and difficulties as a developingcompany seeking to design, develop and manufacture new products in each of ourtargeted markets.  Our future successalso depends upon our ability to effectively market fuel cell products and hydrogengeneration products once developed.

 

***We must lower thecost of our fuel cell and hydrogen generation products and demonstrate theirreliability, or consumers will be unlikely to purchase our products and we willtherefore not generate sufficient revenues to achieve and sustainprofitability.***

*** ***

Fuel cells currently costmore than many established competing technologies, such as internal combustionengines and batteries.  The prices offuel cell and hydrogen generation products are dependent largely upon materialand manufacturing costs.  We cannotguarantee that we will be able to lower these costs to a level where we will beable to produce a competitive product or that any product we produce usinglower cost materials and manufacturing processes will not suffer from lowerperformance, reliability and longevity. If we are unable to produce fuel cell and hydrogen generation productsthat are competitive with other technologies in terms of price, performance,reliability and longevity, consumers will be unlikely to buy our fuel cell andhydrogen generation products. Accordingly, we would not be able to generate sufficient revenues withpositive gross margins to achieve and sustain profitability.

 

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***Any failures ordelays in field tests of our products could negatively affect our customerrelationships and increase our manufacturing costs.***

*** ***

We regularly field test ourproducts and we plan to conduct additional field tests in the future.  Any failures or delays in our field testscould harm our competitive position and impair our ability to sell ourproducts.  Our field tests may encounterproblems and delays for a number of reasons, including the failure of ourtechnology, the failure of the technology of others, the failure to combinethese technologies properly, operator error and the failure to maintain andservice the test prototypes properly. Many of these potential problems and delays are beyond our control.  In addition, field test programs, by theirnature, may involve delays relating to product roll-out and modifications toproduct design, as well as third party involvement.  Any problem or perceived problem with ourfield tests, whether it originates from our technology, our design, or thirdparties, could hurt our reputation and the reputation of our products and limitour sales.  Such field test failures maynegatively affect our relationships with customers, require us to extend fieldtesting longer than anticipated before undertaking commercial sales and requireus to develop further our technology to account for such failures prior to thefield tests, thereby increasing our manufacturing costs.

 

***The components ofour products may contain defects or errors that could negatively affect ourcustomer relationships and increase our development, service and warrantycosts.***

*** ***

Our products are complexand must meet the stringent technical requirements of our customers.  The software and other components used in ourfuel cell and hydrogen generation products may contain undetected defects orerrors, especially when first introduced, which could result in the failure ofour products to perform, damage to our reputation, delayed or lost revenue,product returns, diverted development resources and increased development,service and warranty costs.

 

***Rapidtechnological advances or the adoption of new codes and standards could impairour ability to deliver our products in a timely manner and, as a result, ourrevenues would suffer.***

*** ***

Our success depends inlarge part on our ability to keep our products current and compatible withevolving technologies, codes and standards. Unexpected changes in technology or in codes and standards could disruptthe development of our products and prevent us from meeting deadlines for thedelivery of products.  If we are unableto keep pace with technological advancements and adapt our products to new codesand standards in a timely manner, our products may become uncompetitive orobsolete and our revenues would suffer.

 

***We depend uponintellectual property and our failure to protect that intellectual propertycould adversely affect our future growth and success.***

*** ***

Failure to protect ourintellectual property rights may reduce our ability to prevent others fromusing our technology.  We rely on acombination of patent, trade secret, trademark and copyright laws to protectour intellectual property.  Some of ourintellectual property is currently not covered by any patent or patentapplication.  Patent protection issubject to complex factual and legal criteria that may give rise to uncertaintyas to the validity, scope and enforceability of a particular patent.  Accordingly, we cannot be assured that:

 

·                  anyof the United States, Canadian or other patents owned by us or third partypatents licensed to us will not be invalidated, circumvented, challenged,rendered unenforceable, or licensed to others; or

 

·                  anyof our pending or future patent applications will be issued with the breadth ofprotection that we seek, if at all.

 

In addition, effectivepatent, trademark, copyright and trade secret protection may be unavailable,limited, not applied for or unenforceable in foreign countries.

 

Furthermore, although wetypically retain sole ownership of the intellectual property we develop, incertain circumstances, such as with Dow Corning and General Motors, we providefor shared intellectual property rights. For instance, where intellectualproperty is developed pursuant to our use of technology licensed from GeneralMotors, we have committed to provide certain exclusive or non-exclusivelicences in favour of General Motors, and in some cases the intellectualproperty is jointly owned.  As a resultof these licences, we may be limited or precluded, as the case may be, in theexploitation of such intellectual property rights.

 

We have also entered intoagreements with other customers and partners that involve shared intellectualproperty rights.  Any developments madeunder these agreements will be available for future commercial use by allparties to the agreement.

 

We also seek to protectour proprietary intellectual property through contracts including, whenpossible, confidentiality agreements and inventors’ rights agreements with ourcustomers and employees.  We cannot besure that the parties that enter into such agreements with us will not breachthem, that we will have adequate remedies for any breach or that such personsor institutions will not assert rights to intellectual property arising out ofthese relationships.  If necessary or desirable,we may seek licences under the patents or other intellectual property rights ofothers.  However, we cannot be sure thatwe will obtain such licences or that the 

 

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terms of anyoffered licences will be acceptable to us. Our failure to obtain a license from a third party for intellectualproperty we use in the future could cause us to incur substantial liabilitiesand to suspend the manufacture and shipment of products or our use of processesthat exploit such intellectual property.

 

***Our involvement inintellectual property litigation could negatively affect our business.***

*** ***

Our future success andcompetitive position depend in part upon our ability to obtain or maintain theproprietary intellectual property used in our principal products.  In order to establish and maintain such acompetitive position we may need to prosecute claims against others who webelieve are infringing our rights and defend claims brought by others whobelieve that we are infringing their rights. Our involvement in intellectual property litigation could result insignificant expense to us, adversely affect the sale of any products involvedor the use or licensing of related intellectual property and divert the effortsof our technical and management personnel from their principalresponsibilities, regardless of whether such litigation is resolved in ourfavour.  If we are found to be infringingon the intellectual property rights of others, we may, among other things, berequired to:

 

·                  paysubstantial damages;

 

·                  ceasethe development, manufacture, use, sale or importation of products thatinfringe upon such intellectual property rights;

 

·                  discontinueprocesses incorporating the infringing technology;

 

·                  expendsignificant resources to develop or acquire non-infringing intellectualproperty; or

 

·                  obtainlicences to the relevant intellectual property.

 

We cannot offer anyassurance that we will prevail in any such intellectual property litigation or,if we were not to prevail in such litigation, that licences to the intellectualproperty that we are found to be infringing upon would be available oncommercially reasonable terms, if at all. The cost of intellectual property litigation as well as the damages,licensing fees or royalties that we might be required to pay could have amaterial adverse effect on our business and financial results.

 

***Our products useflammable fuels that are inherently dangerous substances and could subject usto product liabilities.***

*** ***

Our financial resultscould be materially impacted by accidents involving either our products or thoseof other fuel cell manufacturers, either because we face claims for damages orbecause of the potential negative impact on demand for fuel cell products.  Our products use hydrogen, which is typicallygenerated from gaseous and liquid fuels such as propane, natural gas ormethanol in a process known as reforming. While our fuel cell products do not use these fuels in a combustionprocess, natural gas, propane and other hydrocarbons are flammable fuels thatcould leak and then combust if ignited by another source.  In addition, certain of our OEM partners andcustomers may experience significant product liability claims.  As a supplier of products and systems tothese OEMs, we face an inherent business risk of exposure to product liabilityclaims in the event that our products, or the equipment into which our productsare incorporated, malfunction and result in personal injury or death.  We may be named in product liability claimseven if there is no evidence that our systems or components caused the accidents.  Product liability claims could result insignificant losses from expenses incurred in defending claims or the award ofdamages.  Since our products have not yetgained widespread market acceptance, any accidents involving our systems, thoseof other fuel cell products or those used to produce hydrogen could materiallyimpede acceptance of our products.  Inaddition, although our management believes that our liability coverage iscurrently adequate to cover these risks, we may be held responsible for damagesbeyond the scope of our insurance coverage.

 

**Risk Factors Related toOwnership of Our Common Shares**

** **

***If we fail tomaintain the requirements for continued listing on the Nasdaq, our commonshares could be delisted from trading on Nasdaq, which would materiallyadversely affect the liquidity of our common shares, the price of our commonshares, and our ability to raise additional capital.***

*** ***

Failure to meet theapplicable continued listing requirements of Nasdaq could result in our commonshares being delisted from Nasdaq. In the past we have been unable to meet thecontinued listing requirements of Nasdaq and may not be able to meet therequirements in the future. On May 10, 2007 and February 19, 2008, wereceived notices from Nasdaq informing us that we failed to maintain a minimumclosing bid price on Nasdaq of at least $1.00 per share for our common sharesfor 30 consecutive business days, as we are required to do under NasdaqMarketplace Rule 4450(a)(5) (the “Minimum Bid Price Rule”). On bothoccasions, we were given 180 days to regain compliance by having the bid priceof our common shares close at $1.00 per share or more for a minimum of 10consecutive business days prior to the end of the 180-day period. While weregained compliance on both occasions, we can give no assurances that we willbe able to maintain future compliance with the Minimum Bid Price Rule orall of the continued listing requirements of Nasdaq.

 

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As at June 23, 2009,we are not in compliance with the Minimum Bid Price Rule; however given thecontinued extraordinary market conditions, Nasdaq has suspended the enforcementof the Minimum Bid Price Rule. Enforcement of the rule is scheduled to resume on July 20,2009.  While we may explore variousactions to meet the Minimum Bid Price Rule, including implementing a shareconsolidation, there is no guarantee that any such action will be successful inbringing us into, or maintaining, compliance.

 

If we fail to satisfyNasdaq’s continued listing requirements, our common shares could be delistedfrom Nasdaq, in which case we may transfer to the Nasdaq Capital Market, whichgenerally has lower financial requirements for initial listing or, if we failto meet its listing requirements, the over-the-counter bulletin board. However,there can be no assurance that our common shares will be eligible for tradingon any such alternative exchanges or markets in the United States.

 

If we are delisted fromNasdaq, it would materially reduce the liquidity of our common shares, lowerthe price of our common shares, and impair our ability to raise financing.

 

***In order to complywith Nasdaq’s Minimum Bid Price Rule we may, subject to any regulatoryapprovals (including from the TSX), implement a share consolidation, whichcould adversely affect our common share price and its liquidity.***

*** ***

Subject to any regulatoryapprovals (including from the TSX), we may implement a share consolidation inorder to comply with Nasdaq’s Minimum Bid Price Rule.  In light of the Company’s past non-compliancewith the Minimum Bid Price Rule, at the annual and special meeting of ourshareholders held on May 13, 2009, our shareholders approved a specialresolution that gave authority to our Board of Directors, in its solediscretion, to amend our articles of incorporation to allow for a consolidationof our issued and outstanding common shares at any time prior to March 24,2010, and to select the exact consolidation ratio, provided that (i) the ratiomay be no smaller than one post-consolidation share for every 10pre-consolidation shares, and no larger than one post-consolidation share forevery 25 pre-consolidation shares, and (ii) the number ofpre-consolidation shares in the ratio must be a whole number of shares.Assuming receipt of the necessary approvals, the exact number of shares of theCompany to be consolidated, if at all, would be determined by our Board ofDirectors before the share consolidation would be effective, and the Companywill issue a news release announcing the ratio as determined by our Board ofDirectors.

 

Notwithstanding theapproval of the share consolidation by our shareholders, our Board of Directorsmay, in its sole discretion, abandon the share consolidation without furtherapproval or action by or prior notice to shareholders.

 

Our shareholders approveda similar special resolution at the Company’s annual and special meeting ofshareholders on May 6, 2008, which authorized our Board of Directors, inits sole discretion, to implement a share consolidation at any time prior to March 10,2009 based on a consolidation ratio no smaller than one post-consolidationshare for every five pre-consolidation shares, and no larger than onepost-consolidation share for every 10 pre-consolidation shares, but otherwisesubject to the same conditions described above. Although our Board of Directorsdid not believe it to be in the best interests of the Company to implement a shareconsolidation during that time, as in the past, our Board of Directors hasconsidered the potential adverse effects to the Company of a delisting fromNasdaq, and has determined that the flexibility afforded by a shareconsolidation could allow the Company to comply with Nasdaq’s Minimum Bid PriceRule.

 

While such shareconsolidation could bring us back into compliance with the listing requirementsof Nasdaq, there can be no assurance that any increase in the market price ofour common shares resulting from a share consolidation, if implemented, wouldbe sustainable.  There are numerousfactors and contingencies that would affect such price, including the marketconditions for our common shares at the time, our reported results ofoperations in future periods and general economic, geopolitical, stock marketand industry conditions. Accordingly, the total market capitalization of ourcommon shares after a share consolidation may be lower than the total marketcapitalization before such share consolidation and, in the future, the marketprice of our common shares might not exceed or remain higher than the marketprice prior to such share consolidation. There can be no assurance that a shareconsolidation would result in a per share market price that attractsinstitutional investors or investment funds, or that such price would satisfythe investing guidelines of institutional investors or investment funds. As aresult, the trading liquidity of our common shares might not improve as aresult of a share consolidation. Furthermore, the liquidity of our commonshares could be adversely affected by the reduced number of our common sharesthat would be outstanding after the share consolidation.

 

***If at any time wequalify as a passive foreign investment company under United States tax laws,our shareholders may be subject to adverse tax consequences.***

*** ***

We would be classified asa passive foreign investment company (“PFIC”), for United States federal incometax purposes, in any taxable year in which, after applying relevantlook-through rules with respect to the income and assets of oursubsidiaries, either at least 75% of our gross income is ‘‘passive income,’’ oron average at least 50% of the gross value of our assets is attributable toassets that produce passive income or are held for the production of passiveincome.

 

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Based on the structure ofthe Company, and the composition of our income and assets, the Company does notbelieve that it was a PFIC for the taxable year ended December 31, 2008 orits prior taxable year.  However, therecan be no assurance that the IRS will not successfully challenge our positionor that we will not become a PFIC in a future taxable year, as PFIC status isre-tested each year and depends on our assets and income in such year. If weare classified as a PFIC at any time that a U.S. Holder (as defined below)holds our common shares, such holder may be subject to an increased UnitedStates federal income tax liability and a special interest charge in respect ofgain recognized on the sale or other disposition of our common shares and uponthe receipt of certain ‘‘excess distributions’’ (as defined in the UnitedStates Internal Revenue Code of 1986, as amended (the “Code”)).

 

U.S. Holders shouldconsult their own tax advisors concerning the United States federal income taxconsequences of holding our common shares if we were a PFIC in any taxable yearand its potential application to their particular situation.

*** ***

***A limited numberof shareholders collectively own a significant portion of our common shares andmay act, or prevent corporate actions, to the detriment of other shareholders.***

*** ***

A limited number ofshareholders, including our founders and General Motors, currently own asignificant portion of our outstanding common shares.  General Motors currently owns approximately12.3% of our outstanding common shares. Accordingly, these shareholders may exercise significant influence overall matters requiring shareholder approval, including the election of amajority of our directors and the determination of significant corporateactions.  This concentration could alsohave the effect of delaying or preventing a change in control that couldotherwise be beneficial to our shareholders.

 

In addition to GeneralMotors’ current ownership of our common shares, pursuant to our strategicalliance with General Motors, for so long as General Motors holds at least 10%of our outstanding shares, if any of our founders, Pierre Rivard, JosephCargnelli or Boyd Taylor, wish to transfer (i) all or substantially all oftheir shares to any person, or (ii) any of their shares to a personactively competing with General Motors in the automotive or fuel cell industry,he must first offer the shares to General Motors. Moreover, if we issueadditional equity securities or securities convertible into equity securitiesfor cash consideration, we have granted General Motors the right to participatein such offering on a pro rata basis based on the fully diluted number ofcommon shares that it holds, subject to certain limited exceptions. We havealso agreed that one director nominated by General Motors shall be included inthe slate of directors that is presented to shareholders for approval at ourgeneral meeting. As a principal shareholder and party to the strategic allianceand representative on our board, General Motors has the ability to influenceour corporate actions and in a manner that may be adverse to your interests.

 

***Future sales ofcommon shares by our principal share-holders could cause our share price tofall and reduce the value of a shareholder’s investment.***

*** ***

If our principalshareholders, including our founders, sell substantial amounts of their commonshares in the public market, the market price of our common shares could falland the value of a shareholder’s investment could be reduced.  The perception among investors that thesesales may occur could have a similar effect. Share price declines may be exaggerated if the low trading volume thatour common shares have experienced to date continues.  These factors could also make it more difficultfor us to raise additional funds through future offerings of our common sharesor other securities.

 

***Our articles ofincorporation authorize us to issue an unlimited number of common and preferredshares, and significant issuances of common or preferred shares could dilutethe share ownership of our shareholders, deter or delay a takeover of us thatour shareholders may consider beneficial or depress the trading price of ourcommon shares.***

*** ***

Our articles ofincorporation permit us to issue an unlimited number of common and preferredshares.  If we were to issue asignificant number of common shares, it would reduce the relative voting powerof previously outstanding shares.  Suchfuture issuances could be at prices less than our shareholders paid for theircommon shares.  If we were to issue asignificant number of common or preferred shares, these issuances could alsodeter or delay an attempted acquisition of us that a shareholder may considerbeneficial, particularly in the event that we issue preferred shares withspecial voting or dividend rights.  WhileNasdaq and TSX rules may require us to obtain shareholder approval forsignificant issuances, we would not be subject to these requirements if weceased, voluntarily or otherwise, to be listed on Nasdaq and the TSX.  Significant issuances of our common orpreferred shares, or the perception that such issuances may occur, could causethe trading price of our common shares to drop.

 

***U.S. investors maynot be able to enforce U.S. civil liability judgments against us or ourdirectors and officers.***

*** ***

We are organized underthe laws of Canada.  A majority of ourdirectors and officers are residents of Canada and all or a substantial portionof their assets and substantially all of our assets are located outside of theUnited States.  As a result, it may bedifficult for U.S. holders of our common shares to effect service of process onthese persons within the United States or to realize in the United States uponjudgments rendered against them.  Inaddition, a shareholder should not assume that the courts of Canada 

 

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(i) would enforcejudgments of U.S. courts obtained in actions against us or such personspredicated upon the civil liability provisions of U.S. federal securities lawsor other laws of the United States, or (ii) would enforce, in originalactions, claims against us or such persons predicated upon the U.S. federalsecurities laws.

 

***Our share price isvolatile and we may continue to experience significant share price and volumefluctuations.***

*** ***

Since our common shareswere initially offered to the public in November 2000, the stock markets,particularly in the technology and alternative energy sectors, and our shareprice have experienced significant price and volume fluctuations.  Our common shares may continue to experiencevolatility for reasons unrelated to our own operating performance, including:

 

·                  performanceof other companies in the fuel cell or alternative energy business;

 

·                  newsannouncements, securities analysts’ reports and recommendations and otherdevelopments with respect to our industry or our competitors; or

 

·                  changesin general economic conditions.

 

***As at May 31,2009, there were 7,535,168 options to purchase our common shares.  If these securities are exercised, ourshareholders will incur substantial dilution.***

*** ***

A significant element inour plan to attract and retain qualified personnel is the issuance to suchpersons of options to purchase our common shares.  As of May 31, 2009, we have issued andoutstanding 7,535,168 options to purchase our common shares at an average priceof Cdn. $2.90 per common share. Accordingly, to the extent that we are required to issue significantnumbers of options to our employees, and such options are exercised, you couldexperience significant dilution.

 

**Selected Risk FactorsRelated to Our Financial Condition as of December 31, 2008**(as presented in our Annual Report for the year ended December 31,2008, which was furnished to the Securities and Exchange Commission (“SEC”) as Exhibit 99.3on the Form 6-K on March 26, 2009)

** **

***If we areunsuccessful in increasing our revenues or raising additional funding, we maypossibly cease to continue as we currently do.***

*** ***

Although our consolidatedfinancial statements for the year ended December 31, 2008 have beenprepared on a going concern basis, which contemplates the realization of assetsand liquidation of liabilities during the normal course of operations,  our ability to continue as a going concern isdependent on the successful execution of the Company’s business plan, whichincludes an increase in revenue and additional funding to be provided bypotential investors as well as non-traditional sources of financing.

 

We have sustained lossesand negative cash flows from operations since our inception. We expect thatthis will continue throughout 2009. If we do not raise additional capitalbefore 2010, we do not expect our operations to generate sufficient cash flowto fund our obligations as they come due.

 

Additional funding may bein the form of debt or equity or a hybrid instrument depending on the needs ofthe investor. In order to improve our chances of securing funding, we filed abase shelf prospectus during the third quarter of 2008.  Given the prevailing global economic andcredit market conditions, we may not be able to raise additional cash resourcesthrough these traditional sources of financing. Although we are also investigating non-traditional sources of financingincluding monetizing a portion of our accumulated tax losses, the global creditmarket crisis has also adversely affected the ability of potential parties topursue such transactions. We do not believe that the ability to access capitalmarkets or these adverse conditions are likely to improve significantly in thenear future. Accordingly, we may have to pursue a combination of operating andrelated initiatives, such as further restructurings and/or asset sales.

 

There can be noassurances that we will achieve profitability or positive cash flows or be ableto obtain additional funding or that, if obtained, they will be sufficient, orwhether any other initiatives will be successful, such that we may continue asa going concern.

 

***Our inability togenerate sufficient cash flows, raise additional capital and actively manageour liquidity may impair our ability to execute the Company’s business plan,and result in our reducing or eliminating product development andcommercialization efforts, reduce our sales and marketing efforts, and havingto forego attractive business opportunities.***

*** ***

At December 31,2008, we had approximately $22.7 million of cash and cash equivalents andrestricted cash.  There are uncertaintiesrelated to the timing and use of our cash resources and working capitalrequirements. These uncertainties include, among other things, the timing andvolume of commercial sales and associated gross margins of our existingproducts and the development of markets for, and customer acceptance of newproducts. Due to these and other factors, many of which are outside of ourcontrol, we may not be able to accurately predict our necessary cashexpenditures or obtain financing in a timely manner to cover any shortfalls.

 

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If we are unable togenerate sufficient cash flows or obtain adequate additional financing, whichgiven the current global economy and credit markets is challenging, we may beunable to respond to the actions of our competitors or we may be prevented fromexecuting the Company’s business plan, or conducting all or a portion of ourplanned operations. In particular, the development and commercialization of ourproducts could be delayed or discontinued if we are unable to fund our researchand product development activities or the development of our manufacturingcapabilities. In addition, we may be forced to reduce our sales and marketingefforts or forego attractive business opportunities.

 

***A sustained andbroad economic recession could continue to have a negative impact on ourbusiness, results of operations and financial condition, or our ability toaccurately forecast our results, and it may cause a number of the risks that wecurrently face to increase in likelihood, magnitude and duration.***

*** ***

Macro-level changes inthe global economy began to affect our business in the fourth quarter of 2008.Operationally, we experienced a delay in closing orders and, in one case, adelay in a shipment as a result of a customer not being able to pay for thebalance of an order. Financially, we experienced more challenging conditions asa result of weaker capital markets worldwide and anticipate this may adverselyalter our ability to raise capital on favourable terms and could change theterms of our credit facility.

 

The condition of thecurrent global economy and credit markets affect our outlook in two primaryways. First, our products depend, to some degree, on general world economicconditions and activity. If the current condition of the economy results in asustained broad economic recession, demand for our products is likely todecline. Secondly, the current economic and credit climate could adverselyaffect our ability to conduct normal day-to-day selling activities which dependon the granting of short-term credit to a wide variety of purchasers andparticularly the corresponding need of those purchasers to finance purchases byaccessing credit. Our business is dependent on purchasers of our productshaving access to adequate levels of credit. If the current condition of theeconomy is not resolved in a manner that will provide access to credit to potentialpurchasers of our products, our business will likely suffer as a result.

 

With a sustained orexpanding economic downturn, we expect that we will continue to experiencesignificant difficulties on a number of fronts, depending upon the duration andseverity of these events. As a result, we may face new risks as yetunidentified, and a number of risks that we ordinarily face and that arefurther described herein may increase in likelihood, magnitude and duration.These risks include but are not limited to deferrals or reductions of customerorders, potential deterioration of our customers’ ability to finance purchases,reduced revenue, further deterioration in our cash balances and liquidity dueto foreign exchange impacts, and an inability to access capital markets. Thefinancial crisis and economic downturn will also reduce our ability toaccurately forecast our performance, results or cash position.

** **

**ITEM4.  INFORMATION ON THE COMPANY**

** **

**HISTORYAND DEVELOPMENT OF HYDROGENICS CORPORATION**

** **

Our legal name isHydrogenics Corporation - Corporation Hydrogenique.  We were incorporated under the CanadaBusiness Corporations Act on August 1, 1988 as Traduction MilitechTranslation Inc.  By articles ofamendment dated August 20, 1990, we changed our name to SocieteHydrogenique Incorporée - Hydrogenics Corporation Incorporated.  From 1990 to August 1995, SocieteHydrogenique Incorporée - Hydrogenics Corporation Incorporated did not activelycarry on business.  In August 1995,we commenced our fuel cell technology development business.  By articles of amendment dated January 24,2000, we changed our name to Hydrogenics Corporation - CorporationHydrogenique.  Our registered andprincipal executive offices are located at 5985 McLaughlin Road, Mississauga,Ontario, L5R 1B8, Canada, (905) 361-3660. Our agent for service in the United States is CT Corporation System, 111Eighth Avenue, New York, New York 10011, (212) 894-8400.

 

Capital expenditures forthe year ended December 31, 2008 were $0.9 million, compared with $1.3million and $1.7 million for the years ended December 31, 2007 and 2006,respectively, and consisted primarily of capital expenditures for equipment andcomputer equipment. We expect capital expenditure plans for 2009 and subsequentyears to result in further investment in capital assets as we continue ourmanufacturing and development initiatives. Our current budget for 2009 includesa capital budget of less than $1.0 million to purchase and manufacture testingand other equipment, primarily for our research and development programs butalso in support of ongoing operational needs. We expect that less than half of our investments will be in Canada.  We currently have a commitment to purchasemanufacturing equipment for approximately 375,000 euros.  Our capital requirements will be affected bymany factors, including the success of our current product offerings, theability to enhance our current products and our ability to develop andintroduce new products that keep pace with technological developments in themarketplace.

 

As at December 31,2008 we had cash and cash-equivalents and short-term investments ofapproximately $22.7 million.

 

There have been no publictakeover offers by third parties in respect of the Company’s shares.

 

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***On June 12, 2009, we announced that we have enteredinto an agreement with the Algonquin Board, which will result in a non-dilutivefinancing to Hydrogenics with gross cash proceeds of approximately Cdn. $10.8million, or approximately Cdn. $9.3 million net of transaction relatedexpenses.  The transaction involves aplan of arrangement and offers pursuant to which, among other things, we willoffer to acquire all of the issued and outstanding units and convertibledebentures of Algonquin Power in exchange for new securities ofHydrogenics.  Pursuant to the plan ofarrangement, we will transfer our business and operations, including substantiallyall assets and liabilities, excluding certain tax attributes, to our newlycreated subsidiary, 7188501 Canada Inc. (“New Hydrogenics”). New Hydrogenicswill have substantially all of the same assets, liabilities, directors,management and employees as Hydrogenics has currently, except for certain taxattributes that will remain behind, and Hydrogenics shareholders will becomeshareholders of New Hydrogenics. Pursuant to the offers, unitholders ofAlgonquin Power will be offered to exchange their units for a new class ofcommon shares of Hydrogenics, and debentureholders of Algonquin Power will beoffered to exchange their convertible debentures for convertible debentures ornew common shares of Hydrogenics, which will result in, among other things,securityholders of Algonquin Power who accept the offers becomingsecurityholders of Hydrogenics and Algonquin Power becoming a subsidiary entityof Hydrogenics. Upon completion of the Plan of Arrangement, old Hydrogenicswill be renamed “Algonquin Power Inc.” and New Hydrogenics will continue theHydrogenics business as “Hydrogenics Corporation.”  The transaction is subject to variousconditions, including the receipt of regulatory approvals, approval by the OntarioSuperior Court of Justice and by shareholders of Hydrogenics.  As a result of the transaction, ourshareholders will no longer have any interest in old Hydrogenics and AlgonquinPower’s securityholders who accept the offers will hold all of the interests inold Hydrogenics.  We will receive theapproximately Cdn. $9.3 million (or approximately $8 million), after expenses,for the tax attributes that have been retained by Algonquin Power Inc. Foradditional information regarding the transaction, see the notice of specialmeeting and management proxy circular dated June 25, 2009, which was furnishedto the SEC as part of the Registrant’s Form 6-K filed on June 29, 2009, and isincorporated by reference herein.***

** **

**BUSINESSOVERVIEW**

** **

**Overview**

** **

Hydrogenics, togetherwith its subsidiaries, designs, develops and manufactures hydrogen generationproducts based on water electrolysis technology and fuel cell products based onproton exchange membrane, or PEM technology. We were incorporated under theCanada Business Corporations Act in 1988 and commenced our fuel celldevelopment activities in 1996. We maintain operations in Belgium, Canada andGermany. We operate in various geographical markets and organize ourselves infour reportable segments.

 

Our OnSite Generationbusiness segment is based in Oevel, Belgium and develops products forindustrial gas, hydrogen fueling and renewable energy storage markets. For theyear ended December 31, 2008 our OnSite Generation business reportedrevenues of $31.2 million and at December 31, 2008 had 73 full-timeemployees.

 

Our Power Systemsbusiness segment is based in Mississauga, Canada with a satellite facility inGladbeck, Germany. This segment develops products for stationary and motivepower applications. For the year ended December 31, 2008 our Power Systemsbusiness reported revenues of $5.6 million and at December 31, 2008 had 81full-time employees.

 

Our Test Systems businesssegment is based in Burnaby, Canada and provided fuel cell testing services andsold fuel cell test stations. In November 2007, we announced that we wouldimplement an orderly windup of our Test Systems business in order to focus ourresources on our OnSite Generation and Power Systems businesses. We expect tocomplete the windup by the end of 2009. For the year ended December 31,2008, our Test Systems business reported revenues of $2.5 million and at December 31,2008 had five full time employees.

 

Our Corporate and Otherbusiness segment provides corporate services and administrative support. At December 31,2008, our Corporate and Other business had seven full time employees.

 

Our business issummarized below:

 

***OnSite Generation***

*** ***

Our OnSite Generationbusiness segment is based on alkaline water electrolysis technology whichinvolves the decomposition of water (H2O) into oxygen (O2) and hydrogen gas(H2) by passing an electric current through a liquid electrolyte. The resultanthydrogen gas is then captured and used for industrial gas applications,hydrogen fueling applications, and used to store renewable energy in the form ofhydrogen gas. Our HySTAT® branded electrolyzer products are based on 60 yearsof hydrogen experience, meet international standards such as ASME, CE,Rostechnadzor and UL and are certified ISO 9001 from design to delivery. Weconfigure our HySTAT® products for both indoor and outdoor applications andtailor our product to accommodate various hydrogen gas requirements.

 

The worldwide market forhydrogen, which includes the merchant gas market for hydrogen, is estimated at$5 billion annually, and is served by industrial gas companies as well ason-site hydrogen generation product manufacturers such as ourselves.  We believe that the annual market for on-sitehydrogen generation is approximately $100 million to $200 million in respect ofour products.

 

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Our OnSite Generationproducts are sold to leading merchant gas companies such as Air Liquide S.A.and Linde AG and end users requiring high purity hydrogen produced on-site forindustrial applications.  We also sellproducts to progressive oil and gas companies, such as Shell Hydrogen,requiring hydrogen fueling stations for transportation applications. Recently,we have begun to sell our products to leading electric power utilities,including Powertech Labs, Inc., a wholly owned subsidiary of BC Power, andNewfoundland and Labrador Hydro (Hydro) requiring renewable energy storage.

 

The business objectivesfor our OnSite Generation group are to: (i) further increase the grossmargins of existing product lines by improving our procurement andmanufacturing processes; (ii) further increase the reliability anddurability of our products to exceed the expectations of our applications; (iii) reducethe cost of ownership of our products through design and technologyimprovement; (iv) continue to pursue opportunities for customers toconvert renewable energy, such as wind and solar energy, into hydrogen; and (v) furtherexpand into ready markets such as Eastern Europe (including Russia), Asia andthe Middle East.

 

Our Onsite Generationbusiness competes with suppliers of delivered hydrogen, manufacturers ofon-site hydrogen generation products using electrolysis and small steam methanereforming products — a development stage technology which, to our knowledge,has yet to emerge as commercially competitive to either delivered gas oron-site electrolysis.  In the deliveredhydrogen segment, we compete with Air Liquide S.A., Air Products and Chemicals, Inc.,Linde AG and Praxair, Inc. In the on-site electrolysis market, we competewith Distributed Energy Systems Corporation, Norsk Hydro ASA (Statoil),Purification Equipment Research Institute of CISC and Teledyne Energy Systems, Inc.and H2Gen, a provider of hydrogen using stream methane reforming technology.

 

***Power Systems***

*** ***

Our Power Systemsbusiness is based on PEM fuel cell technology which transforms chemical energyto electrical energy when liberated during the electrochemical reaction ofhydrogen and oxygen. Our HyPM® branded fuel cell products are based on ourextensive track record of on-bench testing and real-time deployments across awide range of stationary and motive power profiles. We configure our HyPM®products to multiple electrical power outputs ranging from 4 to 65 kilowattswith ease of integration, high reliability and operating efficiency, deliveredin a highly compact footprint.

 

Our target marketsinclude backup power for data centres and telecom applications plus motivepower applications such as forklift trucks. We also target military applications for our products, historically anearly technology adopter.  The worldwidemarket for data centre backup power is estimated to be in excess of $6 billionand the market for telecom backup power is estimated to be $2 to $3 billion inthe U.S. alone, based on a complete displacement of existing batterysystems.  The addressable market forforklift truck products is estimated at $0.4 billion.

 

Our Power Systemsproducts are sold to leading OEMs, such as American Power Conversion Corp.(“APC”), a wholly owned subsidiary of Schneider Electric, and Commscope, Inc.,to provide backup power applications for data centres and telecom sites, and toCrown Equipment Corporation, Linde Materials Handling, Mitsubishi Forklifts andNACCO Materials Handling Group, Inc. for prototype field tests of our fuelcell power modules directed at replacing traditional lead-acid battery packsused by indoor industrial forklift trucks. We also sell our Power Systemsproducts to the military and other early adopters of emerging technologies.

 

The business objectivesfor our Power Systems group are to: (i) offer a common fuel cell platformacross many markets enabling ease of manufacturing and reducing developmentspending; (ii) achieve further market penetration in the backup power andmotive power markets by tailoring our HyPM® fuel cell products to meet marketspecific requirements including price, performance and features; (iii) investin sales and market development activities in the backup power and motive powermarkets; (iv) continue to target the military and other early adopters ofemerging technologies as a bridge to future commercial markets; and (v) securethe requisite people and processes to align our anticipated growth plans withour resources and capabilities.

 

Our Power Systemsbusiness competes with providers of incumbent technologies, such as batteriesand diesel generators, and businesses that have fuel cell developmentprograms.  Companies that we currentlycompete with include Anuvu, Altergy Systems, Ballard Power Systems Inc.,Distributed Energy Systems Corporation, Giner, Inc., IdaTech plc,Intelligent Energy, Nuvera, Plug Power Inc., Worldwide, Inc., ReliOn Inc.,Teledyne, and United Technologies Corporation. Competing companies with programs for fuel cells other than PEM fuelcells include Fuel Cell Energy Inc., Hitachi, Ltd. and United TechnologiesCorporation. We also compete with companies that are developing other types offuel cells.

 

There are four types offuel cells other than PEM fuel cells that are generally considered to havepossible commercial applications: phosphoric acid fuel cells, molten carbonatefuel cells, solid oxide fuel cells and alkaline fuel cells. Each of these fuelcell technologies differ in their component materials, and operatingcharacteristics.  While all fuel celltypes may have potential environmental and efficiency advantages overtraditional power sources, we believe that PEM fuel cells can be manufacturedless expensively and are more efficient and more practical in small-scalestationary and motive power applications. Further, most automotive companieshave selected PEM technology for fuel-cell-

 

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poweredautomobiles. We expect this will help establish a stronger industry around PEMtechnology and may result in a lower cost as compared to the other fuel celltechnologies.

 

***Test Systems***

*** ***

We provided test servicesto many of the world’s leading automotive companies such as General Motors,Nissan and Toyota as well as to fuel cell developers and component supplierscurrently engaged in their own fuel cell development programs. Until recently,we sold test products to such customers as well. On November 7, 2007, weannounced our decision to commence an orderly windup of our fuel cell testproducts and design, development and manufacturing business. We anticipate thatthis windup will be completed by the end of 2009 and require approximately $3.5million of funding with a corresponding charge to earnings. The substantialmajority of the cash requirements and corresponding charge to earnings occurredin the fourth quarter of 2007.

 

***Segmented Revenues***

*** ***

Our revenues aresegmented as follows:

 
| ** **        | ** ** | **2008  (in millions)** | ** ** | **2007  (in millions)** | ** ** | **2006  (in millions)** | ** ** |
|-------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| OnSite Generation |       | $                       | 31.2       |                    | $          | 19.6                    |       | $ | 12.0 |   |
| Power Systems     |       | 5.6                     |       | 6.1                     |       | 6.9                     |       |
| Test Systems(1)   |       | 2.5                     |       | 12.3                    |       | 11.1                    |       |
| Total             |       | $                       | 39.3       |                    | $          | 38.0                    |       | $ | 30.0 |   |

 

----

Note:

 

(1)          Test Systemsrevenues include $0.4 million for engineering services in 2008 and $3.5 millionfor engineering services in 2007, primarily provided to General Motors.

 

For additional financialinformation by business segment, see “Note 22 — Segmented FinancialInformation” under the Notes to Consolidated Financial Statements, which can befound on page F-27of this form, and is incorporated by reference herein.

 

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Ourrevenues are segmented by geography as follows:

 
| ** **           | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|
| Russia               |       | $        | 12,927     |     | $          | 5,629    |       | $ | 68 |   |
| United States        |       | 8,428    |       | 5,609    |       | 8140     |       |
| Belgium              |       | 2,020    |       | —   |       | 319      |       |
| Spain                |       | 1,815    |       | 138      |       | 1445     |       |
| Saudi Arabia         |       | 1,790    |       | —   |       | —   |       |
| Sweden               |       | 1,600    |       | 119      |       | 849      |       |
| China                |       | 1,351    |       | 1,435    |       | 266      |       |
| Korea                |       | 1,271    |       | 1,070    |       | 2499     |       |
| France               |       | 1,144    |       | 2,633    |       | 3163     |       |
| United Kingdom       |       | 1,076    |       | 552      |       | 877      |       |
| Brazil               |       | 712      |       | 2,017    |       | —   |       |
| Germany              |       | 655      |       | 1,395    |       | 2471     |       |
| Poland               |       | 639      |       | —   |       | —   |       |
| Canada               |       | 534      |       | 4,378    |       | 3163     |       |
| Japan                |       | 492      |       | 2,256    |       | 2841     |       |
| Romania              |       | 83       |       | 277      |       | 1367     |       |
| United Arab Emirates |       | 20       |       | 1,255    |       | —   |       |
| Argentina            |       | 8        |       | 2,010    |       | —   |       |
| Slovenia             |       | 3        |       | 1,275    |       | —   |       |
| Rest of world        |       | 2,772    |       | 5,942    |       | 3591     |       |
| ** **           |       | $        | 39,340     |     | $          | 37,990   |       | $ | 30,059 |   |

 

**Our Strategy**

** **

Ourstrategy is to develop electrolyzer and fuel cell products for sale to OEMs,electric utilities, merchant gas companies and end-users requiring highlyreliable products offered at competitive prices. We believe that our successwill be substantially predicated on the following factors:

 

***Advancing OurProduct Designs***

*** ***

Within our OnSiteGeneration business segment, we are focused on reducing the cost of our HySTAT®electrolyzer and improving its efficiency. Concurrently, we are developing anelectrolyzer having four times the active area per cell to allow us to competemore favourably in cases where greater volumes of hydrogen are required forindustrial, hydrogen fueling or renewable energy storage applications.

 

Within our Power Systemsbusiness segment, we are focused on increasing the durability and efficiency ofour fuel cells and fuel cell systems as well as reducing their cost. For marketopportunities such as the home and backup power market requiring between 4 and12 kilowatts of electrical power, we are developing a PEM based electrolyzer.We are attempting to offset a portion of the associated development expenses byentering into cost sharing agreements with OEMs and government agencies.

 

Recently, we have seenconsiderable interest in using hydrogen as a medium to store renewable energy,particularly wind and solar power, due to the favourable characteristics ofhydrogen as an energy carrier.  We havedeveloped a renewable energy storage 

 

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product incorporatingan alkaline electrolyzer, PEM fuel cell electrical generator and associatedsystems software (as at December 31, 2008, such product was indevelopment). We anticipate adding other proprietary technologies to thisproduct offering based on continued market intelligence. In time, we anticipatedeveloping a product offering that will benefit from ancillary electrical powerservices such as grid balancing and load profiling.

 

***Increasing MarketPenetration***

*** ***

As at December 31,2008, we had seven full time staff employed in sales functions. Our seniormanagement team is also actively involved in sales initiatives includingmaintaining close contact with our more significant customers.

 

Additionally, we havedeveloped relationships with third parties that we believe are well positionedin our markets to identify new sales opportunities for our products. In theindustrial gas market, these third parties include leading merchant gascompanies such as Air Liquide and Linde Gas. In the backup power market, thesethird parties include leading OEMs such as APC by Schneider Electric andCommscope, Inc. In the forklift truck market, these OEMs include CrownEquipment Corporation and NAACO Materials Handling Group, Inc.

 

We have recently begun tosell our renewable energy storage products to progressive electric powerutilities seeking a robust and cost effective solution for renewable energystorage. We have begun to access this market through trade events, meetingdirectly with electrical utilities, and marketing to governmental agenciesmandated to provide power to remote communities.

 

***Responding toMarket Conditions***

*** ***

Macro-level changes inthe global economy began to undermine our business in the fourth quarter of2008. Operationally, we experienced a delay in closing orders, and in one case,a delay in an order shipment as a result of a customer not being able to payfor the balance of an order. Financially, we experienced more challengingconditions as a result of weaker capital markets worldwide and anticipate thismay adversely reduce our ability to raise capital on favourable terms as wellas our credit facility with a Canadian chartered bank.

 

With regard to theeconomic slowdown, we have taken a number of initiatives to better positionourselves including: (i) revising our annual and three-year financial plans toreflect a more conservative outlook in our relevant markets; (ii) implementinga downsizing in January 2009 involving 25 full-time positions representingapproximately $1.3 million of annual payroll costs; (iii) curtailing ordeferring operating expenditures to reduce our overhead levels; (iv) havingour senior management more fully engaged with our major accounts to betterassess sales opportunities; and (v) aggressively managing our workingcapital.

 

We are encouraged,however, with our business prospects in many of our relevant markets inaddition to the Corporation’s continued improved operating performance.Additionally, recent government legislation has been proposed or passed in manyjurisdictions to support renewable energy initiatives including passage of theAmerican Recovery and Reinvestment Act of 2009 in the United States and theGreen Energy and Green Economy Act, 2009 in Ontario, Canada. We will continueto selectively pursue opportunities we believe are the most promising for usand can be delivered on the most advantageous terms.

 

***SecuringAdditional Capital***

*** ***

As at December 31,2008, we had $22.7 million of cash, cash equivalents and restricted cash andhad $25.5 million of shareholders’ equity. We do not anticipate achieving aconsistent level of profitability or generate consistent positive cash flowfrom operations for the next several quarters. While our OnSite Generation businessachieved $2.1 million of segment income in 2008, our Power Systems andCorporate and Other business units incurred a combined segment loss of $16.4million in 2008.  As mentioned under“Item 4.  Information of the Company —History and Development of Hydrogenics Corporation”, we have entered into anagreement with the Algonquin Board to implement a non-dilutive financingtransaction, which will provide us with working capital.   The transaction is subject to variousconditions, including the receipt of regulatory approvals, such as the approvalof the TSX and Nasdaq,  approval by theOntario Superior Court of Justice and by shareholders of Hydrogenics. Thetransaction is also subject to approval by unitholders of Algonquin Power withrespect to certain amendments to Algonquin Power’s declaration of trust inconnection with the transaction, and Algonquin Power unitholders tendering therequisite number of units to the take-over bid to be made by Hydrogenics inconnection with the transaction.

 

The failure to raisesufficient funds necessary to finance future cash requirements could adverselyaffect our ability to pursue our strategy and negatively affect our operationsin future periods. We are addressing this matter in a number of ways. We aremaintaining frequent contact with analysts and institutional investors tobetter articulate our investment merits.

 

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***Retaining andEngaging Our Staff***

*** ***

As at December 31,2008, we had 166 full-time staff, the majority of whom have been employed bythe Company for several years and possess strong technical backgrounds withextensive industry experience. We strive to maintain a high level of employeeengagement by offering compensation at market rates, providing interesting andchallenging work, and, over time, the opportunity to create wealth byparticipating in our stock ownership program.

