UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
[ ] 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 endedDecember 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report
For the transition period from ___________ to ____________
Commission File Number:0-27524
DYNAMOTIVE ENERGY SYSTEMS CORPORATION
(Exact name of Registrant as specified in its charter)
Province of British Columbia (Canada)
(Jurisdiction of incorporation or organization)
Suite 230 -1700 West 75th Avenue
Vancouver, British Columbia
V6P 6G2 Canada
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:.None
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Common Shares Without Par Value
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: .None
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Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the
close of the period covered by the annual report:
Outstanding at December 31, 2006
171,765,776
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes [ ] No [X]
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Securities Act of 1934. Yes [ ] No [X]
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 [X] Item 18 [ ]
If this is an annual report, indicate by check mark whether if the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST
FIVE YEARS)
Indicate by check marck whether the registrant has filed all documents and reports required by
Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities
under a plan confirmed by a court. Yes [ ] No [ ]
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TABLE OF CONTENTS
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GENERAL
In this Annual Report on Form 20-F, all references to “we”, “us”, “our”, the “Company” or “Dynamotive” refer to Dynamotive Energy Systems Corporation and its subsidiaries. The Company is currently listed on the over-the-counter bulletin board (OTCBB) under the symbol: DYMTF.OB.
The Company uses the U.S. dollar as its reporting currency. All references in this document to “dollars” or “$” are expressed in U.S. dollars, unless otherwise indicated. Unless otherwise indicated, all financial information contained in this Annual Report on Form 20-F is in U.S. dollars and based on Canadian generally accepted accounting principles (“GAAP”).
Except as noted, the information set forth in this Annual Report is as of May 16, 2007 and all information included in this document should only be considered correct as of such date.
FORWARD-LOOKING STATEMENTS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements as defined under federal securities law that reflect our current expectations about our future results, performance, prospects and opportunities. Where possible, the forward-looking statements are identified by words such as "believes," "anticipates," "plans," "expects," "seeks," "estimates," “intends,” “may,” “will,” and other similar expressions; however, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterization of future events or circumstances are forward-looking statements. Forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those expressed in or implied by such statements. Such risks, uncertainties and factors include, but are not limited to, future capital needs, changes and delays in product development plans and schedules, customer acceptance of new products, changes in pricing or other actions by competitors, patents owned by the Company and its competitors, and general economic conditions, as well as other risks detailed in the “Risk Factors” section of this Form 20-F. The Company undertakes no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances occurring subsequent to the filing of this report or for any other reason.
PART I
Item 1. Identity Of Directors, Senior Management and Advisers
Not applicable, this is an Annual Report only.
Item 2. Offer Statistics and Expected Timetable
Not applicable, this is an Annual Report only.
Item 3. Key Information
A. Selected financial data
The following table represents selected consolidated financial information of Dynamotive Energy Systems Corporation. The table should be read together with “Item 5. Operating and Financial
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Review and Prospects.” Except as otherwise indicated, the following selected financial data have been prepared in accordance with Canadian generally accepted accounting principles.
| | Fiscal Year |
| | 2006 | 2005 | 2004 | 2003 | 2002 |
| (US Dollars) | | | | | |
| Results of operations: | | | | | |
| Revenue | — | — | — | — | 68,569 |
| Loss from operations Cdn GAAP | (14,319,641) | (11,822,274) | (9,917,889) | (4,995,624) | (3,733,499) |
| Loss from operations US GAAP | (14,401,201) | (12,015,523) | (9,917,889) | (4,995,624) | (3,733,499) |
| Loss from continuing operations Cdn GAAP | (14,252,382) | (11,997,344) | (9,916,215) | (4,921,650) | (4,366,454) |
| Loss from continuing operations US GAAP | (14,669,647) | (13,124,724) | (8,405,184) | (4,984,681) | (5,264,469) |
| Net loss per Cdn GAAP | (14,252,382) | (11,997,344) | (9,916,215) | (4,984,681) | (5,261,607) |
| Net loss per US GAAP | (14,669,647) | (13,124,724) | (8,405,184) | (4,984,681) | (5,264,469) |
| Net loss per share Cdn GAAP | (0.09) | (0.11) | (0.12) | (0.09) | (0.12) |
| Net loss per share US GAAP | (0.10) | (0.12) | (0.10) | (0.09) | (0.12) |
| Net loss from continuing operation per share | (0.09) | (0.11) | (0.12) | (0.09) | (0.10) |
| | | | | | |
| Financial position at year-end: | | | | | |
| Total assets, Cdn GAAP | 38,093,699 | 16,962,573 | 13,198,698 | 3,759,605 | 1,285,813 |
| US GAAP | 37,993,062 | 16,962,573 | 13,198,698 | 3,759,605 | 1,285,813 |
| | | | | | |
| Total liabilities, Cdn GAAP | 6,958,287 | 8,670,165 | 8,911,500 | 2,035,168 | 1,957,625 |
| US GAAP | 6,958,287 | 8,692,977 | 8,911,500 | 2,035,168 | 1,957,625 |
| | | | | | |
| Non-controlling interest, Cdn GAAP | 1,354,923 | — | — | — | — |
| US GAAP | 1,354,923 | — | — | — | — |
| | | | | | |
| Shareholder’s equity, Cdn GAAP | 29,780,489 | 8,292,408 | 4,287,198 | 1,724,437 | (671,812) |
| Shareholder’s equity, US GAAP | 29,679,852 | 8,269,596 | 4,287,198 | 1,724,437 | (671,812) |
| | | | | | |
| Common shares issued | 171,765,776 | 123,211,875 | 93,129,798 | 69,915,654 | 49,941,000 |
The Company has not declared or paid any dividends since incorporation.
B. Capitalization and indebtedness
Not applicable, this is an Annual Report only.