 

**Our Products andServices**

** **

Our products includeHySTATTM hydrogen generation equipment in our OnSite Generation business andHyPM® fuel cell products in our Power Systems business.  A summary of our product lines is notedbelow.

 

***HySTATTM HydrogenStations***

*** ***

HySTATTM Hydrogen Stationsoffer a dependable on-site supply of hydrogen for a variety of hydrogenapplications, including vehicle fueling, distributed power, and a variety ofindustrial processes.  From a selectionof versatile modular components, we configure the optimum HySTATTM Hydrogen Stationto precisely meet customer needs for hydrogen generation and storage. We alsoprovide spare parts and service for our entire installed base.

 

We currently offer ourHySTATTM Hydrogen Station in multiple configurations depending on the amount ofhydrogen required. This product is suitable for producing continuous or batchsupplies of hydrogen typically for industrial processing applications andgenerates between 15 - 60 normal cubic meters per hour (“Nm3/hr”) of hydrogen.Multiple standard units can be installed for larger applications with thecapability of generating up to 500 Nm3/hr of hydrogen.

 

***HyPM® Fuel CellProducts***

*** ***

Our HyPM® fuel cell products provide high performance, high efficiency electricalpower from clean hydrogen fuel.  TheHyPM® product is well suited to compete with existing battery applications byoffering longer runtimes and life, at a significantly smaller size andweight.  The HyPM® product line alsocompetes with certain diesel power applications by offering clean, quietoperation and higher demand reliability. Our products are built on a common platform allowing us to achievevolume purchasing and manufacturing efficiencies.

 

·                  *HyPM®  Fuel Cell Power Modules*.  Our HyPM® power module runs on high purityhydrogen and produces DC power in standard outputs of 8, 12, 16 and 65 kW.   This product is suitable for a wide range ofstationary, mobile and portable power applications.   The HyPM® XR model is targeted at backuppower applications and the HyPM® HD model is targeted at motive powerapplications.

 

·                  *HyPXTM Fuel Cell Power Pack*. Our HyPXTM Power Pack includes a standard HyPM® power module integratedwith hydrogen storage tanks and ultracapacitors that provide higher power inshort bursts.  This product has the sameform, fit and function as large battery packs used in devices such as forklifttrucks and tow tractors.

 

·                  *Integrated Fuel Cell Systems*.  Our integrated fuel cell systems are builtaround our HyPM® power modules and are targeted to portable and stationaryapplications including portable and auxiliary power units for militaryapplications and direct current or DC backup power system for cellular towersites.

 

·                  *Engineering Development Services*.  We also enter into engineering developmentcontracts with certain customers for new or custom products.

 

***Sales andMarketing***

*** ***

We have a direct salesforce of seven full-time sales professionals in Belgium, Canada, China,Germany, India, Russia and the United States, along with a global network ofsales agents and distribution channels. We believe that our ability to market and sell a diversified productportfolio through global sales and distribution channels provides us with an advantageover our competitors.  Our sales force islargely organized by region for each business unit.

 

***Customers***

*** ***

The primary customers forour OnSite Generation products are leading industrial gas companies, industrialend users, oil and gas companies and utilities. The primary customers for ourPower Systems products are OEMs, systems integrators and end users.

 

In 2008, three customerscomprised 18%, 7% and 5% of our revenue (in 2007, three customers comprised12%, 5% and 5% of our revenue).  In 2008,24% of our revenues were derived from Europe, 22% from North America, 45% fromAsia, and the 

 

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remaining 9% were derivedfrom other foreign jurisdictions (in 2007 these numbers were 32%, 26%, 15%, and27%, respectively).  Accordingly, we havemitigated risk to any single market or adoption rate by diversifying ourproduct portfolio across the markets in which we operate.

 

We have entered intoagreements with several customers to pursue commercial opportunities which weview as important to our success.  Ourkey customer agreements are summarized below.

 

·                  *Military OEM*.  In December 2005,we entered into a multi-year joint cooperation agreement with a militaryOEM.  For reasons of confidentiality, wecannot disclose the name of this OEM.  Inconjunction with the signing of the cooperation agreement, we were awarded an$8 million contract for multiple units of fuel cell power systems based on our500 series fuel cell stack technology.

 

·                  *American Power Conversion Corp*.   In November 2004, we entered into acollaborative development agreement with APC by Schneider Electric and weannounced an order for 25 fuel cell power modules to be incorporated into theirbackup power products for data centres. APC is a leading global supplier of high availability systems fornetwork-critical physical infrastructure. Our HyPM® XR is a key component of APC’s InfraStruXureTM productline.  In August 2006, we announcedthat we had entered into a supply agreement with APC to deliver up to 500 fuelcell modules for backup power applications. In 2008, we entered into a second supply agreement with APC, broadeningthe scope of our August 2006 supply agreement to support APC’s fuel cellbackup power program.

 

·                  *Leading Global Industrial Gas Companies*. We have previouslyestablished preferred supplier agreements with Air Liquide S.A., Air Productsand Chemicals, Inc., and Linde A.G., three of the leading globalindustrial gas companies.  Typically,these agreements provide that, for industrial applications, we will be thepreferred supplier of onsite, electrolysis-based hydrogen generators to theapplicable industrial gas company.  Webelieve that these relationships represent valuable sales channels, while providingvalidation of our technology from highly credible partners.

 

·                  *General Motors*. In October 2001, we entered into anagreement with General Motors to accelerate the development of fuel celltechnology.  This agreement includesshared intellectual property rights and joint efforts in fuel cell productdevelopment, engineering, prototyping, testing, branding and marketingstrategies. In connection with this agreement, we issued General Motorsapproximately 11.4 million of our common shares, or approximately 21% of ourthen outstanding common shares, and warrants to purchase approximately 2.5million additional shares.  Thesewarrants were subsequently cancelled in December 2005 (see “Item 7. MajorShareholders and Related Party Transactions — Related Party Transactions —Transactions with General Motors”).

 

***Research and ProductDevelopment***

*** ***

Our research and productdevelopment team consists of approximately 10 staff, the substantial majorityof whom are located in Mississauga, Ontario and are focused primarily on ourfuel cell activities. The remainder is located in Oevel, Belgium.  Collectively, these individuals have manyyears of experience in the design of electrolysis and fuel cell products. Ourproduct development team combines leaders with extensive experience in theirfields with younger graduates from leading universities.

 

Our objective is todevelop complete products rather than components and to ensure that theseproducts are constantly improved throughout the product life.  Our research activities are unique to each ofour business units but typically focus on the cost, performance and durabilityof our products. Our product development activities commence with a marketrequirement document establishing the business case for the proposed product.This process involves staff from our business development, finance, engineeringand operations departments who balance the requirements of performance, time tomarket, and product cost.  Prototypes areoften validated by lead customers such as APC by Schneider Electric andCommScope, Inc.

 

We seek cost-sharingprojects with various government agencies, mainly in North America, topartially offset our research and product development expenses.  We currently have contribution agreementswith the Province of Ontario, Ministry of Research and Innovation, and with theCanada Foundation for Sustainable Development Technology, a corporation withoutshare capital incorporated under the Canada Corporations Act and continuedunder the Sustainable Development Technology Act (Canada).  In 2008, $1.4 million, or 16.3% of ourresearch and product development expenses were funded by various governments.

 

Our current research andproduct development plans are summarized below:

 

·                  *OnSite Generation*. Our research activities are focused onperformance improvements of our electrolyzer cell stacks. Our productdevelopment activities are focused on large scale electrolyzers to storerenewable or other zero-emission energy as hydrogen, thereby helping to addressthe intermittency problem associated with most renewable energies, or to refuelvehicles from locally-produced non-fossil sources. Our larger-scale andlower-scale product developments aim to make Hydrogenics the “one-stop shop” forall on-site hydrogen generation needs.

 

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·                  *Power Systems*.  At thefuel cell stack, or component level, we are focused on testing, adapting andintegrating new materials, design concepts, manufacturing techniques, and oncost reduction.  At the module or productlevel, we are focused on cost reduction and on meeting market specificrequirements for durability and performance. Additionally, our productdevelopment focuses on size reduction, allowing the same power module to bedeployed in both mobile and stationary applications. Our product developmentalso focuses on small scale PEM electrolyzers, which we believe will havegreater demand due to their lower cost and size in the small capacity range of<10 Nm3/h.

 

***IntellectualProperty***

*** ***

We protect ourintellectual property by means of a combination of patent protection,copyrights, trademarks, trade secrets, licences, non-disclosure agreements andcontractual provisions. We generally enter into a non-disclosure andconfidentiality agreement with each of our employees, consultants and thirdparties that have access to our proprietary technology.  We currently hold 55 patents in a variety ofjurisdictions and have more than 191 patent applications pending.  Additionally, we enter into commerciallicences and cross-licences to access third party intellectual property.

 

We typically retain soleownership of intellectual property developed by us. In certain situations, suchas with Dow Corning and General Motors, we provide for shared intellectualproperty rights. In the case of General Motors, we have a non-exclusive,royalty-free license to use certain of General Motors’ proprietary fuel cellstack intellectual property in certain applications and markets.  We have these rights in perpetuity, includingsubsequent improvements to the licensed technology. In the case of Dow Corning,we jointly own a U.S. patent application, together with all inventions fallingwithin the description of such patent application specific to sealing andsealing materials for fuel cell and electrolyzer assemblies.

 

Given the relative earlystages of our industry, our intellectual property is and will continue to beimportant in providing differentiated products to customers.

 

***Manufacturing***

*** ***

The majority of ourmanufacturing services, including parts procurement, kitting, assembly andrepair, are carried out in-house at our respective business unit manufacturingfacilities. We also perform certain manufacturing related functions in-house,including manufacturing engineering, and the development of manufacturing testprocedures and fixtures.

 

We anticipate being ableto move various aspects of our manufacturing operations to third parties orother lower cost jurisdictions as production volumes increase.  By moving to third parties, we would benefitfrom contract manufacturing economies of scale, access to high qualityproduction resources and reduced equipment capital costs and equipmentobsolescence risk.  We have alsocommenced sourcing components from third parties in Asia and expect to increasethe volume over time to reduce our material costs.

 

We are dependent uponthird party suppliers for certain key materials and components for our productssuch as membrane electrode assemblies and ultra capacitors.  We believe that we have sufficient sourcesand price stability of our key materials and components.

 

We have certifications inISO 9001-2000 in both of our Oevel and Mississauga facilities, and ISO 14001and OHSAS 18001 in our Oevel facility.

 

**Government Regulation**

** **

We are not subject toregulatory commissions governing traditional electric utilities and otherregulated entities in any of the jurisdictions that we operate in. Our productsare however subject to oversight and regulation by governmental bodies inregards to building codes, fire codes, public safety, electrical and gas pipelineconnections and hydrogen siting, among others.

 

**ORGANIZATIONAL STRUCTURE**

** **

As of May 31,2009, we beneficially owned, directly or indirectly, 100% of the voting andnon-voting securities of the material subsidiaries listed below.

 

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| **Subsidiaries**                                                                   | ** ** | **Jurisdiction of  Incorporation** |
|------------------------------------------------------------------------------------|------------|------------------------------------|
|                                                                               |       |                               |
| Hydrogenics Test Systems Inc. (formerly Greenlight Power  Technologies, Inc.) |       | Canada                             |
|                                                                               |       |                               |
| Stuart Energy Systems Corporation                                                  |       | Canada                             |
|                                                                               |       |                               |
| Hydrogenics Europe NV                                                              |       | Belgium                            |
|                                                                               |       |                               |
| Hydrogenics  GmbH                                                                  |       | Germany                            |

** **

**PROPERTY, PLANT AND EQUIPMENT**

 

We have the followingfacilities:

 

·                  *Mississauga, Ontario, Canada*.  Our 96,000 square foot facility inMississauga, Ontario serves as our corporate headquarters and Power Systemsmanufacturing facility and is leased until August 31, 2010. Principalactivities at this facility include the manufacture and assembly of our fuelcell power and research and product development for our fuel cell powerproducts, fuel cell testing services and our corporate activities.

 

·                  *Oevel-Westerlo, Belgium*. Our 32,000 square foot facility in Oevel-Westerlo, Belgium serves as ourmanufacturing facility for our OnSite Generation business and is leased until August 30,2014.  Principal activities at thisfacility include the manufacture and assembly of our hydrogen generationequipment, water electrolysis research and product development as well asadministrative functions related to our OnSite Generation business.

 

·                  *Burnaby, British Columbia, Canada*.  Our 54,000 square foot facility in Burnaby,British Columbia served as our manufacturing facility for our Test Systemsbusiness and is leased until December 31, 2009. Principal activities atthis facility included the manufacture and assembly of our test products, testproducts research and product development as well as administrative functionsrelated to our Test Systems business. In November 2007, we announced ourdecision to commence an orderly windup of our fuel cell test products anddesign, development and manufacturing business. As a result, we expect tovacate this facility during 2009.

 

·                  *Gladbeck, Germany*. Our Power Systems group maintains a 6,458 square foot facility inGladbeck, Germany, which is leased until November 2010.  This facility is used to provide fuel cellintegration services for European customers and serves as our European officefor fuel cell activities of our Power Systems business.

 

·                  *Shanghai, China*.  Ourprocurement group maintains a 100 square foot facility in Shanghai, China. Thisfacility is used for sourcing of products in China and other Asian countries.

 

In 2005, we assumed leaseobligations previously established by Stuart Energy, including a vacant 53,240square foot facility in Shawinigan, Quebec, with an annual lease cost ofapproximately $0.3 million expiring in May 2011.  This Shawinigan property was sublet in2006.  In connection with its acquisitionof Vandenborre Technologies NV in February 2003, Stuart Energy sought torationalize its operations in 2003.  As aresult, Stuart Energy has previously taken a financial charge relating to theShawinigan, Quebec facility.

 

We also have small salesoffices in Asia, Europe, and North America. We believe our facilities are presently adequate for our operations andwe will be able to maintain suitable space needed on commercially reasonableterms.

** **

**ITEM4A.               UNRESOLVED STAFFCOMMENTS**

 

None.

** **

**ITEM5.  OPERATING AND FINANCIAL REVIEW ANDPROSPECTS**

** **

**OPERATING RESULTS**

 

This section provides adetailed discussion of our financial performance based on our consolidatedfinancial statements found on pages F-6 to F-10 of this form.  All references to per share amounts pertainto net loss per share. Certain of the prior year’s figures have beenreclassified to conform to the current year’s presentation.

 

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**Summary FinancialAnalysis**

 

(in thousand of US dollars, except for share and per share amounts)

 
| ** **                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Increase (Decrease)** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------|------------|
| ** **                                                                               | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| **Consolidated Statements  of Operations**                                               |       |       |       |       |       |       |       |                      |       |   |   |
| OnSite Generation                                                                        |       | 31,207     |       | 19,608     |       | 12,032     |       | 59                        | %          | 63 | % |
| Power Systems                                                                            |       | 5,643      |       | 6,103      |       | 6,943      |       | (8                        | )%         | (12 | )% |
|                                                                                     |       | 36,850     |       | 25,711     |       | 18,975     |       | 43                        | %          | 35 | % |
| Test Systems                                                                             |       | 2,490      |       | 12,279     |       | 11,084     |       | (80                       | )%         | 11 | % |
| Revenues                                                                                 |       | 39,340     |       | 37,990     |       | 30,059     |       | 4                         | %          | 26 | % |
| Gross Margin                                                                             |       | 7,894      |       | 4,389      |       | 699        |       | 80                        | %          | 528 | % |
| % of Revenues                                                                            |       | 20         | %          | 12         | %          | 2          | %          |                      |       |   |   |
|                                                                                     |       |       |       |       |       |       |       |                      |       |   |   |
| Selling, General and  Administrative Expenses                                            |       | 15,022     |       | 24,006     |       | 27,892     |       | (37                       | )%         | (14 | )% |
|                                                                                     |       |       |       |       |       |       |       |                      |       |   |   |
| Research and Product  Development Expenses                                               |       | 7,296      |       | 9,690      |       | 9,379      |       | (25                       | )%         | 3 | % |
|                                                                                     |       |       |       |       |       |       |       |                      |       |   |   |
| Net Loss                                                                                 |       | (14,319    | )          | (28,068    | )          | (130,759   | )          | (49                       | )%         | (79 | )% |
| Net Loss Per Share                                                                       |       | $          | (0.16      | )          | $          | (0.31      | )          | $                         | (1.42      | ) | (48 | )% | (78 | )% |
|                                                                                     |       |       |       |       |       |       |       |                      |       |   |   |
| **Consolidated Statements  of Cash Flows**                                               |       |       |       |       |       |       |       |                      |       |   |   |
| Cash used in Operating  Activities                                                       |       | (6,802     | )          | (28,416    | )          | (24,488    | )          | (76                       | )%         | 16 | % |
|                                                                                     |       |       |       |       |       |       |       |                      |       |   |   |
| **Other Measures**                                                                       |       |       |       |       |       |       |       |                      |       |   |   |
| Cash Operating Costs(1)                                                                  |       | 21,624     |       | 32,143     |       | 35,438     |       | (33                       | )%         | (9 | )% |
| Earnings Before Interest,  Taxes, Depreciation and Amortization (“EBITDA”) (1) |       | (14,424    | )          | (31,323    | )          | (36,571    | )          | (54                       | )%         | (14 | )% |
|                                                                                          |            |            |            |            |            |            |            |                           |            |  |  |  |  |  |

 

----

Notes:

 

(1)          Cash OperatingCosts and EBITDA are Non-GAAP measures. Please refer to “Item 5. Operating and Financial Review and Prospects —Operating Results — Reconciliation and Definition of Non-GAAP Measures.”

*** ***

***Highlights for2008 compared to 2007***

 

·                  Revenuesincreased $11.1 million or 43%, exclusive of Test Systems revenues, as a resultof revenue growth in our OnSite Generation business unit.

 

·                  Cashoperating costs decreased $10.5 million or 33%, primarily resulting from our2007 business streamlining initiatives and the decision to wind up our testequipment business and the absence of $4.1 million in severance and relatedexpenses.

 

·                  EBITDAloss decreased $16.9 million or 54%, reflecting: (i) a $3.5 millionincrease in gross margin corresponding to an increase of eight percentagepoints; (ii) a $9.0 million decrease in selling, general andadministrative expenses; (iii) a $2.4 million decrease in research andproduct development expenses; and (iv) the absence of a $2.0 millionprovision recorded in 2007 in respect of the wind up of our test equipmentbusiness.

 

·                  Netloss decreased $13.8 million or 49% ($0.15 per share), reflecting a lowerEBITDA loss, partially offset by decreased interest income and foreign currencygains.

 

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·                  Cashused in operating activities decreased $21.6 million, or 76% reflecting; (i) a$16.9 million decrease in our EBITDA loss; (ii) an $8.9 million decreasein non-cash working capital requirements; offset by (iii) a $3.8 milliondecrease in net interest income and foreigncurrency gains; and (iv) $0.3 million of other items.

*** ***

***Highlights for2007 compared to 2006***

 

·                  Revenues increased $6.7 million, or 35%,exclusive of Test Systems revenues, as a result of the resumption of productionin our OnSite Generation business unit to historical levels, partially offsetby an $0.8 million decrease in revenues from our Power Systems business unit.

 

·                  Cash operating costs decreased $3.3 millionor 9%, primarily resulting from business streamlining initiatives and thedecision to wind up our test equipment business, both taken in 2007.

 

·                  EBITDA loss decreased $5.2 million or 14%,reflecting: (i) a $3.7 million increase in gross margin; and (ii) $3.3million of decreased cash operating costs, partially offset by a $2.0 millionprovision in respect of the wind up of our test equipment business.

 

·                  Net loss decreased $102.7 million ($1.11 pershare) or 78%, reflecting the changes in EBITDA noted above and the absence of$90.8 million of impairment charges in 2006 attributed to our acquisition ofStuart Energy and Greenlight Power Technologies, Inc. (“GreenlightPower”).

 

·                  Cash used in operating activities increased$3.9 million or 16%, reflecting an increase in working capital requirements aswe resumed production in our OnSite Generation business unit to historicallevels, partially offset by the decreased EBITDA loss noted above.

** **

**Business Segment Review**

 

We report our results infour business segments, OnSite Generation, Power Systems, Test Systems, andCorporate and Other. These segments are differentiated by the productsdeveloped and services provided. Our reporting structure reflects how we manageour business and how we classify our operations for planning and measuringperformance.  See “Item 4.  Information on the Company — BusinessOverview” for a description of our business segments.

*** ***

***OnSite Generation***

* *

*Summary Financial Analysis*

 
| ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Increase (Decrease)** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------|------------|
| **(in thousand of US dollars)**              | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| Revenues                                     |       | 31,207     |       | 19,608     |       | 12,032     |       | 59                        | %          | 63 | % |
| Gross Margin                                 |       | 6,919      |       | 610        |       | (5,767     | )          | 1.034                     | %          | (111 | )% |
| % of Revenues                                |       | 22         | %          | 3          | %          | (48        | )%         |                      |       |   |   |
|                                         |       |       |       |       |       |       |       |                      |       |   |   |
| Selling, General and Administrative Expenses |       | 3,552      |       | 4,182      |       | 5,494      |       | (15                       | )%         | (24 | )% |
| Research and Product Development Expenses    |       | 1,261      |       | 1,865      |       | 3,160      |       | (32                       | )%         | (41 | )% |
| Segment Income/(Loss)                        |       | 2,106      |       | (5,436     | )          | (14,885    | )          | (139                      | )%         | (62 | )% |

 

**Revenues**for2008 were $31.2 million, an increase of $11.6 million or 59% compared to 2007,as a result of increased product demand, operational improvements and productcost reductions. Revenues in 2008 consisted of the sale of electrolyzerproducts to customers in industrial gas, hydrogen fueling and renewable energystorage markets. As at December 31, 2008, we had $14.6 million ofconfirmed orders, all of which are anticipated to be delivered and recognizedas revenue in 2009.  Revenues for 2007increased $7.6 million compared to 2006 primarily as a result of the resumptionof production to historical levels.

** **

**GrossMargin**for 2008 was $6.9 million (22% of revenues), comparedto $0.6 million (3% of revenues) in 2007 reflecting operational improvementsand increased overhead absorption. Gross margin in 2007 was $0.6 million (3% ofrevenues) compared to

 

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negative $5.8million (negative 48% of revenues) in 2006, reflecting a more favourableabsorption of overhead, production cost efficiencies and the absence of $2.4million of warranty reserves incurred in connection with units shipped prior toour acquisition of Stuart Energy in January 2005.

** **

**Selling,General and Administrative (“SG&A”) Expenses**for 2008were $3.6 million, a decrease of $0.6 million or 15% compared to 2007. SG&Aexpenses for 2007 were $4.2 million, a decrease of $1.3 million or 24% comparedto 2006. These decreases are primarily the result of streamlining and costreduction initiatives.

** **

**Researchand Product Development (“R&D”) Expenses**for 2008 were$1.3 million, a decrease of $0.6 million or 32% compared to 2007, and reflectthe adoption of a standard product platform to service multiple marketapplications. R&D expenses for 2007 were $1.9 million, a decrease of $1.3million or 41% compared to 2006 reflecting streamlining and cost reductioninitiatives coupled with the adoption of a standard product platform.

** **

**SegmentIncome**for 2008 was $2.1 million compared to a segment lossof $5.4 million in 2007, reflecting increased product demand combined withoperational improvements, cost efficiencies and increased overhead absorption.Segment loss for 2007 was $5.4 million, a $9.4 million or 62% improvementcompared to 2006, reflecting increased revenues and higher overhead absorptionas a result of a return to historical production levels in 2007 and the absenceof $2.4 million in warranty reserves relating to estimated future warrantycosts for units shipped prior to the acquisition of Stuart Energy in January 2005.

*** ***

***Power Systems***

* *

*Summary Financial Analysis*

 
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Increase (Decrease)** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------|------------|
| **(in thousand of US dollars)**               | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| Revenues                                      |       | 5,643      |       | 6,103      |       | 6,943      |       | (8                        | )%         | (12 | )% |
| Gross  Margin                                 |       | 214        |       | 846        |       | 3,043      |       | (75                       | )%         | (72 | )% |
| % of  Revenues                                |       | 4          | %          | 14         | %          | (44        | )%         |                      |       |   |   |
|                                          |       |       |       |       |       |       |       |                      |       |   |   |
| Selling,  General and Administrative Expenses |       | 4,162      |       | 8,247      |       | 6,159      |       | (50                       | )%         | 34 | % |
| Research  and Product Development Expenses    |       | 5,808      |       | 6,882      |       | 4,826      |       | (16                       | )%         | 43 | % |
| Segment  Loss                                 |       | (9,757     | )          | (14,283    | )          | (7,182     | )          | (32                       | )%         | 99 | % |

 

**Revenues**for2008 were $5.6 million, a decrease of $0.5 million or 8% compared to 2007 andreflect a higher proportion of revenues from backup power and motive powermarkets, as opposed to pre-commercial markets. As at December 31, 2008, wehad $7.6 million of confirmed orders for Power Systems’ products and services,over half of which are anticipated to be delivered and recognized as revenue in2009. Revenues for 2007 decreased by $0.8 million or 12%, compared to 2006primarily as a result of an increased effort to focus on backup power andmotive power applications having longer lead times.

** **

**GrossMargin**for 2008 was $0.2 million (4% of revenues) compared to$0.8 million (14% of revenues) in 2007 reflecting a higher proportion ofrevenues from backup power and motive power markets, which generally have lowermargins as we aim to replace incumbent technologies in these markets. Grossmargin for 2007 was $0.8 million (14% of revenues) compared to $3.0 million(44% of revenues) in 2006, reflecting a lower proportion of higher marginmilitary and demonstration orders, appreciation of the Canadian dollar relativeto the US dollar resulting in higher material and labour costs, a $0.5 millionprovision for obsolete inventory and lower overhead absorption as a result oflower revenues.

** **

**SG&AExpenses**for 2008 were $4.2 million, a decrease of $4.1million or 50% compared to 2007, and reflect the results of streamlining andcost reduction initiatives and the absence of $2.9 million in severance andrelated expenses associated with initiatives commenced in 2007. SG&Aexpenses for 2007 were $8.2 million, an increase of $2.1 million compared to2006, primarily as a result of $2.9 million in severance and other relatedexpenses associated with our 2007 streamlining and cost reduction initiatives.

** **

**R&DExpenses**for 2008 were $5.8 million, a decrease of $1.1million or 16% compared to 2007 and reflect a $0.3 million decrease in R&Dexpenditures attributable to developing standard products for multiple market applicationscombined with $0.8

 

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million ofincreased third party funding as a result of the partial deployment of Class 1lift trucks for long-term customer testing. R&D expenses for 2007 were $6.9million, an increase of $2.1 million, reflecting a decreased reliance on thirdparty funding.

** **

**SegmentLoss**for 2008 was $9.8 million compared to a segment loss of$14.3 million in 2007, reflecting $0.6 million of decreased gross margin, $4.1million in decreased SG&A expenses, and $1.0 million in decreased R&Dexpenditures resulting from our streamlining and cost reduction initiativesundertaken during 2007, and lower gross margin. Segment loss for 2007 was $14.3million, compared to a segment loss of $7.2 million in 2006, reflecting a $2.2million decrease in gross margin, a $2.1 million increase in SG&A and a$2.1 million increase in R&D expenses, partially offset by businessstreamlining and cost reduction initiatives.

 

Power Systems incurred anet loss of $7.2 million for the year ended December 31, 2006 compared toa net loss of $9.0 million in 2005 primarily as a result of increased revenuesand lower cost of revenues.

*** ***

***Test Systems***

 

*Summary Financial Analysis*

** **
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Increase (Decrease)** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------|------------|
| **(in thousand of US dollars)**               | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| Revenues                                      |       | 2,490      |       | 12,279     |       | 11,084     |       | (80                       | )%         | 11 | % |
| Gross  Margin                                 |       | 761        |       | 2,933      |       | 3,423      |       | (74                       | )%         | (6 | )% |
| % of  Revenues                                |       | 31         | %          | 24         | %          | 28         | %          |                      |       |   |   |
|                                          |       |       |       |       |       |       |       |                      |       |   |   |
| Selling,  General and Administrative Expenses |       | 1,171      |       | 2,069      |       | 2,593      |       | (43                       | )%         | (20 | )% |
| Research  and Product Development Expenses    |       | 60         |       | 318        |       | 646        |       | (81                       | )%         | (51 | )% |
| Windup  of Test Equipment Business Expense    |       | —     |       | 2,016      |       | —     |       | (100                      | )%         | 100 | % |
| Segment  Income/(Loss)                        |       | (469       | )          | (1,465     | )          | 279        |       | (68                       | )%         | (625 | )% |

 

**Revenues**for2008 were $2.5 million, a decrease of $9.8 million or 80% as a result of ourdecision in 2007 to wind up our test equipment business. Test Systems’ revenuesfor 2008 relate to the delivery of orders received prior to our decision towind up this business. As at December 31, 2008, we had no orders for TestSystems’ products and services remaining to be delivered. Revenues for 2007increased by $1.2 million compared to 2006 primarily as a result of deliveringa greater number of higher output test equipment units.

 

**GrossMargin**for 2008 was $0.8 million (31% of revenues) comparedto $2.9 million (24% of revenues) in 2007 reflecting the gross margin realizedon our remaining orders. Gross margin for 2007 was $2.9 million (24% ofrevenues) compared to $3.4 million (28% of revenues in 2006), reflecting theappreciation of the Canadian dollar relative to the US dollar in 2007,resulting in higher material and labour costs and a reduced proportion of testservices revenues compared to 2006.

** **

**SG&AExpenses**for 2008 were $1.2 million, a decrease of $0.9million from 2007 and $1.5 million for 2006. The reductions in both yearsreflect our decision to downsize and subsequently wind up our test equipmentbusiness.

** **

**R&DExpenses**for 2008 were less than $0.1 million, a decrease of$0.3 million from 2007 and $0.6 million for 2007. The reduction both yearsreflect our decision to downsize and subsequently wind up our test equipmentbusiness.

** **

**Wind upof Test Equipment Business Expenses**decreased $2.0 million or100% compared to 2007 as a result of our November, 2007 decision to wind up ourfuel cell test equipment business. In 2008, we incurred $0.6 million of netcosts attributable to the windup of our test equipment business which wereallocated to the various accounts as incurred. We anticipate incurring amaximum of $0.9 million of costs in 2009 to complete the wind up business onaccount of remediating our manufacturing facility and satisfying remainingwarranty obligations. In November 2007, we indicated that we anticipatedincurring a cash cost and corresponding charge to earnings of between $3.5million and $4.0 million to complete the wind up. We now expect to incur atotal of no more than $3.5 million to wind up our test equipment business.

** **

**SegmentLoss**for 2008 was $0.5 million compared to a segment loss of$1.5 million in 2007 and segment income of $0.3 million in 2006.

 

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***Corporate and Other***

*** ***

*Summary Financial Analysis*

 
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Increase (Decrease)** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------|------------|
| **(in thousands of US dollars)**              | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| Selling,  General and Administrative Expenses |       | 6,137      |       | 9,508      |       | 13,645     |       | (35                       | )%         | (30 | )% |
| Research  and Development Expenses            |       | 167        |       | 625        |       | 747        |       | (73                       | )%         | (16 | )% |
| Segment  Loss                                 |       | (6,199     | )          | (6,884     | )          | (108,971   | )          | (10                       | )%         | (94 | )% |

 

**SG&AExpenses**for 2008 were $6.2 million, a decrease of $3.3million or 35% compared to 2007 reflecting: (i) the results of our streamliningand cost reduction initiatives undertaken in the fourth quarter of 2007; and (ii) theabsence of $1.0 million in severance and other related expenses associated withthese streamlining and cost reduction initiatives; partially offset by $0.3 millionof costs incurred associated with various financing initiatives. SG&Aexpenses for 2007 were $9.5 million, a decrease of $4.1 million or 30% comparedto 2006 reflecting: (i) $4.4 million of savings relating to consulting,deferred compensation arrangements with certain executives, Sarbanes-Oxley Actcompliance and other business strategy matters; (ii) $1.3 million of otheritems, partially offset by: (iii) $1.0 million of severance chargesincurred during 2007 relating to streamlining initiatives; and (iv) $0.8million of higher costs as a result of the weakening of the US dollar relativeto the euro and the Canadian dollar.

** **

**R&DExpenses**for 2008 were $0.2 million, a decrease of $0.5million or 73% compared to 2007 reflecting decreased intellectual propertyfees. R&D expenses for 2007 were $0.6 million, a decrease of $0.1 millionor 16% compared to 2006 also reflecting decreased intellectual propertymanagement fees.

 

**SegmentLoss**for 2008 was $6.2 million, a decrease of $0.7 million or10% compared to 2007 attributable to reduced operating costs as a result ofstreamlining initiatives taken in 2007. Segment loss for 2007 was $6.9 million,a decrease of $102.1 million or 94% compared to 2006 reflecting the absence of$90.8 million in impairment charges for identifiable intangible assets andgoodwill coupled with various cost reduction initiatives and foreign exchangegains, partially offset by increased severance and related compensationpayments.

 

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**Financial Condition**

 

*A discussion of the significant changes in ourconsolidated balance sheets.*

 

As at December 31, (in thousands of US dollars)

 
| ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                         | ** ** | **2008**   | ** ** | **2007**   | ** ** | **$**      | ** ** | **%**      | ** ** | **Commentary** | ** ** |
| Cash, cash equivalents  restricted cash and short-term investments |       | $          | 22,731     |       | $          | 30,492     |       | (7,761     | )          | (25 | ) | ·      Please refer  to “Item 5. Operating and Financial Review and Prospects –Liquidity and  Capital Resources” |   |
|                                                               |       |       |       |       |       |       |       |       |       |   |   |
| Accounts  receivable                                               |       | 3,974      |       | 12,713     |       | (8,739     | )          | (69        | )          | ·      Improved  management of accounts receivable and strong cash collections prior to year-end |   |
|                                                               |       |       |       |       |       |       |       |       |       |   |   |
| Inventory                                                          |       | 10,101     |       | 12,659     |       | (2,558     | )          | (20        | )          | ·      Decreased  work-in-process as a result of improved product lead times |   |
|                                                               |       |       |       |       |       |       |       |       |       |   |   |
| Accounts payable and  accrued liabilities                          |       | 17,298     |       | 18,166     |       | (868       | )          | (5         | )          | ·      Improved  product lead times and decreased inventory levels.

 

·      Refer to note  11 of our consolidated financial statements for a breakdown of this account. |   |
|                                                               |       |       |       |       |       |       |       |       |       |   |   |
| Unearned  revenue                                                  |       | 4,785      |       | 9,042      |       | (4,257     | )          | (47        | )          | ·      Fewer  deposits for orders received prior to the end 2008 compared to 2007 |   |
|                                                                    |            |            |            |            |            |            |            |            |            |  |  |  |  |

 

33

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**Tableof Contents**

 

**Summary Of QuarterlyResults**

* *

*A summary view of our quarterly financial performance.*

 

Thefollowing table highlights selected financial information for the eight consecutivequarters ending December 31, 2008.*

 

(in thousands of US dollars, except for share and pershare amounts)

 
| ** **                                 | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Q4**     | ** ** | **Q3**     | ** ** | **Q2** | ** ** | **Q1** | ** ** | **Q4** | ** ** | **Q3** | ** ** | **Q2** | ** ** | **Q1** | ** ** |
| Revenues                                   |       | $          | 8,855      |       | $          | 10,984 |   | $ | 8,790 |   | $ | 10,711 |   | $ | 11,051 |   | $ | 10,624 |   | $ | 9,465 |   | $ | 6,850 |   |
| Gross Margin                               |       | 2,568      |       | 1,488      |       | 1,973 |   | 1,865 |   | 1,430 |   | 1,080 |   | 965 |   | 914 |   |
| % of Revenues                              |       | 29         | %          | 14         | %          | 22 | % | 17 | % | 13 | % | 10 | % | 10 | % | 13 | % |
| EBITDA                                     |       | (2,004     | )          | (3,446     | )          | (5,066 | ) | (3,908 | ) | (9,585 | ) | (7,171 | ) | (5,672 | ) | (8,895 | ) |
| Net Loss                                   |       | (1,950     | )          | (3,728     | )          | (4,319 | ) | (4,322 | ) | (9,497 | ) | (6,478 | ) | (3,787 | ) | (8,306 | ) |
| Net Loss Per Share (Basic and diluted)     |       | (0.02      | )          | (0.04      | )          | (0.05 | ) | (0.05 | ) | (0.10 | ) | (0.07 | ) | (0.04 | ) | (0.09 | ) |
| Weighted Average Common Shares Outstanding |       | 92,406,666 |       | 92,378,737 |       | 91,765,686 |   | 91,896,689 |   | 91,765,691 |   | 91,765,691 |   | 91,765,691 |   | 91,896,363 |   |
|                                            |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

Note:

 

*  Certain minor variances exist between theannual consolidated financial statements and this summary.

 

In the first quarter of2008, our net loss decreased by $3.9 million ($0.04 per common share) comparedto the first quarter of 2007 due to increased revenues and gross margins in ourOnSite Generation business unit and the absence of $2.1 million of severanceand related expenses associated with business streamlining and cost reductioninitiatives.

 

In the second quarter 2008,our net loss increased by $0.5 million ($0.01 per common share) compared to thesecond quarter of 2007 due to $0.9 million of SG&A expenses associated withdeferred compensation arrangements indexed to our share price, partially offsetby increased gross margins.

 

In the third quarter of2008, our net loss decreased by $2.8 million ($0.03 per common share) comparedto the third quarter of 2007 due to increased revenues and gross margincombined with decreased SG&A and R&D expenses, partially offset by lowerinterest income and foreign exchange gains.

 

In the fourth quarter of2008, our net loss decreased $7.5 million ($0.08 per common share) compared tothe fourth quarter of 2007 as noted below.

 

·                  Revenuesfor the fourth quarter of 2008 were $8.9 million, a $0.7 million or 9%increase, excluding Test Systems, compared to the fourth quarter of 2007 due toincreased demand for our OnSite Generation products.

 

·                  Grossmargin was $2.6 million (29% of revenues) in the fourth quarter of 2008compared to $1.4 million (13% of revenues) in the fourth quarter of 2007,reflecting operational improvements and product cost reductions as well asfavourable overhead absorption levels.

 

·                  SG&Aexpenses for the fourth quarter of 2008 were $2.8 million, a decrease of $4.1 millionor 59% compared to the fourth quarter of 2007 reflecting the absence of $4.0million of severance and other associated costs incurred during the fourthquarter of 2007 as well as overall cost reductions as a result of ourstreamlining initiatives.

 

·                  R&Dexpenses for the fourth quarter of 2008 were $1.7 million, a decrease of $0.3million or 16% compared to the fourth quarter of 2007 reflecting streamliningand cost reduction initiatives coupled with the adoption of a standard productplatform.

 

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·                  Netloss was $2.0 million ($0.02 per share), a $7.5 million or 79% decreasecompared to $9.5 million in the fourth quarter of 2007 ($0.10 per share) as aresult of: (i) an increase of 15 percentage points in gross margin; (ii) theabsence of $4.0 million in severance and other costs incurred during the fourthquarter of 2007 associated with our streamlining initiatives and the decisionto wind up our fuel cell test equipment business; and (iii) overall costreductions as a result of our streamlining initiatives.

 

The information in thissection was obtained from our quarterly unaudited consolidated financial statements,which are denominated in US dollars and have been prepared in accordance withCanadian GAAP. This information, in the opinion of management, has beenprepared using accounting policies consistent with the audited consolidatedfinancial statements and includes all adjustments necessary for the fair presentationof the results of the interim periods. We expect our operating results to varysignificantly from quarter to quarter and they should not be relied upon topredict future performance.

** **

**Reconciliation andDefinition of Non-GAAP Measures**

* *

*A description, calculation, and reconciliation ofcertain measures used by management.*

 

Non-GAAP financialmeasures including EBITDA and Cash Operating Costs are used by management toprovide additional insight into our performance and financial condition.  We believe these Non-GAAP measures are animportant part of the financial reporting process and, and are useful incommunicating information that complements and supplements the consolidatedfinancial statements.  In accordance withCanadian Securities Administration Staff Notice 52-306, we have providedreconciliations of our Non-GAAP financial measures to the most directlycomparable Canadian GAAP number, disclosure of the purposes of the Non-GAAPmeasure, and how the Non-GAAP measure is used in managing the business.

*** ***

***EBITDA***

 

We report EBITDA becauseit is a key measure used by management to evaluate the performance of businessunits and the Company.  EBITDA is ameasure commonly reported and widely used by investors as an indicator of acompany’s operating performance and ability to incur and service debt, and as avaluation metric.  We believe EBITDAassists investors in comparing a company’s performance on a consistent basiswithout regard to depreciation and amortization, which are non-cash in natureand can vary significantly depending on accounting methods or non-operatingfactors such as historical cost.

 

EBITDA is not acalculation based on Canadian GAAP or US GAAP and should not be considered analternative to operating income or net income in measuring ourperformance.  Nor should it be used as anexclusive measure of cash flow, because it does not consider the impact ofworking capital growth, capital expenditures, debt principal reductions andother sources and uses of cash, which are disclosed in the consolidatedstatements of cash flows.  Investorsshould carefully consider the specific items included in our computation ofEBITDA.  While EBITDA has been disclosedherein to permit a more complete comparative analysis of our operatingperformance relative to other companies, investors should be cautioned thatEBITDA as reported by us may not be comparable in all instances to EBITDA asreported by other companies.

 

*EBITDA*

*(in thousands of us dollars)*

 
| ** **                                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net loss                                      |       | $        | (14,319    | )        | $          | (28,068  | )          | $ | (130,759 | ) |
| Amortization of property, plant and equipment |       | 855      |       | 903      |       | 1,285    |       |
| Amortization of intangible assets             |       | 249      |       | 251      |       | 7,139    |       |
| Impairment of intangible assets and goodwill  |       | —   |       | —   |       | 90,834   |       |
| Other income                                  |       | 1,325    |       | 4,431    |       | 4,890    |       |
| Income tax expense (recovery)                 |       | 116      |       | 22       |       | (180     | )          |
| EBITDA                                        |       | $        | (14,424    | )        | $          | (31,323  | )          | $ | (36,571 | ) |

 

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***Cash OperatingCosts***

 

We report Cash OperatingCosts because it is a key measure used by management to measure the fixedoperating costs required to operate the ongoing business units of theCompany.  We believe Cash Operating Costsis a useful measure in assessing our fixed operating costs.

 

Cash Operating Costs arenot based on Canadian or US GAAP and should not be considered an alternative toloss from operations in measuring the Company’s performance, nor should it beused as an exclusive measure of our operating costs because it does notconsider certain stock-based compensation expenses, which are disclosed in theconsolidated statements of operations. Investors should carefully consider the specific items included in ourcomputation of Cash Operating Costs. While Cash Operating Costs are disclosed herein to permit a morecomplete comparative analysis of our cost structure relative to othercompanies, investors should be cautioned that Cash Operating Costs as reportedby us may not be comparable in all instances to Cash Operating Costs asreported by other companies.

 

The following is areconciliation of Cash Operating Costs with Loss from Operations.  Cash Operating Costs are regularly reportedto the chief operating decision maker and corresponds to the definition used inour historical quarterly discussions.

* *

*Cash Operating Costs****(in thousands of US dollars)*

 
| ** **                                           | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Loss from operations                                 |       | $        | (15,528    | )        | $          | (32,477  | )          | $ | (135,829 | ) |
| Less: Gross margin                                   |       | 7,894    |       | 4,389    |       | 699      |       |
| Less: Windup of test equipment business              |       | —   |       | 2,016    |       | —   |       |
| Less: Stock-based compensation                       |       | 694      |       | 1,553    |       | 1,832    |       |
| Less: Amortization of property, plant and  equipment |       | 855      |       | 903      |       | 1,285    |       |
| Less: Amortization of intangible assets              |       | 249      |       | 251      |       | 7,139    |       |
| Less: Impairment of intangible assets and goodwill   |       | —   |       | —   |       | 90,834   |       |
| Cash Operating Costs                                 |       | $        | 21,624     |     | $          | 32,143   |       | $ | 35,438 |   |

** **

**Impact of Inflation**

 

None.

** **

**Impact of ForeignCurrency Fluctuations**

 

For information regardingthe impact of foreign currency fluctuations on our Company, see “Item 5. Operatingand Financial Review and Prospects — Liquidity and Capital Resources — ForeignCurrency Risk” and “Note 4 — Risk Management Arising from Financial Instruments— Foreign Currency Risk” under the Notes to Consolidated Financial Statements,which can be found on page F-16 of this form, and is incorporated byreference herein.  We currently havelimited currency hedging through financial instruments. We carry a portion ofour short-term investments in Canadian dollars and euros.

** **

**Governmental Policies**

 

For information regardingthe potential impact of changes in governmental policies on the Company, see“Item 3.  Key Information — Risk Factors— Risk Factors Related to Our Business and Industry.”

** **

**LIQUIDITY AND CAPITAL RESOURCES**

 

The following section explainshow we manage our cash and capital resources to carry out our strategy anddeliver results.

 

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**Cash Used in OperatingActivities**

 

*(in thousands of US dollars)*

 
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                | ** ** | **2008**   | ** ** | **2007**   | ** ** | **$**      | ** ** | **%** | ** ** |
| EBITDA  loss                        |       | (14,424    | )          | (31,323    | )          | 16,899     |       | 54 |   |
| Other  income (expenses)            |       | 1,325      |       | 4,431      |       | (3,106     | )          | (70 | ) |
| Change  in non-cash working capital |       | 4,817      |       | (4,100     | )          | 8,917      |       | 217 |   |
| Other  items                        |       | 1,480      |       | 2,576      |       | (1,096     | )          | (43 | ) |
| Cash  used in operating activities  |       | (6,802     | )          | (28,416    | )          | 21,614     |       | 76 |   |

 

Changes in cash used inoperating activities in 2008 compared to 2007 are discussed below.

 

·                  EBITDAloss decreased $16.9 million or 54% as more particularly described in “Item 5.Operating and Financial Review and Prospects — Operating Results” above.

 

·                  Otherincome (expenses) decreased $3.1 million or 70% as a result of $1.3 million oflower interest income net, and $2.4 million of lower foreign currency gains,offset by $0.6 million of other items. The decrease in interest, net reflectslower interest rates and a lower asset base. The decrease in foreign currencygains resulted from the absence of gains incurred during 2007 from holding Canadiandollar denominated marketable securities at a time when the value of theCanadian dollar appreciated relative to the US dollar and the significantvariations in the US dollar relative to both the Canadian dollar and the euroduring 2008.

 

·                  Changesin non-cash working capital increased $8.9 million as more particularlydescribed in “Item 5. Operating and Financial Review and Prospects — OperatingResults — Financial Conditions” above.

 

·                  Otheritems decreased $1.1 million or 40% as a result of changes in various othercash and non-cash items.

 

We anticipate consumingbetween of $12 million to $17 million in 2009 to fund our anticipated EBITDAlosses, non-cash working capital requirements and capital expenditures.

** **

**Cash Provided byInvesting Activities**

 

*(in thousands of US dollars)*

 
| ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **2008**   | ** ** | **2007**   | ** ** | **$**      | ** ** | **%** | ** ** |
| Cash  used in operating activities |       | $          | 13,061     |       | $          | 37,987     |       | (24,926 | ) | (66 | ) |
|                                    |            |            |            |            |            |            |            |  |  |  |  |

 

Cash provided byinvesting activities was $13.0 million in 2008, a decrease of $25.0 million or66% compared to 2007. The $13.0 million of cash used in investing activitiesreflects a $15.0 million reduction in short-term investments to fund ouroperating requirements, offset by: (i) a $1.1 million increase inrestricted cash being held as partial securitization for standby letters ofcredit and letters of guarantee and (ii) $0.9 million of capitalexpenditures.

 

**Cash Used in FinancingActivities**

 

*(in thousands of US dollars)*

 
| ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **2008**   | ** ** | **2007**   | ** ** | **$**      | ** ** | **%** | ** ** |
| Cash  used in financing activities |       | $          | (118       | )          | $          | (48        | )          | $ | (70 | ) | (146 | ) |
|                                    |            |            |            |            |            |            |            |  |  |  |  |  |

 

Cash used in financingactivities was $0.1 million in 2008, a decrease of less than $0.1 millioncompared to 2007 and reflect a $0.2 million decrease in deferred research andproduct development grants offset by $0.1 million of funds received on theexercise of stock options.

 

**Credit Facilities**

 

We routinely utilize acredit facility with a Canadian chartered bank to better manage our short termcash requirements and to support letters of guarantee provided to customers. Asat December 31, 2008, we had $11.5 million of credit available to usecompared to $13.8 million as at December 31, 2007, the result of exchangerate differences. As at December 31, 2008 and 2007, we had no indebtednesson this credit facility.  In April 2009,we terminated our existing credit facility with the bank and established a 

 

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new Cdn. $2million credit facility with the bank (the “2009 Credit Facility”). Pursuant tothe 2009 Credit Facility, we may borrow up to Cdn. $1 million for generalborrowing purposes and up to Cdn. $1 million for letters of credit andguarantee, subject to an equal amount of cash being provided as security tosupport any letters of credit and guarantee issued. The 2009 Credit Facilitybears interest at the bank’s prime rate plus 3% and is conditional uponHydrogenics maintaining a minimum cash balance of Cdn. $8 million and a currentasset to current liability ratio of 1.25:1.00.

 

Our operating facilitiesare denominated in Canadian dollars and the euro and bear interest at theCanadian chartered bank’s prime rate plus 0.5% and EURIBOR, respectively. Thefacilities are due on demand and collateralized by a general security agreementover all of our assets and $1.1 million of restricted cash as at December 31,2008. We had $2.3 million of letters of credit and letters of guaranteeoutstanding as at December 31, 2008 ($5.2 million as at December 31, 2007)with expiry dates extending to October 2011. We are in compliance with ourdebt covenants.

 

**Financial Instruments**

 

The Company’s financialinstruments and the nature of the risks, existing or potential, are set out inthe following table:

 
| ** **                                                                                                        | ** ** | **Risk**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Market Risks** | ** ** |
| ** **                                                                                                        | ** ** | **Credit** | ** ** | **Liquidity** | ** ** | **Currency** | ** ** | **Interest Rate** | ** ** |
| Cash  and cash equivalents and restricted cash (which are primarily held in euros  and Canadian and U.S. dollars) |       | n          |       |   |   | n |   | n |   |
| Short-term  investments                                                                                           |       | n          |       |   |   | n |   | n |   |
| Accounts  receivable                                                                                              |       | n          |       |   |   | n |   |   |   |
| Accounts  payable and accrued liabilities                                                                         |       | n          |       | n |   | n |   |   |   |

 

**Credit Risk**

 

Credit risk arises fromthe potential that a counterparty will fail to perform its obligations. Creditrisk associated with cash and cash equivalents and short-term investments isminimized by ensuring financial assets are placed for short periods of time,generally less than 90 days, with governments, well capitalized financialinstitutions and other creditworthy counterparties. An ongoing review isperformed by management to evaluate changes in the status of counterparties.

 

Credit risk associatedwith accounts receivable is minimized by carrying out a detailed review andapproval by senior management of credit extensions to customers taking intoaccount customer history, any amounts that are past due and any availablerelevant information on the customers’ liquidity and potential going concernproblems. In addition, progress payments are generally required by customers ascontracts are executed which usually results in between 35% and 100% of acontract value being collected before shipments are made. Where credit termsare extended beyond shipment, terms are normally not granted beyond 60 days. Wemaintain provisions for potential credit losses and any such losses to datehave been insignificant.

 

Credit risk associatedwith grants receivable is substantially minimized by ensuring that fundingagreements are accepted from government entities or well capitalizedcorporations.

** **

**Foreign Currency Risk**

 

While our functionalcurrency is the US dollar, we conduct a significant portion of our business inforeign currencies including the Canadian dollar and the euro. Monetary assetsand liabilities denominated in foreign currencies are affected by changes inthe exchange rate between the functional currency of the operation and theseforeign currencies.

 

Our objective in managingforeign currency risk is to minimize our net exposures to foreign currency cashflows by converting cash balances into foreign currencies to the extentpractical to match other foreign currency obligations. Our foreign exchangerisk management program includes the use of foreign exchange currency forwardcontracts to fix the exchange rates on short-term Canadian dollar and eurodenominated transactions and commitments.

 

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**Interest Rate Risk**

 

Interest rate risk arisesbecause of the fluctuation in market interest rates.We are subject to interest rate risk on our cash and cash equivalents andshort-term investments; however, we do not have any long-term debt and henceare not subject to interest rate risk from borrowings.

** **

**Liquidity**

 

Liquidity risk arisesfrom our general funding needs and in the management of our assets, liabilitiesand capital structure. We manage liquidity risk by maintaining sufficientliquid financial resources to fund our balance sheet and meet our commitmentsand obligations in the most cost-effective manner.

 

We have sustained lossesand negative cash flows from operations since our inception. At December 31,2008, we had approximately $22.7 million of cash and cash equivalents andrestricted cash. There are significant uncertainties related to the timing anduse of our cash resources and working capital requirements. These uncertaintiesinclude, among other things, the timing and volume of commercial sales, theassociated gross margin of our existing products and the development of marketsfor, and customer acceptance of new products.

 

Throughout 2009 and 2010,we do not expect our operations to generate sufficient cash flow to fund ourobligations as they come due. As such, these obligations will be funded out ofexisting cash resources to the extent possible. In the first quarter of 2009,we took actions to streamline our business, including additional headcountreductions as well as additional cost saving measures in order to minimize thedraw on our cash resources.

 

As a result of theexpected use of our existing cash resources, we anticipate requiring additionalfunding to meet our anticipated obligations. Such funding may be in the form ofdebt or equity or a hybrid instrument depending on the needs of the investor.Given the current state of the global economic and credit market conditions, wemay not be able to raise additional cash from traditional financing sources. Assuch, we are also pursuing non-traditional sources of financing including anattempt to monetize a portion of our accumulated tax losses. There is noassurance we will be successful in our financing efforts or that they will besufficient.

 

As mentioned under “Item4.  Information of the Company — Historyand Development of Hydrogenics Corporation”, we have entered into an agreementwith the Algonquin Board to implement a non-dilutive financing transaction,which will provide us with working capital.  The transaction is subject to various conditions as described above.

 

The condition of thecurrent global economy and credit markets affects our outlook in two primaryways. First, our products depend, to some degree, on general world economicconditions and activity. If the current condition of the economy results in asustained broad economic recession, demand for our products is likely to decline.Secondly, the current economic and credit climate could adversely affect ourability to conduct normal day-to-day selling activities which often depend onthe granting of short-term credit to a wide variety of purchasers andparticularly the corresponding need of those purchasers to finance purchases byaccessing credit. Our business is dependent on purchasers of our productshaving access to adequate levels of credit. If the current condition of theeconomy is not resolved in a manner that will provide access to credit topotential purchasers of our products, our business will likely suffer as aresult. Given these uncertainties, we will continue to monitor our operatingstrategy.

 

On October 16, 2008,Nasdaq, citing “extraordinary market conditions” temporarily suspended until January 16,2009 its continued listing requirements related to a minimum $1 closing bidprice and a minimum market value of publicly held shares. Nasdaq has extendedits suspension until July 20, 2009. There can be no assurance that the temporary suspension of such rules willbe extended beyond July 20, 2009. If the suspension of such rules is lifted, there can be noassurance that we will be able to maintain compliance with the listingrequirements.  On December 31, 2008,the per share price of our common shares closed at $0.41 on the Nasdaq. If weare not able to maintain compliance with such continuing listing requirementsafter July 20, 2009, our stock may be delisted from Nasdaq. This couldmaterially reduce the liquidity of our common shares, affect the price of ourcommon shares, and impair our ability to raise financing.

 

In order to mitigate ourrisk with regard to maintaining the listing requirement noted above, at theannual and special meeting of our shareholders held on May 13, 2009, ourshareholders approved a special resolution that gave authority to our Board ofDirectors, in its sole discretion, to amend our articles of incorporation toallow for a consolidation of our issued and outstanding common shares at anytime prior to March 24, 2010, and to select the exact consolidation ratio,provided that (i) the ratio may be no smaller than one post-consolidationshare for every 10 pre-consolidation shares, and no larger than onepost-consolidation share for every 25 pre-consolidation shares, and (ii) thenumber of pre-consolidation shares in the ratio must be a whole number ofshares. Assuming receipt of the necessary approvals, the exact number of sharesof the Company to be consolidated, if at all, would be determined by our Boardof Directors before the share consolidation would be effective, and the Companywill issue a news release announcing the ratio as determined by our Board ofDirectors.  Notwithstanding the approvalof the share consolidation by our 

 

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shareholders, ourBoard of Directors may, in its sole discretion, abandon the share consolidationwithout further approval or action by or prior notice to shareholders (see“Item 14. Material Modifications to the Rights of Security Holders and Use ofProceeds — Material Modifications to the Rights of Security Holders — ProposedShare Consolidation”).

 

**Long-Term Debt**

 

Our long-term debtconsists of capital leases of office equipment. Where appropriate, for reasonssuch as cash flow and changes in technology, we use leases as an additionalsource of financing. In cases where substantially all of the benefits and risksof ownership of the property are transferred to us, the lease is treated as acapital lease and included in long-term debt. For further information on our long-term debt, see “Note 12 — Long-TermDebt” under the Notes to Consolidated Financial Statements, which can be foundon page F-21 of this form, and is incorporated by reference herein.

** **

**Commitments**

 

The following table ofour material contractual obligations as at December 31, 2008, sets forththe aggregate effect that these obligations are expected to have on our cashflows for the period indicated:

 

*(in thousands of US dollars)*

* *
| **Payments due in*** | ** ** | **Operating  Leases** | ** **  | **Capital  Leases** | ** ** | **Total** | ** ** |
|----------------------|------------|-----------------------|-------------|---------------------|------------|-----------|------------|
| 2009                 |       | $                     | 1,556       |                | $          | 10        |       | $ | 1,566 |   |
| 2010                 |       | 970                   |        | —              |       | 970       |       |
| 2011                 |       | 544                   |        | —              |       | 544       |       |
| 2012                 |       | 422                   |        | —              |       | 422       |       |
| 2013 and thereafter  |       | 620                   |        | —              |       | 620       |       |
|                 |       | $                     |  4,112 |                | $          | 10        |       | $ | 4,122 |   |

 

----

*Note: We cannot be certain that we have or will be able to raisesufficient capital to repay our short and long-term contractual obligations andmaintain planned levels of operations.

 

We do not have anymaterial obligations under forward foreign exchange contracts, guaranteecontracts, retained or contingent interests in transferred assets, outstandingderivative instruments or non-consolidated variable interests.

 

Our treasury policy is toinvest in high-yield monetary interests to maximize yield and safeguard capitalto fund our operating requirements.

** **

**RESEARCH AND DEVELOPMENT**

 

For information regardingour research and development policies, see “Item 4. Information of the Company— Business Overview — Research and Product Development.”  For information regarding research andproduct development expenses for the fiscal years ended December 31, 2006,December 31, 2007, and December 31, 2008, see “Note 14 — Research andProduct Development” under the Notes to Consolidated Financial Statements,which can be found on page F-23 of this form, and is incorporated byreference herein.

** **

**AdvancingOur Product Designs**.**** Within our OnSite Generation business segment,we are focused on reducing the cost of our HySTATTM electrolyzer and improvingits efficiency. Concurrently, we are developing an electrolyzer having fourtimes the active area per cell to allow us to compete more favourably in caseswhere greater volumes of hydrogen are required for industrial, hydrogen fuelingor renewable energy storage applications.

 

Within our Power Systemsbusiness segment, we are focused on increasing the durability and efficiency ofour fuel cells and fuel cell systems as well as reducing their cost. For marketopportunities such as the home and backup power market requiring between 4 and12 kilowatts of electrical power, we are developing a PEM based electrolyzer.We are attempting to offset a portion of the associated development expenses byentering into cost sharing agreements with OEMs and government agencies.

 

Recently, we have seenconsiderable interest in using hydrogen as a medium to store renewable energy,particularly wind and solar power, due to the favourable characteristics ofhydrogen as an energy carrier. We are developing a renewable energy storageproduct incorporating an alkaline electrolyzer, PEM fuel cell electricalgenerator and associated systems integration software. We anticipate addingother proprietary technologies to this product offering based on continuedmarket intelligence. In time, we anticipate developing a product offering thatwill benefit from ancillary electrical power services such as grid balancingand load profiling.

 

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Research costs and costsincurred in applying for patents and licenses are expensed as incurred. Productdevelopment costs are expensed as incurred until the product or process isclearly defined and the associated costs can be identified, technicalfeasibility is reached, there is an intention to produce or market the product,the future market is clearly defined and adequate resources exist or areexpected to be available to complete the project. To date, no productdevelopment costs have been capitalized.

 

Funding for research andproduct development includes government and non-government research and productdevelopment support. Research and product development support is recognized asthe applicable costs are incurred unless it is for reimbursement of an asset,in which case it is accounted for as a reduction in the cost of the applicableasset.

 

**TREND INFORMATION**

** **

**Current MarketEnvironment**

** **

Recent market events andthe resulting tightening of credit have reduced available liquidity and overalleconomic activity. Governments around the world have taken unprecedentedactions to limit the impact of these events, but it is still too early toassess the severity and duration of this slowdown. As a global company, we aresubject to the risks arising from adverse changes in global economicconditions. For example, as a result of the recent financial crisis in thecredit markets, the direction and relative strength of many economies havebecome increasingly uncertain. If economic growth in leading economies isslowed, our current or potential customers may delay or reduce purchases. Thiscould result in reductions in sales of our products, longer sales cycles,slower adoption of new technologies and increased price competition, whichcould materially and adversely affect our business, results of operations andfinancial condition.

 

Over the past few years,the Company has taken significant steps to strengthen its operations andfinancial position to better face a difficult economic situation. On January 5,2009, in order to try to further streamline operations, the Company reduced itsheadcount by an additional 15% as well as implemented additional cost savingmeasures in order to maximize the Corporation’s cash resources. We have nofunded or secured debt obligations outstanding; we maintain an order backlog of$17.7 million as at March 31, 2009, spread across numerous geographicalregions.

 

In recent months we havewitnessed governments in many jurisdictions recently show a willingness toincrease spending on alternative energy projects to stimulate the economy andwe believe we are well positioned to benefit from government initiatives inCanada, the European Union and the United States which will positively impactour business. However, as no business is immune to a slowdown in the economy,we have experienced some effects of the recent economic downturn in the firstquarter of 2009. The Company closely monitors its exposure to the followingpotential risks, which could impact future profitability and cash flows, and isready to proactively respond should one or the other materialize: (i) sustainedlower levels of orders, higher cancellation rates or significant delay of orders,any one of which would require production adjustments; and (ii) loweravailable customer financing, which could affect our customers’ ability tofinance their purchases.

 

With a sustained orexpanding economic downturn, we expect that we will continue to experiencesignificant difficulties on a number of fronts, depending upon the duration andseverity of these events. These risks include but are not limited to deferralsor reductions of customer orders, potential deterioration of our customers’ abilityto finance purchases, reduced revenue, further deterioration in our cashbalances, working capital and revenues, and an inability to access capitalmarkets. The financial crisis and economic downturn will also reduce ourability to accurately forecast our performance, results or cash position. Weanticipate consuming between $12.0 million to $17.0 million (prior toreflecting anticipated proceeds and expenses in connection with ournon-dilutive financing transaction with the Algonquin Board) over the full yearin 2009 to fund our anticipated EBITDA losses, non-cash working capitalrequirements and capital expenditures based on our outlook for the year ending December31, 2009. For further discussion of our revenues and delivery outlook, see“Delivery Outlook” below.

 

**Delivery Outlook**

** **

We operate in variousmarkets and in this Annual Report on Form 20-F, define the market in whichwe have a product offering as a relevant market. Our delivery outlook issegmented by market and is subject to a number of factors that are within ourcontrol, such as product development and market engagement initiatives, as wellas a number of factors that are beyond our control, such as macro economicconditions. As part of our annual business planning cycle, we make a number ofassumptions regarding delivery outlook in each of our relevant markets in orderto best allocate our resources.

 

Set forth below is asummary assessment of those factors we anticipate will most significantlyinfluence deliveries by relevant market as well as our anticipated level ofdeliveries by relevant market.  Wecaution that readers should not place undue reliance on this assessment andrefer to our caution regarding forward-looking statements on page 1 ofthis Form 20-F.

 

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| **Relevant  Market**           | ** ** | **Economic  Activity in 2008** | ** ** | **External and Company  Specific Considerations**                                                                                                                                                                                                                                                                                                                                                                            | ** ** | **Anticipated Economic  Activity  in 2009** |
|--------------------------------|------------|--------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|
| **Industrial  Gas**            |       | 37 units  delivered            |       | GDP growth in  emerging markets and developing economies will remain above worldwide average  real GDP growth levels over the next few years but lower than recent years.

 

Natural gas  prices will remain lower than 2008 levels favouring SMR products over  electrolysis.

 

Due to the  impact of the current economic slowdown, certain customers have requested  deferral of deliveries of their orders. | ** ** | ** ̄**                                  |   | We anticipate revenues and orders delivered will be somewhat lower  than 2008 |
| ** **                     |       |                           |       |                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | ** **                                  |   |   |
| **Hydrogen  Fueling Stations** |       | 4 units  delivered             |       | Governments have  recently announced initiatives to accelerate the use of hydrogen fueling  stations for the transportation sector.

 

Our continued  market presence positions us to secure additional business.                                                                                                                                                                                                      | ** ** | **ô**                                  |   | We anticipate revenues and orders delivered will be similar to 2008 |
| ** **                     |       |                           |       |                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | ** **                                  |   |   |
| **Renewable  Energy Storage**  |       | 1 units  delivered             |       | Renewable energy  storage continues to receive considerable attention throughout the world.

 

We were awarded  three projects in 2008 providing us with important first mover advantages.

 

We are  dedicating more resources to this market opportunity in 2009 compared to 2008                                                                                                                              | ** ** | ****                                        |   | We anticipate revenues and orders delivered will be higher in 2008 |
| ** **                     |       |                           |       |                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | ** **                                  |   |   |
| **Backup  Power**              |       | 13 units  delivered            |       | 30% tax credit  introduced in the US for fuel cell backup power products.

 

Progress with  OEMs advancing.

 

Product  development initiatives now well advanced.                                                                                                                                                                                                                                               | ** ** | ****                                        |   | We anticipate revenues and orders delivered will be higher in 2008 |
| ** **                     |       |                           |       |                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | ** **                                  |   |   |
| **Motive  Power**              |       | 50 units  delivered            |       | 30% tax credit  introduced in the US for motive power products.

 

General Motors  Oshawa, Canada deployment of nineteen fuel cell powered forklifts advancing.

 

Positive  feedback from OEMs.Product development initiatives advanced in 2008.                                                                                                                                                                | ** ** | ****                                        |   | We anticipate revenues and orders delivered will be higher in 2008 |
| ** **                     |       |                           |       |                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | ** **                                  |   |   |
| **Other  Power Products**      |       | 17 units  delivered            |       | Less focused on  Other markets as we concentrate on backup power and motive power markets.                                                                                                                                                                                                                                                                                                                                   | ** ** | **ô**                                  |   | We anticipate revenues and orders delivered will be similar to 2008 |

 
| **  **Indicates an unfavourable trend in the market  categories in which the Company competes.        |
|-----------------------------------------------------------------------------------------------------------------|
| **ô****  **Indicates  a neutral trend in the market categories in which the Company competes.    |
| ** ̄****  **Indicates  a favourable trend in the market categories in which the Company competes. |

 

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**Industry Trends**

** **

A discussion of industrytrends, by its nature, necessarily contains certain forward-lookingstatements.  Forward-looking statementsrequire us to make assumptions and are subject to inherent risks anduncertainties that could cause actual results or events to differ materiallyfrom current expectations.  Please referto the caution regarding forward-looking statements contained in the “ForwardLooking Statements” section on page 1 and “Item 3.  Key Information — Risk Factors” for adiscussion of such risks and uncertainties and the material factors and assumptionsrelated to the statements set forth in this section.

 

We anticipate ourbusiness will continue to benefit from several broad trends including: (i) highprices for oil and natural gas; (ii) increased government legislation andprograms worldwide promoting alternative energy sources such as syntheticfuels, including hydrogen; (iii) increased awareness of the adverse impactof fossil fuels on our climate and environment; and (iv) the need forindustrialized economies to access alternative sources of energy to reducefossil fuel dependency.  We anticipatethese trends will continue and intensify in the future, allowing the benefitsof hydrogen to be further demonstrated in numerous applications.  In particular, “green” hydrogen can begenerated universally from renewable power sources such as hydroelectric,geothermal, solar and wind or from low-emission sources such as biomass andnuclear.  These industry trends arediscussed below.

 

*Highprices for oil and natural gas.* In recent years, oil and natural gas prices haveincreased and it is anticipated that the general trend of prices will continueto rise over the long term due to increased demand from emerging marketeconomies such as China and India, localized supply constraints and politicalinstability in oil producing areas.  Asthe cost of these commodities increase relative to the price of electricity,our electrolysis-based on-site hydrogen generation products stand to becomemore cost competitive with other forms of hydrogen production and delivery,thereby increasing on-site generation market share.  Similarly, we expect that the higherefficiency of fuel cells will make them increasingly appealing relative toconventional internal combustion engines.

 

*Increasedgovernment legislation and programs worldwide promoting alternative energysources including hydrogen.* In recentyears, numerous governments have introduced legislation to promote and developthe use of hydrogen in energy applications as a partial response to the risksand adverse effects associated with fossil fuels.  We anticipate this interest will accelerateover time.  Recent government legislationhas been proposed or passed in many jurisdictions to support renewable energyinitiatives including passage of the American Recovery and Reinvestment Act of2009 in the United States and the Green Energy and Green Economy Act, 2009 inOntario, Canada.

 

The European Union hasadopted an action plan to replace 20% of vehicles using diesel and gasolinefuels in the road transportation sector with vehicles that use natural gas andhydrogen by 2020.  European effortsinclude the European Commission (“EC”) establishing a platform to bringhydrogen and fuel cells to market and a proposed Joint Technology Initiativefor public-private partnership.  The EC’s6th Framework Programme is currently providing $2.2 billion over five years forhydrogen and fuel cell initiatives under the European Hydrogen and Fuel CellTechnology Platform.  As well, the EC hasannounced spending of approximately 1 billion euros per year between 2007 and2013 as part of a European Strategic Energy Technology Plan tied to a proposednew energy policy for Europe. Hydrogen and fuel cells are included in thatplan.

 

Additionally, severalAsian countries are responding to environmental, energy, security andsocio-economic concerns by introducing legislation and initiatives to promotehydrogen and fuel cell technologies. Japan, Korea, India and China continue to invest significantly in thedevelopment and commercialization of hydrogen and fuel cells.

 

*Increasedawareness of the adverse impact of fossil fuels on our climate, environment andair quality. *Governments worldwide continue to enactlegislation aimed at curtailing the impact of fossil fuels on theenvironment.  Most notably, the KyotoAccord, a United Nations sanctioned protocol, attempts to address globalwarming problems by reducing greenhouse gas emissions.  Jurisdictions are also enacting legislationaimed at curbing idling or emissions that affect urban air quality, or affectindoor operation of utility vehicles. In October 2006, the Canadiangovernment announced the Clean Air Act designed to tackle pollution andgreenhouse gas emissions.  This actstrictly enforces industry compliance to a set of national standards on bothair pollution and emissions of greenhouse gases.

 

*The needfor industrialized economies to access alternative sources of energy to reducetheir dependency on fossil fuels.* Manyindustrialized nations, including some of the fastest growing economies, importmost of the fossil fuels consumed in their respective economies. This creates adependency on external sources and exposes them to significant tradeimbalances.

 

For stationary power, inthe United States alone, approximately 400,000 megawatts of new electricitygenerating capacity is forecast to be needed by 2020 to meet growing demand andto replace retiring generating units. The existing electricity transmission and distribution grid in theUnited States is overburdened in many regions. By locating power generation products close to where the power is used,known as distributed generation, it is possible to bypass the overloadedtransmission and distribution grid. Hydrogen and fuel cell technologies are well suited to a distributedgeneration model thereby providing an emerging opportunity for hydrogen fuelcells and hydrogen powered internal combustion engines to provide stationarygenerating capacity.

 

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China and India also havegrowing concerns about energy supply and security which are leading thosecountries to pursue initiatives promoting hydrogen and energy efficiencyprograms. Further, as the introduction of automobiles continues to acceleratein India and China, such dependency on fossil fuels may become increasinglyunsustainable, creating an opportunity for hydrogen and fuel cells.

 

**Additional TrendsInformation**

** **

For additional trendsinformation, see “Item 3. Key Information — Risk Factors” and “Item 4.Information of the Company — Business Overview — Our Strategy” in this Form 20-F,and the relevant information presented in the management’s discussion andanalysis of financial condition and results of operations for the three monthsended March 31, 2009 and related financial information for the threemonths ended March 31, 2009, which were furnished to the SEC as part ofthe Registrant’s Form 6-K filed on May 13, 2009, and are incorporateby reference herein.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

** **

**Contingent Off-BalanceSheet Arrangements**

** **

We do not have anymaterial obligations under forward foreign exchange contracts, guaranteecontracts, retained or contingent interests in transferred assets, outstandingderivative instruments or non-consolidated variable interests.

 

As a result of theGovernment of Canada’s commitment to developing domestic alternative energytechnologies, we have entered into repayable contribution and other R&Darrangements with various Canadian governmental ministries and public sectorenterprises. Under these arrangements, Stuart Energy had received $10.9 millionof funding toward agreed upon R&D project costs prior to its acquisition byHydrogenics. Pursuant to the agreements, the funding parties have a right toreceive as repayment between 0.3% and 4.0% of gross revenues attributable tothe commercial exploitation of the associated technologies, and, in one case0.53% of Stuart Energy’s gross business revenues. To date, we have recognized$42.8 million in revenues from these technologies and recorded a repayableamount of $0.2 million. At this time, the amount of further product revenues tobe recognized is uncertain, and accordingly no further liabilities forrepayment have been accrued. These arrangements expire between September 30,2006 and March 31, 2016, or when total amounts repaid reach the utilizedamount of the advance, depending on the terms of the individual contracts. Theamount of funding available to us under similar arrangements varies from yearto year, and although we believe that these agencies and enterprises willcontinue to support the industry, there is no guarantee of the amount of futurefunding.

 

In 1998, Stuart Energy,now a wholly-owned subsidiary of the Corporation, entered into an agreementwith Technologies Partnerships Canada (“TPC”), a program of Ministry ofIndustry of the Government of Canada to develop and demonstrate Hydrogen FleetFuel Appliances. This agreement was amended in 2003 to expand Stuart Energy’sscope of work and resulted in Stuart Energy receiving a total of $5.6 millionof funding from TPC. Pursuant to the amended TPC agreement, Stuart Energyundertook to repay $14.2 million (the “Repayable Loan Amount”). The amendedagreement requires Stuart Energy to commence making royalty payments againstthe Repayable Loan Amount on the earlier of Stuart Energy’s revenues reachingCdn. $90 million or April 1, 2007 at 0.53% of Stuart Energy’s annual grossbusiness revenues for a period of 12 years or until the Repayable Loan Amountis fully repaid. We are in discussion with TPC regarding Stuart Energy’sobligations to TPC and anticipate that we will enter into an amended agreementwith TPC concerning Stuart Energy. As discussions with TPC are ongoing, we arenot able to ascertain the exact nature and extent of how payments against theRepayable Loan Amount will be made at this time.

 

We have entered intoindemnification agreements with our current and former directors and officersto indemnify them, to the extent permitted by law, against any and all charges,costs, expenses, and amounts paid in settlement and damages incurred as aresult of any lawsuit or any other judicial, administrative or investigativeproceeding in which they are sued as a result of their services. Any suchindemnification claims will be subject to any statutory or other legallimitation periods. The nature of the indemnification agreements prevents usfrom making a reasonable estimate of the maximum potential amount we could be requiredto pay to counterparties. We have purchased directors’ and officers’ liabilityinsurance. We are unaware of any actions with respect to these agreements. Noamount has been recorded in the consolidated financial statements with respectto these indemnification agreements.

 

In the normal course ofoperations, we may provide indemnification agreements, other than those listedabove, to counterparties that would require us to compensate them for costsincurred as a result of changes in laws and regulations or as a result oflitigation claims or statutory sanctions that may be suffered by thecounterparty as a consequence of the transaction. The terms of theseindemnification agreements will vary. The nature of the indemnificationagreements prevents us from making a reasonable estimate of the maximumpotential amount we could be required to pay to counterparties. We are unawareof any actions with respect to these agreements. No amount has been recorded inthe consolidated financial statements with respect to these indemnificationagreements.

 

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**TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS**

 

*As of December 31,2008*

 
| ** **                                                                                                                    | ** ** | **Payments due by period** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**                                                                                                   | ** ** | **Total**                  | ** ** | **less than 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **more than 5  years** | ** ** |
| Long-Term Debt Obligations                                                                                                    |       | —                     |       | — |   | — |   | — |   | — |   |
| Capital (Finance) Lease Obligations                                                                                           |       | 10                         |       | 10 |   |   |   |   |   |   |   |
| Operating Lease Obligations                                                                                                   |       | 4,112                      |       | 1,556 |   | 1,514 |   | 1,042 |   |   |   |
| Purchase Obligations                                                                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Other Long-Term Liabilities Reflected on the  Company’s Balance Sheet under the GAAP of the primary financial statements |       | —                     |       | — |   | — |   | — |   | — |   |
| Total                                                                                                                         |       | 4,122                      |       | 1,566 |   | 1,514 |   | 1,042 |   | — |   |

 

**ITEM6.  DIRECTORS, SENIOR MANAGEMENT ANDEMPLOYEES**

** **

**DIRECTORS AND SENIOR MANAGEMENT**

** **

**Directors**

** **

Thefollowing table sets forth information with respect to our directors as of June 23,2009:

 
| **Name**                 | ** ** | **Province  or State and  Country of Residence** | ** ** | **Title**                                              | ** ** | **Director  or  Executive Officer  Since** |
|--------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------|
| Norman M.  Seagram(1)    |       | Ontario, Canada                                  |       | Chairman of our  Board of Directors(5)                 |       | 2000                                       |
| Douglas S.  Alexander(2) |       | Ontario, Canada                                  |       | Director(5)                                            |       | 2006                                       |
| Michael  Cardiff(3)      |       | Ontario, Canada                                  |       | Director(5)                                            |       | 2007                                       |
| Henry J. Gnacke          |       | Michigan, United  States                         |       | Director(5)                                            |       | 2008                                       |
| V. James  Sardo(4)       |       | Ontario, Canada                                  |       | Director(5)                                            |       | 2003                                       |
| Joseph Cargnelli         |       | Ontario, Canada                                  |       | Chief Technology  Officer and Director(5)              |       | 1996                                       |
| Daryl Wilson             |       | Ontario, Canada                                  |       | President and  Chief Executive Officer and Director(5) |       | 2006                                       |
| Lawrence E. Davis        |       | Ontario, Canada                                  |       | Chief Financial  Officer and Corporate Secretary       |       | 2005                                       |
| Jennifer Barber          |       | Ontario, Canada                                  |       | Vice President,  Finance and Corporate Controller      |       | 2005                                       |
| Wido Westbroek           |       | Geel, Belgium                                    |       | Vice President  and General Manager                    |       | 2006                                       |

 

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Notes:

 
| (1)    |   | Chairman of the Board of Directors, member of the Human Resources and  Corporate Governance Committee, and a member of the Audit Committee. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                        |
| (2)    |   | Chair  of the Audit Committee and member of the Human Resources and Corporate  Governance Committee.                                        |

 

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| (3)    |   | Member  of the Audit Committee and the Human Resources and Corporate Governance  Committee.                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (4)    |   | Chair  of the Human Resources and Corporate Governance Committee and member of the  Audit Committee. Between April 3, 2006 and May 3, 2006,  Mr. Sardo, who was then a director of Royal Group Technologies Limited,  was prohibited from trading in securities of Royal Group Technologies Limited  pursuant to a management cease trade order issued by the Ontario Securities  Commission in connection with the delay in filing of certain of Royal Group  Technologies Limited’s financial statements. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (5)    |   | Each  director will hold office until the next annual and special meeting of  shareholders, or until his successor is duly elected or appointed.                                                                                                                                                                                                                                                                                                                                                                                |

 

*Norman M.Seagram*, Chairmanof our Board of Directors. Mr. Seagram has served as Chairman of our Boardof Directors since September 2007. He previously served in this position from July 2000 to December 2006following which he acted as Lead Director until September 2007. Mr. Seagramwas President of Sportsco International LP (SkyDome) from February 2001 toMarch 2003. From September 1996 to May 1997, Mr. Seagramwas President and Chief Executive Officer of Molson Inc., a company he hadpreviously served for 24 years in a variety of senior management positions.From October 1992 to August 1996, Mr. Seagram was Chairman andChief Executive Officer of Air Liquide Canada, Inc., a producer ofindustrial gases. Mr. Seagram is a trustee of Trinity College School andthe Toronto Symphony Foundation, and he is a director of HarbourfrontFoundation. He serves on the advisory board of the Faculty of Applied Scienceand Engineering, University of Toronto, and he is a former director of theToronto Economic Development Corporation (TEDCO).

 

*DouglasS. Alexander*,Director. Mr. Alexander joined our Board of Directors in May 2006.   Mr. Alexander is a Director and memberof the Audit Committee of Critical Outcome Technologies Inc., and has served asthe Chief Financial Officer of various Canadian public companies for 15 years. Mr. Alexanderwas formerly lead director and chair of the Audit Committee of Saxon FinancialInc. Mr. Alexander served as a director of Stuart Energy from 2003 to January 2005.From 1999 to 2004, Mr. Alexander was Executive Vice President and ChiefFinancial Officer of Trojan Technologies Inc., an international environmentalhigh technology company. Mr. Alexander is a Chartered Director, havinggraduated in 2009 from Director’s College, a joint venture between McMasterUniversity and the Conference Board of Canada.

 

*MichaelCardiff*,Director. Mr. Cardiff joined our Board of Directors in November 2007.Currently, Mr. Cardiff is the Chief Executive Officer of Accelerents, aconsulting firm focused on strategy development. Prior to holding thatposition, Mr. Cardiff held numerous senior positions in a number oftechnology companies including large multinationals such as EDS and IBM as wellas startup companies such as Fincentric, Convergent Technologies, Tandem, andStratus Computer. Mr. Cardiff is currently a director of Descartes SystemsGroup, Burntsand Inc.  and SoftwareGrowth Inc. Mr. Cardiff has also served as a director of Husky InjectionMolding Systems, Solcorp, Visible Genetics, Spectra Security Software VisibleDecisions and the Toronto Film Festival and Roy Thomson Hall. Mr. Cardiffreceived many awards including “A Canadian Export Life Time Achievement Award.”In 1998, Mr. Cardiff was named one of Canada’s “Top 40 Under 40,”recognizing him as one of the nation’s most successful young leaders. Mr. Cardiffis a member of, and holds the ICD.d designation from, the Institute ofCorporate Directors.

 

*JosephCargnelli*, ChiefTechnology Officer and Director. Mr. Cargnelli is one of our founders andserved as a director from January 1996 to January 2005, when heresigned in connection with the closing of the Stuart Energy acquisition. Mr. Cargnelliwas re-elected at the meeting of shareholders on May 17, 2005. Mr. Cargnelliserved as our Treasurer from January 1996 until July 2000.  Mr. Cargnelli was appointed as our VicePresident, Technology in July 2000. His title was changed to Chief Technology Officer in April 2003.  Mr. Cargnelli earned both a Masters ofApplied Science degree in Mechanical Engineering and a Bachelor of AppliedScience degree in Mechanical Engineering from the University of Toronto.  From April 1992 to April 1993, Mr. Cargnelliserved as a Research Engineer with the Laboratory of Advanced Concepts inEnergy Conversion Inc., a laboratory engaged in the research, development anddemonstration of alkaline fuel cells and hydrogen storage methods.  Mr. Cargnelli is a member of theProfessional Engineers of Ontario.

 

*Henry J.Gnacke*, Director.Mr. Gnacke joined our Board of Directors in May 2008. Formerly, Mr. Gnackewas the Executive Director, Global Purchasing Supply chain at General Motors.He was responsible for fuel cell propulsion systems and General Motors’ E-Flexprograms. Mr. Gnacke has over 30 years of experience and has held numerouspositions at General Motors, including several international assignments in theMiddle East, Asia and Europe. Mr. Gnacke is the nominee of General Motorsin connection with our strategic alliance with General Motors.

 

*V. JamesSardo*, Director. Mr. Sardojoined our Board of Directors in May 2003. Mr. Sardo is a CorporateDirector. In 2005, he became a director of New Flyer Industries Inc., NorthAmerica’s largest manufacturer of city buses, and has been a director of SonnenEnergy, a solar integration company, from 2007 to 2009. During 2004 to 2007, Mr. Sardoserved as a trustee of Union Waterheater Income Trust, a waterheater rentalcompany, as a director of Royal Group Technologies, a plastics buildingproducts company, and as a director and Chairman of Countryside Power, a powergeneration company. From 2003 to 2007, he was a trustee of Custom Direct IncomeFund, a manufacturer and direct marketer of custom cheques. Prior to theseappointments, Mr. Sardo was interim Chief Executive Officer of Royal GroupTechnologies Limited, from 2004 to 2005, President of the Canadian Operationsof Moore Corporation Limited, a business forms and communications company, from1999 to 2001, and President and Chief Executive Officer of SMK SpeedyInternational Inc., an international automotive repair company from 1997 to1999. Prior to 1997 Mr. Sardo 

 

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was ChiefExecutive Officer of Amre Inc., a Dallas based marketer of home improvementproducts, and Chief Executive Officer of SNE Inc., a manufacturer and marketerof windows and doors. Mr. Sardo is also a member of the Institute ofCorporate Directors, and holds the ICD.d designation.

 

*DarylWilson*, Presidentand Chief Executive Officer and Director. Mr. Wilson was appointedPresident and Chief Executive Officer in December 2006.  Prior to joining Hydrogenics, Mr. Wilsonheld senior leadership positions at Royal Group Technologies Inc., ZENONEnvironmental Inc., Toyota and Dofasco Inc. In 1990 Mr. Wilson earned anMBA from McMaster University in Operations Management/Management Science. Mr. Wilsonalso holds a Bachelor’s degree in Chemical Engineering from the University ofToronto. Mr. Wilson is a Chartered Director, having graduated in 2009 fromDirector’s College, a joint venture between McMaster University and the ConferenceBoard of Canada.

 

**Executive Officers**

** **

The following table setsforth information with respect to our executive officers as of June 23,2009:

 
| **Name**          | ** ** | **Province  or State and  Country of Residence** | ** ** | **Title**                                          | ** ** | **Director  or  Executive Officer  Since** |
|-------------------|------------|--------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------|
| Joseph Cargnelli  |       | Ontario, Canada                                  |       | Chief Technology Officer and Director              |       | 1996                                       |
| Daryl Wilson      |       | Ontario, Canada                                  |       | President and Chief Executive Officer and Director |       | 2006                                       |
| Lawrence E. Davis |       | Ontario, Canada                                  |       | Chief Financial Officer and Corporate Secretary    |       | 2005                                       |
| Jennifer Barber   |       | Ontario, Canada                                  |       | Vice President, Finance and Corporate Controller   |       | 2005                                       |
| Wido Westbroek    |       | Geel, Belgium                                    |       | Vice President and General Manager                 |       | 2006                                       |

 

*LawrenceE. Davis*, ChiefFinancial Officer and Corporate Secretary. Mr. Davis has served as ourChief Financial Officer since April 1, 2005.  Mr. Davis has over 20 years of financialand operational experience.  He has beena Chartered Accountant since 1987.  From1999 to 2003, Mr. Davis was the Chief Financial Officer of GDI Global DataInc., a wireless data services company.  Mr. Davisalso acted as the President of Saturn Capital Corporation, a merchant bank thatadvises, invests in and assumes senior management positions for high growthbusinesses from 1997 until 1999.  From1987 to 1997, Mr. Davis served as a Vice President forPricewaterhouseCoopers LLP and he previously worked for two years with Ernst &Young.

 

*JenniferBarber*, VicePresident, Finance and Corporate Controller. Ms. Barber joined us through our acquisition of Stuart Energy in January 2005and was appointed to the position of Vice President Finance and CorporateController in May 2005.  Sincetaking on this position, Ms. Barber has led the finance team through afull range of financial consolidations arising from the acquisition, with theadded responsibility of integrating Sarbanes-Oxley requirements into all of ourfinancial processes and procedures. Hired by Stuart Energy in 2001, Ms. Barber served as Director,Corporate Finance from 2003 onward, and prior to that as Controller.  She was employed from 1997 to 2001 byPricewaterhouseCoopers LLP.  Ms. Barberreceived Institute of Chartered Accountant accreditation in 2000.

 

*WidoWestbroek*, VicePresident and General Manager.  Mr. Westbroekjoined us in 2006 as Vice President, Operations of the Belgium On-Sitedivision.  His former career, spanning 18years, was with Powerlasers, a developer and manufacturer of unique laserwelding technology and a maker of auto parts for major automotive OEMs based inCanada and the US.  Mr. Westbroekreceived his Bachelor of Science in Physics at the University of Waterloo inOntario.

 

For information regardingthe backgrounds of Mr. Cargnelli and Mr. Wilson, see “Directors”above.

 

**COMPENSATION**

** **

As the Company reportsits financial results in U.S. dollars, the following discussion is preparedshowing U.S. dollars, except as otherwise noted, notwithstanding that thecurrencies in which our President and Chief Executive Officer, our ChiefFinancial Officer and our three most highly compensated executives, other thanthe President and Chief Executive Officer and Chief Financial Officer(collectively, the “Named Executive Officers”) are paid are in Canadian dollarsand euros. The average exchange rates for the year ended December 31,2008, for the purposes of the following disclosure, are US$1 = Cdn. $1.07, andUS$1 = 0.68 euros.