C. Reasons for the offer and use of proceeds
Not applicable, this is an Annual Report only.
D. Risk factors
RISK FACTORS
You should carefully consider the risks, uncertainties and other factors described below because they could materially and adversely affect our business, financial condition, operating results, prospects and or the market price of our common shares.
RISKS RELATED TO OUR OPERATIONS
WE HAVE INCURRED NET LOSSES SINCE COMMENCING BUSINESS AND EXPECT LOSSES TO CONTINUE FOR THE FORESEEABLE FUTURE
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We have had limited revenues to date and have not shown a profit since inception. The Company had a net loss of $14,252,382 for the year ended December 31, 2006 as well as a net loss of $11,997,344 for the year ended December 31, 2005. As at December 31, 2006, the Company has a working capital of $4,938,473. As this is a new business, we may experience typical problems, difficulties, complications and delays. We expect to show a substantial net loss for the year ended 2007. We do not expect revenues to occur in any significant way until we have successfully established commercial BioOil operations. Accordingly, we may not be able to operate profitably on a consistent basis, if at all.
The ability of the Company to continue as a going concern is in substantial doubt and is dependent on achieving profitable operations, commercializing its BioOil production technology and obtaining the necessary financing in order to develop this technology. The outcome of these matters cannot be predicted at this time. The Company’s future operations are dependent on the market’s acceptance of its products in order to ultimately generate future profitable operations, and the Company’s ability to secure sufficient financing to fund future operations. There can be no assurance that the Company’s products will be able to secure market acceptance. Management plans to raise additional equity financing to enable the company to complete its development plans. These financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Subsequent to the year end, during the period from January 1 to April 17, 2007, the Company issued 2,280,259 common shares for total proceeds of $2,480,900 relating to a private placement commencing during the first quarter of 2007. In addition during the period from January 1 to April 17, 2007, the Company received $4,373,000 on the exercise of 744,166 options and 6,851,049 warrants. Management is of the opinion that this and expected future financing along with expected sales will provide sufficient working capital to meet the Company’s liabilities and commitments as they become due.
OUR TECHNOLOGY MAY NOT PROVE COMMERCIALLY VIABLE
Our technology is currently being tested at a commercial scale. Ongoing efforts at commercialization may expose operational flaws and unanticipated costs that may inhibit or preclude ultimate market acceptance. Our technology has not demonstrated it can generate positive cash flow or a return on investment.
WE HAVE LIMITED FINANCIAL AND MANAGEMENT RESOURCES TO PURSUE OUR GROWTH STRATEGY
Our growth strategy may place a significant strain on our management, operational and financial resources. We have negative cash flow from operations and continue to seek additional capital. We will have to obtain additional capital either through debt or equity financing to continue our research and development strategies and the commercial expansion of our technologies. There can be no assurance, however, that we will be able to obtain such financing on terms acceptable to the Company. If adequate funds are not available on acceptable terms when needed, we may be required to delay, scale-back or eliminate the manufacturing, marketing or sales of one or more of our products or research and development programs.
If we raise additional funds through the issuance of equity or convertible securities, these new securities may contain certain rights, preferences or privileges that are senior to those of our Common Shares. Additionally, the percentage of ownership of the Company held by existing shareholders will be reduced.
WE MUST DEVELOP AND EXPAND OUR SALES AND MARKETING CAPABILITIES
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Our sales and marketing experience is very limited. We will be required to further develop our marketing and sales force in order to effectively demonstrate the advantages of our technology over more traditional technology, as well as other competitors’ technology. We may not be able to establish adequate sales and distribution capabilities, and there is no guarantee that our sales and marketing experience will be successful.
WE MAY NOT BE ABLE TO SUCCESSFULLY PROTECT OUR PROPRIETARY RIGHTS
Patents and other intellectual property are a critical aspect of the present operation and future success of our business. Policing unauthorized use of our proprietary technologies and other intellectual rights could entail significant expense and could be difficult or impossible, particularly given that the laws of some countries afford little or no effective protection of our intellectual property. Given the nature of our business, third parties may bring claims of copyright, patent or trademark infringement against us. Further, third parties may claim that we have misappropriated their creative ideas or otherwise infringed on their proprietary rights in connection with our technologies. Any claims of infringement, with or without merit, could be time consuming to defend, result in costly litigation, divert management attention, require us to enter into costly royalty or licensing agreements or prevent us from using important technologies or methods.
OUR BUSINESS ENVIRONMENT IS VERY COMPETITIVE
The markets for alternative energy technologies is highly competitive, and other providers of such technologies, especially producers of ethanol from biomass, may have various advantages in competition with ours. Many of our competitors have established long-standing relationships with power generation companies, utilities, manufacturers and others that we view as potential customers. Many competitors also have substantially greater access to capital and technical resources than we do and may therefore have a significant competitive advantage.
Our primary technologies face market acceptance barriers that do not affect already established technologies. To date, our primary technologies have gained only limited market acceptance and have generated minimal revenues.
WE MAY BE SUBJECT TO HAZARDOUS WASTE LIABILITIES
BioOil and some of its derivative products may be deemed to be hazardous wastes for which a liability may be imposed upon us should any contamination from improper storage or handling occur. Liability costs associated with environmental cleanups of contaminated sites historically have been very high as have been the level of fines imposed by regularity authorities upon parties deemed to be responsible for environmental contamination. We have obtained limited insurance protection but this may not be sufficient insurance protection from such liabilities if they should ever arise. If contamination should take place for which we are deemed to be liable, potentially liable or a responsible party, the resulting costs could have a material effect on our business.
OUR BUSINESS WILL SUFFER IF WE LOSE KEY SKILLED PERSONNEL
We are dependent on certain members of our management and engineering staff, and if we lose their services our business could be severely impacted. In particular, we rely on the services of our Chief Executive Officer and Vice President Engineering. In addition, our ability to manage growth effectively will require that we continue to implement and improve our management systems and recruit and train new employees. We may not be able to successfully attract and hire skilled and experienced personnel.
OUR STRATEGIC ALLIANCES MAY NOT ACHIEVE THEIR GOALS
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We expect to partially rely on strategic alliances for development contracts, assistance in research and development and marketing expertise. Even if we are successful in forming these alliances, they may not achieve their goals.
THE ABILITY TO TRADE THE COMPANY’S STOCK MAY BE LIMITED
Shares of the Company’s Common Shares currently trade only upon the Over-the-Counter Bulletin Board market. This may not provide the same liquidity for the trading of securities as the NASDAQ or other exchanges. Because our shares are not listed on NASDAQ or any other exchange, the Company’s stock presently comes within the definition of a “penny stock” as defined in the Securities Exchange Act of 1934 and the rules under that Act.
Generally, the penny stock rules require a broker-dealer, before a transaction in a penny stock to deliver a standardized risk disclosure document prepared by the SEC that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for a stock that is subject to the penny stock rules. Therefore, investors may find it more difficult to sell their shares.
OUR STOCK’S TRADING PRICE WILL BE SUBJECT TO MARKET VOLATILITY
In recent years, the stock market in general, and the prices of stock of technology companies including our own, have experienced extreme price fluctuations, sometimes without regard to the fundamentals of the particular company. These broad market and industry fluctuations may adversely affect the market price of our Common Shares.
Item 4. Information On The Company
A. History and development of the Company
The Company’s principal business is the development and commercialization of technology for biomass-to-liquid fuel conversion using a process called “Fast Pyrolysis”. Fast Pyrolysis is a process that rapidly heats biomass in the absence of oxygen to produce a liquid fuel (“BioOil”). BioOil is a clean, renewable fuel which, providing the equipment is suitably modified, can replace natural gas, diesel and other fossil fuels to produce power, mechanical energy and heat in certain industrial boilers, fuel gas turbines and other industrial applications. The Company aims to generate significant amounts of energy, in the form of BioOil fuels, based upon utilization of relatively abundant and inexpensive biomass waste streams from agricultural and forest operations and other post-industrial biomass residues. In many cases, the feedstock sources are costly to dispose of and therefore are available at zero cost or are potentially revenue generating when converted into BioOil. The process of biomass to energy conversion is sustainable, renewable and greenhouse gas neutral, and is consistent with other renewable energy sources such as wind, hydro and solar. The significant advantage of biomass energy over other renewable forms of energy, is that biomass is capable of delivering energy on a 24/7 basis, whereas wind, hydro and solar energy sources are all subject to natural fluctuations often entailing significant downtime.
Dynamotive is attempting to establish its patented technology as the industry standard for the production of liquid biomass based fuels (other than ethanol and biodiesel), in competition with other pyrolysis technologies, and other biomass to energy applications. The Company’s fast pyrolysis process converts raw forest and agricultural biomass residues such as sawdust, sugar
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cane bagasse, rice husks and wheat straw, amongst others, into three fuel types: Liquid (BioOil), Solid (char) and Gas (non-condensable gases). The non-condensable gases are used to fuel the pyrolysis process. The entire system is a closed loop with virtually no emissions or waste byproducts. The process was developed by RTI.
In 1996, the Company obtained the exclusive worldwide rights from RTI for air emissions control products from this technology. In 1998, this exclusive arrangement with RTI was expanded to include the Fast Pyrolysis process and virtually any new products derived from BioOil including fuels and slow release fertilizers. In February 2000, the Company acquired the patent to this technology from RTI and entered into a research agreement with RTI on biofuels and BioOil derivative products. The research agreement has terminated and the patents are owned royalty-free.
The Company and its partners are also engaged in research and development on a range of derivative products that, if successful, could further enhance the market and value for BioOil as an alternative fuel and product source.
In September 2006, the Company and Pendana Limited BVI (“Pendana”) entered into joint venture agreement to establish DBRC (a company incorporated federally in Canada) with the purpose of securing biomass and to source project development opportunities and additional biofuel and green credit pipeline opportunities. The agreement expires on December 31, 2016.
Pursuant to terms of the agreement, the Company earned a 51% interest in Dynamotive Biomass Resource Corporation (“DBRC”) by contributing cash of $500,000 and granting DBRC certain rights associated with specific biomass development opportunities in Canada, South America, and Europe. In return for a 49% ownership in DBRC, Pendana’s contribution amounted to cash payments of $2,000,000 ($1.5 million was received in DBRC as at December 31, 2006 and $500,000 received subsequent to year end). In addition, the Company has agreed to lend DBRC up to $1 million, with terms to be entered into at a later date. Pendana has also further agreed to provide a $20 million revolving line of credit to DBRC. Any sums advanced under this credit facility shall at Pendana’s sole discretion, be repayable on demand and shall bear interest at 4% above the rate of the Royal Bank of Scotland. Pendana shall be entitled to security in the projects or assets funded under this clause of the credit facility. As at December 31, 2006 and to date, no funds have been advanced by Pendana under this credit facility.
In September 2006, the Company and Pendana entered into an agreement in connection with the Company’s then wholly-owned subsidiary Dynamotive Europe Limited (“DEL”). The agreement was made in an effort to establish DEL as a permanent presence in Europe to develop European projects. Under the terms of the agreement, Pendana completed a private placement with the Company, whereby the Company issued 2,332,361 common shares and 583,090 share purchase warrants for gross cash proceeds of $2,000,000. The warrants were exercisable at $1.26 and expired on February 24, 2007. In addition, the Company issued a total of 3,000,000 warrants, with an exercise price of $1.2375, to Pendana, 1,000,000 of these warrants expire on April 24, 2007 and the remaining 2,000,000 warrants expire on February 28, 2007. Pendana also received a 20% interest in DEL, with Dynamotive maintaining the remaining 80% interest. The Company further agreed to loan DEL $2,000,000 on commercial terms.