 

*Thefollowing compensation discussion and analysis is intended to supplement themore detailed information concerning compensation of executive officers anddirectors that appears in the tables that follow. Our goal is to provide abetter understanding  of our compensationpractices and decisions made concerning the compensation payable to ourexecutive officers and directors for 2008.*

 

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**Elements of ExecutiveCompensation Program**

** **

Our executivecompensation program has three principal components:

 

·                  base salary;

 

·                  short-term incentive (paid in cash); and

 

·                  long-term, equity-based incentives.

 

We believe that thisvariable compensation encourages high performance, promotes accountability andensures that the interests of our executive officers are aligned with theinterests of shareholders by linking individual performance and increases inshareholder value. Each of the components’ specified objectives are set forthbelow.

 

The Company also offersall employees, and the President and Chief Executive Officer, our ChiefFinancial Officer and our three most highly compensated executives, other thanthe President and Chief Executive Officer and Chief Financial Officer, certainbenefits, such as short-term disability income benefits, long-term disabilityincome benefits, healthcare, dental care, survivor benefits, dependentcoverage, employee life insurance, dependent life insurance, accidental death,dismemberment and specific loss insurance, which form an integral part of thetotal compensation offered by the Company.

 

***Base Salary***

*** ***

The objectives of basesalary are to recognize market pay, acknowledge competencies and skills ofindividuals and reward individual contribution. The annual base salary for each of our Named Executive Officers wasinitially determined at the time of hire based on a number of customaryfactors, and is documented in an employment agreement provided to the executiveofficer (see also “Employment Agreements” below). Historically, we retaincompensation consultants to assist in determining appropriate levels of salaryand bonus payable to our executive officers, based on relevant market dataconcerning the market place and our peer group. This data is then used as abasis for determining the executive officer’s initial base salary.

 

***Short-termIncentives***

*** ***

We provide a short-termincentive plan in which the Named Executive Officers, as well as other  managers and employees participate. Thisincentive plan is intended to reward achievement of short-term financialperformance and milestones and focus on key financial, strategic and otherbusiness objectives.  Pursuant to theshort-term incentive plan, we have established layers of performance incentivesup to certain percentages of base salary based on market benchmarking. Inlandmark years, the committee may elect to award a “stretch maximum” of 100% ofbase salary. The percentage that an executive is awarded is based on theachievement of corporate objectives, the achievement of business unitobjectives and the achievement of individual objectives. Certain NamedExecutive Officers have employment agreements with us that modify ourshort-term incentive compensation (see “Employment Agreements” below in this“Elements of Executive Compensation Program” section).

 

For 2008, the targetbonuses were equal to 40% of the base salary for the Vice President and GeneralManager and Vice President, Finance and Corporate Controller, and 50% for eachof President and Chief Executive Officer, Chief Financial Officer and CorporateSecretary and Chief Technology Officer. Within each layer, the executive hasthe ability to achieve an additional 10% of base salary incentive if theyexceed performance, at the discretion of the Human Resources and CorporateGovernance Committee.

 

***Long-termIncentives***

*** ***

Long-term compensation isdesigned to focus executives’ attention on the long-term interests of theCompany and its shareholders, and consists of two elements for our executiveofficers:

 

·                  Stock Option Plan (the “stock option plan”)— pursuant to which we grant options to certain employees and officers topurchase our common shares at a fixed price; and

 

·                  Restricted Share Unit Plan (the “RSUPlan”) — pursuant to which we grant certain executive officers RSUs,representing the cash equivalent of our common shares, subject to the vesting,forfeiture and other restrictions the Board of Directors may determine.

 

Together,we believe these stock options and RSUs link the executives’ long-termcompensation directly to the appreciation in the price of our common shares.See also “Item 14. Material Modifications to the Rights of Security Holders andUse of Proceeds — Material Modifications to the Rights of Security Holders —Amendments to Share Incentive Plans.”

 

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***Stock Options***

*** ***

Our stock option planallows the Human Resources and Corporate Governance Committee to grantdirectors, officers, eligible employees and consultants of the Company optionsto acquire common shares.  The purpose ofthe stock option plan is to align the incentives of our employees, managementand directors with the results realized by shareholders, while providingcompetitive compensation arrangements that reward the creation of shareholdervalue over the long-term.  In 2004, theHuman Resources and Nomination  Committeereviewed the Company’s approach to directors’ compensation.  As a result of this review, and in order tobetter align the interests of non-employee directors with the interests of ourshareholders, we established the deferred share unit plan (“DSU Plan”) in 2004and determined not to grant additional options to directors (see “Compensationof Directors — Deferred Share Units” below in this “Elements of ExecutiveCompensation Program” section).

 

The stock option planprovides that options will expire no later than 10 years from the grant dateor, if that date occurs during a blackout period or other period during whichan insider is prohibited from trading in our securities by our insider tradingpolicy, 10 business days after the period ends, subject to certain exceptions.Options will have an exercise price per share of not less than the closingprice of our common shares on the TSX on the trading day before the option isgranted.  Unless otherwise specified in aparticular option agreement, options granted under this plan will vest overfour years with one quarter of the option grant vesting each year.

 

Issuances of optionsunder the stock option plan are subject to the several restrictions.  No more than 10% of the common sharesoutstanding immediately prior to an issuance, less the number of common sharesissued pursuant to the exercise of options during the preceding year, may beissued under the stock option plan in any one year period.  In addition, the number of common sharesreserved for issuance pursuant to options granted to any one person cannotexceed 5% of the outstanding common shares.

 

Additional restrictionsgovern the issuance of options to insiders of the Company.  The aggregate number of common sharesreserved for issuance pursuant to options granted to insiders cannot exceed 10%of the outstanding common shares. Further, within any one year period, insiders may not, in the aggregate,be issued a number of common shares which exceeds 10% of the outstanding issueand no individual insider may be issued a number of common shares that exceeds5% of the outstanding issue.

 

Shareholder approval isrequired for the following amendments to the stock option plan: (i) increasingthe number of common shares reserved for issuance under the stock option plan; (ii) reducingthe exercise price of an option except appropriate reductions in connectionwith a subdivision or consolidation of common shares or similar capitalreorganization or payment of a stock dividend or an amalgamation, combinationor other reorganization involving the Company; (iii) extending the term ofan option beyond the expiry date or beyond 10 years from its grant date (exceptwhere an expiry date would have occurred within a blackout period of theCompany); (iv) extending the participation of non-employee directors andnon-consultants in the stock option plan; (v) permitting options to betransferred other than by testate or intestate succession; (vi) permittingthe addition or modification of a cashless exercise feature, payable in cash orcommon shares, unless it provides for a full deduction of the number ofunderlying common shares from the stock option plan reserve; (vii) permittingawards, other than options, to be made under the stock option plan; or (viii) pursuantto the Company’s bylaws or the rules or policies of any exchange, thatrequire shareholder approval.

 

Currently there are12,000,000 common shares reserved for issuance under the stock option planrepresenting approximately 13% of the total number of issued and outstandingcommon shares.

 

As at May 31, 2009,the Company had 7,535,168 stock options outstanding. As of May 31, 2009,640,897 stock options remain available for grant, and a net total of 10,631,408stock options have been granted to participants in the stock option plan, withthe underlying common shares representing approximately 11.5% of the totalnumber of issued and outstanding common shares, taking into account optionsthat have been forfeited or cancelled. Since the stock option plan was adopted, options exercised resulted inthe issuance of 3,144,340 common shares as of May 31,2009.

 

If an option holder’semployment or term as a director or consultant ceases as a result of the optionholder’s death, retirement or disability, vested options may be exercised for180 days (or, if earlier to the end of the term) and unvested options arecancelled.  If an option holder’semployment or term as a director or consultant is terminated without cause orby voluntary resignation, vested options may be exercised for 90 days (or, ifearlier, to the end of the term) and unvested options are cancelled.  If an option holder’s employment or term as adirector or consultant is terminated for cause, all options are immediatelycancelled.  Notwithstanding theforegoing, but subject to applicable securities laws, the Board of Directorsmay, in its discretion, permit the exercise of any or all options held by anoption holder in the manner and on the terms authorized by the Board; providedthat the Board may not authorize the exercise of an option beyond 10 years fromthe date of grant, excluding any automatic extension for an expiry date whichfalls in a blackout period.

 

Options arenon-transferable. The Board of Directors has the discretion to acceleratevesting and expiration of options in connection with a change of control of theCompany, a sale of all or substantially all of the assets of the Company or adissolution or liquidation of the Company. The Board of Directors may further take such steps it deems equitableand appropriate to adjust the 

 

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number of commonshares that may be acquired on the exercise of any options or the exerciseprice in the event that the Company effects a subdivision or consolidation ofthe common shares, any similar capital reorganization, payment of a stockdividend (other than in lieu of a cash dividend), or other change incapitalization of the Company, or upon any amalgamation, continuation,reorganization involving the Company, by exchange of common shares, by sale orlease of assets or otherwise, to preserve the proportionality of the rights andobligations of the option holders.

 

All options are accountedfor at the fair value as determined by the Black-Scholes option pricing modelusing amounts that are believed to approximate the volatility of the tradingprice of the common shares, the expected lives of awards of options, the fairvalue of the common shares, and the risk-free interest rate.

 

***Restricted ShareUnits***

*** ***

We established the RSU Planin March 2008. The RSU Plan is meant to complement the stock optionplan  and allow the Company to offer, through combinations of these equity-basedincentive programs, optimal alignment of the interests of  management and certain employees of theCompany and its affiliates to that of its shareholders. The Human Resources andCorporate Governance Committee believes that the RSU Plan, together with theaward of stock options and the DSU Plan provide a total compensation packagethat is well aligned with shareholder interests.

 

The RSU Plan is designedto retain certain employees of the Company and its affiliates, allow them toparticipate in the long-term success of the Company and to promote a greateralignment of their interests with the interests of the Company and itsshareholders.

 

The RSU Plan provides forgrants of restricted share units (“RSUs”) to certain employees (each a“participant”) of the Company and its affiliates. In determining the number ofRSUs to be granted, the Human Resources and Corporate Governance Committee maytake into account such milestones and criteria it determines at the time ofgrant. An RSU is a right to receive the cash equivalent of a common share,subject to the vesting, forfeiture and other restrictions the Board ofDirectors may determine. RSUs are credited to an account in the name of theparticipant. If a dividend is paid on common shares, each participant’s RSUaccount is credited with additional RSUs (a “dividend RSU”) equal to a fractionwhere the numerator is the product of: (a) the number of RSUs credited tothe participant on the date the dividends are paid, and (b) the dividendpaid per common share, and the denominator, which is the closing price percommon share on the TSX on the last trading day on which the common shares weretraded preceding the date on which dividends are paid.

 

Unless otherwise determinedby the Board of Directors, with the input of the Human Resources and CorporateGovernance Committee, each RSU vests on a date no later than December 31of the third calendar year following the calendar year in respect of which theRSU is granted, as is determined in our Board’s discretion.  RSUs are redeemed within 30 days followingthe vesting date, by a cash payment to the participant equal to the number ofvested RSUs multiplied by the closing price per common share on the TSX on thelast trading day on which the common shares were traded preceding the vestingdate. A dividend RSU vests on the same day as the RSU in respect of which itwas granted and is redeemed by the Company on the same date as the applicableRSU.

 

If a participant dies, orhis or her employment is terminated by the Company without cause, prior to thevesting date, then a pro rata portion of RSUs credited to the participant willvest immediately prior to the date of the participant’s death or termination ofemployment.  If the employment of aparticipant is terminated by resignation of the participant or for cause priorto the vesting date, the participant forfeits all rights to the RSUs that havenot vested. Notwithstanding the foregoing, if a participant’s employment isterminated without cause or for constructive termination, within six monthsfollowing a change of control of the Company, all of that participant’s RSUsvest immediately prior to the termination date.

 

RSUs are non-assignable.The Board of Directors determines, with the input of the Human Resources andCorporate Governance Committee, which employees will be granted RSUs; the timeor times when RSUs will be granted; the number of RSUs to be granted; and thedate or dates on which RSUs will vest. The Human Resources and CorporateGovernance Committee administers the RSU Plan, including: interpreting anyprovisions of the RSU Plan; making recommendations to the Board of Directorsconcerning the determination of which employees are eligible participate in theRSU Plan and the number of RSUs to be credited to each participant’s RSUaccount; and, generally, taking such other actions in connection with theadministration of the RSU Plan that it deems necessary or advisable.

 

The Board may from timeto time amend or suspend the RSU Plan in whole or in part and may at any timeterminate the RSU Plan without prior notice. However, except as expressly setforth in the RSU Plan, no such amendment, suspension, or termination mayadversely affect the RSUs previously granted to a participant at the time ofsuch amendment, suspension or termination, without the consent of the affectedparticipant. If the Board of Directors terminates or suspends the RSU Plan, nonew RSUs will be credited to a participant’s account, provided that the Boardof Directors may elect to credit a participant’s account with dividend RSUsafter the date of termination or during the period of suspension, asapplicable.

 

Unless otherwisedetermined by the Board of Directors, with the input of the Human Resources andCorporate Governance Committee, each RSU vests on a date no later than December 31of the third calendar year following the calendar year in respect of which theRSU is granted, as is determined in our Board’s discretion. RSUs are redeemedwithin 30 days following the vesting date, 

 

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by a cash paymentto the participant equal to the number of vested RSUs multiplied by the closingprice per common share on the TSX on the last trading day on which the commonshares were traded preceding the vesting date. A dividend RSU vests on the sameday as the RSU in respect of which it was granted and is redeemed by the Companyon the same date as the applicable RSU. All RSUs are accounted for at theirintrinsic value.

 

***SummaryCompensation Table***

*** ***

The following tableprovides a summary of compensation earned during the financial year ended December 31,2008 by the Named Executive Officers.

 
| **Name and Principal Position**                                      | ** ** | **Salary  ($)** | ** ** | **Share-  Based  Awards  ($)** | ** ** | **Option-  Based  Awards  ($)** | ** ** | **Non-Equity  Incentive Plan  Compensation  (1)  ($)** | ** ** | **All Other  Compensation  (2)  ($)** | ** ** | **Total  Compensation  ($)** | ** ** |
|----------------------------------------------------------------------|------------|-----------------|------------|--------------------------------|------------|---------------------------------|------------|--------------------------------------------------------|------------|---------------------------------------|------------|------------------------------|------------|
| Daryl Wilson, *President & Chief Executive Officer*         |       | 370,336         |       | 228,788                        |       | 105,117                         |       | 185,168                                                |       | Nil                                   |       | 889,408                      |       |
| Lawrence Davis, *Chief Financial Officer and Corporate Secretary*    |       | 234,390         |       | 135,769                        |       | 66,523                          |       | 117,195                                                | (3)        | Nil                                   |       | 553,877                      |       |
| Joseph  Cargnelli, *Chief Technology Officer*                        |       | 187,512         |       | 89,051                         |       | 43,634                          |       | 96,100                                                 | (4)        | Nil                                   |       | 416,297                      |       |
| Wido Westbroek,*Vice  President and General Manager*                 |       | 186,044         |       | 25,287                         |       | 12,391                          |       | 77,817                                                 |       | Nil                                   |       | 301,539                      |       |
| Jennifer Barber,  *Vice President, Finance and Corporate Controlle*r |       | 145,322         |       | 22,036                         |       | 10,804                          |       | 46,503                                                 | (5)        | Nil                                   |       | 224,665                      |       |

 

----

Notes:

 
| (1)    |   | This  represents the Company’s short-term incentive plan. The Company does not have  any non-equity long-term incentive plans.         |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                        |
| (2)    |   | Benefits  did not exceed the lesser of Cdn. $50,000 and 10% of the total annual salary  and bonuses of any of the Named Executive Officers. |

 

***EmploymentAgreements***

*** ***

On December 8, 2006,we entered into an employment agreement with Daryl Wilson. Mr. Wilson’sagreement provides for a base salary of Cdn. $395,000, subject to annualreview, and a discretionary short-term incentive bonus of up to 50% of his basesalary.

 

On February 21,2005, we entered into an employment agreement with Lawrence Davis, which wassubsequently amended on January 16, 2008. Mr. Davis’ agreementprovides for a base salary of Cdn. $250,000, subject to annual review, and adiscretionary short-term incentive bonus of up to 50% of his base salary.

 

On April 16, 2001,we entered into an employment agreement with Joseph Cargnelli, which wassubsequently amended on February 11, 2005. Mr. Cargnelli’s agreementprovides for a base salary of Cdn. $205,000, subject to annual review, and adiscretionary short-incentive bonus of up to 50% of his base salary.

 

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On July 12, 2006, weentered into an employment agreement with Wido Westbroek, which wassubsequently amended on January 16, 2008. Mr. Westbroek’s agreement provides for a base salary 126,500 euros,and a discretionary short-term incentive bonus of up to 40% of his base salary.

 

On May 16, 2005, weentered into an employment agreement with Jennifer Barber, which wassubsequently amended on August 7, 2008. Ms. Barber’s agreementprovides for a base salary of Cdn. $155,000, subject to annual review, and adiscretionary short-term incentive bonus of up to 40% of her base salary.

 

***Incentive PlanAwards***

*** ***

*Outstanding Share-Based Awards and Option-Based AwardsDuring the Year Ended December 31, 2008*

 
| ** **        | ** ** | **Option-based Awards**                                          | ** ** | **Share-based Awards**                | ** ** |
|-------------------|------------|------------------------------------------------------------------|------------|---------------------------------------|------------|
| **Name**          | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#)** | ** ** | **Option  Exercise  Price  Cdn. ($)** | ** ** | **Option Expiration  Date** | ** ** | **Value of  Unexercised  In-The-  Money  Options** | ** ** | **Number of  Shares or Units  of Shares That Have Not Vested** | ** ** | **Market or Payout  Value of Share-  Based Awards That  Have Not Vested  Cdn.($)** | ** ** |
| Daryl  Wilson     |       | 225,000                                                          |       | $                                     | 1.60       |   | December 8,  2016 |   | Nil |   | 567,500 |   | 283,750 |   |
|              |       | 214,100                                                          |       | $                                     | 1.17       |   | March 23,  2017 |   | Nil |   |   |   |   |   |
|              |       | 377,500                                                          |       | $                                     | 0.58       |   | March 12,  2018 |   | Nil |   |   |   |   |   |
|              |       |                                                             |       |                                  |       |   |   |   |   |   |   |   |   |
| Lawrence  Davis   |       | 100,000                                                          |       | $                                     | 5.10       |   | February 8,  2015 |   | Nil |   | 359,200 |   | 179,600 |   |
|              |       | 65,000                                                           |       | $                                     | 4.51       |   | May 16,  2015 |   | Nil |   |   |   |   |   |
|              |       | 105,370                                                          |       | $                                     | 3.37       |   | May 23,  2016 |   | Nil |   |   |   |   |   |
|              |       | 277,900                                                          |       | $                                     | 1.17       |   | March 23,  2017 |   | Nil |   |   |   |   |   |
|              |       | 238,900                                                          |       | $                                     | 0.58       |   | March 12,  2018 |   | Nil |   |   |   |   |   |
|              |       |                                                             |       |                                  |       |   |   |   |   |   |   |   |   |
| Joseph  Cargnelli |       | 156,700                                                          |       | $                                     | 0.58       |   | March 12,  2018 |   | Nil |   | 235,600 |   | 117,800 |   |
|              |       |                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |
| Wido  Westbroek   |       | 75,000                                                           |       | $                                     | 2.19       |   | July 14,  2016 |   | Nil |   | 66,900 |   | 33,450 |   |
|              |       | 68,700                                                           |       | $                                     | 1.17       |   | March 23,  2017 |   | Nil |   |   |   |   |   |
|              |       | 44,500                                                           |       | $                                     | 0.58       |   | March 12,  2018 |   | Nil |   |   |   |   |   |
|              |       |                                                             |       |                                  |       |   |   |   |   |   |   |   |   |
| Jennifer  Barber  |       | 5,550                                                            |       | $                                     | 7.70       |   | October 1,  2011 |   | Nil |   | 58,300 |   | 29,150 |   |
|              |       | 25,000                                                           |       | $                                     | 4.51       |   | May 16,  2015 |   | Nil |   |   |   |   |   |
|              |       | 25,400                                                           |       | $                                     | 3.37       |   | May 23,  2016 |   | Nil |   |   |   |   |   |
|              |       | 64,500                                                           |       | $                                     | 1.17       |   | March 23,  2017 |   | Nil |   |   |   |   |   |
|              |       | 38,800                                                           |       | $                                     | 0.58       |   | March 12,  2018 |   | Nil |   |   |   |   |   |

 

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*Incentive Plan Awards - Value Vested or Earned Duringthe Year Ended December 31, 2008*

 
| **Name**         | ** ** | **Option-Based Awards -  Value Vested During the  Year****($)** | ** ** | **Share-Based Awards -  Value Vested During the Year****($)** | ** ** | **Non-Equity Incentive  Plan  Compensation -   Value Earned During the Year****($)** | ** ** |
|------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** **                                                      | ** ** | ** **                                                    | ** ** | ** **                                                                           | ** ** |
| Daryl Wilson     |       | Nil                                                             |       | Nil                                                           |       | 185,168                                                                              |       |
| Lawrence Davis   |       | Nil                                                             |       | Nil                                                           |       | 117,195                                                                              |       |
| Joseph Cargnelli |       | Nil                                                             |       | Nil                                                           |       | 96,100                                                                               |       |
| Wido Westbroek   |       | Nil                                                             |       | Nil                                                           |       | 77,817                                                                               |       |
| Jennifer  Barber |       | Nil                                                             |       | Nil                                                           |       | 46,503                                                                               |       |

 

**Compensation ofDirectors**

** **

***DirectorCompensation Table***

*** ***

The following tableprovides a summary of compensation earned during the financial year ended December 31,2008 by our directors.

 
| **Name**                | ** ** | **Fees   Earned  ($)** | ** ** | **Share-Based  Awards  ($)** | ** ** | **Option-based  awards  ($)** | ** ** | **Non-Equity  Incentive  Plan Compensation  ($)** | ** ** | **All Other   Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|-------------------------|------------|------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------------------------------|------------|-----------------------------------|------------|----------------|------------|
| Norman  M. Seagram      |       | Nil                    |       | 92,500                       |       | n/a                           |       | n/a                                               |       | Nil                               |       | 92,500         |       |
| Douglas  S. Alexander   |       | 17,000                 |       | 51,000                       |       | n/a                           |       | n/a                                               |       | Nil                               |       | 68,000         |       |
| Michael  Cardiff        |       | 28,500                 |       | 27,000                       |       | n/a                           |       | n/a                                               |       | Nil                               |       | 55,500         |       |
| Henry  J. Gnacke        |       | Nil                    |       | Nil                          |       | n/a                           |       | n/a                                               |       | Nil                               |       | Nil            |       |
| V.  James Sardo         |       | 34,000                 |       | 32,750                       |       | n/a                           |       | n/a                                               |       | Nil                               |       | 66,750         |       |
| Frank  Colvin           |       | Nil                    |       | 20,560                       |       | n/a                           |       | n/a                                               |       | Nil                               |       | 20,560         |       |
| William  A. Szkodzinski |       | Nil                    |       | Nil                          |       | n/a                           |       | n/a                                               |       | Nil                               |       | Nil            |       |
| Hugo  Vandenborre       |       | 17,560                 |       | Nil                          |       | n/a                           |       | n/a                                               |       | Nil                               |       | 17,560         |       |

 

In 2008, each of ourdirectors who is considered “independent” was paid an annual fee of $12,000 forhis services as a director and an attendance fee of $1,000 for each Board orcommittee meeting attended.  Eachcommittee chair received an additional attendance fee of $500 for eachcommittee meeting attended.  Our Chairmanof the Board was paid an annual fee of $25,000 for his services and anattendance fee of $1,500 for each Board meeting attended.  All directors were reimbursed for travel andother reasonable expenses incurred in attending Board and committee meetings.

 

***Deferred ShareUnits***

*** ***

We established the DSUPlan and director ownership guidelines in 2004, in an effort to better alignthe interests of non-employee directors with the interests of our shareholdersby linking annual short-term incentive awards to the future value of theShares.  Pursuant to the DSU Plan,independent directors are entitled to elect to receive all or any portion oftheir annual retainer and meeting fees in the form of deferred share units(“DSUs”) instead of cash.  A DSU is aunit, equivalent in value to a Share, credited by means of a bookkeeping entryin the books of the Company, to an account in the name of the independentdirector.  At the end of the director’stenure as a member of the Board, the director is paid, in cash, the marketvalue of the Shares represented by the DSUs or at the option of the Company,that number of Shares purchased by the Company that is equal to the marketvalue of the Shares represented by the DSUs. As a result of the implementation of the DSU Plan, directors were noteligible to receive additional awards 

 

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of stockoptions.  The Board of Directors hasapproved the following annual DSU grants to independent directors:  independent director — $24,000 equivalent inDSUs; Chair of the Human Resources and Corporate Governance Committee - $34,000equivalent in DSUs; Chair of the Audit Committee - $34,000 equivalent in DSUs;and Chairman of the Board of Directors - $39,000 equivalent in DSUs.

 

Contemporaneously withthe adoption of the DSU Plan, the Board also established ownership guidelinesfor directors pursuant to which each non-employee director is required to holdShares and/or DSUs equal to five times the director’s annual cash retainerwithin three years of initial appointment.

 

***Incentive PlanAwards***

*** ***

*Outstanding Share-Based Awards and Option-Based AwardsDuring the Year Ended December 31, 2008*

 
| ** **              | ** ** | **Option-based Awards**                                          | ** ** | **Share-based Awards**           |
|-------------------------|------------|------------------------------------------------------------------|------------|----------------------------------|
| **Name**                | ** ** | **Number of  securities  underlying  unexercised  options  (#)** | ** ** | **Option  exercise  price  ($)** | ** ** | **Option  Expiration  Date** | ** ** | **Value of  Unexercised  In-The-  Money  Options** | ** ** | **Number of  Shares or  Units of  Shares That  Have Not  Vested** | ** ** | **Market or Payout Value  of  Share-Based Awards That  Have Not Vested  Cdn. ($)** |
| Norman M.  Seagram      |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| Douglas S.  Alexander   |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| Michael Cardiff         |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| Henry J. Gnacke         |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| V. James Sardo          |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| Frank Colvin            |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| William A.  Szkodzinski |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |
| Hugo Vandenborre        |       | n/a                                                              |       | n/a                              |   | n/a |   | n/a |   | n/a |   | n/a |

 

*Incentive Plan Awards - Value Vested or Earned Duringthe Year Ended December 31, 2008*

 
| **Name**                | ** ** | **Option-Based Awards -  Value Vested During the  Year  ($)** | ** ** | **Share-Based Awards -  Value Vested During the  Year  ($)** | ** ** | **Non-Equity Incentive  Plan Compensation -   Value Earned During the Year  ($)** |
|-------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|
| Norman M.  Seagram      |       | n/a                                                           |       | 92,500                                                       |       | n/a                                                                               |
| Douglas S.  Alexander   |       | n/a                                                           |       | 51,000                                                       |       | n/a                                                                               |
| Michael Cardiff         |       | n/a                                                           |       | 27,000                                                       |       | n/a                                                                               |
| Henry J. Gnacke         |       | n/a                                                           |       | Nil                                                          |       | n/a                                                                               |
| V. James Sardo          |       | n/a                                                           |       | 32,750                                                       |       | n/a                                                                               |
| Frank Colvin            |       | n/a                                                           |       | 20,560                                                       |       | n/a                                                                               |
| William A.  Szkodzinski |       | n/a                                                           |       | Nil                                                          |       | n/a                                                                               |
| Hugo Vandenborre        |       | n/a                                                           |       | Nil                                                          |       | n/a                                                                               |

 

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**Post-retirement BenefitObligations**

** **

For information regardingaccrued post-retirement benefit obligations, see “Note 11 — Accounts Payable andAccrued Liabilities” under the Notes to Consolidated Financial Statements,which can be found on page F-21 of this form, and is incorporated byreference herein.

 

**BOARD PRACTICES**

** **

For information regardingthe period during which the directors and executive officers have served inoffice, see “Item 6. Directors, Senior Management And Employees — Directors andSenior Management” above.  Each directorelected will hold office until the next annual meeting of shareholders or untilhis successor is duly elected or appointed.

 

**Termination and Changeof Control Benefits of Executive Directors**

** **

Mr. Wilson’semployment agreement provides that Mr. Wilson is entitled to 18 months’salary and bonus in lieu of notice if he is terminated without cause from hisposition at any time, or if he is terminated upon a change of control of theCompany.  This amount is equal to amaximum of approximately Cdn. $997,375 based on Mr. Wilson’s currentcompensation. The agreement also provides that all outstanding stock optionsheld by Mr. Wilson will immediately vest upon termination without cause ortermination resulting from a change of control of the Company. Mr. Wilsonhas agreed to refrain from competing with and interfering in the business ofHydrogenics for a period of one year subsequent to his termination for anyreason. Under the RSU Plan, if Mr. Wilson’s employment is terminated bythe Company without cause, prior to the vesting date of any awarded RSUs, thena pro rata portion of such RSUs will vest immediately prior to the date of histermination of employment. The value of such RSUs, as of December 31,2008, is Cdn. $76,444.

 

Mr. Cargnelli’semployment agreement provides that Mr. Cargnelli is entitled to 24 months’salary and bonus in lieu of notice if Mr. Cargnelli is terminated withoutcause from his position at any time, or if he is terminated upon a change ofcontrol of the Company.  This amount isequal to a maximum of approximately Cdn. $552,500 based on Mr. Cargnelli’scurrent compensation. Mr. Cargnelli has agreed to refrain from competingwith and interfering in the business of Hydrogenics for a period of two yearssubsequent to his termination for any reason. Under the RSU Plan, if Mr. Cargnelli’s employment is terminated bythe Company without cause, prior to the vesting date of any awarded RSUs, thena pro rata portion of such RSUs will vest immediately prior to the date of histermination of employment. The value of such RSUs, as of December 31,2008, is Cdn. $31,736.

 

**Human Resources andCorporate Governance Committee**

** **

As of May 6, 2008,we have a Human Resources and Corporate Governance Committee, which resultedfrom the combination of the Human Resources and Compensation Committee and theNomination and Corporate Governance Committee.

 

***Compositionof Human Resources and Corporate Governance Committee***

*** ***

The following individualsserved as the members of the Human Resources and Corporate Governance Committeeas at December 31, 2008: V. James Sardo, Chair, Douglas S. Alexander andMichael Cardiff and Norman M. Seagram.

 

Each member of the HumanResources and Corporate Governance Committee is independent under testsestablished by legal and stock exchange requirements to which the Company issubject.  None of the members of theHuman Resources and Corporate Governance Committee is an officer, employee orformer officer or employee of the Company or any of its affiliates.

 

***Nominationof Directors and Compensation***

*** ***

Annually, the HumanResources and Corporate Governance Committee assesses the size of the Board ofDirectors, the competencies, skills and personal qualities required of theBoard of Directors in order to add value to the Company, and the competencies,skills and personal qualities of existing directors.  Based on this assessment, the Human Resourcesand Corporate Governance Committee will consider whether to recommend anychanges to the composition of the Board of Directors, including proposingnominations to the Board for approval. When required, the Human Resources and Corporate Governance Committeewill evaluate potential candidates for serving as a director having regard tothe background, employment and qualifications of possible candidates and willconsider whether the candidate’s competencies, skills and personal qualitiesare aligned with the Company’s needs.

 

In fulfillingits charter, the committee’s role also includes reviewing and reporting to theBoard on: human resource planning, including the terms of the compensationpackages provided to our employees; succession planning and senior managementappointments; the levels and form of executive compensation in general; and thespecific compensation of senior executives, including the annual compensationof the President and Chief Executive Officer. The committee also administersthe Company’s stock option plan, the DSU Plan and the RSU Plan and reviews andmakes recommendations to the Board regarding the annual compensation ofnon-employee directors.

 

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***Reportof the Human Resources and Corporate Governance Committee***

*** ***

The Human Resources andCorporate Governance Committee ensures that the Company develops and implementsan effective and efficient approach to corporate governance and has a plan forthe continuity of its officers and an executive compensation plan that ismotivational and competitive, which will attract, retain and inspire executivemanagement and other key personnel.

 

The committee ensuresthat our business and affairs are carried out in a transparent manner that willenhance shareholder value.  The committeeassesses the effectiveness of our corporate governance processes andcompensation policies and, where appropriate, makes recommendations withrespect to the implementation, development and modification with respect tothese processes and policies.

 

In 2008, the HumanResources and Corporate Governance Committee, in fulfilling itsresponsibilities, took the following measures:

 

·                  monitoredand reviewed emerging SOX, Nasdaq, TSX and CSA corporate governance standards;

 

·                  reviewedits own charter in the context of emerging corporate governance best practices;

 

·                  completedan annual Board effectiveness survey, including assessments of the Board andBoard committees and the contributions of individual directors;

 

·                  reviewedthe size and composition of the Board and committees to ensure that directorscontinue to have the appropriate expertise and background to support corporatestrategy and operations;

 

·                  preparednomination recommendations in respect of the Board for approval byshareholders;

 

·                  reviewedour approach to compensation for our employees, officers and directors;

 

·                  reviewedand approved incentive bonus awards and the salary for each officer of theCompany;

 

·                  reviewedand recommended stock option awards;

 

·                  approvedthe short-term incentive awards for our officers; and

 

·                  engagedthe services of an independent external consultant to provide advice andexpertise regarding director and executive compensation.

 

The Human Resources andCorporate Governance Committee met two times in 2008 (and its predecessorcommittees, consisting of the Human Resources and Compensation Committee andthe Nomination and Corporate Governance Committee, each met twice in 2008). TheHuman Resources and Corporate Governance Committee is satisfied that it hasfulfilled its charter during the year ended December 31. 2008.

 

***OtherCommittee Assessments***

*** ***

The Human Resources andCorporate Governance Committee is responsible for supervising the assessment ofthe effectiveness of the Board of Directors as a whole and each committee ofthe Board of Directors, for evaluating the performance of the Chairman of theBoard, the Chair of each committee and the performance and contribution of individualdirectors.  The process involves theHuman Resources and Corporate Governance Committee assigning the task ofconducting an annual survey of directors (with respect to their views on theeffectiveness of the Board of Directors, Chairman of the Board, each committeeof the Board and its Chair and individual directors).  The form of the survey is approved by theHuman Resources and Corporate Governance Committee. The results of the surveyare communicated in writing to the Chairman of the Board and the Chairman thenreports the overall results and the Chairman’s recommendations to theBoard.  The Chairman also meets in personor by telephone with each Board member to confidentially discuss his peerevaluation.  The Chairman also meets withthe Chair of the Human Resources and Corporate Governance Committee to reviewthe results of the survey prior to the Human Resources and Corporate GovernanceCommittee meeting to finalize its recommendations for Board and committeenominations.  The Chair of the Human Resourcesand Corporate Governance Committee meets with the Chairman of the Board todiscuss the Chairman’s performance assessment.

 

The Human Resources andCorporate Governance Committee administers the Company’s executive compensationprogram for executive officers, including with respect to the Named ExecutiveOfficers.

 

The committee has primaryresponsibility for determining executive remuneration and for the design andreview of the Company’s compensation plans. In fulfilling this role, the committee seeks to:

 

·                  providetotal compensation that is closely linked to the Company’s performance and toindividual performance;

 

·                  alignthe interests of the Company’s executive officers with those of itsshareholders through potential stock ownership; and

 

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·                  ensurethat compensation and benefits are at levels such that the Company is able toattract and retain the caliber of executives and officers it needs to achieveits desired growth and performance targets.

 

**Audit Committee**

** **

Our Board of Directorshas delegated to the Audit Committee responsibility for assisting the Board inits oversight role with respect to the quality and integrity of financialinformation and reporting disclosure, risk management, the performance,qualifications and independence of the external auditors and legal andregulatory compliance.  The AuditCommittee regularly meets in camera to review management’s financialstewardship.  The Audit Committeeconsists entirely of unrelated and independent and financially literatedirectors.

 

During the past year, theAudit Committee, in fulfilling its responsibilities, took the followingmeasures:

 

·                  reviewedand discussed with management and the auditors the audited annual consolidatedfinancial statements and the management’s discussion and analysis (“MD&A”);

 

·                  discussedwith the external auditors all matters pertaining to professional auditingguidelines and standards in Canada and the United States, including theexternal auditors’ independence; and

 

·                  receivedwritten disclosure from the external auditors as recommended by The CanadianInstitute of Chartered Accountants and the Independence Standards Board in theUnited States.

 

Based on thisinformation, the Audit Committee recommended to the Board that the consolidatedaudited financial statements and MD&A be included in our annual report toshareholders.

 

During the past year, theAudit Committee also took the following measures:

 

·                  reviewedthe performance of the external auditors and recommended reappointment of theexternal auditors for shareholders’ approval;

 

·                  reviewedthe independence and qualification of the external auditors based  on the external auditors’ disclosure of itsrelationships with the Company;

 

·                  approvedthe audit and non-audit fees paid to the external auditors;

 

·                  ensuredthat all services to be provided by the auditors are approved in advance by thecommittee or are approved by the Chair of the committee and subsequentlyreported to the committee as a whole in the following meeting of the committee,all in accordance with the external Auditors’ Pre-approval Policy;

 

·                  reviewedwith the external auditors and management the overall scope and plans of theannual audit;

 

·                  reviewedwith management and the external auditors the interim quarterly financialstatements, including a discussion with the external auditors of matters thatare required to be disclosed under generally accepted auditing standards;

 

·                  reviewedwith management and the auditors all financial information and financialstatements contained in our annual information form, our annual report on form40-F and our management proxy circular, in each case prior to publication;

 

·                  reviewedwith management our investment policy;

 

·                  metwith management and the external auditors to discuss and review the Company’scontrol environment and culture, and the Company’s program to maintain SOX Section 404compliance;

 

·                  reviewedour overall risk management strategy;

 

·                  metregularly in camera with the internal and external auditors; and

 

·                  reviewedprocedures for the receipt and treatment of complaints regarding accounting,internal accounting controls or auditing matters, and the confidential,anonymous submission by employees of concerns regarding questionable accountingor auditing matters. These procedures can be found on the Company’s investorrelations web page at www.hydrogenics.com.

 

The Audit Committee metfive times in 2008.  The Audit Committeeis satisfied that it has fulfilled its charter during the year ended December 31,2008.

 

The Audit Committee ofour Board of Directors operates under a written charter that sets out itsresponsibilities and composition requirements. As at June 23, 2009, the members of the committee were: Douglas S.Alexander (Chair), Michael Cardiff, V. James Sardo and Norman M. Seagram.  The following sets out the education andexperience of each director relevant to the performance of his duties as amember of the committee.

 

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Douglas Alexander isChair of our Audit Committee.  He is alsothe current Chair of the Audit Committee for Saxon Financial Inc.  From 1999 to 2004 Mr. Alexander wasexecutive Vice President and Chief Financial Officer of Trojan TechnologiesInc., an international environmental high technology company.  In his roles, Mr. Alexander wasresponsible for all aspects of corporate financial affairs, as well asstrategic management and corporate development. Mr. Alexander is a chartered accountant under the Institute ofChartered Accountants of Ontario since 1985 and under the Institute ofChartered Accountants of Scotland since 1980 and holds a Bachelor ofAccountancy from Glasgow University.

 

Michael Cardiff iscurrently the Chief Executive Officer of Accelerents, a consulting firm focusedon strategy development. Mr. Cardiff also serves as a member of the auditcommittee of  Descartes Systems Group, aglobal on-demand software-as-a-service (SaaS) logistics solutions provider. Mr. Cardiffis also a member of the Institute of Corporate Directors and has achieved hisICD.d designation.

 

V. James Sardo has beenChairman of the Board of Trustees of Countryside Power Income Fund, and, since2005, has been a director of New Flyer Industries Inc., North America’s largestmanufacturer of city buses. Mr. Sardo holds a Master’s in BusinessAdministration from McMaster University and is a member of the Institute ofCorporate Directors.  Mr. Sardo waspreviously chief executive officer of seven public companies or theirwholly-owned subsidiaries. Mr. Sardo is also a member of the Institute ofCorporate Directors and has achieved his ICD.d designation.

 

Norman M. Seagram is aCorporate Director.  Mr. Seagramholds a Master’s of Science in Engineering Production from the University ofBirmingham and a Bachelor of Applied Science in Engineering & Businessfrom the University of Toronto.

 

The Audit Committeecharter requires that each member of the Audit Committee be unrelated andindependent, and the composition of the Audit Committee satisfy theindependence, experience and financial expertise requirements of the Nasdaq,the TSX and Section 10A of the Securities Exchange Act of 1934 (UnitedStates), as amended by the Sarbanes-Oxley Act of 2002 (United States), and the rules promulgatedthereunder.  Accordingly, all committeemembers are required to be financially literate or be willing and able toacquire the necessary knowledge quickly. Financial literacy means that theperson has the ability to read and understand financial statements that presenta breadth and level of complexity of accounting issues that are generallycomparable to the breadth and complexity of the issues that can reasonably beexpected to be raised by our financial statements. We believe all of thecurrent members of the Audit Committee are financially literate.

 

In addition, the AuditCommittee charter contains independence requirements that each committee membermust satisfy and each current member meets those requirements. Specifically,the charter provides that no member of the committee may be an officer orretired officer of Hydrogenics and each member must be independent ofHydrogenics within the meaning of all applicable laws, rules andregulations and any other relevant consideration, including laws, rules andregulations particularly applicable to Audit Committee members.

 

The Audit Committee has apolicy restricting the provision of non-audit services by our auditors. Anysuch services must be permitted engagements as provided by the Audit Committeecharter and must be pre-approved by the Audit Committee.  The Audit Committee also pre-approves auditservices and the related fees.

 

**EMPLOYEES**

** **

As at December 31,2008, we employed approximately 166 full-time staff of which 25 areprofessional staff, including engineers, scientists, and other technicalspecialists. Our full-time staff is divided between 73 full-time staff in ourOnSite Generation business, 81 full-time staff in our Power Systems business, 5full-time staff in our Test Systems business and 7 full-time staff in ourcorporate services group.

 

Asof December 31, 2008, seven of our employees were located in our Mississauga,Ontario corporate headquarters seventy-four employees were located in our Mississauga, Ontario power systems group, 11employees were located in our Mississauga,Ontario OnSite generation group, eight employees were located in our Gladbeck, Germany power generation group and62 employees were located in our Oevel-Westerlo, Belgium OnSitegeneration group.  We also employed 2temporary and contract employees at our Mississauga, Ontario facility and eightsubcontractors at our Oevel-Westerlo,Belgium facility.

 

As at December 31,2007, we employed approximately 186 full-time staff of which 27 areprofessional staff, including engineers, scientists, and other professionals.Our full-time staff is divided between 80 full-time staff in our OnSite Generationbusiness, 84 full-time staff in our Power Systems business, 13 full-time staffin our Test Systems business and 9 full-time staff in our corporate servicesgroup.

 

As at December 31,2006, we employed approximately 265 full-time staff of which 40 areprofessional staff, including engineers, scientists, and other professionals,including 4 PhDs. Our full-time staff is divided between 82 full-time staff inour OnSite Generation business, 106 full-time staff in our Power Systemsbusiness, 57 full-time staff in our Test Systems business and 20 full-timestaff in our Corporate Services business.

 

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Our ability to attract,motivate and retain qualified personnel is critical to our success.  We attempt to align the interests of ouremployees with those of shareholders through the use of incentive stock optionsand a performance-based compensation structure. A majority of employees own our common shares or options to purchase ourcommon shares.  We have entered intonon-disclosure and confidentiality agreements with key management personnel andwith substantially all employees.  Noneof our employees are represented by a collective bargaining agreement and webelieve that our relations with our employees are good.

 

**SHARE OWNERSHIP**

** **

For information regardingarrangements for involving employees in the capital of our Company, see “Item6. Directors, Senior Management And Employees — Compensation — Elements ofExecutive Compensation Program — Long-term Incentives” above.

 

**ITEM7.          MAJOR SHAREHOLDERS AND RELATEDPARTY TRANSACTIONS**

** **

**MAJOR SHAREHOLDERS**

** **

To the knowledge of ourdirectors and officers, as of June 23,2009, no person or company beneficially owns, directly or indirectly, orexercises control or direction over common shares carrying more than 5% of thevoting rights attached to our outstanding common shares other than GeneralMotors Corporation, which owns 11,364,006 common shares, representing 12.3% ofour outstanding common shares.

 

For information regardingthe pre-emptive right granted to General Motors, see “Item 7. MajorShareholders and Related Party Transactions — Related Party Transactions —Transactions with General Motors” below.

 

Our major shareholders donot have voting rights different from those of our other shareholders.

 

As of March 31,2009, United States residents held approximately 46,997,900 of our outstandingcommon shares.