Pursuant to the terms of the agreement, 20% of the net cash generated by DEL will be distributed to Pendana’s agent and 80% to the Company in settlement of the intercompany debt. In the event DEL wishes to seek further debt or equity funding to finance specific projects at any time following the date of the agreement, Pendana shall have the right of first refusal.
The Company was incorporated on April 11, 1991 in the Province of British Columbia, Canada, under the name of Dynamotive Canada Corporation. On October 31, 1995, the shareholders approved a change of name to Dynamotive Technologies Corporation and on June 26, 2001, the shareholders again approved a change of name to the Company’s current name.
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As at December 31, 2006, the Company had five wholly-owned subsidiaries Dynamotive Canada Inc., federally incorporated under the laws of Canada in 2000; Dynamotive Corporation, incorporated under the laws of Rhode Island, U.S.A in 1990.; Dynamotive USA Inc. incorporated under the laws of Delaware, U.S.A. in 2006; Dynamotive Latinoamericana S.A., incorporated under the laws of Buenos Aires, Argentina in 2006; First Resources Corporation, incorporated under the laws of British Columbia, Canada in 2006. In addition, the Company maintains an 80% ownership interest in DEL, formally known as Dynamotive Technologies (UK) Ltd, incorporated in the United Kingdom in 1996 and owns a 99.98% interest in the West Lorne BioOil Co-Generation LP, formed under the laws of Ontario, Canada in 2003. Dynamotive Canada Inc. acts as the General Partner of the Limited Partnership, which operates the West Lorne BioOil and electricity generation plant. The Company also holds a 51% interest of DBRC, incorporated in Canada in 2006, which the Company has determined to be a variable interest entity.
The principal executive office of the Company is Suite 230 - 1700 West 75th Avenue, Vancouver, British Columbia, Canada, V6P 6G2 (Telephone: 604-267-6000).
B. Business Overview
Dynamotive’s primary focus is to commercialize its patented BioOil production technology and establish this technology as the worldwide industry standard for production of BioOil as a clean, renewable fuel utilizing biomass feedstocks. To support this goal, the Company plans over the next year to develop full commercial scale BioOil production facilities in conjunction with its alliance partners and then expand upon its existing marketing efforts to generate new licensees throughout Canada, Europe, the USA, Asia and Latin America.
The Company is currently commercializing its Fast Pyrolysis biomass-to-energy technology that converts low or zero cost forest and agricultural biomass residues into liquid BioOil that is then used as a “green” renewable fuel alternative for power generation, industrial use or as the raw material for a range of derivative products. In 2005 the Company completed construction of its first 100 tpd commercial scale plant (currently being upgraded and expanded to 130 tpd capacity), located adjacent to the Erie Flooring and Wood Products manufacturing plant in West Lorne, Ontario, Canada. In addition, the Company is currently completing construction of a 200 tpd plant in Guelph, Ontario, Canada which is expected to enter operation in the second quarter or early third quarter of 2007.
I. CORE TECHNOLOGIES
Initial applications for BioOil are targeted for generating heat, power and mechanical energy in industrial boilers, gas turbines and stationary reciprocating engines. The char can also be used as a fuel or as a feedstock for the production of charcoal briquettes, in its raw form as a coal or coke alternative; or in other potential value added applications including activated carbon for use in the water and wine industries and carbon black for domestic and industrial uses. The char can also be added back into the BioOil to produce an “Intermediate” grade BioOil with higher energy content. The noncondensable gases are re-cycled in the Fast Pyrolysis process and provide the majority of the energy required for the process.
Dynamotive has six phases to its commercialization program as shown below:
Phase 1: Bench scale, “proof of concept” was completed by Resource Transforms International, Ltd. (RTI) in 1996. Dynamotive licensed the Fast Pyrolysis technology in 1997 and purchased the exclusive worldwide rights to the technology from RTI in 2000.
Phase 2: In 1997, Dynamotive built a 0.5 tonnes per day (tpd) prototype plant in Vancouver, BC, which was upgraded in 1998 to a capacity of 2 tpd. This plant has operated for over 3,000 hours.
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Phase 3: In 2001, Dynamotive entered into a strategic alliance with Tecna S.A. of Argentina to develop commercial energy systems based on Dynamotive’s pyrolysis technology in Latin America and other markets on a non-exclusive basis. Tecna would also collaborate with Dynamotive to provide technical design and optimization input on Dynamotive’s BioOil production technology. Tecna has provided valuable technical support, engineering and consulting services to validate the basic engineering and operation of the BioOil technology and to evaluate and quantify the potential for improvements to the efficiency of the BioOil technology. This work has been on going since and resulted in confirmation of the basic BioOil designs and process efficiencies, development of process designs and equipment specification and design details that are being incorporated into the current BioOil plant designs.
Phase 4: Dynamotive completed commissioning of a new 10 tpd pilot plant in March 2001 which was de-commissioned in December 2002. The plant was built to industrial specifications complete with a state-of-the-art distributed control system (DCS). The plant had a production capacity of 6,000 litres of BioOil per day and achieved or exceeded this capacity output for more or less continuous periods of up to 10 days at a time. The plant has exceeded design parameters operating on a continuous basis at 50% above its nominal design capacity.
Phase 5: Following the 10 tpd pilot, Dynamotive began construction of a 100 tpd commercial scale plant, with initial commissioning in 2005. This plant processes wood residues and is designed for continuous 24-hour production at commercial scale although this capacity has only been achieved for short periods of time since commissioning. This project is also intended to demonstrate continuous operation of end use applications (boilers/kilns and gas turbines). The principal goal of the commercial demonstration project is to demonstrate the economics of the process, and to secure future engineering, procurement and construction (EPC) commitments from the Company’s current partners and potential future service and equipment providers. Ultimately, the Company expects these EPC commitments to facilitate lending commitments to execute on BioOil project developments as part of the Company’s final commercialization phase.
During the period January 1 to December 31, 2006, the plant was either producing or available (e.g. reactor warm) for 135 days. During this period, the West Lorne plant produced BioOil and Char for a number of purposes including BioOil shipments to the US of $123,954 and deliveries of electricity to the grid of $30,966; successful commercial scale fuel demonstrations in a number of industries within Canada; running of the turbine; providing BioOil for business development and research initiatives in North America and Europe (including emulsification development); and providing a commercial scale platform for the Company in its evaluation of design and process improvements for its 200tpd unit now completing construction in Guelph.
In December 2006, the Company began an upgrade and expansion of the West Lorne plant that will increase its capacity to 130 tonnes per day. It is expected to re-enter operations in Q3, 2007.
The West Lorne facility has provided Dynamotive with a showcase of its commercial BioOil technology to many interested companies and government institutions and has been fundamental in the Company’s successes in sale of plant and master licenses previously disclosed and those currently in negotiation.
Phases 6/7: With completion of the West Lorne 100 tpd plant, Dynamotive and partners are working to develop multiple commercial plants at the 200 tpd scale and larger and to bring the costs of the plants down significantly. The Company is currently near completion of its first 200 tpd plant, located in Guelph, Ontario, Canada. The Company is presently seeking to secure rights to multiple ‘high disposal cost’ biomass waste streams around the world, in order to accelerate its commercial efforts. The Company believes that by securing rights to these biomass waste streams and related BioOil, power and/or energy purchase commitments will be able to catalyze the development of commercial BioOil projects that incorporate the design, engineering and licensing of its Fast Pyrolysis technology.
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By virtue of being derived from biomass residues, all BioOil fuels are considered to be carbon dioxide and greenhouse gas neutral. When combusted, they produce no sulfur dioxide and significantly reduced nitrogen oxide emissions compared with hydrocarbon fuels, therefore having significant environmental advantages over these fuels with respect to atmospheric pollution.
1) BIOOIL PRODUCTION PROCESS
In the fast pyrolysis reactor, biomass waste materials are rapidly heated in the absence of oxygen. The rapidly vaporized volatiles are then quickly condensed, forming a liquid fuel referred to as BioOil, solid char and non-condensable gases. Depending upon the feedstock used (many different sources of feedstock have been bench tested thus far), the process typically produces 60-75 tons of BioOil, 15-25 tons of char and approximately 15 tons of non-condensable gases from 100 tons of biomass residues. The Company believes that the overall simplicity of the Fast pyrolysis process and the fact that all the major equipment is already well proven in existing related industrial applications gives the Company’s BioOil technology competitive advantages over other pyrolysis conversion technologies such as lower capital and operating costs, higher product yields, a significantly higher quality BioOil and the flexibility to process a wide variety of feedstocks.
The Company began producing batch quantities of BioOil in 1997 in its 0.5 tpd Fast Pyrolysis pilot plant located at the Company’s research and development facility in Vancouver, BC. By the end of 1998, the BioOil Technology Group had upgraded, commissioned and operated the plant to a capacity of two tpd on a continuous basis. In 1999, further changes were made to the feed system, Fast Pyrolysis reactor, cyclone, and instrumentation and control systems to provide increased stable operation. Once these changes were made, the Fast Pyrolysis was re-commissioned and produced BioOil of sufficiently high quality to meet fuel specification requirements as defined by our engine testing partners.
The Company’s 10 tpd BioOil plant was commissioned in March, 2001. Commissioning included a sustained 10 day, 24 hr/7 day a week operation which demonstrated that this design with minor adjustments could yield 14.5 tpd rather than the estimated 10 tons. The Company believes that the plant conforms to all applicable British Columbia safety, electrical and mechanical design standards, utilizing state-of-the-art “smart” instrumentation and a high-powered industrial-grade distributed control system. The Company adopted this design policy in order to facilitate easy scaleup to commercial plant capacities.
2) BIOOIL COMMERCIAL DEMONSTRATIONS, APPLICATIONS AND MARKETS
During 2004, the Company began construction of its first 100 tpd plant in Ontario, Canada at the Erie Flooring and Wood Products (“Erie Flooring”) facilities in West Lorne, Ontario, Canada (“West Lorne”). The integrated plant utilizes wood residue from Erie Flooring’s operations and is comprised of wood conditioning equipment, pyrolysis plant and power island. Pyrolysis and generation equipment are to be provided by Dynamotive and Magellan Aerospace, Orenda division (Orenda) respectively. Erie Flooring provides wood residue for the project and will receive char for process heat for its operations. The project began to export green power to Ontario’s grid system in 2005. The project is expected to reach operating cash flow positive in 2007 based on sales of BioOil for energy and derivative products and sales of electricity and char. Operating costs are expected to be approximately $2 million per year or more on a normalized basis.
The Company has entered into lease, wood supply, steam and other agreements with Erie Flooring, which allow for operation of the plant. The Company has received its generation license from the Ontario Energy Board and has an interconnection agreement with Hydro One for the export of electric power to the Ontario electricity grid and in January 2007 was approved for a contract with the Ontario Power Authority to sell all of its electricity at C$110/Mwh over a 20 year period. On April 5, 2007 the Company entered into certain amended agreements with Erie Flooring regarding the supply by Erie Flooring of wood to the West Lorne BioOil plant over the
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next 12 years at no charge and the provision of char from the BioOil plant to Erie at no charge. In relation to these agreements, the Company agreed to pay for the purchase and installation of a char based boiler system and related char delivery infrastructure. The terms include an immediate payment of $500,000 to Erie Flooring and a further $359,000 to Erie in equal monthly payments plus 8% interest, over the next 10 years for the purchase of the boiler.