 

**RELATED PARTY TRANSACTIONS**

** **

**Transactions with VikingEngineering & Tool Co.**

** **

We subcontract somemanufacturing in the normal course of our operations to Viking Engineering &Tool Co., a company owned by the father and uncle of Joseph Cargnelli, ourChief Technology Officer and one of our principal shareholders.  For the fiscal year ended December 31,2008, this company invoiced us approximately $0.2 million.  For the fiscal year ended December 31,2007, billings by this related company totaled $0.8 million, a decrease of $0.2million from the $1.0 million billed in the previous year. At December 31,2007, we had an accounts payable balance due to this related company of $0.1million.  For the fiscal year ended December 31,2006, billings by this related company totaled $1.0 million, an increase of$0.1 million from the $0.9 million billed in the previous year. At December 31,2006, we had an accounts payable balance due to this related company of$1,000.  We believe that the rates thiscompany has charged us for its services are comparable to rates we could haveobtained from an unrelated third party.

 

**Transactions withGeneral Motors**

** **

In October 2001, weformed a strategic alliance with General Motors to accelerate the developmentof fuel cell technology in global commercial markets.  In connection with this strategic alliance,we issued to General Motors approximately 11.4 million of our common shares, orapproximately 21% of our outstanding shares at October 2001, and warrantsto purchase approximately 2.5 million additional shares.  We cancelled these warrants in a transactionwith General Motors in December 2005 for consideration of $750,000, whichwe paid in the form of a credit against the amount due from General Motors inrespect of testing services.  All testingservices have since been completed.  Wehave agreed that one director nominated by General Motors shall be included inthe slate of directors that is presented to shareholders for approval at ourgeneral meeting.

 

In connection with thisstrategic alliance, General Motors granted us a non-exclusive, royalty freelicence to use certain of General Motors’ proprietary fuel cell stackintellectual property in certain applications and modules.  The use or incorporation of General Motors’fuel stack intellectual property outside these defined areas requires theconsent of General Motors.  We granted toGeneral Motors, its affiliates and any third parties with whom General Motorshas a technical or business relationship related to fuel cells a perpetual,royalty-free, non-exclusive licence to use all of the intellectual property wedevelop that (i) uses General Motors’ proprietary fuel cell stackintellectual property, and/or (ii) is funded by General Motors.  Intellectual property that is not funded byGeneral Motors but which uses General Motors’ fuel cell stack technology islicensed to General Motors non-exclusively. Intellectual property that has been developed through funding by GeneralMotors, whether owned solely by us or jointly by us and General 

 

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Motors, is licensed toGeneral Motors on an exclusive basis for mobile applications and on a non-exclusive basis for all other applications. In the event that we wish to liquidate or discontinue activity in thefuel cell business, or otherwise wish to transfer any of the intellectualproperty associated with General Motors’ proprietary fuel cell stackintellectual property developed using funds from General Motors, we arerequired to offer it first to General Motors. We have also agreed to provide General Motors with certain services,access to technology and testing resources in connection with its fuel celldevelopment program and we have agreed that all products, material hardware andresources purchased from us by General Motors will be at our most favourablecommercial prices.

 

For so long as GeneralMotors holds at least 10% of our outstanding shares, in the event that any of ourfounders, Pierre Rivard, Joseph Cargnelli or Boyd Taylor, wish to transfer (i) allor substantially all of their shares to any person, or (ii) any of theirshares to a person actively competing with General Motors in the automotive orfuel cell industry, he must first offer the shares to General Motors.  In addition, in the event that we issueadditional equity securities or securities convertible into equity securitiesfor cash consideration, we have granted General Motors the right to participatein such offering on a pro rata basis based on the fully diluted number ofcommon shares that it holds.  GeneralMotors’ pre-emptive right is subject to certain limited exceptions, includingthe issuance of shares in connection with acquisitions.

 

**Indebtedness ofDirectors and Executive Officers**

** **

From January 1, 2006to June 23, 2009, none of our currentdirectors or executive officers are indebted to the Company.

*** ***

***Indebtednessof Directors and Executive Officers Under (1) Securities Purchase and (2) OtherPrograms***

 
| **Name and Principal  Position**                                                       | ** ** | **Involvement of  Company or  Subsidiary**                                                                           | ** ** | **Largest Amount  Outstanding  During 2006 ($)** | ** ** | **Amount  Outstanding as  at****May 31****, 2009  ($)** | ** ** | **Financially  Assisted  Securities  Purchases  During 2006** | ** ** | **Security for  Indebtedness (#  of shares)** | ** ** | **Amount  Forgiven  During  2006 ($)** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------|------------|
| Securities  Purchase Program                                                           |       |                                                                                                                 |       |                                             |       |                                                         |       |                                                          |       |                                          |       |                                   |       |
|                                                                                   |       |                                                                                                                 |       |                                             |       |                                                         |       |                                                          |       |                                          |       |                                   |       |
| Jon Slangerup,(1)(2)(3) former President  and Chief Executive Officer of Stuart Energy |       | Provided loan by Stuart Energy (now a  subsidiary of the Company) to purchase common shares of Stuart Energy(2) |       | 957,887                                          |       | Nil                                                          |       | Nil                                                           |       | 150,775                                       |       | Nil                                    |       |

 

----

Notes:

 

(1)   Jon Slangerup was the President and ChiefExecutive Officer of Stuart Energy from July 2001 until January 2005,when he resigned in connection with our acquisition of Stuart Energy.

 

(2)   At the time of hiring Mr. Slangerup in July 2001,Stuart Energy’s board of directors determined that it was desirable andappropriate to align Mr. Slangerup’s interests with those of theshareholders of Stuart Energy by encouraging Mr. Slangerup to purchase upto 203,750 common shares of Stuart Energy. On September 28, 2001, as partof Mr. Slangerup’s inducement option which was approved by theshareholders of Stuart Energy at the September 25, 2001 shareholders’meeting, Stuart Energy provided a loan to Mr. Slangerup in the principalamount of approximately Cdn.$1,151,188 to facilitate the purchase by Mr. Slangerupof 203,750 treasury common shares of Stuart Energy at Cdn.$5.65 per share. Thisloan was secured by a demand promissory note and a pledge by Mr. Slangerupof the purchased common shares. The loan was interest free, unless in default,in which case the loan bears interest at 6% after default. In January 2005,when we acquired Stuart Energy, our separation agreement with Mr. Slangerupbecame effective. As part of that agreement, we agreed to extend until December 31,2006 (the “Extension Date”) the term of this loan which would otherwise expireupon the termination of Mr. Slangerup’s employment with Stuart Energy. The203,750 common shares of Stuart Energy pledged by Mr. Slangerup assecurity for the loan were exchanged for 150,775 Shares, which in turn havebeen pledged in favour of the Company as security for the loan. Consistent withthe terms of Mr. Slangerup’s then employment arrangement, the separationagreement provides that the outstanding loan may be forgiven by Hydrogenics atany time. In addition, Mr. Slangerup and Hydrogenics had agreed that atthe end of the Extension Date (or any time prior to the Extension Date, at theelection of Hydrogenics), Hydrogenics shall purchase for cancellation thepledged shares from Mr. Slangerup, subject to compliance with applicablesecurities laws, and shall apply the proceeds from the sale to the loanrelating to such pledged shares. Should proceeds from the sale of the pledgedshares be less than the amount of the loan, subject to applicable law, thebalance of the loan will be forgiven and Mr. Slangerup will be compensatedfor any negative tax consequences resulting from forgiveness of the loan.

 

(3)   On March 20, 2007 the Company purchasedfor cancellation the pledged shares and applied the amount resulting therefromto Mr. Slangerup’s loan. The balance of the loan was forgiven and Mr. Slangerupwill be compensated for any negative tax consequences resulting from thisforgiveness, in accordance with the Company’s contractual commitments to Mr. Slangerup.

 

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**INTERESTS OF EXPERTS AND COUNSEL**

** **

None.

 

**ITEM8.          FINANCIAL INFORMATION**

** **

**CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION**

** **

**Financial Statements**

** **

See “Item 18.Financial Statements.”

 

**Legal Proceedings**

** **

We are not currentlyparty to any material legal proceedings.

 

**Dividends Policy**

** **

We have never declared orpaid any cash dividends on our common shares. We currently intend to retain any future earnings to fund thedevelopment and growth of our business and we do not anticipate paying any cashdividends in the foreseeable future.

 

**SIGNIFICANT CHANGES**

** **

For information regarding significant changes since December 31, 2008,see the relevant information presented in the management’s discussion andanalysis of financial condition and results of operations for the three monthsended March 31, 2009 and related financial information for the three monthsended March 31, 2009, which were furnished to the SEC as part of the Registrant’sForm 6-K filed on May 13, 2009.

** **

**ITEM9.          THE OFFER AND LISTING**

** **

**LISTING DETAILS**

** **

The followingtable sets forth the reported trading prices in Canadian dollars and U.S.dollars, respectively, for our common shares on the TSX and Nasdaq.

 
| ** **                   | ** ** | **TSX**         | ** ** | **Nasdaq**     | ** ** |
|------------------------------|------------|-----------------|------------|----------------|------------|
| ** **                   | ** ** | **High (Cdn$)** | ** ** | **Low (Cdn$)** | ** ** | **High (US$)** | ** ** | **Low (US$)** | ** ** |
| **Annual Market Prices**     | ** ** | ** **      | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2004                         |       | 9.78            |       | 4.21           |       | 7.60 |   | 3.19 |   |
| 2005                         |       | 6.45            |       | 2.93           |       | 5.38 |   | 2.50 |   |
| 2006                         |       | 5.03            |       | 1.35           |       | 4.40 |   | 1.21 |   |
| 2007                         |       | 1.73            |       | 0.90           |       | 1.65 |   | 0.84 |   |
| 2008                         |       | 2.47            |       | 0.37           |       | 2.45 |   | 0.32 |   |
| **Quarterly  Market Prices** |       |            |       |           |       |   |   |   |   |
| *2007*                       | * *   | * *        | * *   | * *       | * *   | * * | * * | * * | * * |
| First Quarter                |       | 1.54            |       | 1.09           |       | 1.33 |   | 0.94 |   |
| Second Quarter               |       | 1.45            |       | 0.94           |       | 1.36 |   | 0.84 |   |
| Third Quarter                |       | 1.73            |       | 1.15           |       | 1.65 |   | 1.10 |   |
| Fourth Quarter               |       | 1.43            |       | 0.90           |       | 1.42 |   | 0.90 |   |
| *2008*                       | * *   | * *        | * *   | * *       | * *   | * * | * * | * * | * * |
| First Quarter                |       | 1.05            |       | 0.51           |       | 1.07 |   | 0.49 |   |
| Second Quarter               |       | 1.99            |       | 0.50           |       | 1.95 |   | 0.50 |   |
| Third Quarter                |       | 2.47            |       | 0.60           |       | 2.45 |   | 0.55 |   |
| Fourth Quarter               |       | 0.98            |       | 0.37           |       | 0.92 |   | 0.32 |   |

 

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| ** **                         | ** ** | **TSX**         | ** ** | **Nasdaq**     | ** ** |
|------------------------------------|------------|-----------------|------------|----------------|------------|
| ** **                         | ** ** | **High (Cdn$)** | ** ** | **Low (Cdn$)** | ** ** | **High (US$)** | ** ** | **Low (US$)** | ** ** |
| *2009*                             | * *   | * *        | * *   | * *       | * *   | * * | * * | * * | * * |
| First Quarter                      |       | 0.73            |       | 0.38           |       | 0.63 |   | 0.29 |   |
| Second Quarter(until June 15) |       | 0.80            |       | 0.48           |       | 0.75 |   | 0.39 |   |
| **Monthly  Market Prices**         |       |            |       |           |       |   |   |   |   |
| *2008*                             |       |            |       |           |       |   |   |   |   |
| December                           |       | 0.60            |       | 0.37           |       | 0.49 |   | 0.32 |   |
| *2009*                             |       |            |       |           |       |   |   |   |   |
| January                            |       | 0.73            |       | 0.49           |       | 0.63 |   | 0.42 |   |
| February                           |       | 0.57            |       | 0.41           |       | 0.46 |   | 0.32 |   |
| March                              |       | 0.64            |       | 0.38           |       | 0.51 |   | 0.29 |   |
| April                              |       | 0.69            |       | 0.48           |       | 0.58 |   | 0.39 |   |
| May                                |       | 0.75            |       | 0.51           |       | 0.65 |   | 0.44 |   |
| June 1 to June 15        |       | 0.80            |       | 0.56           |       | 0.75 |   | 0.50 |   |

 

**Plan ofDistribution**

 

Not applicable.

 

**MARKETS**

** **

Our common shares arelisted on the TSX under the symbol “HYG” and on the Nasdaq under the symbol “HYGS.”

 

**SELLING SHAREHOLDERS**

** **

Not applicable.

** **

**DILUTION**

** **

Not applicable.

 

**EXPENSES OF THE ISSUE**

** **

Not applicable.

 

**ITEM10.       ADDITIONAL INFORMATION**

** **

**SHARE CAPITAL**

** **

Not applicable.

 

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**MEMORANDUM AND ARTICLES OF ASSOCIATION**

** **

**Company Purpose**

** **

The Company’s restatedarticles of incorporation, together with any amendments thereto, which we referto as our articles of incorporation, are filed with Industry Canada, pursuantto the Canada Business Corporations Act, which we refer to as the CBCA. Ourarticles of incorporation do not have a stated purpose.

 

Our authorized capitalconsists of an unlimited number of common shares with no par value and anunlimited number of preferred shares with no par value issuable in series, ofwhich 92,405,666 common shares and no preferred shares were issued andoutstanding as of May 31, 2009.

 

**Directors**

** **

Pursuant to applicableCanadian law, our directors, in exercising their powers and discharging theirduties must act honestly and in good faith with a view to the best interests ofthe Company. They must also exercise the care, diligence and skill that areasonably prudent person would exercise in comparable circumstances.

 

Pursuant to theprovisions of the CBCA, a director who is party to a material contract ortransaction with the Company, is a director or an officer or an individualacting in a similar capacity of a party to the contract or transaction, or whohas a material interest in a party to a material contract or transaction withthe Company must disclose to the Company the nature and extent of such interestin writing or request to have such interest noted in the minutes of meetings ofthe directors. Furthermore, a director who has a material interest in a matterbefore the board must refrain from voting on the matter unless the contract: iswith one of our affiliates;  relates tothe director’s remuneration as a director or officer of the Company; or,relates to our indemnity or insurance for our officers and directors.

 

Pursuant to the CBCA atleast 25% of our directors must be resident Canadians. The CBCA also requiresthat we have not less than three directors, at least two of whom are notofficers, directors or employees of the Company. We currently have sevendirectors, six of whom are resident Canadians. Our articles of incorporationprovide that the minimum size of our board of directors be three and the maximumsize of our board of directors be twelve. Our directors may, from time to time,determine the number of directors on the board by resolution, which iscurrently seven directors. Our articles of incorporation and our by-laws do notimpose any other director qualification requirements.

 

***DirectorShare Ownership Guidelines***

*** ***

We have establisheddirector share ownership guidelines that require each of our directors to holdShares or DSUs equal to five times the director’s annual cash retainer withinthree years of his initial appointment. The General Motors nominee on the Boardis not required to comply with these guidelines.

 

Given the recent declinein the price for our common shares, exacerbated by prevailing global economicand credit market conditions, the Human Resources and Corporate GovernanceCommittee has amended the guidelines to permit the value to be measured ateither the year-end Share price, or a director’s acquisition cost ofShares.  The Board has approved thisamendment and all Directors are in compliance.

 

**SHAREHOLDER RIGHTS**

** **

Our authorized capitalconsists of an unlimited number of common shares and an unlimited number ofpreferred shares issuable in series, of which 92,405,666 common shares and nopreferred shares were issued and outstanding as of May 31, 2009.

 

Our articles ofincorporation permit us to issue an unlimited number of common and preferredshares.  If we were to issue asignificant number of common shares, it would reduce the relative voting powerof previously outstanding shares.

 

Each common share carriesone vote on all matters to be voted on by our shareholders.  Holders of common shares are entitled toreceive dividends if, as and when declared by our Board of Directors and toshare ratably in our remaining assets available for distribution, after paymentof liabilities, upon Hydrogenics’ liquidation, dissolution or winding up.  Common shares do not carry pre-emptive rightsor rights of conversion into any other securities.  However, we have granted General Motors a pre-emptiveright.  See “Item 7 — Major Shareholdersand Related Party Transactions — Related Party Transactions — Transactions withGeneral Motors.”  All outstanding commonshares are fully paid and non-assessable. There are no limitations onthe rights of non-resident owners of common shares to hold or vote theirshares.

 

Our Board of Directorshas the authority, without further action by the shareholders, to issue anunlimited number of preferred shares in one or more series and, in the eventthat preferred shares are issued, the Board also has the authority to fix thedesignations, powers, preferences, privileges and relative, participating,optional or special rights of any preferred shares including anyqualifications, limitations or restrictions. Special rights that may be granted to a series of preferred sharesinclude dividend rights, 

 

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conversion rights, votingrights, redemption and liquidation preferences, any or all of which may besuperior to the rights of the common shares. Preferred share issuances could decrease the market price of commonshares and may adversely affect the voting and other rights of the holders ofcommon shares.  The issuance of preferredshares could also have the effect of delaying or preventing a change in controlof Hydrogenics.

 

We have never declared orpaid any cash dividends on our common shares. We currently intend to retain any future earnings to fund thedevelopment and growth of our business and we do not anticipate paying any cashdividends in the foreseeable future.

 

**CHANGES TO SHAREHOLDER RIGHTS**

** **

Under the CBCA,amendments to our articles of incorporation will generally require approval byspecial resolution. A special resolution is a resolution passed by a majorityof not less than two-thirds of the votes cast by the shareholders who voted inperson or by proxy in respect of that resolution at the annual or special meetingcalled for such purpose. If the amendment is of a nature affecting a particularclass or series of our shares in a manner requiring a separate class or seriesvote, that class or series is entitled to vote on the amendment whether or notit otherwise carries the right to vote. Under the CBCA, our directors may make,amend or repeal any by-law that regulates our business or affairs. Where ourdirectors make, amend or repeal a by-law, they are required to submit theby-law, amendment or repeal to the shareholders at the next meeting ofshareholders, and the shareholders may, by an ordinary resolution, which is aresolution passed by a simple majority of the votes cast by shareholders whovoted in respect of the resolution, confirm, reject or amend the by-law,amendment or repeal.

 

**SHAREHOLDER MEETINGS**

** **

Our board is required tocall an annual meeting of the shareholders no later than 15 months after theholding of the last preceding annual meeting. Our board may also call a specialmeeting of the shareholders at any time. The only persons entitled to attend ameeting of our shareholders are our directors, our auditors and those personsentitled to vote at such meeting and any other persons who, although notentitled to vote at the meeting, are entitled to attend such meeting pursuantthe provisions of the CBCA. Under our by-laws, a quorum of shareholders shallbe two persons present in person or represented by proxy holding in theaggregate not less than 25% of the outstanding shares of the Company.

 

**LIMITATIONS**

** **

There are no limitations in our articles ofincorporation or by-laws or under Canadian federal or provincial laws, on theright of non-residents of Canada or foreign owners to hold or vote our commonshares, except for transactions involving or being deemed to involve anacquisition of control, which requires compliance with the Investment CanadaAct.

 

**CHANGE IN CONTROL**

** **

Our articles ofincorporation and by-laws do not contain any provisions that would have theeffect of delaying, deferring or preventing a change in control of the Company.

 

Under the CBCA, certainextraordinary corporate actions, such as amalgamations, continuances, sales,leases or exchanges of all or substantially all of the property of acorporation other than in the ordinary course of business, and otherextraordinary corporate actions such as liquidations or dissolutions are alsorequired to be approved by special resolution. In certain cases, a specialresolution to approve an extraordinary corporate action is also required to beapproved separately by the holders of a class or series of shares.

 

**DISCLOSURE OF SHAREHOLDINGS**

** **

Our by-laws do not imposean ownership threshold, above which shareholder ownership must be disclosed andany obligation to make such disclosure would be the subject of applicablesecurities laws.

 

**MATERIAL CONTRACTS**

** **

For the two yearsimmediately preceding the date of this Annual Report, no material contractshave been terminated, entered into or assigned by us other than in the ordinarycourse of business and other than the material contracts summarized below,which were entered into in connection with the transaction with Algonquin Powerdescribed under “Item 4.  Information ofthe Company — History and Development of Hydrogenics Corporation.”

 

·                  SupportAgreement dated June 11, 2009, among Hydrogenics, the Algonquin Board and NewHydrogenics.  The Support Agreement setsout the terms and conditions pursuant to which the parties would implement anon-dilutive financing 

 

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transaction,involving (i) a plan of arrangement among Hydrogenics and its wholly-ownedsubsidiaries, Stuart Energy, Hydrogenics Test Systems Inc. (“Test Systems”) andNew Hydrogenics, and (ii) a take-over bid pursuant to which Hydrogenicswill make offers to acquire all of the issued and outstanding units andconvertible debentures of Algonquin Power.

 

·                  ExpenseReimbursement Agreement dated June 11, 2009, among Algonquin PowerManagement Inc. (“APMI”), Hydrogenics and New Hydrogenics.  The Expense Reimbursement Agreement withAPMI, the Manager of Algonquin Power, provides for the payment by one party tothe other of professional advisory costs and expenses incurred in connectionwith the transactions contemplated in the Support Agreement, to a maximumamount of Cdn. $1,000,000 if the transactions fail to be completed undercertain conditions.

 

·                  APMIGuarantee dated June 11, 2009, among APMI., Hydrogenics and NewHydrogenics.  Pursuant to the APMIGuarantee, APMI has agreed to unconditionally and irrevocably guarantee theobligations of the Algonquin Board under the Support Agreement.

 

·                  AlgonquinPower Guarantee dated June 11, 2009, among Algonquin Power, APMI,Hydrogenics and New Hydrogenics.****** Pursuant to the Algonquin Power Guarantee, AlgonquinPower has agreed to unconditionally and irrevocably guarantee the obligationsof APMI under the Expense Reimbursement Agreement and the APMI Guarantee.

 

**EXCHANGE CONTROLS**

** **

There is no law,government decree or regulation in Canada restricting the export or import ofcapital or affecting the remittance of dividends, interest or other payments toa nonresident holder of common shares, other than withholding tax requirements.

 

**TAXATION**

** **

Because Canadian andUnited States tax consequences may differ from one holder to the next, thediscussion set out below does not purport to describe all of the taxconsiderations that may be relevant to a shareholder and such shareholder’sparticular situation. Accordingly, a shareholder is advised to consult a taxadvisor as to the United States and Canadian federal, provincial, state andother tax consequences of owning our common shares. The statements of UnitedStates and Canadian tax law set out below are based upon the laws andinterpretations in force as of the date of this annual report, and are subjectto changes occurring after that date.

 

**Canadian Federal IncomeTax Considerations**

** **

In this summary, a “U.S.holder” means a person who, for the purposes of the Income Tax Act (Canada)(the “Income Tax Act”) and the Canada-United States Income Tax Convention(1980) (the “Convention”), is a resident of the United States and not of Canadaand who, for the purposes of the Income Tax Act:

 

·                  dealsat arm’s length with us;

 

·                  holdsour common shares as capital property;

 

·                  doesnot use or hold and is not deemed to use or hold our common shares in thecourse of carrying on a business in Canada; and

 

·                  doesnot carry on an insurance business in Canada and elsewhere.

 

Our common shares will becapital property to a U.S. holder unless they are held in the course ofcarrying on a business or in an adventure in the nature of trade. This summarydoes not apply to a U.S. holder that is a “financial institution” for purposesof the rules contained in the Income Tax Act. There are no Canadianfederal estate taxes applicable to the purchase or ownership of our commonshares. Under the Income Tax Act, on death, a U.S. holder would be deemed todispose of all of his or her assets, including our common shares.

 

This summary is based onthe current provisions of the Income Tax Act and the regulations in force underthe Income Tax Act on the date of this annual report, the Convention, currentpublished administrative and assessing practices of the Canada  Revenue Agency, all specific proposals toamend the Income Tax Act and the regulations publicly announced by the Ministerof Finance (Canada) prior to the date of this annual report and all judicialdecisions currently in effect.

 

This summary is notexhaustive and, except for the proposed amendments to the Income Tax Act, doesnot take into account or anticipate prospective or retrospective changes in thelaw or the administrative or assessing practices of the Canada Revenue Agency,whether these changes are effected by judicial, governmental or legislativeaction or interpretation. This summary does not take into account taxlegislation or considerations of any province or territory of Canada. None ofthe tax consequences described herein depend or rely upon any of the proposedamendments to the Income Tax Act passing into law. Because Canadian taxconsequences may differ from one holder to the next,

 

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this summary does notpurport to describe all of the tax considerations that may be relevant to ashareholder and his particular situation. The Canadian tax treatment to a U.S.holder may differ from the treatment described herein. A shareholder is advisedto consult a tax advisor.

 

***Dividends***

*** ***

Dividends paid, creditedor deemed to have been paid or credited on our common shares are subject tonon-refundable Canadian withholding tax under the Income Tax Act at the rate of25%, although this rate may be reduced by the provisions of an applicableincome tax treaty. Subject to the exceptions noted immediately below, under theConvention, U.S. holders who are entitled to beneficits under the Conventionand who beneficially own the dividends will be subject to a 15% withholding taxon the gross amount of such dividends. In the case of a U.S. holder that isentitled to benefits under the Convention and is a corporation whichbeneficially owns at least 10% of our voting shares, the applicable rate ofwithholding tax on dividends will be reduced to 5%. In the case of dividendspaid, credited or deemed to be credited to a U.S. holder that is a tax exemptorganization as described in Article XXI of the Convention, generally nowithholding tax will be payable.

 

***Dispositions***

*** ***

Under the Income Tax Act,assuming that a shareholder is a U.S. holder and provided that our commonshares are listed on a stock exchange, which includes the TSX and the Nasdaq,the shareholder will be exempt from Canadian tax on a capital gain realized onan actual or deemed disposition of the common shares unless such shareholder,persons with whom such shareholder did not deal at arm’s length or suchshareholder together with such persons owned 25% or more of our issued sharesof any class at any time during the five-year period before the actual ordeemed disposition. For this purpose, a holder of an interest in or option toacquire our shares will be considered to hold the shares to which such interestor option relates.

 

**United States FederalIncome Taxation**

** **

This section summarizesthe material United States federal income tax consequences to a ‘‘U.S. Holder’’(as defined below) of the acquisition, ownership and disposition of our commonshares. This section assumes that you hold your common shares as capital assetswithin the meaning of Section 1221 of the Code. This section does notpurport to be a complete analysis of all of the potential United States federalincome tax considerations that may be relevant to a particular holder’sacquisition, ownership or disposition of our common shares in light of theirparticular circumstances nor does it address the United States federal incometax consequences applicable to holders subject to special tax rules, includingbanks, brokers, dealers in securities or currencies, traders in securities thatelect to use a mark-to-market method of accounting for their securities holdings,tax-exempt entities, insurance companies, persons liable for alternativeminimum tax, persons that actually or constructively own or have owned 5% ormore of our common shares, persons that hold common shares as part of astraddle or a hedge, constructive sale, synthetic security, conversion or otherintegrated transaction, partnerships and other pass-through entities, personswhose functional currency is not the U.S. dollar, financial institutions, andexpatriates of the United States. In addition, this discussion does not addressthe tax consequences arising under the tax laws of any state, local or foreignjurisdiction.

 

If any entity that isclassified as a partnership for United States federal income tax purposes holdscommon shares, the tax treatment of its partners will generally depend upon thestatus of the partner and the activities of the partnership. Partnerships andother entities that are classified as partnerships for United States federalincome tax purposes and persons holding common shares through a partnership orother entity classified as a partnership for United States federal income taxpurposes are urged to consult their own tax advisors regarding the consequencesof the acquisition, ownership and disposition of our common shares.

 

This section is based onthe Code, the Treasury regulations thereunder (the “Treasury Regulations”),published United States Internal Revenue Service (“IRS”) rulings,administrative interpretations and judicial decisions, all as currently ineffect. These authorities are subject to change, repeal or revocation, possiblyon a retroactive basis, which may result in United States federal income taxconsequences different from those discussed below.

 

For purposes of thisdiscussion, you are a ‘‘U.S. Holder’’ if you are a beneficial owner of commonshares and you are for United States federal income tax purposes (i) anindividual who is a citizen or resident of the United States, (ii) acorporation or other entity taxable as a corporation created or organized underthe laws of the United States or any political subdivision thereof, (iii) anestate whose income is subject to United States federal income tax regardlessof its source, or (iv) a trust (a) if a United States court canexercise primary supervision over the trust’s administration and one or moreUnited States persons are authorized to control all substantial decisions ofthe trust or (b) that has a valid election in effect under applicableTreasury Regulations to be treated as a United States person.

 

This summary does notdiscuss United States federal income tax consequences to any beneficial ownerof common shares that is not a U.S. Holder. Each U.S. Holder is urged toconsult with its own tax advisor regarding the tax consequences of theacquisition, ownership and disposition of common shares, including the effectsof United States federal, state, local, non-United States and other tax laws.

 

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***Taxationof Distributions on Common Shares***

*** ***

Subject to the PFIC rules discussedbelow, the gross amount of any actual or deemed distribution by us (includingany Canadian taxes withheld therefrom) with respect to your common shares willbe included in your gross income as a dividend to the extent such distributionis paid out of our current or accumulated earnings and profits, as determinedunder United States federal income tax principles. To the extent that theamount of any distribution exceeds our current and accumulated earnings andprofits, such excess first will be treated as a tax-free return of capital tothe extent of your adjusted tax basis in the common shares, and then to theextent in excess of your adjusted tax basis in the common shares, it will betaxed as a capital gain. Dividends will not be eligible for the dividendsreceived deduction generally allowed to United States corporations in respectof dividends received from other United States corporations.

 

If you are anon-corporate U.S. Holder, including an individual, dividends you receive intaxable years beginning before January 1, 2011, may be subject to UnitedStates federal income tax at the lower rates applicable to capital gains,provided (a) that we are a ‘‘qualified foreign corporation’’ and (b) thatcertain holding period and other requirements are satisfied. A qualifiedforeign corporation includes a non-United States corporation that is eligiblefor the benefits of a comprehensive income tax treaty with the United Statesthat includes an exchange of information program and that the United StatesTreasury Department has determined to be satisfactory for purposes of thequalified dividend provisions of the Code. The United States Treasury Departmenthas determined that the income tax treaty between the United States and Canadais satisfactory for purposes of the qualified dividend provisions of the Code.In addition, a foreign corporation not otherwise treated as a qualified foreigncorporation shall be so treated with regard to any dividend paid by suchcorporation if the stock with respect to which the dividend is paid isregularly tradable on an established securities market in the United States. Aqualified foreign corporation does not include a non-United States corporationthat is a PFIC for the taxable year in which a dividend is paid or that was aPFIC for the preceding taxable year. Accordingly, dividends on the commonshares will be eligible for these lower rates of taxation as long as we are nota PFIC in the taxable year the dividend is paid or the preceding taxable year,we are eligible for the benefits of the income tax treaty between the UnitedStates and Canada or our common shares are readily tradable on an establishedsecurities market in the United States, and you satisfy the holding period andother requirements. You should consult your own tax advisors regarding theapplication of these rules.

 

If you are entitled tobenefits under the Canada-United States Income Tax Convention, dividends youreceive with respect to common shares will be subject to Canadian withholdingtax at the rate of 15%. Additionally, such dividends generally should betreated as foreign source income and passive category income or generalcategory income for United States foreign tax credit limitation purposes. AnyCanadian tax withheld may, subject to certain limitations, be claimed as aforeign tax credit against your United States federal income tax liability ormay be claimed as a deduction for United States federal income tax purposes.The rules relating to United States foreign tax credits are complex andthe availability of a foreign tax credit depends on numerous factors. Youshould consult your own tax advisors concerning the application of the United Statesforeign tax credit rules to your particular situation.

 

The gross amount ofdistributions paid in Canadian dollars will be included by each U.S. Holder ingross income in a U.S. dollar amount calculated by reference to the exchangerate in effect on the day the distributions are paid, regardless of whether thepayment is in fact converted into U.S. dollars on such date. If the Canadiandollars are converted into U.S. dollars on the date of the payment, the U.S.Holder should not be required to recognize any foreign currency gain or losswith respect to the receipt of the Canadian dollar distributions. If insteadthe Canadian dollars are converted at a later date, any currency gains orlosses resulting from the conversion of the Canadian dollars will be treated asU.S. source ordinary income or loss.

 

***Taxationof Dispositions of Common Shares***

*** ***

Subject to the PFIC rules discussedbelow, upon a sale or other taxable disposition of common shares, you willrecognize capital gain or loss for United States federal income tax purposesequal to the difference, if any, between the amount that you realize and youradjusted tax basis in your common shares. Your adjusted tax basis in our commonshares generally will be the cost to you of such shares, as determined underUnited States federal income tax principles. For taxable years beginning beforeJanuary 1, 2011, capital gain of a non-corporate U.S. Holder, including anindividual, generally will be taxed at a maximum rate of 15% if the propertyhas been held for more than one year. The deductibility of capital losses issubject to limitations. The gain or loss will be gain or loss from sourceswithin the United States for United States foreign tax credit limitationpurposes.

 

If a U.S. Holder receivesany Canadian dollars on the sale or other taxable disposition of our commonshares, such U.S. Holder may recognize ordinary income or loss as a result ofcurrency fluctuations between the date of the sale or other taxable dispositionof our common shares and the date the sale proceeds are converted into U.S.dollars.

 

***PassiveForeign Investment Company Considerations***

*** ***

Special, generallyadverse, United States federal income tax rules apply to United Statespersons owning shares of a PFIC. A non-United States corporation will beclassified as a PFIC for United States federal income tax purposes in anytaxable year in which, 

 

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after applying relevantlook-through rules with respect to the income and assets of subsidiaries,either at least 75% of its gross income is ‘‘passive income,’’ or on average atleast 50% of the gross value of its assets is attributable to assets thatproduce passive income or are held for the production of passive income. Forthis purpose, passive income generally includes, among other things, dividends,interest, certain rents and royalties and gains from the disposition ofproperty that produces such income. If we are classified as a PFIC for anytaxable year in which a U.S. Holder has held our common shares, we may continueto be classified as a PFIC for any subsequent taxable year in which the U.S.Holder continues to hold our common shares, even if our income or assets wouldnot cause us to be a PFIC in such subsequent taxable year.

 

Based on the structure ofthe Company, and the composition of our income and assets, the Company does notbelieve that it was a PFIC for the taxable year ended December 31, 2008 orits prior taxable year.  However, therecan be no assurance that the IRS will not successfully challenge our positionor that we will not become a PFIC in a future taxable year, as PFIC status isre-tested each year and depends on our assets and income in such year. If weare classified as a PFIC at any time that you hold our common shares, you maybe subject to an increased United States federal income tax liability and aspecial interest charge in respect of gain recognized on the sale or other dispositionof your common shares and upon the receipt of certain ‘‘excess distributions’’(as defined in the Code).

 

Rather than being subjectto this tax regime, you may be eligible to make:

 

·                  a‘‘qualified electing fund’’ election (a QEF election), as defined in the Code,to be taxed currently on your pro rata portion of our ordinary earnings and netcapital gain, whether or not such earnings or gain is distributed in the formof dividends or otherwise, or

 

·                  a‘‘mark-to-market’’ election and thereby agree for the year of the election andeach subsequent tax year to recognize ordinary gain or loss (but only to theextent of prior ordinary gain) based on the increase or decrease in marketvalue for such taxable year. Your tax basis in our common shares would beadjusted to reflect any such income or loss amounts.

 

In order for you to beable to make a QEF election, we would have to provide certain informationregarding your pro rata share of our ordinary earnings and net capital gain. Wecurrently do not intend to provide such information in the event we areclassified as a PFIC. In order for you to be able to make a mark-to-marketelection, our common shares must be ‘‘marketable.’’  We believe that our common shares shouldqualify as marketable stock (although there can be no assurance that this willcontinue to be the case).

 

You should consult yourown tax advisors concerning the United States federal income tax consequencesof holding our common shares if we were a PFIC in any taxable year and itspotential application to your particular situation.

 

***InformationReporting and Backup Withholding***

*** ***

If you are anon-corporate U.S. Holder, information reporting requirements on IRS Form 1099will apply to:

 

·                  dividendpayments or other taxable distributions made to you within the United States,and

 

·                  thepayment of proceeds to you from the sale of common shares effected at a UnitedStates office of a broker,unless you come within certain categories of exemptrecipients.

 

Additionally, backupwithholding may apply to such payments if you are a non-corporate U.S. Holderthat does not come within certain categories of exempt recipients and you:

 

·                  failto provide an accurate taxpayer identification number,

 

·                  arenotified by the IRS that you have failed to report all interest and dividendsrequired to be shown on your United States federal income tax returns, or

 

·                  incertain circumstances, fail to comply with other applicable requirements of thebackup withholding rules.

 

A U.S. Holder who doesnot provide a correct taxpayer identification number may be subject topenalties imposed by the IRS. If backup withholding applies to you, undercurrent law 28% of the gross amount of any payments to you with respect to ourcommon shares will be withheld and paid over to the IRS.

 

Any amounts withheld frompayments to you under the backup withholding rules will be allowed as acredit against your United States federal income tax liability and may entitleyou to a refund, provided the required information is timely furnished to theIRS. You should consult your own tax advisor regarding the application ofbackup withholding in your particular situation, the availability of anexemption from backup withholding and the procedure for obtaining such anexemption, if available.

 

**DIVIDENDS AND PAYING AGENTS**

** **

Not applicable.

 

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**STATEMENT BY EXPERTS**

** **

Not applicable.

 

**DOCUMENTS ON DISPLAY**

** **

Any statement in this Form 20-Fabout any of our contracts or other documents is not necessarily complete. Ifthe contract or document is filed as an exhibit to the Form 20-F thecontract or document is deemed to modify the description contained in this Form 20-F.You must review the exhibits themselves for a complete description of thecontract or document.

 

You may review a copy ofour filings with the SEC, including exhibits and schedules filed with it, atthe SEC’s Public Reference Room, 100 F Street, N.E., Washington,D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information.In addition, the SEC maintains an Internet site at http://www.sec.gov thatcontains reports and other information regarding issues that fileelectronically with the SEC. These SEC filings are also available to the publicfrom commercial document retrieval services.

 

We are required to filereports and other information with the SEC under the Exchange Act and regulationsunder that act. As a foreign private issuer, we are exempt from the rules underthe Exchange Act prescribing the form and content of proxy statements and ourofficers, directors and principal shareholders are exempt from the reportingand short swing profit recovery provisions contained in Section 16 of theExchange Act.

 

In addition, we arerequired to file documents required by Canadian securities laws electronicallywith Canadian securities regulatory authorities and these filings are availableon our or Brookfield Asset Management’s SEDAR profile at www.sedar.com.  Written requests for such documents should bedirected to our Corporate Secretary at 5985 McLaughlin Road, Mississauga,Ontario, Canada L5R 1B8.

 

**SUBSIDIARY INFORMATION**

** **

Not applicable.

 

**ITEM11.       QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

** **

For information regardingquantitative and qualitative disclosures about market risk, please see “Item 5.Operating and Financial Review and Prospects — Liquidity and Capital Resources.”

** **

**ITEM12.       DESCRIPTION OF SECURITIES OTHERTHAN EQUITY SECURITIES**

** **

Not applicable.

 

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**PART II**

** **

**ITEM13.       DEFAULTS, DIVIDEND ARREARAGESAND DELINQUENCIES**

** **

None.

 

**ITEM14.       MATERIAL MODIFICATIONS TO THERIGHTS OF SECURITYHOLDERS AND USE OF PROCEEDS**

** **

**MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS**

** **

**Proposed ShareConsolidation**

** **

Shareholders approved aspecial resolution at the annual and special meeting of shareholders on May 13,2009 which gave authority to the Board of Directors to implement aconsolidation of our issued and outstanding common shares (the “ShareConsolidation”) at any time prior to March 24, 2010.  This special resolution gives our Board ofDirectors the authority, in its sole discretion, to select the exactconsolidation ratio, provided that (i) the ratio may be no smaller thanone post-consolidation common share for every 10 pre-consolidation commonshares and no larger than one post-consolidation common share for every 25pre-consolidation common shares, and (ii) the number of pre-consolidationcommon shares in the ratio must be a whole number of common shares. Inaddition, notwithstanding approval of the proposed Share Consolidation byshareholders, the Board of Directors, in its sole discretion, may abandon theShare Consolidation without further approval or action by or prior notice toshareholders.

 

Shareholders approved asimilar resolution at our annual and special meeting of shareholders on May 6,2008, giving authority to our Board of Directors, in its sole discretion, toimplement a share consolidation at any time prior to March 10, 2009. Thatshare consolidation was not implemented.  See “Background to and Reasons for the ShareConsolidation” below.

 

The background to andreasons for the Share Consolidation, and certain risks associated with theShare Consolidation and related information, are described below.

 

***Backgroundto and Reasons for the Share Consolidation***

*** ***

Our common shares arecurrently quoted on the TSX and the Nasdaq. In order for our common shares tocontinue to be quoted on Nasdaq, we must satisfy various listing maintenancestandards established by Nasdaq. Among other things, our common shares musthave a minimum bid price of at least $1.00 per common share.

 

On May 10, 2007 and February 19,2008, we received notices from Nasdaq informing us that we failed to maintain aminimum closing bid price on Nasdaq of at least $1.00 per share for our commonshares for 30 consecutive business days, as we are required to do under theMinimum Bid Price Rule. On both occasions, we were given 180 days to regaincompliance by having the bid price of our common shares close at $1.00 percommon share or more for a minimum of 10 consecutive business days prior to theend of the 180-day period. While we regained compliance on both occasions, wecan give no assurances that it will be able to maintain future compliance withthe Minimum Bid Price Rule. Indeed, as at June 23, 2009, we are notcompliant with the Minimum Bid Price Rule; however, given the continuedextraordinary market conditions, Nasdaq has suspended, for all issuers,enforcement of the Minimum Bid Price Rule until July 20, 2009.

 

After the Minimum BidPrice Rule is reinstated, if we fail to maintain a minimum closing bidprice on Nasdaq of at least $1.00 per share for our common shares for 30consecutive business days, and cannot regain compliance under Nasdaq’s terms, Nasdaqstaff will notify us that the common shares will be delisted from Nasdaq. Uponreceipt of the delisting notice, we may appeal staff’s determination to the NasdaqListings Qualifications Panel (the “Hearing Panel”), on the grounds that weintend to consolidate the issued and outstanding common shares, subject toreceipt of all necessary approvals, and that such consolidation should allowthe minimum $1.00 bid price requirement to be met.

 

Our request for a hearingwill stay the delisting, pending a decision by the Hearing Panel. If we lose ourappeal or are unable to come into compliance with Nasdaq requirements withinsuch time as may be allowed by the Hearing Panel, the common shares may betransferred to the Nasdaq Capital Market if we satisfy all criteria for the commonshares to be included on such market other than compliance with the Minimum BidPrice Rule. In the event of such a transfer, we would be provided an additional180 calendar days to comply with the Minimum Bid Price Rule while on the NasdaqCapital Market.

 

In light of our pastnon-compliance with the Minimum Bid Price Rule, shareholders approved a specialresolution at our annual and special meeting of shareholders on May 6,2008 to amend our articles of incorporation to allow for a consolidation of ourissued and outstanding common shares. That special resolution gave authority toour Board of Directors, in its sole discretion, to 

 

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implement, a share consolidationat any time prior to March 10, 2009 and to select the exact consolidationratio, provided that: (i) the ratio may be no smaller than onepost-consolidation common share for every five pre-consolidation common shares,and no larger than one post-consolidation common share for every 10pre-consolidation common shares; and (ii) the number of pre-consolidationcommon shares in the ratio must be a whole number of common shares. Our Boardof Directors did not, however, believe it to be in the best interests of theCompany to implement a share consolidation during that time.

 

As in the past, the Boardof Directors considered the potential adverse effects to the Company of adelisting from Nasdaq, and determined that the flexibility afforded by a ShareConsolidation would allow us to comply with Nasdaq’s Minimum Bid Price Rule.The exact number of common shares of the Company to be consolidated is to bedetermined by our Board of Directors before the Share Consolidation iseffective, and we will issue a news release announcing the ratio as determinedby the Board of Directors.

 

In addition to being ableto maintain a broader market for our common shares with a listing on Nasdaq,our Board of Directors also believes that the Share Consolidation may have anumber of other benefits for the Company and its shareholders:

 

·                  *Greater investor interest* — a higher post-consolidationcommon share price could help generate interest in the Company among investors,as a higher anticipated common share price may meet investing guidelines forcertain institutional investors and investment funds that are currentlyprevented under their investing guidelines from investing in the common sharesat current price levels;

 

·                  *Reduction of shareholder transaction cost*s — shareholdersmay benefit from relatively lower trading costs associated with a higher commonshare price. It is likely that many investors pay commissions based on thenumber of common shares traded when they buy or sell common shares. If thecommon share price were higher, investors may pay lower commissions to trade afixed dollar amount than they would if the common share price is lower; and

 

·                  *Improved trading liquidity*— the combination of potentiallylower transaction costs and increased interest from investors could ultimatelyimprove the trading liquidity of the common shares.

 

We cannot assure you thatit will be able to maintain its Nasdaq listing after the Share Consolidation iseffected or that the market price per common share after the ShareConsolidation will exceed or remain in excess of the $1.00 minimum bid pricefor a sustained period of time.