The Company believes that the near term commercial application for BioOil is as a clean burning fuel that can be used to replace natural gas, diesel and other fossil fuels in boilers, gas turbines and slow and medium speed reciprocating engines for heat and power generation, to replace natural gas in the forest industry and for lumber dry kiln and lime kiln applications. Initial markets may include Canada, the US, Europe, Latin America, Asia and Island based economies.
Orenda is in the second phase of a program to develop a commercial gas turbine package fueled by Dynamotive’s BioOil. The 2.5 MW (megawatt) GT2500 turbine was successfully commissioned on BioOil in 2005 and is at the West Lorne site. Orenda has also identified further commercial scale projects for its turbines and BioOil, in addition to West Lorne as referred to above.
Dynamotive also targets the industrial fuels market. Working with the Canadian federal department of Natural Resources CANMET Energy Technology Centre in Ottawa, Ontario, it developed a burner nozzle design for stable BioOil fuel combustion. This has created opportunities for early commercial applications for BioOil as a clean burning fuel to replace natural gas, diesel and other fossil fuels in the multi-billion dollar industrial boilers, kiln fuels and specialty heating applications markets. Testing of BioOil in lumber kilns was successfully completed in 2002. In 2003, Dynamotive completed pilot scale limekiln testing of BioOil fuel in conjunction with the University of British Columbia (UBC) and in July 2006 completed an industrial scale lime kiln burn in British Columbia, Canada. In 2006, the Company also completed test burns in greenhouses and in an aluminium smelter with Alcoa. Customers for BioOil fuels could potentially include local, regional and international power generators and electrical utilities (fuel substitution in large scale power plants and fuel for district heating), fuel distributors, forest companies (natural gas substitute in lime kilns, lumber kilns and boilers), oil and gas producers (steam production for extraction) and manufacturing companies (process heat) including sawmills, pulp mills and greenhouses. Beyond the programs above, testing continued with various industrial burner and boiler combustion experts and manufacturers and with industrial customers in 2006. These tests are a necessary prerequisite to long term fuel sales agreements.
The Company has completed a series of production runs converting 100% softwood bark derived from spruce, pine and fir into fuel quality BioOil. Lower value bark residues are a major problem for the forest industry; as bark has little or no value and is costly to dispose of. Canada, for example, produces approximately 18 million tons of sawmill residues per year of which 5 to 6 million tons are considered wastes and are subsequently incinerated or landfilled.
3) BIOOIL APPLICATIONS & DERIVATIVE PRODUCTS
BioOil has a wide range of potential commercial applications. As the BioOil industry matures it has the potential to follow a similar development path as the petroleum industry, beginning with exploitation of basic unrefined BioOil fuels for power generation and district heating followed by blends and emulsions for transportation. Development of higher value products, including agro-products, resins, adhesives, specialty chemicals, slow release fertilizers and other derivatives, may occur as refining and processing techniques are established by future licensees or partnerships with Dynamotive. Over time, we anticipate that BioOil will be refined in much the same way that petroleum is today in order to derive the highest value energy and chemical products.
The Company is following a staged approach to product development, focusing initially on the earliest and most appropriate application of BioOil as a clean, renewable fuel to generate power and heat in industrial boilers and kilns, gas turbines and stationary reciprocating engines. The
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Company is also supporting efforts to develop a next generation of higher-value fuels, including BioOil/ethanol blends, BioOil/diesel emulsions and catalytic reforming of BioOil to produce synthetic fuels and bio-methanol. BioOil also has potential as a raw material to produce agro-products such as slow release fertilizers and other high-value products.
Over the longer term, the Company believes that exploitation of specialty chemicals contained in BioOil has the potential to create significant value. Dynamotive and colaborating research institutions are developing techniques to extract chemicals such as hydroxyacetaldehyde, levoglucosan, levoglucosenone, acetol, acetic acid and formic acid. These chemicals have a wide variety of possible applications including food flavorings, adhesives, resins, pharmaceuticals, bio-based pesticides and paper brighteners.
CHAR PRODUCTION
Char is a significant co-product of the Company’s pyrolysis process comprising 15% to 20% yield from the input biomass at a value of approximately one half that of BioOil on a weight basis when used for fuel purposes. Char is a granular solid with properties similar to coal. At 23 – 30 Giga Joules per tonne, pyrolysis char has a higher heating value than wood and many grades of coal. Like BioOil, it is a “green” fuel which is CO2 (carbon dioxide) neutral and contains virtually no sulfur.
A commercial scale BioOil plant processing 200 tpd of wood residue is expected to produce approximately 13,000 tons per year of char with a total energy value of 300,000 – 325,000 Giga Joules, dependent on the composition and species of the feedstock.
Early stage applications of char will focus on direct substitution or augmentation of fossil fuels to produce process heat and power via commercially available technologies in BioOil plants, sawmills, thermal power generation and cement production. Char also has potential for use as a feedstock for manufacturing of charcoal briquettes. Dynamotive char has been successfully tested at industrial scale and the prototype briquettes showed excellent results, meeting or exceeding all charcoal industry quality standards. The char can also be added back into the BioOil to produce an “Intermediate” grade BioOil with higher energy content.
In 2003 and 2004 the Company, with the University of Saskatchewan, completed initial analysis concluding that char is an appropriate material for activated carbon. Research and testing in this area continued through 2006.
4) BIOOIL STRATEGIC PARTNERS, INVESTMENT AND GOVERNMENT FUNDING
The Company’s BioOil technologies are consistent with the environmental and economic objectives of many governments around the world.
The Company has received strong support from Canadian government departments and funded entities.
During 1997, the Company entered into a contribution agreement with Industry Canada-Technology Partnerships Canada (TPC) whereby the Company is entitled to receive a maximum of approximately $7 million (Cdn$ 8.2 million) or 37% of eligible expenditures, as defined in the agreement. The agreement, as amended, specifies that in the event commercial viability is achieved, then the assistance is repayable, commencing January 1, 2005 based on royalties from sales of specified products resulting from the project to a maximum of $13.7 million (Cdn$16 million) or until the expiration of contract on December 31, 2014.
TPC is a key element in the federal government’s innovation strategy, leveraging private sector investments in research, development and innovation in critical, leading-edge technologies. As at
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December 31, 2006, the Company had claimed US$7.1 million to fund pre-commercial Fast Pyrolysis research and development. The contribution agreement was amended to confirm a maximum reimbursement cap of $7.1 million and extend the agreement to March 31, 2006. The Company is required to repay these funds from a percentage of future sales up to a maximum of US$13.7 million. The Company will focus all funding from the amended contribution agreement towards construction of a full commercial-scale forestry demonstration BioOil facility in Canada. As the Company has not achieved commercial viability and no revenue has been recorded from the project, no repayment has been made and no amount accrued for TPC assistance as at December 31, 2006.
In 2003, the Company was approved to receive a funding contribution for the West Lorne Project from Sustainable Development Technology Canada (SDTC). On March 5, 2004 the Company signed the Contribution Agreement with SDTC, confirming their $ 4.3 million (C$5,000,000) capital grant to the Project, subject to completion of the agreed work plan and documentation of eligible costs and other reporting requirements over a three year period following completion of the Project (the “Contract Period”). In 2004, the Company received the three payments totaling $3.2 million (C$3.7 million) from SDTC. In November 2005, the Company received a payment of $0.7 million (C$0.8 million) from SDTC. In December 2006, the Company received the remaining $0.4 million (C$0.5 million). The funds received from SDTC have been accounted for as a credit to the carrying cost of the West Lorne Plant.
II. RAW MATERIALS AND SUPPLIERS
For the most part, the Company's products are custom designed and manufactured and are not produced for inventory. BioOil units will only be produced for specific projects with procurement commencing when project funding has been fully committed.
The Company outsources the final assembly of its products prior to sale and does not manufacture the major components of its systems. The manufactured components and materials used in the Company's products are obtained from both domestic and foreign sources. Historically, lead-time for delivery of materials has not been a problem.
While the Company has chosen to use only a limited number of manufacturers to produce the components for its technologies, in the opinion of management, the Company has a readily available supply of components and raw materials for all of its anticipated products from various sources and does not anticipate any difficulties in obtaining the components and raw materials necessary to its business. These components comprise primarily pyrolysis reactor chambers, burner assemblies, and conveyers.
The Company believes that this licensing and focused, outsourced manufacturing strategy allows it to deliver superior products without the high capital expenditures that the Company would otherwise require in order to manufacture the components in house. As a result of limiting the number of suppliers for the key components for the Company's products, the Company believes it is better able to control costs while still maintaining high quality specifications for the components' manufacture. Moreover, the Company believes that it is better able to limit the number of third parties who have access to the Company's proprietary technologies.
III. EFFECT OF GOVERNMENTAL AND ENVIRONMENTAL PROTECTION REGULATIONS
Operators of the Company’s pyrolysis plants will be subject to federal, provincial, state or foreign environmental laws. If full commercial use of BioOil in power generation, heat and other applications commences, the Company will become subject to various federal, local and foreign laws and regulations pertaining to the discharge of material into the environment, the use of biological waste products as feedstock, and otherwise relating to the protection of the
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environment. The Company believes that it will be able to comply with such laws at a cost which will not be prohibitive.
The Company currently has two plants in Canada and is developing opportunities globally. There is no seasonality in current operations. Marketing of fuels is conducted directly with industrial customers.
C. Organizational Structure
As at December 31, 2006, the Company had five wholly-owned subsidiaries Dynamotive Canada Inc., federally incorporated under the laws of Canada in 2000; Dynamotive Corporation, incorporated under the laws of Rhode Island, U.S.A in 1990.; Dynamotive USA Inc. incorporated under the laws of Delaware, U.S.A. in 2006; Dynamotive Latinoamericana S.A., incorporated under the laws of Buenos Aires, Argentina in 2006; First Resources Corporation, incorporated under the laws of British Columbia, Canada in 2006. In addition, the Company maintains an 80% ownership interest in Dynamotive Europe Limited, formally known as Dynamotive Technologies (UK) Ltd, incorporated in the United Kingdom in 1996 and owns a 99.98% interest in the West Lorne BioOil Co-Generation LP, formed under the laws of Ontario, Canada in 2003. Dynamotive Canada Inc. acts as the General Partner of the Limited Partnership, which operates the West Lorne BioOil and electricity generation plant.
The Company also holds a 51% interest of Dynamotive Biomass Resource Corporation, incorporated in Canada in 2006, which the Company has determined to be a variable interest entity.
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D. Property, Plants and Equipment
The Company’s office facilities are leased. The Company’s corporate headquarters, leased for a five-year period which commenced in May 2004, are located in a business park complex in Vancouver, BC, Canada with approximately 8,000 square feet of office space. The Company’s principal capital asset is the West Lorne Plant discussed above and the Guelph plant currently nearing completion of construction.
Item 4A. Unresolved Staff Comments
None.