 

The Share Consolidationwould be implemented, if at all, only upon a determination by our Board ofDirectors that it is in the best interests of the Company at that time. Inconnection with any determination to implement a consolidation, our Board ofDirectors will set the timing for such consolidation and select the specificratio from within the range of ratios set forth in the special resolution. TheBoard of Directors’ selection of the specific ratio would be based primarily onthe price level of the common shares at that time and the expected stability ofthat price level. Currently, our Board of Directors believes that an initialpost-consolidation common share price in the range of $3.00 to $7.50 per commonshare would be an appropriate initial price level for the common shares. However,the Board of Directors may, in its sole discretion, select a ratio from withinthe range set forth in the special resolution that would be expected to resultin an initial post-consolidation common share price that is above or below thisrange. No further action on the part of shareholders would be required in orderfor the Board of Directors to implement the Share Consolidation.

 

If our Board of Directorsdoes not implement the Share Consolidation before March 24, 2010, theauthority granted by the special resolution to implement the ShareConsolidation on these terms would lapse and be of no further force or effect.The special resolution also authorized the Board of Directors to elect not toproceed with, and abandon, the Share Consolidation at any time if itdetermines, in its sole discretion, to do so. The Board of Directors wouldexercise this right if it determined that the Share Consolidation was no longerin the best interests of the Company and its shareholders. No further approvalor action by or prior notice to shareholders would be required in order for theBoard of Directors to abandon the Share Consolidation.

 

In connection with theproposed non-dilutive financing transaction announced on June 12, 2009,involving the Algonquin Board and New Hydrogenics, and to give effect to thewishes of our shareholders, who will become shareholders of New Hydrogenicsupon completion of the transaction, the New Hydrogenics board of directors, andHydrogenics as its sole shareholder, approved a resolution on June 11,2009 such that the Share Consolidation may be effected after completion of thetransaction in respect of the New Hydrogenics common shares on identical termsas approved by our shareholders. Should the Board of Directors, however,determine to implement the Share Consolidation prior to completion of thetransaction, shareholders will be notified and the Share Consolidation inrespect of the New Hydrogenics common shares will not be implemented.

 

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***Certain risks associatedwith the Share Consolidation***

*** ***

*Ourtotal market capitalization immediately after the proposed consolidation may belower than immediately before the proposed consolidation.*

* *

There are numerousfactors and contingencies that could affect the common share price followingthe Share Consolidation, including the status of the market for the commonshares at the time, our reported results of operations in future periods, andgeneral economic, geopolitical, stock market and industry conditions.

 

*Adecline in the market price of the common shares after the Share Consolidationmay result in a greater percentage decline than would occur in the absence of aconsolidation, and the liquidity of the common shares could be adverselyaffected following such a consolidation.*

* *

If the ShareConsolidation is implemented and the market price of the common sharesdeclines, the percentage decline may be greater than would occur in the absenceof the consolidation. The market price of the common shares will, however, alsobe based on our performance and other factors, which are unrelated to thenumber of common shares outstanding. Furthermore, the liquidity of the commonshares could be adversely affected by the reduced number of common shares thatwould be outstanding after the Share Consolidation.

 

*Theconsolidation may result in some shareholders owning “odd lots” of less than100 common shares on a post-consolidation basis which may be more difficult tosell, or require greater transaction costs per common share to sell.*

* *

The ShareConsolidation may result in some shareholders owning “odd lots” of less than100 common shares on a post-consolidation basis. Odd lots may be more difficultto sell, or require greater transaction costs per common share to sell, thancommon shares in “board lots” of even multiples of 100 common shares.

 

***No Fractional CommonShares to be Issued***

*** ***

No fractionalcommon shares will be issued in connection with the Share Consolidation and, inthe event that a shareholder would otherwise be entitled to receive afractional common share upon the Share Consolidation, such fraction will berounded down to the nearest whole number.

 

***Principal Effects of theShare Consolidation***

*** ***

If implemented,the Share Consolidation will occur simultaneously for all of the common sharesand the consolidation ratio will be the same for all of such common shares. Theconsolidation will affect all shareholders uniformly. Except for any variancesattributable to fractional shares, the change in the number of issued andoutstanding common shares that will result from the Share Consolidation willcause no change in the capital attributable to the common shares and will not materiallyaffect any shareholders’ percentage ownership in the Company, even though suchownership will be represented by a smaller number of common shares.

 

In addition, theShare Consolidation will not affect any shareholder’s proportionate votingrights. Each common share outstanding after the Share Consolidation will beentitled to one vote and will be fully paid and non-assessable.

 

The principaleffects of the consolidation will be that:

 

·                  Reduction in number of common shares outstanding — the number of commonshares issued and outstanding will be reduced from approximately 92,405,666common shares as of June 23, 2009 to between approximately 3,696,227 and9,240,567 common shares, depending on the ratio selected by our Board ofDirectors; and

 

·                  Reduction in number of common shares reserved for issuance under the stockoption plan — the number of common shares reserved for issuance under our stockoption plan will be reduced proportionately based on the consolidation ratioselected by our Board of Directors.

 

Earnings percommon share will be proportionately affected as a result of the ShareConsolidation.

 

***Effect on Non-registeredShareholders***

*** ***

Non-registeredshareholders holding their common shares through a bank, broker or othernominee should note that such banks, brokers or other nominees may havedifferent procedures for processing the Share Consolidation than those thatwill be put in place by us for registered shareholders. Shareholders who holdtheir common shares with such a bank, broker or other nominee and havequestions in this regard, are encouraged to contact thier nominee.

 

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***Effect on Share Certificates***

*** ***

If the proposedShare Consolidation is implemented, registered shareholders will be required toexchange their share certificates representing pre-consolidation common sharesfor new share certificates representing post-consolidation common shares.Following the announcement by us of the consolidation ratio selected by ourBoard of Directors and the effective date of the Share Consolidation,registered shareholders will be sent a letter of transmittal from our transferagent, CIBC Mellon, as soon as practicable after the effective date of theShare Consolidation. The letter of transmittal will contain instructions on howto surrender your certificate(s) representing your pre-consolidationcommon shares to the transfer agent. The transfer agent will forward to eachregistered shareholder who has sent the required documents a new sharecertificate representing the number of post-consolidation common shares towhich the shareholder is entitled. Until surrendered, each share certificaterepresenting pre-consolidation common shares will be deemed for all purposes torepresent the number of whole post-consolidation common shares, to which theholder is entitled as a result of the Share Consolidation.

 

Shareholdersshould not destroy any share certificate(s) and should not submit anyshare certificate(s) until requested to do so.

 

***Procedure forImplementing the Share Consolidation***

*** ***

If our Board of Directors decides to implement the ShareConsolidation, we will promptly file articles of amendment with the Directorunder the CBCA in the form prescribed by the CBCA to amend our articles ofincorporation. The Share Consolidation will become effective on the date shownin the certificate of amendment issued by the Director under the CBCA or suchother date indicated in the articles of amendment provided that, in any event,such date will be prior to March 24, 2010.

 

***No Dissent Rights***

*** ***

Under the CBCA,shareholders do not have dissent and appraisal rights with respect to theproposed Share Consolidation.

 

**Amendments to Share Incentive Plans**

** **

On June 22,2009, our Board of Directors approved certain administrative amendments to thestock option plan, the RSU Plan and the DSU Plan (collectively, the “AmendedShare Incentive Plans”).  The AmendedHydrogenics Share Incentive Plans are currently in force and do not requireapproval of our shareholders because (i) in the case of the RSU Plan andthe DSU Plan, applicable securities laws do not require shareholder approval asthe plans do not provide for the issuance of securities from treasury, and(ii) in the case of the stock option plan, the amendments are of anadministrative and technical nature and are permitted to be made withoutshareholder approval under the express terms of the plan.  The Amended Share Incentive Plans aredescribed in more detail below.

 

***Stock Option Plan***

*** ***

The purpose of thestock option plan is to attract, retain and motivate key members of our team,to align incentives with the results realized by shareholders, and to providecompetitive compensation arrangements that reward the creation of shareholdervalue over the long-term.

 

The stock optionplan provides that options will expire no later than 10 years from the grantdate or, if that date occurs during a blackout period or other period during whichan insider is prohibited from trading in our securities by our insider tradingpolicy, 10 business days after the period ends, subject to certain exceptions.Options will have an exercise price per share of not less than the closingprice of the common shares on the TSX on the trading day before the option isgranted. Unless otherwise specified in a particular option agreement, optionsgranted under this plan will vest over three years with one third of the optiongrant vesting each year.

 

Issuances of optionsunder the stock option plan are subject to the several restrictions. No morethan 10% of the common shares outstanding may be issued under the stock optionplan and all other security based compensation arrangements in any one yearperiod. In addition, the number of common shares reserved for issuance pursuantto options granted to any one person under the stock option plan and all othersecurity based compensation arrangements cannot exceed 5% of the outstandingcommon shares.

 

The aggregatenumber of common shares reserved for issuance pursuant to options granted toinsiders under the stock option plan cannot exceed 10% of the outstandingcommon shares. Further, within any one year period, insiders may not, in theaggregate, be issued under the stock option plan and all other security basedcompensation arrangements a number of common shares which exceeds 10% of theoutstanding issue and no individual insider may be issued a number of commonshares that exceeds 5% of the outstanding issue.

 

Shareholderapproval is required for the following amendments to the stock option plan:(i) increasing the number of common shares reserved for issuance under thestock option plan; (ii) reducing the exercise price of an option exceptappropriate reductions in connection with a subdivision or consolidation ofcommon shares or similar capital reorganization or payment of a stock dividendor an amalgamation, combination or other reorganization involving the Company;(iii) extending the term of an option 

 

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beyondthe expiry date or beyond 10 years from its grant date (except the automaticextension where the expiry date would have occurred within a blackout period ofthe Company); (iv) extending the participation of non-employee directorsand non-consultants in the stock option plan; (v) permitting options to betransferred other than by testate or intestate succession; (vi) permittingthe addition or modification of a cashless exercise feature, payable in cash orcommon shares, unless it provides for a full deduction of the number ofunderlying common shares from the stock option plan reserve;(vii) permitting awards, other than options, to be made under the stockoption plan; or (viii) pursuant to the our bylaws or the rules orpolicies of any exchange, that require shareholder approval.

 

Currently thereare 12,000,000 common shares reserved for issuance under the stock option planrepresenting approximately 13% of the total number of issued and outstandingcommon shares.

 

If an optionholder’s employment or term as a director or consultant ceases as a result ofthe option holder’s death, retirement or disability or because of the sale ofthe Company which employs the option holder, or to which the option holder is adirector or consultant, all options vest immediately and may be exercised for180 days (or, if earlier, to the end of the term). If an option holder’semployment or term as a director or consultant is terminated without cause theoption holder’s options which are vested or which would otherwise have vestedwithin the reasonable or contractual notice period may be exercised for 90 days(or, if earlier, to the end of the term). If an option holder’s employment orterm as a director or consultant is terminated by voluntary resignation, vestedoptions may be exercised for 90 days (or, if earlier, to the end of the term)and unvested options are cancelled. If an option holder’s employment or term asa director or consultant is terminated for cause, all options are immediatelycancelled. Notwithstanding the foregoing, but subject to applicable securitieslaws, the Board of Directors may, in its discretion, permit the exercise of anyor all options held by an option holder in the manner and on the termsauthorized by the Board; provided that the Board may not authorize the exerciseof an option beyond 10 years from the date of grant, excluding any automaticextension for an expiry date which falls in a blackout period.

 

Options arenon-transferable. The Board of Directors has the discretion to acceleratevesting and expiration of options in connection with a change of control of theCompany, a sale of all or substantially all of the assets of the Company or adissolution or liquidation of the Company. The Board of Directors may furthertake such steps it deems equitable and appropriate to adjust the number ofcommon shares that may be acquired on the exercise of any options or theexercise price in the event that the Company effects a subdivision orconsolidation of the common shares, any similar capital reorganization, paymentof a stock dividend (other than in lieu of a cash dividend), or other change incapitalization of the Company, or upon any amalgamation, continuation,reorganization involving the Company, by exchange of common shares, by sale orlease of assets or otherwise, to preserve the proportionality of the rights andobligations of the option holders.

 

***Restricted Share UnitPlan***

*** ***

The RSU Plan isdesigned to retain certain employees of the Company and its affiliates, allowthem to participate in the long-term success of the Company. The RSU Plan ismeant to complement the stock option plan and allow the Company to offer,through combinations of these equity-based incentive programs, optimalalignment of the interests of management and certain employees of the Companyand its affiliates to that of its shareholders.

 

The RSU Planprovides for grants of RSUs to certain employees (each a “participant”) of theCompany and its affiliates. In determining the number of RSUs to be granted,the Human Resources and Corporate Governance Committee may take into accountsuch milestones and criteria it determines at the time of grant. An RSU is aright to receive a cash payment based on the value of a common share, subjectto the vesting, forfeiture and other restrictions the Board of Directors maydetermine. RSUs are credited to an account in the name of the participant. If adividend is paid on common shares, each participant’s RSU account is creditedwith additional RSUs (a “dividend RSU”) equal to a fraction where the numeratoris the product of: (a) the number of RSUs credited to the participant onthe date the dividends are paid, and (b) the dividend paid per commonshare, and the denominator is the closing price per common share on the TSX onthe last trading day on which the common shares were traded preceding the dateon which dividends are paid.

 

Each RSU vests nolater than December 31 of the third calendar year following the calendaryear in respect of which the RSU is granted or such earlier date as isdetermined in our Board’s discretion. RSUs are redeemed within 30 daysfollowing the vesting date (and no later than the December 31 datereferenced above), by a cash payment to the participant equal to the number ofvested RSUs multiplied by the closing price per common share on the TSX on thelast trading day on which the common shares were traded preceding the vesting date.A dividend RSU vests on the same day as the RSU in respect of which it wasgranted and is redeemed by the Company on the same date as the applicable RSU.

 

If a participantdies, retires or his or her employment is terminated by the Company withoutcause, or for disability or because of the sale of the Company which employsthe option holder, or to which the option holder is a director or consultant,then a pro rata portion of unvested RSUs credited to the participant will vestand be redeemed. If the employment of a participant is terminated byresignation of the participant or for cause, the participant forfeits allrights to unvested RSUs. The Board of Directors may accelerate the vesting ofRSUs in connection with a change of control.

 

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RSUs arenon-assignable. The Board of Directors determines which employees will begranted RSUs; the time or times when RSUs will be granted; the number of RSUsto be granted; and the date or dates on which RSUs will vest. The HumanResources and Corporate Governance Committee administers the RSU Plan.

 

The Board may fromtime to time amend or suspend the RSU Plan in whole or in part and may at anytime terminate the RSU Plan without prior notice. However, except as expresslyset forth in the RSU Plan, no such amendment, suspension, or termination mayadversely affect the RSUs previously granted to a participant without theconsent of the affected participant.

 

***Deferred Share Unit Plan***

*** ***

Pursuant to theDSU Plan, independent directors are entitled to elect to receive all or anyportion of their annual retainer and meeting fees in the form of DSUs insteadof cash. A DSU is a right to receive a cash payment based on the value of acommon share, credited by means of a bookkeeping entry in the books of theCompany, to an account in the name of the independent director. At the end ofthe director’s tenure as a member of the Board, the director is paid, in cash,the market value of the common shares represented by the DSUs.

 

**2008 Base Shelf Prospectus**

** **

We have withdrawnour registration statement filed with the U.S. Securities and ExchangeCommission  as we no longer maintain theaggregate market value of the public float of our outstanding Shares to utilizethe registration statement on Form F-10 in the U.S.  We also intend to withdraw our base shelfprospectus dated September 23, 2008 filed with certain provincialsecurities authorities in Canada prior to completion of and as a result of theproposed transaction involving the Algonquin Board and New Hydrogenicsdescribed under “Item 4.  Information ofthe Company — History and Development of Hydrogenics Corporation.”

 

**USEOF PROCEEDS**

** **

Not applicable.

 

**ITEM 15.               CONTROLSAND PROCEDURES**

** **

**EVALUATIONOF DISCLOSURE CONTROLS AND PROCEDURES**

** **

As of the end ofthe period covered by this Annual Report on Form 20-F, an evaluation wascarried out by our management, under the supervision, and with the participation,of our Chief Executive Officer (the “CEO”) and Chief Financial Officer (the“CFO”), of the effectiveness of our disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on thatevaluation, the CEO and CFO concluded that such disclosure controls andprocedures were effective and designed to ensure that material informationrelating to us and our consolidated subsidiaries would be made known to them byothers within those entities.

 

**EVALUATIONOF INTERNAL CONTROLS**

** **

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Internal control over financial reporting is a processdesigned by, or under the supervision of, the President and CEO and the CFO andeffected by the Board of Directors, management and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles.

 

Due to itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Also, projections of any evaluation of theeffectiveness of internal control over financial reporting to future periods aresubject to the risk that the controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

 

Managementassessed the effectiveness of the Corporation’s internal control over financialreporting as at December 31, 2008, based on the criteria set forth inInternal Control — Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on this assessment, management believes that, as atDecember 31, 2008, the Corporation’s internal control over financialreporting is effective. Also, management determined that there were no materialweaknesses in the Corporation’s internal control over financial reporting as atDecember 31, 2008.

 

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**LIMITATIONSOF CONTROLS AND PROCEDURES**

** **

Our management,including our CEO and CFO, believe that any disclosure controls and proceduresor internal controls over financial reporting, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Further, the design of a control systemmust reflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Because of the inherentlimitations in all control systems, they cannot provide absolute assurance thatall control issues and instances of fraud, if any, within us have beenprevented or detected. These inherent limitations include the realities thatjudgments in decision-making can be faulty, and that breakdowns can occurbecause of a simple error or mistake. Additionally, controls can becircumvented by the individual acts of some persons, by collusion of two ormore people, or by unauthorized override of the control. The design of anysystems of controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions.Accordingly, because of the inherent limitations in a cost effective controlsystem, misstatements due to error or fraud may occur and not be detected.

 

**REPORTSON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

Our management’sReport on Internal Control Over Financial Reporting can be found onpage F-2 in this form.  Ourindependent auditors, PricewaterhouseCoopers LLP, a registered publicaccounting firm has audited the accompanying annual consolidated financialstatements for fiscal 2008 and our internal control over financial reporting asat December 31, 2008.  Their attestationreport can be found on page F-3 of our consolidated financial statements.

 

**CHANGESIN INTERNAL CONTROL OVER FINANCIAL REPORTING**

** **

During the yearended December 31, 2008, there were no changes in our internal controlover financial reporting that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

 

**ITEM 16A.            AUDITCOMMITTEE FINANCIAL EXPERT**

** **

**IDENTIFICATIONOF THE AUDIT COMMITTEE**

** **

We have aseparately-designated audit committee established in accordance with section3(a)(58)(A) of the Securities Exchange Act of 1934.  Our audit committee is comprised ofindependent members: Douglas S. Alexander, Michael Cardiff, V. James Sardo andNorman M. Seagram.

 

**AUDITCOMMITTEE FINANCIAL EXPERT**

** **

Our Board ofDirectors has determined that it has at least one audit committee financialexpert serving on its audit committee. Douglas Alexander has been determined tobe an audit committee financial expert and is independent, as that term isdefined by Nasdaq’s listing standards. The U.S. Securities and Exchange Commission has indicated that thedesignation of this individual as an audit committee financial expert does notmake him an “expert” for any purpose, or impose any duties, obligations orliabilities that are greater than those imposed on members of the auditcommittee and board of directors who do not carry this designation or affectthe duties, obligations or liabilities of any other member of the auditcommittee or board of directors.

 

**ITEM 16B.            CODEOF ETHICS**

** **

**CODEOF ETHICS**

** **

We have adopted awritten Code of Business Conduct and Ethics (the “Code”) which governs thebehavior of our directors, officers, and employees. The Code also includesprovisions required by the *Sarbanes-OxleyAct of 2002* that are applicable to our CEO, CFO and other seniorfinancial officers. The Board, through the Human Resources and CorporateGovernance Committee, oversees compliance with the Code. Any amendments to, orwaivers from, any provisions of the Code will be publicly disclosed.  The Code is also accessible on our investorrelations web page at www.hydrogenics.com.

 

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**ITEM 16C.            PRINCIPALACCOUNTANT FEES AND SERVICES**

** **

**PRINCIPALACCOUNTANTS FEES AND SERVICES**

** **

The followingtable sets forth the total remuneration that was paid by us and oursubsidiaries to our independent accountants, PricewaterhouseCoopers LLP, ineach of our previous two fiscal years:

 
| ** **         | ** ** | **2007**                         | ** ** | **2008** | ** ** |
|--------------------|------------|----------------------------------|------------|----------|------------|
| ** **         | ** ** | **Cdn. $ (unaudited)** | ** ** |
| Audit fees         |       | 661,247                          |       | 724,548  |       |
| Audit-related fees |       | 43,832                           |       | 8,904    |       |
| Tax fees           |       | 16,677                           |       | 90,535   |       |
| All other fees     |       | 23,219                           |       | 64,425   |       |
| Total              |       | 744,975                          |       | 888,412  |       |

 

**Audit Fees**

** **

In 2008 and 2007,PwC charged us audit fees totalling, Cdn. $724,548 and Cdn. $661,247,respectively.  In 2008 and 2007, thesefees included professional services rendered for the review of interimfinancial statements, statutory audits of annual financial statements,consultations about financial and reporting standards and other regulatoryaudits and filings, including Sarbanes-Oxley compliance.

 

**Audit-Related Fees**

** **

In 2008 and 2007,PwC charged us audit-related fees of Cdn. $8,904 and Cdn. $43,832,respectively.  In 2008 and 2007, thesefees included professional services that reasonably relate to the aboveservices and Canadian Public Accounting Board Fees.

 

**Tax Fees**

** **

In 2008 and 2007,PwC charged us tax fees of Cdn. $90,535 and Cdn. $16,677, respectively.  In 2008 and 2007, these fees includedprofessional services for tax compliance, tax advice, tax planning and advisoryservices relating to the preparation of corporate tax returns.

 

**All Other Fees**

** **

In 2008 and 2007,PwC charged us other fees of Cdn. $64,425 and Cdn. $23,219, respectively.  In 2008, these fees related to assistancewith the preparation of our base shelf prospectus filed in September, 2008 aswell advisory services related to the implementation of International FinancialReporting Standards and other regulatory matters. In 2007, these fees relatedto advisory services related to the windup of our fuel cell test equipmentbusiness.

 

**PRE-APPROVALPOLICIES**

** **

Our auditcommittee approved all audit and non-audit services provided to us and to oursubsidiaries during the periods listed above. Our audit committee has adopted pre-approval policies and procedures toensure that all services provided by the auditor are approved in advance by theaudit committee or are approved by the chair of the audit committee andsubsequently reported to the committee as a whole at the following meeting ofthe committee, all in accordance with the external auditors’ pre-approvalpolicy.

 

**ITEM 16D.            EXEMPTIONSFROM THE LISTING STANDARDS FOR AUDIT COMMITTEES**

** **

Not applicable.

 

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**ITEM 16E.             PURCHASESOF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS**

** **

None.

 

**ITEM 16F.             CHANGEIN REGISTRANT’S CERTIFYING ACCOUNTANT**

** **

Not applicable.

 

**ITEM 16G.            CORPORATEGOVERNANCE**

** **

We are a foreignprivate issuer and our common shares are listed on the Nasdaq.  Nasdaq Rule 4350(a)(1) permits aforeign private issuer to follow its home country practice in lieu of therequirements of Rule 4350, provided, however, that such an issuer shall:comply with Rules 4350(b)(1)(B), 4350(j) and 4350(m), have an auditcommittee that satisfies Rule 4350(d)(3), and ensure that such auditcommittee’s members meet the independence requirements in Rule 4350(d)(2)(A)(ii).We are intending not to follow Rule 4350(f) (shareholder quorum) butinstead to follow the practice described below.

 

ShareholderMeeting Quorum Requirements: The Nasdaq minimum quorum requirement underRule 4350(f) for a shareholder meeting is 33-1/3% of the outstandingshares of common stock. In addition, a company listed on Nasdaq is required tostate its quorum requirement in its By-Laws. On March 7, 2008, our Boardof Directors approved an amendment to our By-Laws to provide that the quorumrequirement for a meeting of our shareholders is two persons present in personor represented by proxy holding in the aggregate not less than 25% of theoutstanding common shares entitled to vote at the meeting. This amendment wasapproved by our shareholders at an annual and special meeting of shareholderson May 6, 2008. We believe the foregoing is consistent with Canadianpublic companies and consistent with corporate governance best practices inCanada.

 

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**PART III**

** **

**ITEM 17.               FINANCIALSTATEMENTS**

** **

We have respondedto Item 17 in lieu of responding to this item.

 

**ITEM 18.               FINANCIALSTATEMENTS**

** **

The followingfinancial statements are filed as part of this annual report on Form 20-F.

 
| ** **                                                             | **Page** |
|------------------------------------------------------------------------|----------|
|                                                                   |     |
| Index to consolidated  financial statements                            | F-1      |
|                                                                   |     |
| Management’s Report  on Internal Control Over Financial Reporting | F-2      |
|                                                                   |     |
| Independent Auditors’  Report                                     | F-3      |
|                                                                   |     |
| Consolidated Balance  Sheets                                           | F-6      |
|                                                                   |     |
| Consolidated  Statements of Operations                                 | F-7      |
|                                                                   |     |
| Consolidated  Statements of Cash Flows                                 | F-8      |
|                                                                   |     |
| Consolidated  Statement of Shareholders’ Equity                   | F-9      |
|                                                                   |     |
| Notes to  Consolidated Financial Statements                            | F-10     |

 

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**HYDROGENICS CORPORATION**

 

**INDEX TO CONSOLIDATED FINANCIALSTATEMENTS**

 
| ** **                                                             | **Page**   |
|------------------------------------------------------------------------|------------|
| ** **                                                             | ** ** |
| Management’s Report  on Internal Control Over Financial Reporting | F-2        |
|                                                                   |       |
| Independent Auditors’  Report                                     | F-3        |
|                                                                   |       |
| Consolidated Balance  Sheets                                           | F-6        |
|                                                                   |       |
| Consolidated  Statements of Operations                                 | F-7        |
|                                                                   |       |
| Consolidated  Statements of Cash Flows                                 | F-8        |
|                                                                   |       |
| Consolidated  Statement of Shareholders’ Equity                   | F-9        |
|                                                                   |       |
| Notes to Consolidated  Financial Statements                            | F-10       |

 

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**MANAGEMENT’SREPORT ON INTERNAL**

**CONTROL OVER FINANCIAL REPORTING**

 

Management of HydrogenicsCorporation (the “Corporation”) is responsible for establishing and maintainingadequate internal control over financial reporting. Internal control overfinancial reporting is a process designed by, or under the supervision of, thePresident and Chief Executive Officer and the Chief Financial Officer and iseffected by the Board of Directors, management and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withCanadian generally accepted accounting principles. It includes those policiesand procedures that:

 

·                  provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the Corporation’s assets that could have a material effect on the Corporation’sfinancial statements.

 

·                   pertain to the maintenance of records thataccurately and fairly reflect, in reasonable detail, the transactions relatedto and dispositions of the Corporation’s assets;

 

·                  provide reasonable assurance that transactionsare recorded as necessary to permit preparation of consolidated financialstatements in accordance with Canadian generally accepted accounting principles,and that the Corporation’s receipts and expenditures are made only inaccordance with authorizations of management and the Corporation’s directors; and,due to its inherent limitations, internal control over financial reporting maynot prevent or detect misstatements. Also, projections of any evaluation of theeffectiveness of internal control over financial reporting to future periodsare subject to the risk that the controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

Management assessed theeffectiveness of the Corporation’s internal control over financial reporting asat December 31, 2008, based on the criteria set forth in Internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of theTreadway Commission (“COSO”). Based on this assessment, management concludedthat, as at December 31, 2008, the Corporation’s internal control overfinancial reporting was effective.

 

Hydrogenics’ internal controlover financial reporting as at December 31, 2008, has been audited by PricewaterhouseCoopersLLP, independent auditors, who also audited the Corporation’s consolidatedfinancial statements for the year ended December 31, 2008. As stated inthe Independent Auditors’ Report to the Shareholders of the Corporation, PricewaterhouseCoopersLLP, express an unqualified opinion on the effectiveness of the Corporation’sinternal control over financial reporting.

 
| ****                                   | ** ** | ****                         |
|----------------------------------------|------------|------------------------------|
| **Daryl  Wilson**                      | ** ** | **Lawrence  Davis**          |
| President and Chief  Executive Officer |       | **Chief  Financial Officer** |
|                                   |       |                         |
| March 24, 2009                    |       |                         |
| Mississauga, Ontario                   |       |                         |

 

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**INDEPENDENT AUDITORS’ REPORT**

 

**To theShareholders of Hydrogenics Corporation**

 

We have completed integratedaudits of Hydrogenics Corporation’s 2008, 2007, and 2006 consolidated financialstatements and of its internal control over financial reporting as at December 31,2008. Our opinions, based on our audits, are presented below.

 

**Consolidatedfinancial statements**

 

We have audited theaccompanying consolidated balance sheets of Hydrogenics Corporation as at December 31,2008 and December 31, 2007, and the related consolidated statements ofoperations and deficit, shareholder’s equity and cash flows for each of theyears in the three year period ended December 31, 2008. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits ofthe Company’s financial statements in accordance with Canadian generallyaccepted auditing standards and the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform an audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit of financial statementsincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. A financial statement audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of the Company as at December 31,2008 and December 31, 2007 and the results of its operations and its cashflows for each of the years in the three year period ended December 31, 2008in accordance with Canadian generally accepted accounting principles.

 

**Internalcontrol over financial reporting**

 

We have also auditedHydrogenics Corporation’s internal control over financial reporting as at December 31,2008, based on criteria established in *InternalControl - Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting, included in Management’s Report on Internal Control over FinancialReporting. Our responsibility is to express an opinion on the effectiveness ofthe Company’s internal control over financial reporting based on our audit.

 

We conducted our audit ofinternal control over financial reporting in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether effective internal control over financial reporting was maintained inall material respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, assessing the risk that a material weakness exists, testing andevaluating the design and operating effectiveness of internal control based onthe assessed risk, and performing such other procedures as we considernecessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinion.

 

A company’s internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that: (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

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In our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as at December 31, 2008 based on criteria established inInternal Control —Integrated Framework issued by the COSO.

 

Chartered Accountants, LicensedPublic Accountants

 

**March 24, 2009**

Toronto, Ontario

 

**Comments byIndependent Auditor on Canada — US Reporting Difference**

 

In the United States, reportingstandards for auditors require the addition of an explanatory paragraph (followingthe opinion paragraph) when the financial statements are affected by conditionsand events that cast substantial doubt on the company’s ability to continue asa going concern, such as those described in Note 1 to the 2008 consolidatedfinancial statements of Hydrogenics Corporation. Our report to the shareholderson the consolidated financial statements dated March 24, 2009 is expressedin accordance with Canadian reporting standards which do not permit a referenceto such events and conditions in the auditors’ report when these are adequatelydisclosed in the financial statements.

 

Chartered Accountants, LicensedPublic Accountants

 

**March 24, 2009**

Toronto, Ontario

 

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Tableof Contents

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

 

**TABLE OFCONTENTS**

 
| #          |       | **Note**                                                                       |       | **Description**                                                                                                                                             |       | **Page**   |
|------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|       | ** ** | ** **                                                                     | ** ** | ** **                                                                                                                                                  | ** ** | ** ** |
| 1          |       | **Description  of Business and Going Concern**                                 |       | Summary of Business and  Going Concern.                                                                                                                     |       | F-10       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 2          |       | **Summary  of Significant Accounting Policies**                                |       | Summary review of  accounting principles and the methods used in their application by the  Corporation.                                                     |       | F-10       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 3          |       | **New  Accounting Standards**                                                  |       | Summary review of  generally accepted accounting principle developments that do, will or may,  affect the Corporation.                                      |       | F-14       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 4          |       | **Risk  Managemnet Arising from Financial Instruments**                        |       | Summary review of the  Corporation’s exposure to risks arising from financial instruments.                                                             |       | F-16       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 5          |       | **Business  Streamlining Innitiatives and Wind up of Test Equipment Business** |       | Summary review of the  Corporation’s business streamlining activities and decision to Wind up our  Test Equipment Business.                            |       | F-18       |
| ** ** |       |                                                                           |       |                                                                                                                                                        |       |       |
| 6          |       | **Goodwill  and Impariment Charges**                                           |       | Summary review of the  Corporation’s 2005 acquisition of Stuart Energy Systems Corporation and  Greenlight Power Technologies, Inc.               |       | F-19       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 7          |       | **Accounts  Receivable**                                                       |       | Summary schedule of  accounts receivable.                                                                                                                   |       | F-19       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 8          |       | **Inventory**                                                                  |       | Summary schedule of items  comprising inventory.                                                                                                            |       | F-19       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 9          |       | **Property,  Plant and Equipment**                                             |       | Summary schedule of items  comprising property, plant & equipment.                                                                                 |       | F-20       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 10         |       | **Intangible  Assets**                                                         |       | Summary schedule of  intangible assets and related disclosures.                                                                                             |       | F-20       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 11         |       | **Accounts  Payable and Accrued Liabilities**                                  |       | Summary schedule of items  comprising accounts payable and accrued liabilities.                                                                             |       | F-21       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 12         |       | **Long-term  Debt**                                                            |       | Summary schedule of  long-term debt and related disclosures.                                                                                                |       | F-21       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 13         |       | **Employee  Stock-Based Compensation**                                         |       | Summary schedules and  review of compensation arising from share options awards, deferred share  units and restricted share units.                          |       | F-22       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 14         |       | **Research  and Product Development**                                          |       | Summary schedule of items  comprising research and product development expenses and funding.                                                                |       | F-23       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 15         |       | **Commitments**                                                                |       | Summary review of  commitments and lease obligations.                                                                                                       |       | F-24       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 16         |       | **Contingencies**                                                              |       | Summary review of  contingent liabilties and guarantees.                                                                                                    |       | F-24       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 17         |       | **Lines of  Credit**                                                           |       | Summary review of bank  facilities.                                                                                                                         |       | F-25       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 18         |       | **RelatedParty  Transactions**                                                 |       | Summary review of  transactions with non arm’s length parties                                                                                          |       | F-25       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 19         |       | **Income  Taxes**                                                              |       | Summary reconciliations of  statutory rate income tax expense to provisions for income taxes and analyses  of future income taxes.                          |       | F-25       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 20         |       | **Net Loss  Per Share**                                                        |       | Summary of per share  calculation methods.                                                                                                                  |       | F-26       |
|       | ** ** | ** **                                                                     | ** ** |                                                                                                                                                        |       |       |
| 21         |       | **Changes  in Non-Cash Working Capital**                                       |       | Summary of the changes in  components of the net change in non-cash working capital.                                                                        |       | F-27       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 22         |       | **Segmented  Financial Information**                                           |       | Summary disclosure of  segmented information regularly reported to the Corporation’s Chief Operating  Decision Maker.                                  |       | F-27       |
|       |       |                                                                           |       |                                                                                                                                                        |       |       |
| 23         |       | **Differences  between Canadian and United States Accounting Principles**      |       | Summary schedules and  review of differences between Canadian and United States generally accepted  accounting principles as they apply to the Corporation. |       | F-30       |

 

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**CONSOLIDATED FINANCIAL STATEMENTS**

 
| **HYDROGENICS CORPORATION**     |
|---------------------------------|
| **CONSOLIDATED BALANCE SHEETS** |
| (in  thousands of US dollars)   |

 
| ** **                                                  | ** ** | **2008** | ** ** | **2007**   | ** ** |
|-------------------------------------------------------------|------------|----------|------------|------------|------------|
| **ASSETS**                                                  |       |     |       |       |       |
| **Current assets**                                          |       |     |       |       |       |
| Cash and cash equivalents                                   |       | $        | 21,601     |       | $          | 15,460 |   |
| Restricted cash                                             |       | 1,130    |       | —     |       |
| Short-term investments                                      |       | —   |       | 15,032     |       |
| Accounts receivable (note 7)                                |       | 3,974    |       | 12,713     |       |
| Grants receivable                                           |       | 505      |       | 850        |       |
| Inventories (note 8)                                        |       | 10,101   |       | 12,659     |       |
| Prepaid expenses                                            |       | 1,161    |       | 1,077      |       |
|                                                        |       | 38,472   |       | 57,791     |       |
| **Property, plant and equipment**(note  9)                  |       | 4,082    |       | 4,847      |       |
| **Intangible assets**(note  10)                             |       | —   |       | 249        |       |
| **Goodwill**(note 6)                                        |       | 5,025    |       | 5,025      |       |
| **Other non-current assets**                                |       | —   |       | 28         |       |
|                                                        |       | $        | 47,579     |       | $          | 67,940 |   |
| **LIABILITIES**                                             |       |     |       |       |       |
| **Current liabilities**                                     |       |     |       |       |       |
| Accounts payable and accrued liabilities  (notes 11 and 18) |       | $        | 17,298     |       | $          | 18,166 |   |
| Unearned revenue                                            |       | 4,785    |       | 9,042      |       |
|                                                        |       | 22,083   |       | 27,208     |       |
| **Long-term debt**(note  12)                                |       | —   |       | 11         |       |
| **Deferred research and development grants**                |       | 13       |       | 337        |       |
|                                                        |       | 22,096   |       | 27,556     |       |
| **Shareholders’ Equity**                               |       |     |       |       |       |
| Common shares                                               |       | 307,000  |       | 306,872    |       |
| Contributed surplus                                         |       | 16,300   |       | 15,606     |       |
| Deficit                                                     |       | (291,420 | )          | (277,101   | )          |
| Accumulated other comprehensive loss                        |       | (6,397   | )          | (4,993     | )          |
| Total deficit and accumulated other  comprehensive loss     |       | (297,817 | )          | (282,094   | )          |
|                                                        |       | 25,483   |       | 40,384     |       |
| ** **                                                  | ** ** | **$**    | **47,579** | ** ** | **$**      | **67,940** |   |

 

Going concern (note 1)

Commitments and contingencies(notes 15 and 16)

The accompanying notes froman integral part of these Consolidated Financial Statements.

 
|                         |   |                         |
|-------------------------|--------|-------------------------|
| Norman Seagram          |   | Douglas Alexander       |
| Chairman                |   | Director                |
| Hydrogenics Corporation |   | Hydrogenics Corporation |

 

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Table of Contents

 

**CONSOLIDATED FINANCIAL STATEMENTS**

 

**HYDROGENICSCORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands of US dollars,except for share and per share amounts)

 
| ** **                                                       | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Revenues**                                                     |       | $          | 39,340     |       | $          | 37,990     |       | $ | 30,059 |   |
| **Cost of revenues**                                             |       | 31,446     |       | 33,601     |       | 29,360     |       |
|                                                             |       | 7,894      |       | 4,389      |       | 699        |       |
| **Operating expenses**                                           |       |       |       |       |       |       |       |
| Selling, general and administrative                              |       | 15,022     |       | 24,006     |       | 27,891     |       |
| Research and product development (note 14)                       |       | 7,296      |       | 9,690      |       | 9,379      |       |
| Windup of test equipment business (note 5)                       |       | —     |       | 2,016      |       | —     |       |
| Amortization of property, plant and  equipment                   |       | 855        |       | 903        |       | 1,285      |       |
| Amortization of intangible assets                                |       | 249        |       | 251        |       | 7,139      |       |
| Impairment of intangible assets and  goodwill (notes 6 and 10)   |       | —     |       | —     |       | 90,834     |       |
|                                                             |       | 23,422     |       | 36,866     |       | 136,528    |       |
|                                                             |       |       |       |       |       |       |       |
| **Loss from operations**                                         |       | (15,528    | )          | (32,477    | )          | (135,829   | )          |
| **Other income**  (expenses)                                     |       |       |       |       |       |       |       |
| Gain on sale of assets                                           |       | 44         |       | —     |       | 477        |       |
| Loss on disposal of property, plant and  equipment (note 5)      |       | —     |       | (308       | )          | —     |       |
| Provincial capital tax                                           |       | 170        |       | (127       | )          | (42        | )          |
| Interest, net                                                    |       | 923        |       | 2,249      |       | 3,551      |       |
| Foreign currency gains                                           |       | 188        |       | 2,617      |       | 904        |       |
|                                                             |       | 1,325      |       | 4,431      |       | 4,890      |       |
|                                                             |       |       |       |       |       |       |       |
| **Loss before income taxes**                                     |       | (14,203    | )          | (28,046    | )          | (130,939   | )          |
| **Current income tax expense**  (recovery) (note 19)             |       | 116        |       | 22         |       | (180       | )          |
| **Net loss for the year**                                        |       | $          | (14,319    | )          | $          | (28,068    | )          | $ | (130,759 | ) |
| ** **                                                       |       |       |       |       |       |       |       |
| **Net loss per share**                                           |       |       |       |       |       |       |       |
| Basic and diluted (note 20)                                      |       | $          | (0.16      | )          | $          | (0.31      | )          | $ | (1.42 | ) |
| Shares used in calculating basic and diluted  net loss per share |       | 92,080,656 |       | 91,797,911 |       | 91,816,049 |       |

 

The accompanying notes form anintegral part of these Consolidated Financial Statements.

 

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Table of Contents

 

**CONSOLIDATED FINANCIAL STATEMENTS**

 

**HYDROGENICSCORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands of US dollars)

 
| ** **                                                              | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **CASH AND CASH EQUIVALENTS PROVIDED BY (USED  IN):**                   |       |     |       |     |       |     |       |
| **Operating activities**                                                |       |     |       |     |       |     |       |
| Net loss for the year                                                   |       | $        | (14,319    | )        | $          | (28,068  | )          | $ | (130,759 | ) |
| Items not affecting cash                                                |       |     |       |     |       |     |       |
| Amortization of property, plant and  equipment                          |       | 1,106    |       | 1,611    |       | 1,948    |       |
| Amortization of intangible assets                                       |       | 249      |       | 251      |       | 7,139    |       |
| Impairment of intangible assets and  goodwill                           |       | —   |       | —   |       | 90,834   |       |
| Unrealized foreign exchange (gains) losses                              |       | 695      |       | 29       |       | (74      | )          |
| Imputed interest on long-term debt                                      |       | —   |       | —   |       | 1        |       |
| Non-cash consulting fees                                                |       | —   |       | —   |       | 39       |       |
| Stock-based compensation                                                |       | 694      |       | 1,553    |       | 1,832    |       |
| Gain on Sale of assets                                                  |       | (44      | )          | —   |       | (477     | )          |
| Loss on disposal of property, plant and  equipment                      |       | —   |       | 308      |       | —   |       |
| Net change in non-cash working capital  (note 21)                       |       | 4,817    |       | (4,100   | )          | 5,029    |       |
|                                                                    |       | (6,802   | )          | (28,416  | )          | (24,488  | )          |
| **Investing activities**                                                |       |     |       |     |       |     |       |
| Decrease (increase) in short-term  investments                          |       | 15,032   |       | 39,318   |       | 26,046   |       |
| Increase in restricted cash                                             |       | (1,130   | )          | —   |       | —   |       |
| Purchase of property, plant and equipment                               |       | (885     | )          | (1,331   | )          | (1,701   | )          |
| Proceeds from sale of assets                                            |       | 44       |       | —   |       | 477      |       |
|                                                                    |       | 13,061   |       | 37,987   |       | 24,822   |       |
| **Financing activities**                                                |       |     |       |     |       |     |       |
| Repayment of long-term debt                                             |       | (11      | )          | (83      | )          | (193     | )          |
| Deferred research and development grant                                 |       | (235     | )          | 204      |       | (17      | )          |
| Common shares issued, (purchased and  cancelled), net of issuance costs |       | 128      |       | (169     | )          | 419      |       |
|                                                                    |       | (118     | )          | (48      | )          | 209      |       |
| **Increase (decrease) in cash and cash equivalents  during the year**   |       | 6,141    |       | 9,523    |       | 543      |       |
| **Cash and cash equivalents - Beginning of  year**                      |       | 15,460   |       | 5,937    |       | 5,394    |       |
| **Cash and cash equivalents - End of year**                             |       | $        | 21,601     |     | $          | 15,460   |       | $ | 5,937 |   |
| **Supplemental disclosure**                                             |       |     |       |     |       |     |       |
| Interest paid                                                           |       | $        | 17         |     | $          | 52       |       | $ | 80 |   |
| Income taxes paid                                                       |       | 118      |       | 63       |       | —   |       |

 

The accompanying notes form anintegral part of these Consolidated Financial Statements.

 

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Table of Contents

 

**CONSOLIDATED FINANCIAL STATEMENTS**

 

**HYDROGENICSCORPORATION**

**CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY**

(in thousands of US dollars, exceptfor share and per share amounts)

 
| ** **                                        | ** ** | ** **            | ** ** | ** **      | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|-----------------|------------|-------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                        | ** ** | ** **            | ** ** | ** **      | ** ** | ** **  | ** ** | ** **        | ** ** | **other**              | ** ** | **Total**  | ** ** |
| ** **                                        | ** ** | **Common share** | ** ** | **Contributed** | ** ** | ** **  | ** ** | **comprehensive** | ** ** | **shareholders’** | ** ** |
| ** **                                        | ** ** | **Number**            | ** ** | **Amount**      | ** ** | **surplus** | ** ** | **Deficit**       | ** ** | **loss**               | ** ** | **equity** | ** ** |
| **Balance at Dec. 31, 2005**                 |       | 91,679,670            |       | $               | 306,957    |        | $          | 11,847            |       | $                      | (118,274   | )          | $          | (5,023 | ) | $ | 195,507 |   |
| Comprehensive loss:                               |       |                  |       |            |       |        |       |              |       |                   |       |       |       |
| Net loss for the year                             |       | —                |       | —          |       | —      |       | (130,759          | )          | —                 |       | (130,759   | )          |
| Foreign currency translation adjustments          |       | —                |       | —          |       | —      |       | —            |       | (281                   | )          | (281       | )          |
| **Comprehensive loss**                            |       |                  |       |            |       |        |       |              |       |                   |       | (131,040   | )          |
| Issuance of common shares on exercise of  options |       | 236,796               |       | 419             |       |        |       |              |       |                   |       | 419        |       |
| Stock-based consulting expense                    |       | —                |       | —          |       | 39          |       | —            |       | —                 |       | 39         |       |
| Employee Stock-based compensation expense         |       | —                |       | —          |       | 1,832       |       | —            |       | —                 |       | 1,832      |       |
| **Balance at Dec. 31, 2006**                 |       | 91,916,466            |       | $               | 307,376    |        | $          | 13,718            |       | $                      | (249,033   | )          | $          | (5,304 | ) | $ | 66,757 |   |
| Comprehensive loss:                               |       |                  |       |            |       |        |       |              |       |                   |       |       |       |
| Net loss for the year                             |       | —                |       | —          |       | —      |       | (28,068           | )          | —                 |       | (28,068    | )          |
| Foreign currency translation adjustments          |       | —                |       | —          |       | —      |       | —            |       | 311                    |       | 311        |       |
| **Comprehensive loss**                            |       |                  |       |            |       |        |       |              |       |                   |       | (27,757    | )          |
| Shares returned to treasury                       |       | (150,775              | )          | (504            | )          | 335         |       | —            |       | —                 |       | 169        |       |
| Employee Stock-based compensation expense         |       | —                |       | —          |       | 1,553       |       | —            |       | —                 |       | 1,553      |       |
| **Balance at Dec. 31, 2007**                 |       | 91,765,691            |       | $               | 306,872    |        | $          | 15,606            |       | $                      | (277,101   | )          | $          | (4,993 | ) | $ | 40,384 |   |
| Comprehensive loss:                               |       |                  |       |            |       |        |       |              |       |                   |       |       |       |
| Net loss for the year                             |       | —                |       | —          |       | —      |       | (14,319           | )          | —                 |       | (14,319    | )          |
| Foreign currency translation adjustments          |       | —                |       | —          |       | —      |       | —            |       | (1,404                 | )          | (1,404     | )          |
| **Comprehensive loss**                            |       |                  |       |            |       |        |       |              |       |                   |       | (15,723    | )          |
| Issuance of common shares on exercise of  options |       | 639,980               |       | 128             |       | —      |       | —            |       | —                 |       | 128        |       |
| Adjustment for partial shares                     |       | (5                    | )          | —          |       | —      |       | —            |       | —                 |       | —     |       |
| Employee Stock-based compensation expense         |       | —                |       | —          |       | 694         |       | —            |       | —                 |       | 694        |       |
| **Balance at Dec. 31, 2008**                 |       | 92,405,666            |       | $               | 307,000    |        | $          | 16,300            |       | $                      | (291,420   | )          | $          | (6,397 | ) | $ | 25,483 |   |

 

The authorized capital stock ofthe Corporation consists of an unlimited number of common shares and anunlimited number of preferred shares in series.

 

The accompanying notes form anintegral part of these Consolidated Financial Statements.

 

F-9

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Tableof Contents

 

**NOTES TO CONSOLIDATED****FINANCIAL STATEMENTS**

 

**NOTE 1 -DESCRIPTION OF BUSINESS AND GOING CONCERN**

 

Hydrogenics Corporation(“Hydrogenics” or the “Corporation”), together with its subsidiaries, designs,develops and manufactures hydrogen generation products based on waterelectrolysis technology and fuel cell products based on proton exchangemembrane, or PEM, technology.

 

While the accompanyingconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and liquidation of liabilitiesduring the normal course of operations, there are material uncertaintiesrelated to certain adverse conditions and events that cast significant doubt onthe validity of this assumption. The Corporation has not yet realizedconsistent profitable operations and continues to use cash to fund itsoperations. The Corporation’s ability to continue as a going concern is dependenton the successful execution of its business plan which involves: (i) securingadditional financing to fund its operations; (ii) advancing productdesigns for efficiency, durability, cost reduction and entry into complimentarymarkets; (iii) increasing market penetration and sales; (iv) activelymanaging its liquidity; and (v) retaining and engaging staff. At present, thesuccess of these initiatives cannot be assured due to the materialuncertainties attributed to the Corporation’s ability to obtain financing andmeet its revenue targets. Given the condition of the global economy and thecondition of the current global credit markets, markets for the Corporation’sproducts may develop more slowly than anticipated, current and potentialcustomers may delay, reduce or cancel purchases and revenues would therefore beless than anticipated. Also the Corporation may not be able to raise additionalcapital, or do so on acceptable terms. These material uncertainties are furtherdescribed in the three risk factors in “Item 3. Key Information — Risk Factors —Selected Risk Factors Related to Our Financial Condition as of December 31,2008” in the annual report on Form 20-F. The consolidated financial statementsdo not include any adjustments or disclosures that may result from theCorporation’s inability to continue as a going concern. If the going concern assumptionwere not appropriate for these consolidated financial statements, adjustmentsmay be necessary in the carrying values of assets and liabilities and thereported expenses and balance sheet classifications, such adjustments could bematerial.

 

**NOTE 2 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Basis ofPresentation**

 

The accompanying consolidatedfinancial statements of Hydrogenics and its subsidiaries have been prepared inaccordance with Canadian generally accepted accounting principles (“CanadianGAAP”) which, in the case of the Corporation, conform in all material respectswith accounting principles generally accepted in the United States (“U. S. GAAP”),except as outlined in note 23.

 

**Principlesof Consolidation**

 

The consolidated financialstatements include the accounts of the Corporation and its subsidiaries, whichare wholly owned. All intercompany transactions and balances have beeneliminated on consolidation.

 

**Use ofEstimates**

 

The preparation ofconsolidated financial statements in accordance with Canadian GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the year. Actual results coulddiffer from those estimates.

 

Significant estimates made bythe Corporation include allowances for the fair value of goodwill, warrantyprovisions, stock-based compensation, potentially uncollectible accountsreceivable, provisions for inventory which is carried in excess of netrealizable value, and provisions for costs to complete contracts in progressand valuation allowances for future income tax assets.

 

**Cash andCash Equivalents**

 

Cash and cash equivalentsconsist of cash on deposit and highly liquid short-term interest bearingsecurities with maturities at the date of purchase of less than 90 days. Cashand cash equivalents are designated as held-for-trading and carried at fairvalue. Changes in fair value are recorded in earnings.

 

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Tableof Contents

 

**NOTES TOCONSOLIDATED****FINANCIALSTATEMENTS**

 

**RestrictedCash**

 

Restricted cash consists ofcash on deposit and highly liquid short-term interest bearing securities withmaturities at the date of purchase of less than 90 days and are carried atamortized cost using the effective interest rate method. These instruments areheld as partial security for standby letters of credit and letters of guarantee.Restricted cash is designated as held-for-trading and carried at fair value. Changesin fair value are recorded in earnings.

 

**Short-termInvestments**

 

Short-term investmentsconsisted of interest bearing securities with original terms to maturity ofless than one year and are classified as held-to-maturity. As a result, short-terminvestments were carried at amortized cost using the effective interest ratemethod. The Corporation had the intention and the ability to hold thesesecurities to maturity. Transaction costs were recognized in net loss whenincurred.

 

**Inventories**

 

Raw materials, work-in-progressand finished goods are valued at the lower of cost, determined on a first-infirst-out basis, and net realizable value. Inventory costs include the cost ofmaterial, labour, variable overhead and an allocation of fixed manufacturingoverhead including amortization based on normal production volumes.

 

**Property, Plantand Equipment**

 

Property, plant and equipmentare recorded at cost less accumulated amortization. Property, plant andequipment are amortized from the date of acquisition or, in respect ofinternally constructed assets, from the time an asset is substantiallycompleted and ready for use. The cost of internally constructed assets includesmaterials, labour and directly attributable overhead costs. Amortization iscomputed using the declining balance method as follows:

 
| Test equipment                 |   | 30% per annum |   |
|--------------------------------|--------|---------------|--------|
| Computer hardware and software |   | 30% per annum |   |
| Furniture and equipment        |   | 20% per annum |   |
| Automobiles                    |   | 30% per annum |   |

 

Leaseholdimprovements are amortized on a straight-line basis over the term of the lease.

 

The Corporation reviews therecoverability of the carrying amount of property, plant and equipment whenevents or circumstances indicate that the carrying amounts may not berecoverable. This evaluation is based on projections of future undiscounted netcash flows. The total of these projected net cash flows is referred to as the “netrecoverable amount.” If the net recoverable amount is less than the carryingvalue, the asset is written down to fair value.

 

**Goodwilland Intangible Assets**

** **

**Goodwill**

 

Goodwill represents theexcess of purchase price over the fair value of identifiable assets acquired ina business combination accounted for using the purchase method of accounting. Goodwillis not amortized but is subject to fair value impairment tests on at least anannual basis and, additionally, whenever events and changes in circumstancesindicate that the carrying value might not be recoverable. Impairment ofgoodwill is tested at the reporting unit level by comparing the reporting unit’scarrying amount, including goodwill, to the fair value of the reporting unit. Thefair values of the reporting units are estimated using a combination of theincome or discounted cash flows approach and the market approach, which utilizescomparable companies’ data. If the carrying amount of the reporting unitexceeds its fair value, then a second step is performed to determine the amountof impairment loss, measured as the amount by which the carrying value of thereporting unit’s goodwill exceeds its fair value, if any. Any impairment losswould be expensed in the consolidated statements of operations.

 

F-11

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Tableof Contents

 

**NOTES TOCONSOLIDATED****FINANCIALSTATEMENTS**

 

**Intangibleassets with finite useful lives**

 

The Corporation’s intangibleassets are all considered to have finite useful lives and are amortized basedon their estimated useful lives as follows:

 
| Intellectual property         |   | 50% per annum declining balance |   |
|-------------------------------|--------|---------------------------------|--------|
| Management services contracts |   | 50% per annum declining balance |   |
| Product technology            |   | 4 - 7 years straight-line       |   |
| Customer relationships        |   | 8 years straight-line           |   |
| Trade names                   |   | 3 years straight-line           |   |
| ISO certifications            |   | 1 year straight-line            |   |

 

Management reviews theamortization methods and useful life estimates for these intangible assetsannually.

 

The Corporation reviews thecarrying amount of intangible assets with finite lives when events or circumstancesindicate that the carrying amount may not be recoverable. This evaluation isbased on projections of future undiscounted net cash flows. The total of theseprojected net cash flows is referred to as the “net recoverable amount.” If thenet recoverable amount is less than carrying value, the asset is written downto fair value.

 

**RevenueRecognition**

 

Revenues from the sale ofequipment are recognized when there is persuasive evidence of an arrangement, goodshave been delivered, the amount is fixed or determinable, and collection isreasonably assured. When customer acceptance clauses are considered to besubstantive, recognition of revenue is deferred until customer acceptance isreceived. If delivery has not occurred, the Corporation will recognize revenueprovided that all other criteria are met and the risks of ownership have passedto the customer, the customer has a fixed commitment to purchase the goods, thecustomer requests that the delivery not occur until a later date, there is afixed schedule for delivery of the goods, the Corporation has not retained anyspecific performance obligations such that the earnings process is not complete,the ordered goods have been segregated from our inventory and is not subject tobeing used to fill other orders and the product is complete and ready forshipment.

 

Revenues from long-termcontracts are determined under the percentage-of-completion method wherebyrevenues are recognized on a pro-rata basis in relation to contract costsincurred. Costs and estimated profit on contracts-in-progress in excess ofamounts billed are reflected as unbilled revenues. Losses, if any, arerecognized immediately.

 

Equipment leases thattransfer substantially all of the benefits and risks of ownership to customersare classified as sales-type leases in accordance with The Canadian Instituteof Chartered Accountants (“CICA”) Handbook Section 3065, “Leases.”

 

Revenues relating toengineering and testing services are recognized as services are rendered. Cashreceived in advance of revenue being recognized on contracts is classified asunearned revenue.

 

The Corporation also entersinto transactions that represent multiple-element arrangements, which mayinclude any combination of equipment and service. These multiple-element arrangementsare assessed to determine whether they can be separated into more than one unitof accounting or element for the purpose of revenue recognition. When theappropriate criteria for separating revenue into more than one unit ofaccounting is met and there is objective evidence of the fair value for allunits of accounting or elements in an arrangement, the arrangementconsideration is allocated to the separate units of accounting or elementsbased on each unit’s relative value. This objective evidence of fair value isestablished through prices charged for each revenue element when that elementis sold separately. The revenue recognition policies described above are thenapplied to each unit of accounting.

 

**ProductWarranties**

 

The Corporation typicallyprovides a warranty for parts and/or labour for up to one year or based oncertain operating specifications such as hours of operation. Warranty costprovisions are based on management’s best estimates of such costs, taking intoaccount the specific arrangements of the transaction, past history and expectedfuture performance of products.

 

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Tableof Contents

 

**NOTES TOCONSOLIDATED****FINANCIALSTATEMENTS**

 

**ResearchAnd Product Development Costs**

 

Research costs and costsincurred in applying for patents and licenses are expensed as incurred. Productdevelopment costs are expensed as incurred until the product or process isclearly defined and the associated costs can be identified, technicalfeasibility is reached, there is an intention to produce or market the product,the future market is clearly defined and adequate resources exist or areexpected to be available to complete the project. To date, no productdevelopment costs have been capitalized.

 

Funding for research andproduct development includes government and non-government research and productdevelopment support. Research and product development support is recognized asthe applicable costs are incurred unless it is for reimbursement of an asset, inwhich case it is accounted for as a reduction in the cost of the applicableasset.

 

**Stock-BasedCompensation**

 

The Corporation hasstock-based compensation plans, which are described in note 13. The Corporationestimates the fair value of stock-based compensation to employees and directorsand expenses the fair value over the estimated vesting period of the stockoptions with the off-set being recorded in contributed surplus. Any considerationpaid by employees or directors on the exercise of stock options or purchase ofstock is credited to share capital together along with any previouslyrecognized compensation expense. If shares or stock options are repurchasedfrom employees or directors, the excess of the consideration paid over thecarrying amount of the shares or stock options cancelled is charged to deficit.Forfeitures of stock-based compensation awards are accounted for in the periodin which the forfeiture occurs.

 

**Deferred ShareUnits**

 

The fair value of theCorporation’s deferred share units is charged to selling, general andadministrative expenses using the graded vesting method. Since the deferredshare units will be settled in cash, the intrinsic value of the vested shareunits is revalued each quarter until the settlement date. The Corporation hasset up a liability in the consolidated balance sheets, included within accountspayable and accrued liabilities, for the total intrinsic value of the vesteddeferred share units. Forfeitures of deferred share units are accounted for inthe period in which the forfeiture occurs.

 

**RestrictedShare Unit Plan**

 

The intrinsic value of theCorporation’s restricted share units are charged to selling, general andadministrative expenses using the graded vesting method. Since the restrictedshare units will be settled in cash, the intrinsic value of the vested shareunits is revalued each quarter until the settlement date. The Corporation hasset up a liability in the consolidated balance sheets, included within accountspayable and accrued liabilities, for the total intrinsic value of the vestedrestricted share units. Forfeitures of restricted share units are accounted forin the period in which the forfeiture occurs.

 

**IncomeTaxes**

 

Income taxes are recordedusing the liability method. Future income tax amounts arise due to temporarydifferences between the accounting and income tax basis of the Corporation’sassets and liabilities and the unused tax losses of the Corporation. Futureincome tax assets and liabilities are measured using substantively enactedincome tax rates in effect for the year in which those temporary differencesare expected to be recovered or settled. The effect on future income tax assetsand liabilities of a change in income tax rates and laws is recognized in theperiod that includes the date of substantive enactment. Future income taxassets are recognized to the extent that realization of such benefits isconsidered to be more likely than not.

 

**ForeignCurrency Translation**

 

Monetary assets andliabilities denominated in currencies other than the functional currency aretranslated at the rate of exchange in effect at the end of the period. Non-monetaryassets and liabilities are translated at historical rates of exchange. Revenueand expense items denominated in currencies other than the functional currencyare translated into functional currency at the average rate of exchange for theperiod, except for amortization, which is translated at historical rates. Resultantgains and losses are included in the results of operations.

 

Assets and liabilities of theCorporation’s Belgian subsidiary are considered to be self-sustaining and aretranslated into US dollars at the period-end exchange rates, and the results ofits operations are translated at the average rate of exchange for the period. Theresulting translation adjustments are accumulated in a separate component ofshareholders’ equity.

 

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**NOTES TOCONSOLIDATED****FINANCIALSTATEMENTS**

 

The operations of theCorporation’s other subsidiaries are considered integrated with those of theCorporation and, accordingly, their accounts are translated into US dollarsusing the temporal method. Under this method, monetary assets and liabilitiesare translated using the period-end exchange rate, and non-monetary items aretranslated using historical rates of exchange. Revenues and expenses of thissubsidiary are translated at the average exchange rate for the period, exceptfor amortization, which is translated at historical rates of exchange.Resultant gains and losses are included in the results of operations.

 

**Net LossPer Share**

 

Basic net loss per share iscalculated based on the weighted average number of common shares outstandingfor the year. Diluted net loss per share is calculated using the daily weightedaverage number of common shares that would have been outstanding during theyear had all potential common shares been issued at the beginning of the yearor when the underlying options or warrants were granted, if later unlessanti-dilutive. The treasury stock method is used to determine the incrementalnumber of shares that would have been outstanding had the Corporation usedproceeds from the exercise of options and warrants to acquire common shares.

 

**FinancialInstruments**

 

All financial instruments aremeasured at fair value on initial recognition. After initial recognition, financialinstruments are measured at their fair values, except for financial assetsclassified as held to maturity or loans and receivables and other financialliabilities, which are measured at amortized cost.

 

**NOTE 3 – NEWACCOUNTING STANDARDS**

 

The Corporation has adoptedthe following changes to its accounting policies:

 

**(i)    Canadianstandards**

 

CICA Handbook Section 1535,“Capital Disclosures,” Section 3862 “Financial Instruments - Disclosures,”and Section 3863, “Financial Instruments - Presentation.” Section 1535establishes disclosure requirements about an entity’s capital and how it ismanaged. The purpose is to enable users of the financial statements to evaluateobjectives, policies and processes for managing capital. Sections 3862 and 3863replaced Section 3861, “Financial Instruments — Disclosure andPresentation,” revising and enhancing disclosure requirements while carryingforward its presentation requirements. These new sections place increasedemphasis on disclosure about the nature and extent of risks arising fromfinancial instruments and how the entity manages those risks. These sectionsapply to interim and annual financial statements relating to fiscal yearsbeginning on or after October 1, 2007. The Corporation has adopted thisnew guidance effective January 1, 2008. These standards changed thedisclosure provided by the Corporation.

 

In May 2007, the CICAissued Handbook Section 3031, “Inventories,” which replaced the existing Section 3030“Inventories.” The standard introduced changes to the measurement anddisclosure of inventory. This standard is effective for interim and annualperiods related to fiscal years beginning on or after January 1, 2008 withearlier application encouraged. The Corporation adopted this new guidanceeffective January 1, 2008. This standard did not have a material impact onits consolidated financial position, results of operations or cash flows; however,the Corporation now carries inventory at the lower of cost and net realizablevalue. Previously, the Corporation carried inventory at the lower of cost andreplacement cost.

 

In May 2007, theCanadian Accounting Standards Board (“AcSB”) amended Section 1400, “GeneralStandards of Financial Statement Presentation,” to change the guidance relatedto management’s responsibility to assess the ability of the entity to continueas a going concern. Management is required to make an assessment of an entity’sability to continue as a going concern and should take into account allavailable information about the future, which is at least, but is not limitedto, 12 months from the balance sheet date. Disclosure is required of materialuncertainties related to events or conditions that may cast significant doubtupon the entity’s ability to continue as a going concern. The Corporationadopted this new guidance effective January 1, 2008.

 

In January 2008, theCICA issued CICA Emerging Issues Committee (“EIC”) EIC-169 “Embedded ForeignCurrency Derivatives” (“EIC-169”). Guidance in EIC-169 should be appliedretrospectively to embedded foreign currency derivatives in host contracts thatare not financial instruments accounted for in accordance with Section 3855in financial statements issued for interim and annual periods ending on orafter March 15, 2008. This new EIC assists in the interpretation of thephrase “routinely denominated” as used in Section 3855 and also assists indetermining which factors can be used to determine whether a contract for thepurchase or sale of a non-financial item such as a commodity is routinelydenominated in a particular currency in commercial transactions around

 

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

the world. The Corporationadopted this standard effective January 1, 2008. The adoption of thisstandard did not have a materialimpact on the Corporation’s consolidated financial position, results ofoperations or cash flows.

 

**(ii)    USstandards**

 

The following changes onlyapply to note 23 of the consolidated financial statements.

 

In September 2006, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS157”). SFAS 157 establishes a framework for measuring the fair value of assetsand liabilities. This framework is intended to provide increased consistency inhow fair value determinations are made under various existing accountingstandards that permit, or in some cases require, estimates of fair market value.SFAS 157 also expands financial statement disclosure requirements about acorporation’s use of fair value measurements, including the effect of suchmeasures on earnings. This standard is effective for fiscal years beginningafter November 15, 2007. The Corporation adopted this new guidanceeffective January 1, 2008. This standard did not change the Corporation’sconsolidated financial position, results of operations or cash flows. Fornon-financial assets and non-financial liabilities, the standard is effectivefor financial statements issued for fiscal years beginning after November 15,2008. The Corporation plans to adopt this guidance effective January 1, 2009.The Corporation is currently assessing the effect this standard may have on theCorporation’s results of operations and consolidated financial position.

 

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities - Including an Amendment of FASB Statement No. 115”(“SFAS 159”). SFAS 159 is expected to expand the use of fair value accountingbut does not affect existing standards which require certain assets orliabilities to be carried at fair value. The objective of SFAS 159 is toimprove financial reporting by providing companies the opportunity to mitigatevolatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. Under SFAS 159, a Corporation may choose, at specified electiondates, to measure eligible items at fair value and report unrealized gains andlosses on items for which the fair value option has been elected in earnings ateach subsequent reporting date. SFAS 159, for financial assets and financialliabilities, is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. The Corporation adopted this newguidance effective January 1, 2008. This standard did not have a materialaffect on the Corporation’s consolidated financial position, results ofoperations or cash flows.

 

**NewAccounting Standards**

 

The following changes will beadopted in the future.

 

**(i)      Canadianstandards**

 

In February 2008, theCICA issued Handbook Section 3064 “Goodwill and Intangible Assets,” whichreplaced existing Sections 3062 “Goodwill and Other Intangible Assets” and 3450“Research and Development Costs.” The new standard introduced changes torecognition, measurement and disclosure of goodwill and intangible assets. Theprovisions relating to the definition and initial recognition of intangibleassets are equivalent to the corresponding provisions of InternationalFinancial Reporting Standard IAS 38, “Intangible Assets.” The new standard alsoprovides guidance for the recognition of internally developed intangible assets,including assets developed from research and development activities, ensuringconsistent treatment of all intangible assets, whether separately acquired orinternally developed. Section 3064 applies to interim and annual financialstatements relating to fiscal years beginning on or after October 1, 2008with earlier adoption encouraged. The Corporation anticipates adopting this newguidance effective January 1, 2009. The Corporation is currently assessingthe effect this standard may have on the Corporation’s results of operationsand consolidated financial position.

 

In January 2009, theCICA issued Handbook Sections 1582 “Business Combinations”, 1601 “ConsolidatedFinancial Statements” and 1602 “Non-controlling interests”. These sectionsreplace the former CICA 1581, Business Combinations and CICA 1600, ConsolidatedFinancial Statements and establish a new section for accounting for anon-controlling interest in a subsidiary. CICA 1582 is effective for businesscombinations for which the acquisition date is on/after the beginning of thefirst annual reporting period beginning on/after January 1, 2011. CICA1601 and CICA 1602 apply to interim and annual consolidated financialstatements relating to years beginning on/after January 1, 2011. TheCorporation is currently assessing the effect these standards may have on theCorporation’s results of operations and consolidated financial position.

 

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**(iii)   USstandards**

 

The following changes willonly apply to note 23 of the consolidated financial statements.

 

In December 2007, theFASB issued Statement SFAS No. 141 (revised 2007), “BusinessCombinations,” which replacesSFAS No 141. The standard retains the purchase method of accounting foracquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized inthe purchase accounting. It also changes the recognition of assets acquired and liabilities assumedarising from contingencies, requires the capitalization of in-process researchand development at fair value,and requires the expensing of acquisition-related costs as incurred. SFAS No. 141Ris effective for the Corporationbeginning January 1, 2009 and will apply prospectively to businesscombinations completed on or after that date.

 

**NOTE 4 -RISK MANAGEMENT ARISING FROM FINANCIAL INSTRUMENTS**

 

For the year ended December 31,2008, the Corporation adopted the requirements of CICA Handbook Section 3862,“Financial Instruments - Disclosures,” which apply to fiscal years beginning onor after October 1, 2007. This section requires disclosures relating to: (i) thesignificance of financial instruments for financial position and performance; and(ii) the nature and extent of the Corporation’s exposure to risks arisingfrom financial instruments, including credit risk, liquidity risk, foreigncurrency risk and interest rate risk, and how the Corporation manages thoserisks.

 

Under Canadian GAAP, financialinstruments are classified into one of the following categories: (i) held-for-trading;(ii) held-to-maturity; (iii) available for sale; (iv) loans andreceivables; (v) and other financial liabilities. The following tablesummarizes information regarding the carrying value of the Corporation’sfinancial instruments:

 
| ** **                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Held for trading (i)             |       | $        | 22,731     |     | $          | 15,460 |   |
| Held to maturity (ii)            |       | —   |       | 15,032   |       |
| Loans and receivables (iii)      |       | 4,479    |       | 13,563   |       |
| Other financial liabilities (iv) |       | 17,298   |       | 18,166   |       |
|                                  |            |          |            |          |            |  |  |

 

----

| (i)   |   | Includes cash and cash  equivalents and restricted cash                                  |
|-------|--------|------------------------------------------------------------------------------------------|
| (ii)  |   | Short-term investments                                                                   |
| (iii) |   | Includes accounts  receivable                                                            |
| (iv)  |   | Includes financial  liabilities included within accounts payable and accrued liabilities |

 

**Liquidity**

 

The Corporation has sustainedlosses and negative cash flows from operations since its inception. At December 31,2008, the Corporation had approximately $22,731 of cash and cash equivalentsand restricted cash. The Corporation’s approach to managing liquidity risk is toensure that it will have sufficient liquidity to meet liabilities when due. TheCorporation achieves this by maintaining sufficient cash and cash equivalentsand short-term investments. The Corporation monitors its financial position ona monthly basis and updates its expected use of cash resources based on thelatest available data.

 

There are uncertaintiesrelated to the timing and use of the Corporation’s cash resources. Note 1. Descriptionof Business and Going Concern, discloses the risks surrounding the timing andthe use of the Corporation’s cash resources.

 

**Credit risk**

 

Credit risk arises from thepotential that a counterparty will fail to perform its obligations. TheCorporation is exposed to credit risk from customers. At December 31, 2008,the Corporation’s two largest customers accounted for 18% (12% at December 31,2007) and 7% (5% at December 31, 2007) of revenues, respectively. In orderto minimize the risk of loss for trade receivables, the Corporation’s extensionof credit to customers involves a review and approval by senior management aswell as progress payments as contracts are executed. The majority of theCorporation’s sales are invoiced with payment terms between 30 and 60 days. TheCorporation’s objective is to minimize its exposure to credit risk fromcustomers in order to prevent losses on financial assets by performing regularmonitoring of overdue balances and provides allowance for potentiallyuncollectible accounts receivable.

 

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

The Corporation reviews itstrade receivable accounts regularly and writes down their carrying values totheir expected realizable values by making an allowance for doubtfulreceivables as soon as the account is determined not to be fully collectible. Thisis done using management’s evaluation of the situation on a customer bycustomer basis. The Corporation’s assessment of outstanding receivables fromcustomers is primarily based on the Corporation’s assessment of the creditworthiness of the customer. The allowance is charged against earnings. Shortfallsin collections are applied against this provision. Estimates for the allowancefor doubtful debts are determined by a customer-by-customer evaluation ofcollectability at each balance sheet reporting date take into account theamounts that are past due and any available relevant information on thecustomers’ liquidity and going concern problems.

 

The Corporation’s tradereceivables have a carrying value of $3,661 as at December 31, 2008, representingthe maximum exposure to credit risk of those financial assets, exclusive of theallowance for doubtful accounts. Normal credit terms for amounts due fromcustomers call for payment within 30 to 60 days. An insignificant amount ofthese receivables were past due as at December 31, 2008.

 

The Corporation’s exposure tocredit risk for trade receivables by geographic area as at December 31, 2008was as follows:

 
| Europe        |   | 46  | % |
|---------------|--------|-----|---|
| United States |   | 13  | % |
| Asia          |   | 32  | % |
| Rest of world |   | 9   | % |
|          |   | 100 | % |

 

The activity of the allowance for doubtful accounts for the period isas follows:

 
| ** **                                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|
| Allowance for doubtful accounts — beginning  of period |       | $        | 351        |     | $          | 320 |   |
| Bad debt expense                                            |       | 126      |       | 191      |       |
| Write-off of bad debts                                      |       | (249     | )          | (160     | )          |
| Allowance for doubtful accounts — end of  period       |       | $        | 228        |     | $          | 351 |   |

 

The Corporation may also havecredit risk relating to cash and cash equivalents and restricted cash, which itmanages by dealing with large chartered Belgian, Canadian and German banks andinvesting in highly liquid investments. The Corporation’s objective is tominimize its exposure to credit risk in order to prevent losses on financialassets by placing its investments in lower risk bank acceptances of theseChartered banks. The Corporation’s cash and cash equivalents and restrictedcash carrying value is $22,731, representing the maximum exposure to creditrisk of these financial assets. Approximately 82% of the Corporation’s cash andrestricted cash at December 31, 2008 were held by four financialinstitutions. The Corporation’s exposure to credit risk relating to cash andcash equivalents and short-term investments, segmented by geographic area as atDecember 31, 2008, was as follows:

 
| Canada  |   | 37  | % |
|---------|--------|-----|---|
| Belgium |   | 54  | % |
| Germany |   | 9   | % |
|    |   | 100 | % |

 

**Foreigncurrency risk**

 

Foreign currency risk arisesbecause of fluctuations in exchange rates. The Corporation conducts asignificant portion of its business activities in foreign currencies, primarilyCanadian dollars and the euro. The Corporation’s objective in managing itsforeign currency risk is to minimize its net exposures to foreign currency cashflows by converting foreign denominated financial assets into the applicablefunctional currency of the subsidiary to the extent practical to match theobligations of its financial liabilities. Financial assets and financialliabilities denominated in foreign currencies will be affected by changes inthe exchange rate between

 

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

the US dollar and theseforeign currencies. The Corporation recognized foreign exchange gains in theyear ended December 31,2008 of $188 compared to foreign exchange gains of $2,617 in the yearended December 31, 2007.

 

If a shift in foreignexchange rates of 10% were to occur, the exchange gain or loss on the netfinancial assets could be plus or minus$1,704. This amount would be recorded in the consolidated statements ofoperations.

 

**Interestrate risk**

 

Interest rate risk arisesbecause of the fluctuation in market interest rates. The Corporation’s objectivein managing interest rate risk is to maximize the return on its cash and cashequivalents and restricted cash. The Corporation is subject to interest raterisk on its cash and cash equivalents and short-term investments; however, theCorporation does not have any long-term debt and hence is not subject tointerest rate risk from borrowings. If a shift in interest rates of 10% were tooccur, the impact on cash and cash equivalents, restricted cash, and short-terminvestments and the related net loss for the period could be plus or minus$100.

 

**Fair value**

 

The carrying value of cashand cash equivalents, restricted cash, accounts receivable, and accountspayable and accrued liabilities approximates their fair value given theirshort-term nature.

 

**Managementof capital**

 

The Corporation’s objectivein managing capital is to ensure sufficient liquidity to pursue its growthstrategy, fund research and product development, undertake selectiveacquisitions, while at the same time taking a conservative approach towardfinancial leverage and management of financial risk.

 

The Corporation’s capital iscomposed of share capital, contributed surplus, accumulated deficit and foreigncurrency translation adjustments included within accumulated othercomprehensive income (loss). The total capital as at December 31, 2008 is$25, 483. The Corporation’s primary uses of capital are to finance operatingcash flow, increases in non-cash working capital and capital expenditures. TheCorporation currently funds these requirements from internally generated cashflows and cash raised through past share issuances. The Corporation’sobjectives when managing capital are to ensure the Corporation will continue tohave enough liquidity so that it can provide its products and services to itscustomers and returns to its shareholders.

 

TheCorporation governs its capital on the basis of the adequacy of its cashresources to fund its business plan. In order to maximize its ability tofinance the Corporation’s ongoing growth, the Corporation does not currentlypay a dividend to holders of its common shares.

 

**NOTE 5 — BUSINESSSTREAMLINING INITIATIVES AND WIND UP OF TEST EQUIPMENT BUSINESS**

 

On March 20, 2007 and November 6,2007, the Corporation’s Board of Directors approved a restructuring andstreamlining of the Corporation’s operations in order to reduce its overallcost structure. In March 2007, the Corporation recorded a $2,100 chargefor severance and related expenses, which are included in selling, general andadministrative expenses. The major part of this charge pertained to the PowerSystems business segment.

 

In November 2007, theCorporation recorded an additional $1,990 charge for severance and relatedexpenses for these initiatives, which are included in selling, general andadministrative expenses as at December 31, 2007. These amounts werecharged to the business segments as follows: $846 for Power Systems; $142 forOnSite Generation; and $1,002 for Corporate and Other business segments. As at December 31,2008, the Corporation had paid $1,981 in respect of these charges. Theremaining balance of $9 at December 31, 2008 is anticipated to be paid in2009.

 

On November 7, 2007, theCorporation announced plans to wind up its fuel cell test products design, developmentand manufacturing business, due to lower than planned gross margin and growthprospects and not achieving certain operating targets. During the year ended December 31,2007, the Corporation incurred $2,016 in respect of severance and relatedexpenses, and the writeoff of inventory. Of the $2,016 recorded during the yearended December 31, 2007, no severance and related expenses remain unpaidat December 31, 2008.

 

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 6 -GOODWILL AND IMPAIRMENT CHARGES**

 

The Goodwill of $5,025relates to the OnSite Generation business acquisition in fiscal 2005.

 

During 2006, the Corporationperformed a comprehensive assessment of its business and operating plans. As aresult of theseassessments,and a resulting change in strategy, management revised its previous estimatesof the growth and development of its OnSite Generation business. In addition, management also determined thatthe revenues of the Test System business would be lower than previously anticipated as a resultof slower adoption of fuel cell technology in end user markets. Due to thesignificance of these changes,management performed an evaluation of the recoverability of the long-livedassets of the OnSite Generation andTest Systems segments and completed fair value impairment tests of the goodwillrelated to the OnSite Generation and Test Systems reporting units as at September 30, 2006, in addition toits annual impairment test at December 31, 2006.  

 

Based on the results of theseassessments, the Corporation recorded the following impairment charges in 2006:

 
| Goodwill of the OnSite Generation reporting  unit          |   | $      | 59,388 |   |
|------------------------------------------------------------|--------|--------|--------|--------|
| Intangible assets of the OnSite Generation  reporting unit |   | 26,333 |   |
| Goodwill of the Test Systems reporting unit                |   | 5,113  |   |
| **Total**                                                  |   | $      | 90,834 |   |

 

The fair value used in theimpairment charge calculations was determined using the Corporation’s bestestimates of future cash flows and considered the weighted average cost ofcapital for comparable companies.

 

The remaining identifiableintangible assets related to the Corporation’s OnSite Generation businesscomprised product technology, which continued to be amortized over its remaininguseful life.

 

**NOTE 7 -ACCOUNTS RECEIVABLE**

 
| ** **                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|
| Trade accounts receivable                             |       | $        | 3,661      |     | $          | 12,683 |   |
| Less: Allowance for doubtful accounts                 |       | (228     | )          | (351     | )          |
| Goods and services tax                                |       | 541      |       | 381      |       |
| Allowance for doubtful accounts – end of  period |       | $        | 3,974      |     | $          | 12,713 |   |

 

**NOTE 8 -INVENTORIES**

 
| ** **       | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------|------------|----------|------------|----------|------------|
| Raw materials    |       | $        | 4,938      |     | $          | 5,070 |   |
| Work-in-progress |       | 5,004    |       | 6,768    |       |
| Finished goods   |       | 159      |       | 821      |       |
|             |       | $        | 10,101     |     | $          | 12,659 |   |

 

During the year-ended December 31,2008, the Corporation recorded write-downs of approximately $1,298 (December 31,2007 – $811). During the period, approximately $29,851 of inventory wasexpensed in cost of sales (December 31, 2007 - $29,725).

 

F-19

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 9 -PROPERTY, PLANT AND EQUIPMENT**

 

As at December 31, 2008,the net book value of property, plant and equipment is as follows:

 
| ** **                     | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** **                   | ** ** |
|--------------------------------|------------|------------|------------|------------------|------------|------------------------------|------------|
| ** **                     | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **Net book Value** | ** ** |
| Test equipment                 |       | $          | 6,250      |             | $          | 5,336                        |       | $ | 914 |   |
| Furniture and equipment        |       | 4,679      |       | 2,471            |       | 2,208                        |       |
| Computer hardware and software |       | 2,619      |       | 1,874            |       | 745                          |       |
| Leasehold improvements         |       | 1,000      |       | 799              |       | 201                          |       |
| Automobiles                    |       | 43         |       | 29               |       | 14                           |       |
|                           |       | $          | 14,591     |             | $          | 10,509                       |       | $ | 4,082 |   |

 

As at December 31, 2007,the net book value of property, plant and equipment is as follows:

 
| ** **                     | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** **                   | ** ** |
|--------------------------------|------------|------------|------------|------------------|------------|------------------------------|------------|
| ** **                     | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **Net book Value** | ** ** |
| Test equipment                 |       | $          | 6,030      |             | $          | 4,544                        |       | $ | 1,486 |   |
| Furniture and equipment        |       | 4,192      |       | 2,141            |       | 2,051                        |       |
| Computer hardware and software |       | 2,829      |       | 1,870            |       | 959                          |       |
| Leasehold improvements         |       | 1,066      |       | 739              |       | 327                          |       |
| Automobiles                    |       | 69         |       | 45               |       | 24                           |       |
|                           |       | $          | 14,186     |             | $          | 9,339                        |       | $ | 4,847 |   |

 

Test equipment and furnitureand equipment under construction, as at December 31, 2008, not yet subjectto amortization amounted to $28 (2007 - $419). The net book value of equipmentunder capital lease as at December 31, 2008 was $33 (2007 - $49).

 

**NOTE 10 -INTANGIBLE ASSETS**

 

As at December 31, 2008,the carrying value of intangible assets is as follows:

 
| ** **         | ** ** | ** ** | ** ** | **Accumulated**         | ** ** | ** **                   | ** ** |
|--------------------|------------|------------|------------|-------------------------|------------|------------------------------|------------|
| ** **         | ** ** | ** ** | ** ** | **amortization**        | ** ** | ** **                   | ** ** |
| ** **         | ** ** | ** ** | ** ** | **and impairment** | ** ** | ** **                   | ** ** |
| ** **         | ** ** | **Cost**   | ** ** | **charge**              | ** ** | **Net book Value** | ** ** |
| Product technology |       | $          | 30,300     |                    | $          | 30,300                       |       | $ | — |   |
|                    |            |            |            |                         |            |                              |            |  |  |  |

 

As at December 31, 2007,the carrying value of intangible assets is as follows:

 
| ** **         | ** ** | ** ** | ** ** | **Accumulated**         | ** ** | ** **                   | ** ** |
|--------------------|------------|------------|------------|-------------------------|------------|------------------------------|------------|
| ** **         | ** ** | ** ** | ** ** | **amortization**        | ** ** | ** **                   | ** ** |
| ** **         | ** ** | ** ** | ** ** | **and impairment** | ** ** | ** **                   | ** ** |
| ** **         | ** ** | **Cost**   | ** ** | **charge**              | ** ** | **Net book Value** | ** ** |
| Product technology |       | $          | 30,300     |                    | $          | 30,051                       |       | $ | 249 |   |
|                    |            |            |            |                         |            |                              |            |  |  |  |

 

F-20

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Tableof Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 11 -ACCOUNTS PAYABLE AND ACCRUED LIABILITIES**

 
| ** **                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Trade accounts payable                      |       | $        | 4,506      |     | $          | 3,748 |   |
| Warranty liability accruals                 |       | 3,717    |       | 3,592    |       |
| Supplier accruals                           |       | 3,165    |       | 1,829    |       |
| Accrued payroll costs                       |       | 2,067    |       | 1,734    |       |
| Facility accruals                           |       | 1,400    |       | 1,975    |       |
| Severance and related compensation payments |       | 1,693    |       | 4,136    |       |
| Accrued professional fees                   |       | 433      |       | 487      |       |
| Provincial capital tax payable              |       | 25       |       | 195      |       |
| Current portion of long-term debt (note 11) |       | 10       |       | 16       |       |
| Other                                       |       | 282      |       | 454      |       |
|                                        |       | $        | 17,298     |     | $          | 18,166 |   |

 

Included within severance andrelated compensation payments is a post-retirement benefit obligation for$1,050. The liability is a defined benefit plan to be paid to a beneficiary. TheCorporation has valued the obligation based on estimates of future cash flows. Thekey assumptions used in this valuation are annual payments ($100) the expectedlife of the beneficiaries (approximately 11.5 years) and the discount rate (4%).The amount expensed in 2008 is $340.

 

Total severance and relatedexpenses included in Selling, General and Administration for 2008 was $nil (2007— $4,090).

 

Information regarding thechanges in the Corporation’s aggregate product warranty liabilities is asfollows for the year ended December 31, 2008:

 
| Balance, December 31, 2007                 |   | $      | 3,592  |   |
|-------------------------------------------------|--------|--------|--------|--------|
| Accruals for warranties issued during the  year |   | 2,332  |   |
| Settlements made during the year                |   | (1,499 | )      |
| Reversals of accruals during the year           |   | (708   | )      |
| Balance, December 31, 2008                 |   | $      | 3,717  |   |

 

**NOTE 12 -LONG-TERM DEBT**

 

The Corporation has variousequipment leases accounted for as capital leases. At December 31, 2008, theoutstanding amount payable, net of future payments representing interest, is$10 (2007 - $27). The Corporation has charged to expense interest of $1 in 2008(2007 - $2) on these capital leases at an effective weighted average interestrate of approximately 11% per annum.

 

The present value of futuredebt repayments is as follows:

 
| 2009                  |   | $   | 10     |   |
|-----------------------|--------|-----|--------|--------|
| Less: Current portion |   | (10 | )      |
|                  |   | $   | — |   |

 

F-21

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 13 - EMPLOYEESTOCK-BASED COMPENSATION**

 

**StockOption Plan**

 

During 2000, the Corporationadopted an employee stock option plan. As at December 31, 2008, the numberof common shares that may be issued under the stock option plan was 12,000,000.As at December 31, 2008, 3,144,340 common shares had been issued throughthe exercise of stock options under this plan. Up to 8,855,660 additionalcommon shares are available to be issued in connection with the exercise ofstock options. Of the 8,855,660 available common shares, 6,129,779 have beenissued as stock options that were outstanding at December 31, 2008. Alloptions are for a term of ten years from the date of grant and vest over fouryears unless otherwise determined by the Board of Directors.

 

A summary of the Corporation’semployee stock option plan activity is as follows:

 
| ** **                       | ** ** | **2008**           | ** ** | **2007**     | ** ** | **2006**           | ** ** |
|----------------------------------|------------|--------------------|------------|--------------|------------|--------------------|------------|
| ** **                       | ** ** | ** **         | ** ** | **Weighted** | ** ** | ** **         | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** **         | ** ** | **average**  | ** ** | ** **         | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                       | ** ** | ** **         | ** ** | **exercise** | ** ** | ** **         | ** ** | **exercise** | ** ** | ** ** | ** ** | **exercise** | ** ** |
| ** **                       | ** ** | **Number**         | ** ** | **price**    | ** ** | **Number**         | ** ** | **price** | ** ** | **Number** | ** ** | **price** | ** ** |
| ** **                       | ** ** | **of shares** | ** ** | **(CAN$)**   | ** ** | **of shares** | ** ** | **(CAN$)** | ** ** | **of shares** | ** ** | **(CAN$)** | ** ** |
| Outstanding, beginning of year   |       | 6,932,303          |       | 4.05         |       | 6,893,353          |       | 4.85 |   | 6,243,753 |   | 5.22 |   |
| Granted                          |       | 1,300,004          |       | 0.58         |       | 1,644,960          |       | 1.17 |   | 1,470,400 |   | 3.16 |   |
| Exercised                        |       | (639,980           | )          | 0.20         |       | —             |       | — |   | (236,500 | ) | 2.01 |   |
| Forfeited                        |       | (1,374,858         | )          | 4.17         |       | (1,250,810         | )          | 4.72 |   | (584,300 | ) | 5.73 |   |
| Expired                          |       | (87,690            | )          | 7.36         |       | (355,200           | )          | 5.65 |   | — |   | — |   |
| Outstanding, end of year         |       | 6,129,779          |       | 3.64         |       | 6,932,303          |       | 4.05 |   | 6,893,353 |   | 4.85 |   |
| Options exercisable, end of year |       | 4,043,830          |       | 4.96         |       | 4,333,740          |       | 4.47 |   | 4,518,681 |   | 5.32 |   |

 

The following tablesummarizes information about the Corporation’s share options outstanding as at December 31,2008:

 

All options granted after November 1,2000, the date of the Corporation’s initial public offering, have an exerciseprice equal to the closing share price on the Toronto Stock Exchange the dayprior to the grant.

 
| ** **                        | ** ** | **Number**              | ** ** | **Weighted**              | ** ** | **Weighted**         | ** ** | **Number**              | ** ** | **Weighted**         | ** ** |
|-----------------------------------|------------|-------------------------|------------|---------------------------|------------|----------------------|------------|-------------------------|------------|----------------------|------------|
| ** **                        | ** ** | **outstanding at** | ** ** | **average**               | ** ** | **average**          | ** ** | **exercisable at** | ** ** | **average**          | ** ** |
| ** **                        | ** ** | **December 31**    | ** ** | **remaining**             | ** ** | **share price** | ** ** | **December 31,**   | ** ** | **share price** | ** ** |
| **Exercise price CAN$** | ** ** | **2008**                | ** ** | **contractual life** | ** ** | **(CAN$)**           | ** ** | **2008**                | ** ** | **(CAN$)**           | ** ** |
| 0.01 - 0.29                       |       | 144,000                 |       | 1.07                      |       | 0.29                 |       | 144,000                 |       | 0.29                 |       |
| 0.30 - 1.00                       |       | 1,230,599               |       | 9.19                      |       | 0.58                 |       | 0                       |       | 0                    |       |
| 1.01 - 2.00                       |       | 1,652,375               |       | 7.55                      |       | 1.22                 |       | 1,044,186               |       | 7.15                 |       |
| 2.01 - 4.00                       |       | 631,050                 |       | 6.96                      |       | 3.22                 |       | 412,906                 |       | 6.28                 |       |
| 4.01 - 5.00                       |       | 597,800                 |       | 4.82                      |       | 4.47                 |       | 576,595                 |       | 4.47                 |       |
| 5.01 - 6.00                       |       | 516,008                 |       | 5.11                      |       | 5.70                 |       | 508,196                 |       | 5.70                 |       |
| 6.01 - 8.00                       |       | 288,617                 |       | 5.26                      |       | 6.60                 |       | 288,617                 |       | 6.60                 |       |
| 8.01 - 18.15                      |       | 1,069,330               |       | 2.56                      |       | 9.36                 |       | 1,069,330               |       | 9.36                 |       |
|                              |       | 6,129,779               |       | 6.21                      |       | 3.64                 |       | 4,043,830               |       | 4.96                 |       |

 

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Stock options granted toemployees during 2008 and 2007 are valued using the Black-Scholes optionpricing model with the following assumptions: risk-free interest rate 3.46% (2007— 4.11%), average expected life of four years, expected volatility 64% (2007 — 56%)and no dividends. The fair value of the stock options granted during 2008 was$387 (2007 - $773) (weighted average $0.30 per share) (2007 - $0.47) and therelated expense recognized in the consolidated statement of operations for theyear ended December 31, 2008 was $694 ($0.01 per share on a basic anddiluted basis) (2007 - $1,553, 2006 - $1,832).

 

**DeferredShare Unit Plan**

 

In 2004, the Board ofDirectors authorized a deferred share unit plan (“DSU Plan”) for directors. Pursuantto the DSU Plan, non-employee directors are entitled to receive all or anyportion of their annual cash retainer and meeting fees in the form of deferredshare units (“DSUs”) instead of cash. In addition, the Board of Directors may, atits discretion, make annual awards to non-employees of DSUs as, or in lieu of, non-cashcompensation. As a result of the implementation of the DSU Plan, directors arenot eligible to receive additional awards of stock options. A DSU is a unit, equivalentin value to a common share of the Corporation, credited by means of abookkeeping entry in the books of the Corporation, to an account in the name ofthe non-employee director. Each DSU entitles the participant to receive a cashpayment or common shares, at the option of the Corporation, upon termination ofdirectorship in an amount calculated with reference to the trading price of aHydrogenics common share on the Toronto Stock Exchange on the date oftermination. Compensation cost for DSUs granted under the DSU Plan is recordedas an expense with a corresponding increase in accrued liabilities and ismeasured at intrinsic value. Changes in intrinsic value between the grant dateand the measurement date result in a change in the measure of compensationcost.

 

During the year ended December 31,2008, 336,755 (2007- 335,420) DSUs were issued with immediate vesting on thedate of issuance. As at December 31, 2008, 750,103 (2007- 443,418) DSUswere outstanding under the DSU Plan. As a result, the Corporation recognized acompensation expense (recovery) of $(170) for the year ended December 31, 2008(2007 - $281; 2006 - $315) as a result of the reduction in the intrinsic valueof the DSUs between the grant date and the measurement date.

 

**RestrictedShare Unit Plan**

 

In 2008, the Board ofDirectors authorized a restricted share unit (“RSU Plan”) for senior executives.Pursuant to the RSU Plan, senior executives may be granted a portion of theirlong term incentive plan in the form of restricted share units (“RSUs”) insteadof stock options.

 

A RSU is a unit, equivalentin value to a common share of the Corporation, credited by means of abookkeeping entry in the books of the Corporation, to an account in the name ofthe senior executive. Each RSU entitles the participant to receive a cashpayment no later than December 31 of the third calendar year following theyear in respect of which the RSUs were granted. Compensation cost for RSUsgranted under the RSU Plan is recorded as an expense with a correspondingincrease in accrued liabilities and is measured at intrinsic value. Changes inintrinsic value between the grant date and the measurement date result in achange in the measure of compensation cost.

 

During the year ended December 31,2008, 1,287,500 (2007 — nil) RSUs were awarded with vesting over a three yearperiod. As at December 31, 2008, 1,287,500 (2007 - nil) RSUs wereoutstanding under the RSU Plan. As a result, the Corporation recognized acompensation expense of $113 for the year ended December 31, 2008 (2007 -$nil, 2006 - $nil).

 

**NOTE 14 -RESEARCH AND PRODUCT DEVELOPMENT**

 

Research and productdevelopment expenses are recorded net of third party program funding receivedor receivable. For 2008, 2007 and 2006, research and product developmentexpenses and program funding, which have been received or are receivable asfollows:

 
| ** **                                       | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Research and product development expenses        |       | $        | 8,716      |     | $          | 10,346   |       | $ | 12,024 |   |
| Research and product development funding         |       | (1,420   | )          | (656     | )          | (2,645   | )          |
| Total research and product development  expenses |       | $        | 7,296      |     | $          | 9,690    |       | $ | 9,379 |   |

 

F-23

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 15 -COMMITMENTS**

 

The Corporation incurredrental expenses of $1,856 under operating leases in 2008 (2007 - $1,823; 2006 -$1,120). The Corporation has future minimum lease payments under operatingleases relating to premises and office equipment as follows:

 
| 2009       |   | $     | 1,556     |   |
|------------|--------|-------|-----------|--------|
| 2010       |   | 970   |      |
| 2011       |   | 544   |      |
| 2012       |   | 422   |      |
| 2013       |   | 391   |      |
| Thereafter |   | 229   |      |
| ** ** |   | **$** | **4,112** |   |

 

The Corporation has enteredinto repayable contribution and other research and development arrangementswith various Canadian governmental ministries and public sector enterprises. Underthese arrangements, the Corporation is eligible to receive up to $10,927 (2007- $13,430; 2006 - $12,051) toward agreed upon research and development projectcosts. The amount received or receivable as at December 31, 2008 was$10,927 (2007 - $13,430; 2006 - $11,594). These arrangements will expire instages ending on March 31, 2016 or when total amounts repaid reach theutilized amount of the advance, depending on the terms of the individualcontracts.

 

**NOTE 16 -CONTINGENCIES**

 

As at December 31, 2008,the Corporation has outstanding standby letters of credit and letters ofguarantee issued by several financial institutions, which total $2,306 (December 31,2007 - $5,213) with expiry dates extending to October 2011. TheCorporation has restricted cash totaling $1,130 as partial security for thesestandby letters of credit and letters of guarantee. These instruments relateprimarily to obligations in connection with the terms and conditions of theCorporation’s sales contracts. The standby letters of credit and letters ofguarantee may be drawn upon by the customer if the Corporation fails to performits obligations under the sales contracts and the Corporation would be liableto the financial institution for the amount of the standby letter of credit orletter of guarantee in the event that the instruments are drawn.

 

In 1998, Stuart Energy, now awholly-owned subsidiary of the Corporation, entered into an agreement withTechnologies Partnerships Canada (“TPC”), a program of Ministry of Industry ofthe Government of Canada to develop and demonstrate Hydrogen Fleet FuelAppliances. This agreement was amended in 2003 to expand the scope of work andresulted in Stuart Energy receiving a total of $5,600 of funding from TPC. Pursuantto the amended TPC agreement, Stuart Energy undertook to repay $14,200 (the “RepayableLoan Amount”). The amended agreement requires Stuart Energy to commence makingroyalty payments on the earlier of Stuart Energy reaching a minimum of CAD$90,000 in annual gross business revenues or April 1, 2007. In accordancewith the terms of the agreement, Stuart Energy is required to commence paymentsto TPC at 0.53% of its annual gross business revenues for a period of 12 yearsor until the Repayable Loan Amount is fully repaid. To date, the Corporationhas recognized $42,800 million in revenues and recorded a repayable amount of$227.

 

The Corporation has enteredinto indemnification agreements with its current and former directors andofficers to indemnify them, to the extent permitted by law, against any and allcharges, costs, expenses, amounts paid in settlement and damages incurred bythe directors and officers as a result of any lawsuit or any other judicial, administrativeor investigative proceeding in which the directors and officers are sued as aresult of their service. These indemnification claims will be subject to anystatutory or other legal limitation period. The nature of the indemnificationagreements prevents the Corporation from making a reasonable estimate of themaximum potential amount it could be required to pay to counterparties. TheCorporation has purchased directors’ and officers’ liability insurance. TheCorporation is unaware of any actions with respect to these agreements. Noamount has been recorded in the consolidated financial statements with respectto these indemnification agreements.

 

In the normal course ofoperations, the Corporation may provide indemnification agreements, other thanthose noted above, to counterparties that would require the Corporation tocompensate them for costs incurred as a result of changes in laws andregulations or as a result of litigation claims or statutory sanctions that maybe suffered by the counterparty as a

 

F-24

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Tableof Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

** **

consequence of thetransaction. The terms of these indemnification agreements will vary based onthe contract. The natureofthe indemnification agreements prevents the Corporation from making areasonable estimate of the maximum potential amount it could be required to pay to counterparties. The Corporation isunaware of any actions pursuant to these agreements. No amount has been recorded in theconsolidated financial statements with respect to these indemnificationagreements.  

 

**NOTE 17 -LINES OF CREDIT**

 

The Corporation has operatinglines of credit available up to $11,535 in total (2007—$13,788). As of December 31,2008 and 2007, the Corporation has no indebtedness on these lines of credit. Theoperating facilities are denominated in Canadian dollars and bear interest atthe Royal Bank of Canada prime rate plus 0.5% and EURIBOR, respectively. Thefacility is due on demand and collateralized by a general security agreementover all assets. The Corporation’s lines of credit available are reduced by theamount of outstanding standby letters of credit and letters of guarantee, ifany issued from time to time by several financial institutions.

 

**NOTE 18 -RELATED PARTY TRANSACTIONS**

 

In the normal course ofoperations, the Corporation subcontracts certain manufacturing functions to acorporation owned by a relative of one of the principal shareholders of theCorporation. Billings by this related corporation for material totalled $220 in2008 (2007 - $823; 2006 - $968). At December 31, 2008, the Corporation hasan accounts payable balance due to this related party of $34 (2007 - $58; 2006- $1). All related party transactions have been recorded at the exchange amount,which is the consideration paid or received as established and agreed to by therelated parties. The cost of these transactions reflect price and terms whichare in accordance with normal trade practices.

 

**NOTE 19 -INCOME TAXES**

 

As at December 31, 2008,the Corporation has available income tax loss carryforwards of $222,719 thatmay be used to reduce taxable income in future years, expiring as follows:

 
| 2009      |   | $      | 33,049  |   |
|-----------|--------|--------|---------|--------|
| 2010      |   | 15,128 |    |
| 2013      |   | 19,757 |    |
| 2014      |   | 35,335 |    |
| 2015      |   | 21,545 |    |
| 2026      |   | 18,716 |    |
| 2027      |   | 22,701 |    |
| 2028      |   | 11,375 |    |
| No expiry |   | 45,113 |    |
|      |   | $      | 222,719 |   |

 

As at December 31, 2008,the Corporation has unclaimed scientific research and experimental developmentexpenditures of $27,355 (2007 - $30,108) that can be used to offset futureincome over an indefinite period. The Corporation also has non-refundableinvestment tax credits amounting to approximately $6,775 (2007 - $7,690) thatcan be used to reduce future federal income taxes payable, expiring between2020 and 2026.

 

F-25

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

** **

Components of theCorporation’s net future income tax asset, which are primarily arising inCanada, are:

 
| ** **                                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Assets**                                                 |       |     |       |     |       |
| Non-capital losses                                         |       | $        | 66,844     |     | $          | 87,122 |   |
| Scientific research and experimental  development expenses |       | 7,835    |       | 8,731    |       |
| Property, plant and equipment and  intellectual property   |       | 12,321   |       | 15,140   |       |
| Investment tax credits                                     |       | 5,759    |       | 6,536    |       |
| Warranty and other provisions                              |       | 533      |       | 937      |       |
| Share issue costs                                          |       | (201     | )          | (145     | )          |
| Valuation allowance                                        |       | (93,091  | )          | (118,321 | )          |
| Net future income tax asset                                |       | $        | —     |     | $          | — |   |

 

The Corporation has recordeda valuation allowance to reflect uncertainties associated with the realizationof all future income tax assets.

 

TheCorporation’s computation of income tax expense is as follows:

 
| ** **                                                                                                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Loss before income taxes                                                                                      |       | $        | (14,203    | )        | $          | (28,046  | )          | $ | (130,939 | ) |
| Statutory income tax rate                                                                                     |       | 33.50    | %          | 36.12    | %          | 32.96    | %          |
| Income tax recovery at statutory rate                                                                         |       | (4,758   | )          | (10,130  | )          | (43,157  | )          |
| Non-deductible expenses                                                                                       |       | 185      |       | 433      |       | 497      |       |
| Other permanent and temporary differences                                                                     |       | 1,018    |       | 24       |       | (359     | )          |
| Expiry of non-capital losses                                                                                  |       | 7,438    |       | —   |       | —   |       |
| Effect of income tax and rate changes on  future income taxes                                                 |       | (1,111   | )          | 10,651   |       | 6,635    |       |
| Effect foreign currency rate changes on  future income taxes                                                  |       | 21,119   |       | (15,528  | )          | —   |       |
| Currency effect of difference in US dollar  financial reporting compared with CAN dollar income tax reporting |       | 1,340    |       | (1,390   | )          | 1,410    |       |
|                                                                                                          |       |     |       |     |       |     |       |
| Foreign exchange gain on CAN dollar  denominated future income taxes                                          |       | —   |       | —   |       | (34      | )          |
| Change in valuation allowance related to  the current year                                                    |       | (25,230  | )          | 15,940   |       | 5,065    |       |
| Writedown of intangible assets and goodwill                                                                   |       | —   |       | —   |       | 29,943   |       |
| Other                                                                                                         |       | $        | 116        |     | $          | 22       |       | $ | (180 | ) |
| Income tax expense (recovery)                                                                                 |       | 116      |       | 22       |       | (180     | )          |

 

**NOTE 20 -NET LOSS PER SHARE**

 

Net loss per share iscalculated using the weighted average number of common shares outstanding forthe year of 92,080,656 shares in 2008 (2007 - 91,797,911; 2006 - 91,816,049). Noeffect has been given to the potential exercise of stock options and warrantsin the calculation of diluted net loss per share as the effect would beanti-dilutive.

 

F-26

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Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

** **

**NOTE 21 - CHANGES IN NON-CASH WORKING CAPITAL**

Components of the net changein non-cash working capital are as follows:

 
| ** **                                     | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Decrease (increase) in current assets**      |       |     |       |     |       |     |       |
| Accounts receivable                            |       | $        | 7,335      |     | $          | (2,687   | )          | $ | (2,305 | ) |
| Grants receivable                              |       | 320      |       | 1,290    |       | (64      | )          |
| Inventories                                    |       | 2,558    |       | 59       |       | (4,033   | )          |
| Prepaid expenses and other current assets      |       | (89      | )          | 507      |       | 814      |       |
|                                           |       |     |       |     |       |     |       |
| **Increase (decrease) in current liabilities** |       |     |       |     |       |     |       |
| Accounts payable and accrued liabilities       |       | (1,050   | )          | (3,486   | )          | 5,580    |       |
| Unearned revenue                               |       | (4,257   | )          | 217      |       | 5,037    |       |
|                                           |       | $        | 4,817      |     | $          | (4,100   | )          | $ | 5,029 |   |

 

**NOTE 22 -SEGMENTED FINANCIAL INFORMATION**

 

The Corporation’s reportablesegments include: (i) OnSite Generation; (ii) Power Systems; and (iii) TestSystems. Where applicable, corporate and other activities are reportedseparately as Corporate and Other. Accordingly, operating segments have changedfrom prior years and all years have been restated to reflect the neworganization.

 

OnSite Generation includesthe design, development, manufacture, and sale of hydrogen generation products.Power Systems includes the design, development, manufacture, and sale of fuelcell products. Test Systems includes the manufacturing and sale of fuel celltest products and diagnostic testing services.

 

Financial information byreportable segment for the years ended December 31, 2008, 2007 and 2006 isas follows:

 
| ** **                                     | ** ** | **Year  ended December 31, 2008** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **OnSite**                             | ** ** | **Power** | ** ** | **Test** | ** ** | **Corporate** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Generation**                         | ** ** | **Systems** | ** ** | **Systems** | ** ** | **and Other** | ** ** | **Total** | ** ** |
| Revenue from external customers                |       | $                                      | 31,207     |   | $ | 5,643 |   | $ | 2,490 |   | $ | — |   | $ | 39,340 |   |
| Amortization of intangible assets              |       | —                                 |       | — |   | — |   | 249 |   | 249 |   |
| Impairment charge                              |       | —                                 |       | — |   | — |   | — |   | — |   |
| Amortization of property, plant and  equipment |       | —                                 |       | — |   | — |   | 855 |   | 855 |   |
| Interest income                                |       | —                                 |       | — |   | — |   | 940 |   | 940 |   |
| Interest expense                               |       | —                                 |       | — |   | — |   | (17 | ) | (17 | ) |
| Income tax expense                             |       | —                                 |       | — |   | — |   | 116 |   | 116 |   |
| **Segment income (loss) (i)**                  |       | $                                      | 2,106      |   | $ | (9,757 | ) | $ | (469 | ) | $ | (6,199 | ) | $ | (14,319 | ) |

 

F-27

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Tableof Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 
| ** **                                     | ** ** | **Year  ended December 31, 2007** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **OnSite**                             | ** ** | **Power** | ** ** | **Test** | ** ** | **Corporate** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Generation**                         | ** ** | **Systems** | ** ** | **Systems** | ** ** | **and Other** | ** ** | **Total** | ** ** |
| Revenue from external customers                |       | $                                      | 19,608     |   | $ | 6,103 |   | $ | 12,279 |   | $ | — |   | $ | 37,990 |   |
| Amortization of intangible assets              |       | —                                 |       | — |   | — |   | 251 |   | 251 |   |
| Amortization of property, plant and  equipment |       | —                                 |       | — |   | — |   | 903 |   | 903 |   |
| Interest income                                |       | —                                 |       | — |   | — |   | 2,301 |   | 2,301 |   |
| Interest expense                               |       | —                                 |       | — |   | — |   | (52 | ) | (52 | ) |
| Income tax expense                             |       | —                                 |       | — |   | — |   | 22 |   | 22 |   |
| **Segment loss (i)**                           |       | $                                      | (5,436     | ) | $ | (14,283 | ) | $ | (1,465 | ) | $ | (6,884 | **)** | **$** | (28,068 | ) |

 
| ** **                                     | ** ** | **Year  ended December 31, 2006** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **OnSite**                             | ** ** | **Power** | ** ** | **Test** | ** ** | **Corporate** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Generation**                         | ** ** | **Systems** | ** ** | **Systems** | ** ** | **and Other** | ** ** | **Total** | ** ** |
| Revenue from external customers                |       | $                                      | 12,032     |   | $ | 6,943 |   | $ | 11,084 |   | $ | — |   | $ | 30,059 |   |
| Amortization of intangible assets              |       | —                                 |       | — |   | — |   | 7,139 |   | 7,139 |   |
| Impairment charge                              |       | —                                 |       | — |   | — |   | 90,834 |   | 90,834 |   |
| Amortization of property, plant and  equipment |       | —                                 |       | — |   | — |   | 1,948 |   | 1,948 |   |
| Interest income                                |       | —                                 |       | — |   | — |   | 3,607 |   | 3,607 |   |
| Interest expense                               |       | —                                 |       | — |   | — |   | (56 | ) | (56 | ) |
| Income tax recovery                            |       | —                                 |       | — |   | — |   | (180 | ) | (180 | ) |
| **Segment income (loss) (i)**                  |       | $                                      | (14,885    | ) | $ | (7,182 | ) | $ | 279 |   | $ | (108,971 | ) | $ | (130,759 | ) |

 

----

(i) Segmentloss includes directly attributable selling, general and administration costs, productresearch and development costs net of associated grants, amortization ofproperty, plant and equipment and amortization of intangible assets.

 

The accounting policies forinter-segment transactions are the same as those described in note 2.

 

Intangible assets andgoodwill relating to the Corporation’s OnSite Generation segment as at December 31,2008 were $nil and $5,025 (2007 - $249 and $5,025), respectively. TheCorporation currently does not allocate its remaining assets among reportablesegments.

 

A significant portion of theCorporation’s intangible assets and goodwill are common across the locations. Therefore,management does not classify intangible assets and goodwill on a locationbasis.

 

F-28

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Tableof Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Revenues and cost of revenuesderived from products and services are as follows:

 
| ** **           | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------|------------|------------|------------|------------|------------|------------|------------|
| **Revenues**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Products             |       | $          | 38,693     |       | $          | 34,486     |       | $ | 26,653 |   |
| Services             |       | 647        |       | 3,504      |       | 3,406      |       |
|                 |       | $          | 39,340     |       | $          | 37,990     |       | $ | 30,059 |   |
|                 |       |       |       |       |       |       |       |
| **Cost of revenues** |       |       |       |       |       |       |       |
| Products             |       | $          | 31,090     |       | $          | 32,402     |       | $ | 28,114 |   |
| Services             |       | 356        |       | 1,199      |       | 1,246      |       |
|                 |       | $          | 31,446     |       | $          | 33,601     |       | $ | 29,360 |   |

 

Revenues are segmented bygeography, as follows:

 
| ** **           | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|
| Russia               |       | $        | 12,927     |     | $          | 5,629    |       | $ | 68 |   |
| United States        |       | 8,428    |       | 5,609    |       | 8,140    |       |
| Belgium              |       | 2,020    |       | —   |       | 319      |       |
| Spain                |       | 1,815    |       | 138      |       | 1,445    |       |
| Saudi Arabia         |       | 1,790    |       | —   |       | —   |       |
| Sweden               |       | 1,600    |       | 119      |       | 849      |       |
| China                |       | 1,351    |       | 1,435    |       | 266      |       |
| Korea                |       | 1,271    |       | 1,070    |       | 2,499    |       |
| France               |       | 1,144    |       | 2,633    |       | 3,163    |       |
| United Kingdom       |       | 1,076    |       | 552      |       | 877      |       |
| Brazil               |       | 712      |       | 2,017    |       | —   |       |
| Germany              |       | 655      |       | 1,395    |       | 2,471    |       |
| Poland               |       | 639      |       | —   |       | —   |       |
| Canada               |       | 534      |       | 4,378    |       | 2,163    |       |
| Japan                |       | 492      |       | 2,256    |       | 2,841    |       |
| Romania              |       | 83       |       | 277      |       | 1,367    |       |
| United Arab Emirates |       | 20       |       | 1,255    |       | —   |       |
| Argentina            |       | 8        |       | 2,010    |       | —   |       |
| Slovenia             |       | 3        |       | 1,275    |       | —   |       |
| Rest of world        |       | 2,772    |       | 5,942    |       | 3,591    |       |
|                 |       | $        | 39,340     |     | $          | 37,990   |       | $ | 30,059 |   |

 

F-29

----

Tableof Contents

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

The Corporation’s largestcustomers comprise the following percentages of revenues:

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| ** ** | ** ** | **%**    | ** ** | **%**    | ** ** | **%**    | ** ** |
| First      |       | 18       |       | 12       |       | 12       |       |
| Second     |       | 7        |       | 5        |       | 10       |       |
| Third      |       | 5        |       | 5        |       | 5        |       |
| Fourth     |       | 5        |       | 4        |       | 4        |       |
| Others     |       | 65       |       | 74       |       | 69       |       |
|       |       | 100      |       | 100      |       | 100      |       |

 

Property, plant and equipmentare located in the following countries:

 
| ** ** | ** ** | **2008** | ** **  | **2007** |   |
|------------|------------|----------|-------------|----------|--------|
| Canada     |       | $        |  2,100 |     | $      |  2,998 |   |
| Belgium    |       | 1,982    |        | 1,849    |   |
|       |       | $        | 4,082       |     | $      | 4,847 |   |

 

A significant portion of theCorporation’s production, testing, equipment, and facilities are common acrossthe segments. Therefore, management does not classify asset information on asegmented basis.

 

**NOTE 23 -DIFFERENCES BETWEEN CANADIAN AND UNITED STATES ACCOUNTING PRINCIPLES**

 

The Corporation’sconsolidated financial statements have been prepared in accordance withCanadian GAAP, which differs in certain respects from those principles that theCorporation would have followed had its consolidated financial statements beenprepared in accordance with US GAAP.

 

A reconciliation of net lossfor the year from Canadian GAAP to conform with US GAAP is as follows:

 
| ** **                                                                              | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Net loss for the year based on Canadian  GAAP                                           |       | $          | (14,319    | )          | $          | (28,068    | )          | $ | (130,759 | ) |
| Impairment charge related to intangible  assets                                         |       | —     |       | —     |       | 13,800     |       |
| Stock-based compensation (i)                                                            |       | 88         |       | —     |       | —     |       |
| Amortization of in-process research and product  development (ii)                       |       | —     |       | —     |       | 1,971      |       |
| Net loss for the year based on US GAAP                                                  |       | $          | (14,231    | )          | $          | (28,068    | )          | (114,988 | ) |
| Basic and fully diluted comprehensive net  loss per share based on US GAAP              |       | $          | (0.15      | )          | $          | (0.31      | )          | $ | (1.26 | ) |
| Weighted average number of shares used in calculating  comprehensive net loss per share |       | 92,080,656 |       | 91,797,911 |       | 91,816,049 |       |

 

A reconciliation of Shareholders’ Equity at December 31,2008 is as follows:

 
| ** **                                                                | ** ** | **2008** | ** **   | **2007** | ** ** | **2006**     | ** ** |
|---------------------------------------------------------------------------|------------|----------|--------------|----------|------------|--------------|------------|
| Shareholders’ Equity based on Canadian GAAP |       | $        |  25,483 |     | $          |  40,384 |       | $ |  66,757 |   |
| Shareholders’ Equity based on US GAAP                                |       | $        | 25,571       |     | $          | 40,384       |       | $ | 66,757 |   |

 

F-30

----

Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

The Condensed Statements ofOperations and Cash Flows for the years ended December 31, under US GAAP, areas follows:

 
| ** **                                       | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues                                         |       | $        | 39,340     |     | $          | 37,990   |       | $ | 30,059 |   |
| Cost of revenues                                 |       | 31,446   |       | 33,601   |       | 29,360   |       |
| Operating expenses                               |       | 23,334   |       | 36,866   |       | 120,757  |       |
| Loss from operations                             |       | (15,440  | )          | (32,477  | )          | (120,058 | )          |
| Net loss for the year                            |       | (14,231  | )          | (28,068  | )          | (114,988 | )          |
|                                             |       |     |       |     |       |     |       |
| Cash used in operating activities                |       | (6,758   | )          | (28,416  | )          | (24,488  | )          |
| Cash provided by investing activities            |       | 13,017   |       | 37,987   |       | 24,822   |       |
| Cash provided by (used in) financing  activities |       | (118     | )          | (48      | )          | 209      |       |
|                                                  |            |          |            |          |            |          |            |  |  |  |

 

(i) **In-process Research and Development**

 

Under US GAAP, in-processresearch and development acquired in a business combination is written off atthe time of acquisition. Under Canadian GAAP, in-process research anddevelopment is capitalized and amortized over the estimated useful life. In-processresearch and development is included in product technology.

 

A reconciliation ofadditional disclosures to conform with US GAAP is as follows:

 

**Consolidatedstatements of cash flows**

 

The consolidated statementsof cash flows have been prepared in accordance with International AccountingStandard 7, ‘Cash flow statements.’ As a result, a reconciliation to US GAAP isnot required.

 

**Businessacqusitions**

 

Stuart Energy SystemsCorporation (“Stuart Energy”) was acquired on January 6, 2005. The acquisitionprovided the foundation for the Corporation’s hydrogen generation business andcomplemented the Corporation’s other Onsite Hydrogen Generation offerings basedon PEM electrolysis and natural gas reforming. The intangible assets acquiredpursuant to the Stuart Energy acquisition and the related amortization periodsare as follows:

 
| ** **             | ** ** | **Amount at**   | ** ** | **Estimated**   | ** ** |
|------------------------|------------|----------------------|------------|-----------------|------------|
| ** **             | ** ** | **Acquisition date** | ** ** | **useful life** | ** ** |
| Product technology     |       | $                    | 30,300     |            | 4-7 years  |   |
| Customer relationships |       | 7,600                |       | 8 years         |       |
| Trade names            |       | 500                  |       | 3 years         |       |
| ISO certificates       |       | 100                  |       | 1 year          |       |
|                   |       | $                    | 38,500     |            |       |   |

 

During 2006, the Corporationperformed a comprehensive assessment of its business and operating plansresulting in a corresponding impairment charge of $26,333. The remainingidentifiable intangible assets related to the Corporation’s OnSite Generationbusiness comprise product technology, which will continue to be amortized overits remaining useful life of five years. The goodwill acquired as part of theacquisition was included in the OnSite Generation segment and was not taxdeductible.

 

As part of the Stuart Energyacquisition, $18,400 of in-process research and development (“IPR&D”) wasacquired. The IPR&D related to improvements to Stuart Energy’s existingtechnology and was to result in the launch of new product models over the nextseveral years.

 

F-31

----

Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Businessstreamlining initiatives and windup of test equipment business**

 

The Corporation expects toincur maximum further charges of approximately $900 after December 31, 2008relating to the windup of the test equipment business.

 

In 2007, the loss on disposalof property, plant and equipment of $308 is classified in operating expensesunder US GAAP. In addition, approximately $400 of charges related to thewrite-down of inventory in connection with the windup are classified as cost ofrevenues under US GAAP.

 

**Sharecapital**

 

The share capital of theCorporation has a nominal par value.

 

**Revenues**

 

Sales taxes collected areexcluded from revenues.

 

**Stock-basedcompensation**

 

The Corporation adopted theprovisions of FAS 123R “Share Based Payments” for US GAAP effective January 1,2006. Shares are issued from treasury upon exercise. No income tax benefit isrecorded in the consolidated statement of operations for these costs.

 

The total intrinsic value ofoptions exercised during the year ended December 31, 2008, 2007 and 2006was approximately $5, nil, and $259 respectively. As of December 31, 2008,there was approximately $325 (December 31, 2007 - $912) of unrecognizedcompensation cost related to stock option awards that is expected to berecognized as expense over a weighted average period of 2.6 years (2007 - 2.6years). The total fair value of stock options that vested during the yearsended December 31, 2008, 2007 and 2006, was approximately $1,329, $1,502and $1,521 respectively.

 

The total intrinsic value ofoptions outstanding as at December 31, 2008 was $25 (December 31, 2007- $572). The total intrinsic value of options exercisable as at December 31,2008 was $25 (December 31, 2007 - $572). The total number of options fullyvested at December 31, 2008 and expected to vest beyond December 31, 2008was 5,516,801 (December 31, 2007-6,497,901). The total intrinsic value ofthese options was $25 at December 31, 2008 ($572 - December 31, 2007)with a weighted average contractual term of 6.2 years (2007 - 6.0 years) and aweighted average exercise price of $3.64 (2007 - $4.05). The weighted averagecontractual term of the options exercisable is 5.0 years (2007 - 4.4 years).

 

The Corporation’s estimate ofan expected option term is based on the exercise behavior of our employees. Theestimated stock price volatility was derived based upon the Corporation’sactual historic stock prices over the past four years, which represents theCorporation’s best estimate of expected volatility. The risk free interest ratefor periods within the contractual life of the award is based on the interestrates of government bonds with similar contractual lives.

 

Deferred share units (“DSUs”)granted to non-employee directors during 2008, 2007, and 2006, are valued usingthe Black-Scholes option pricing model with assumptions materially consistentwith those used to value stock options. In 2008, 2007 and 2006, 336,755, 335,420,and 94,224 DSUs were granted. In 2008, 18,461 DSUs were exercised (2007 -98,049).

 

**IncomeTaxes**

 

The components of loss beforeincome taxes for the years ended December 31, 2008, 2007 and 2006 are asfollows:

 

**Loss before income taxes**

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Canada     |       | $        | (14,471    | )        | $          | (24,834  | )          | $ | (118,137 | ) |
| Foreign    |       | 268      |       | (3,212   | )          | (12,802  | )          |
| Total      |       | $        | (14,203    | )        | $          | (28,046  | )          | $ | (130,939 | ) |

 

F-32

----

Tableof Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Thesignificant components of the income tax benefit for the years ended December 31,2008, 2007 and 2006 are as follows:

 

**Current taxes**

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Canada     |       | $        | —     |     | $          | —   |       | $ | (180 | ) |
| Foreign    |       | 116      |       | 22       |       | —   |       |
| Total      |       | $        | 116        |     | $          | 22       |       | $ | (180 | ) |

 

**Future income taxes**

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Canada     |       | $        | —     |     | $          | —   |       | $ | — |   |
| Foreign    |       | $        | —     |     | $          | —   |       | $ | — |   |
| Total      |       | $        | —     |     | $          | —   |       | $ | — |   |

 

The Corporation adopted theprovisions of FIN 48, “Accounting for Uncertainty in Income Taxes anInterpretation of FASB Statement No. 109,” on January 1, 2007. At December 31,2008, the Corporation does not have any uncertain tax filing positions. As aresult, the Corporation has included all of its tax benefits in its disclosureof future income tax assets. There are no significant changes to thisassessment of uncertain tax filing positions anticipated within the next 12months.

 

The Corporation recognizesaccrued interest and penalties related to unrecognized tax benefits as acomponent of income tax expense. This accounting policy did not change as aresult of the adoption of FIN 48. During the year ended December 31, 2008,the Corporation recognized $nil in interest and penalties (2007-$nil). TheCorproation had $nil of interest and penalties accrued at December 31, 2008(December 31, 2007- nil).

 

The Corporation files incometax returns in the Canadian federal jurisdiction and various provincial andforeign jurisdictions. In the normal course of business, the Corporation issubject to examination by taxing authorities. Open tax years in Canada rangefrom 2003 to 2008. Open tax years in foreign jurisdictions range from 2006 to2008. However, upon examination in subsequent years, if net operating losscarry forwards and tax credit carry forwards are utilized, the Canadian andforeign jurisdictions can reduce net operating loss carry forwards and taxcredit carry forwards utilized in the year being examined if they do not agreewith the carry forward amount. As of December 31, 2008, the Corporationwas not under audit in Canada or non-Canadian taxing jurisdiction.

 

F-33

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**ITEM 19.       EXHIBITS**

 
| **Number** | ** **   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 1.1        |         | Articles of the Company (incorporated by  reference from Exhibit 3.1 to Amendment No. 4 to the Company’s  Registration Statement on Form F-1, File No. 333-42682, filed with  the Securities and Exchange Commission on October 13, 2000)*                                                                                                                                                                                                                                      |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 1.2        |         | By-laws of the Company dated May 7,  2008                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 2.1        |         | Form of share certificate  (incorporated by reference from Exhibit 4.1 to Amendment No. 5 to  the Company’s Registration Statement on Form F-1, File  No. 333-42682, filed with the Securities and Exchange Commission on  October 23, 2000)*                                                                                                                                                                                                                              |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.1        |         | Stock Option Plan dated June 22, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.2        |         | Restricted Share Unit Plan dated June 22, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.3        |         | Deferred Share Unit Plan dated June 22, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.4        |         | Lease, dated June 23, 2000 (as amended  by a Lease Extension Agreement dated February 10, 2005), by and between  Orlando Corporation and the Company                                                                                                                                                                                                                                                                                                                                                |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.5        |         | Support Agreement dated June 11, 2009,  among the Company, the Trustees of Algonquin Power Income Fund and 7188501  Canada Inc. (incorporated by reference from Exhibit 99.2 to the  Company’s Report of Foreign Private Issuer on Form 6-K, File  No. 000-31815, filed with the Securities and Exchange Commission on  June 16, 2009)*                                                                                                                                         |
|       | *** *** | *** ***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.6        |         | Expense Reimbursement Agreement dated  June 11, 2009, among Algonquin Power Management Inc., the Company and  7188501 Canada Inc. (incorporated by reference from Exhibit 99.3 to the  Company’s Report of Foreign Private Issuer on Form 6-K, File  No. 000-31815, filed with the Securities and Exchange Commission on  June 16, 2009)*                                                                                                                                       |
|       | *** *** | *** ***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.7        |         | APMI Guarantee dated June 11, 2009,  among Algonquin Power Management Inc., the Company and 7188501 Canada Inc.  (incorporated by reference from Exhibit 99.4 to the Company’s Report of  Foreign Private Issuer on Form 6-K, File No. 000-31815, filed with  the Securities and Exchange Commission on June 16, 2009)*                                                                                                                                                         |
|       | *** *** | *** ***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.8        |         | Algonquin Power Guarantee dated  June 11, 2009, among Algonquin Power Income Fund, Algonquin Power  Management Inc., the Company and 7188501 Canada Inc. (incorporated by  reference from Exhibit 99.5 to the Company’s Report of Foreign Private  Issuer on Form 6-K, File No. 000-31815, filed with the Securities  and Exchange Commission on June 16, 2009)*                                                                                                                |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 8.1        |         | List of Significant Subsidiaries                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 12.1       |         | Certification of the Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                  |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 12.2       |         | Certification of the Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                  |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 13.1       |         | Certification of the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                             |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 13.2       |         | Certification of the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                             |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 15.1       |         | Consent of PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.1       |         | Unaudited Interim Consolidated  Financial Statements for the three months ended March 31, 2009, and the  Management’s Discussion and Analysis of Financial Condition and Results of  Operationsfor the  three months ended March 31, 2009 (incorporated by reference from  Exhibits 99.1 and 99.2, respectively, to the Company’s Report of Foreign  Private Issuer on Form 6-K, File No. 000-31815, filed with the  Securities and Exchange Commission on June 16, 2009)* |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.2       |         | Notice of Special Meeting and Management  Proxy Circular dated June 25, 2009 (incorporated by reference from Exhibit  99.1 to the Company’s Report of Foreign Private Issuer on Form 6-K, File No.  000-31815, filed with the Securities and Exchange Commission on June 29,  2009)*                                                                                                                                                                                                                     |

 

----

*      Previously filed.

 

80

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Tableof Contents

 

**SIGNATURE**

 

The registranthereby certifies that it meets all of the requirements for filing on Form 20-Fand that it has duly caused and authorized the undersigned to sign this annualreport on its behalf.

 

 
|                 | **HYDROGENICS CORPORATION** |
|----------------------|-----------------------------|
|                 |                        |   |
|                 |                        |   |
| Dated: June 30, 2009 | By:                         | /s/ Lawrence Davis |
|                 |                        |   |
|                 |                        | Name: | Lawrence Davis |
|                 |                        |   |   |
|                 |                        | Title: | Chief Financial Officer |

 

81

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Table of Contents

 

**HYDROGENICS CORPORATION**

 

**INDEX TO EXHIBITS**

 
| **Number** | ** **   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 1.1        |         | Articles of the Company (incorporated by  reference from Exhibit 3.1 to Amendment No. 4 to the Company’s  Registration Statement on Form F-1, File No. 333-42682, filed with  the Securities and Exchange Commission on October 13, 2000)*                                                                                                                                                                                                                                      |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 1.2        |         | By-laws of the Company dated May 7,  2008                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 2.1        |         | Form of share certificate  (incorporated by reference from Exhibit 4.1 to Amendment No. 5 to  the Company’s Registration Statement on Form F-1, File  No. 333-42682, filed with the Securities and Exchange Commission on  October 23, 2000)*                                                                                                                                                                                                                              |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.1        |         | Stock Option Plan dated June 22, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.2        |         | Restricted Share Unit Plan dated June 22, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.3        |         | Deferred Share Unit Plan dated June 22, 2009                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.4        |         | Lease, dated June 23, 2000 (as amended  by a Lease Extension Agreement dated February 10, 2005), by and between  Orlando Corporation and the Company                                                                                                                                                                                                                                                                                                                                                |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.5        |         | Support Agreement dated June 11, 2009,  among the Company, the Trustees of Algonquin Power Income Fund and 7188501  Canada Inc. (incorporated by reference from Exhibit 99.2 to the  Company’s Report of Foreign Private Issuer on Form 6-K, File  No. 000-31815, filed with the Securities and Exchange Commission on June 16,  2009)*                                                                                                                                         |
|       | *** *** | *** ***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.6        |         | Expense Reimbursement Agreement dated  June 11, 2009, among Algonquin Power Management Inc., the Company and  7188501 Canada Inc. (incorporated by reference from Exhibit 99.3 to the  Company’s Report of Foreign Private Issuer on Form 6-K, File  No. 000-31815, filed with the Securities and Exchange Commission on  June 16, 2009)*                                                                                                                                       |
|       | *** *** | *** ***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.7        |         | APMI Guarantee dated June 11, 2009,  among Algonquin Power Management Inc., the Company and 7188501 Canada Inc.  (incorporated by reference from Exhibit 99.4 to the Company’s Report of  Foreign Private Issuer on Form 6-K, File No. 000-31815, filed with  the Securities and Exchange Commission on June 16, 2009)*                                                                                                                                                         |
|       | *** *** | *** ***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.8        |         | Algonquin Power Guarantee dated  June 11, 2009, among Algonquin Power Income Fund, Algonquin Power  Management Inc., the Company and 7188501 Canada Inc. (incorporated by  reference from Exhibit 99.5 to the Company’s Report of Foreign Private  Issuer on Form 6-K, File No. 000-31815, filed with the Securities  and Exchange Commission on June 16, 2009)*                                                                                                                |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 8.1        |         | List of Significant Subsidiaries                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 12.1       |         | Certification of the Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                  |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 12.2       |         | Certification of the Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                  |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 13.1       |         | Certification of the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                             |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 13.2       |         | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                              |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 15.1       |         | Consent of PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.1       |         | Unaudited Interim Consolidated  Financial Statements for the three months ended March 31, 2009, and the  Management’s Discussion and Analysis of Financial Condition and Results of  Operationsfor the  three months ended March 31, 2009 (incorporated by reference from  Exhibits 99.1 and 99.2, respectively, to the Company’s Report of Foreign  Private Issuer on Form 6-K, File No. 000-31815, filed with the  Securities and Exchange Commission on June 16, 2009)* |
|       |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.2       |         | Notice of Special Meeting and Management  Proxy Circular dated June 25, 2009 (incorporated by reference from Exhibit  99.1 to the Company’s Report of Foreign Private Issuer on Form 6-K, File No.  000-31815, filed with the Securities and Exchange Commission on June 29,  2009)*                                                                                                                                                                                                                     |

 

----

*      Previously filed.

 

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