Item 5. Operating and Financial Review and Prospects
OVERVIEW
This section should be read in conjunction with the Company’s financial statements included under Item 17 of this Form 20-F.
Operations
The Company focused its efforts in 2006 on the operation of its Pyrolysis technology and the completion of its first commercial scale (100 tpd) BioOil production facility located in West Lorne, Ontario, Canada.
In Canada, the Company's research and development efforts are focused on optimization of its West Lorne 100 tpd plant and on the planning and design of its proposed 200 tpd plant. In Canada, opportunities in British Columbia, Saskatchewan, Nova Scotia continue to be pursued and additional projects were investigated including promising opportunities in Ontario and elsewhere.
Financing Activities
The Company's financing efforts were successful and continued to support the Canadian focused operations of the Company. The Company is continuing to raise equity capital in support of its project development and its ongoing operations.
In 2006, Dynamotive invested primarily in the construction of its Guelph Plant and as well continued its research and development activities related to its BioOil technology along with business development activities to develop initial commercial projects and market acceptance of BioOil. Ongoing operations were focused in Canada.
A. RESULTS OF OPERATIONS
During the year ended December 31, 2006, the Company recorded a net operating loss of $14,252,382 compared to a net operating loss of $11,997,344 for the year 2005. The increase in operating loss in 2006 as compared to 2005 was primarily attributable to (i) increased activity related to construction of a second, 200 tpd plant, (ii) an increase in marketing and business development expense, (iii) an increase in research and development expenditures and (iv) an increase in general and administrative expense. During the year ended December 31, 2005, the Company recorded a net operating loss of $11,997,344 compared to a net operating loss of $9,916,215 for the year 2004. The increase in operating loss in 2005 as compared to 2004 was primarily attributable to increased activity related to completion of the Company’s 100 tpd plant resulting in (i) an increase in interest expense and (ii) an increase in marketing and business development expense.
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The basic and diluted loss per common share was nine cents ($0.09) for the year 2006 compared to eleven cents ($0.11) for the year 2005. The loss per common share for the year 2004 was twelve cents ($0.12) . The decrease in basic and diluted loss per share for 2006 was due to a combination of the increase in the loss for the year and the increase in the weighted average number of Common Shares outstanding from 108,009,185 shares in 2005 to 153,685,553 in 2006.
For the years 2006, 2005 and 2004, the Company had expended on an annual basis $4,629,465, $3,586,855 and $3,670,936 respectively, on research and development. Of these amounts, $227,121 $782,423 and $765,106 respectively, were reimbursed by government funding. In 2006, the Company also offset product sales of $154,560 (2005 - $nil; 2004 - $nil) against research and development expenses, which are considered incidental sales of BioOil until such time as the Company’s plant has reached commercial production levels. The level of research and development expenditure has increased in 2006 and 2005 in support of development of the commercial scale plant and other product development activities. Future research and development expenditures are expected to be at a similar level.
The Company has been able to draw significantly from government grant and loan facilities, including the Government of Canada’s Technology Partnerships Canada program both for expenditures made in 2005 and technical and project related expenditures in 2006. The Company’s agreement with Technology Partnerships Canada pertains to maximum funding of US$7.1 million (C$8.235 million), of which $6.0 million (C$ 7.0 million) has been received as of year end 2006 and $1.1 million is included in government grants receivable.
Marketing and business development increased to $1,768,063 in 2006 from $1,199,959 in 2005. The increase was due mainly to the increase of business development activities, like public investor relation, commissions paid on the Company’s initial license sales and the corporate brand implementation, and to increased participation in a major environmental conference during the year. Marketing and business development increased to $1,199,959 in 2005 from $466,435 in 2004. The increase was due mainly to the increase of business development activities and participation in environmental and biofuel industry conferences during the year.
General and administrative expenses increased to $7,763,275 in 2006 from $6,257,086 in 2005. The increase in 2006 was mainly due to increased activity in the general administrative expenses, an increase in consulting expenses, an increase in non-cash compensation of $244,014 and an increase in the Company’s development activities with its 200 tpd plant. General and administrative expenses were about stable at $6,257,086 in 2005 from $6,316,110 in 2004. The decrease in 2005 was mainly due to a decrease in non-cash compensation of $1,508,040 largely offset by increased payroll and other business activities.
Amortization and depreciation decreased to $124,067 in 2006 from $148,556 in 2005 due to the write-off of the 10 tpd pilot plant at the year end 2005. Amortization and depreciation increased to $148,556 in 2005 from $130,912 in 2004 due to the replacement of certain computer equipment and an increase in computer equipment for a number of new staff.
Interest and other income increased to $493,610 in 2006 from $5,614 in 2005 due mainly to higher cash balances and the resultant interest income from investments in short-term money market deposits. Interest and other income decreased to $5,614 in 2005 from $8,766 in 2004 due mainly to a decrease of miscellaneous income in 2005.
Interest expense decreased in 2006 to $505,340 from $1,445,918 in 2005 due mainly to the decrease in long-term and convertible debenture financing. Also, all of the outstanding convertible debenture and long-term debt financing were paid off during the first six months of 2006. Interest expense increased in 2005 to $1,445,918 from $151,758 in 2004 due mainly to the accretion of the debt discount and expense incurred on the conversion of long-term and short-term convertible loans.
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There was no write-down of long-term assets in 2006. Loss on the write-down of long-term assets increased to $200,457 in 2005 from $nil in 2004 as the Company wrote-off its 10 tpd pilot plant as management determined its value was permanently impaired.
Loss on settlement of accounts payable increased to $98,189 in 2006 from $nil in 2005 due to a non-cash compensation payment exceeding the book value of the outstanding payable.
Loss on sale of interest in subsidiary increased to $420,400 in 2006 from $nil in 2005 due mainly to sell-off of a 20% interest of Dynamotive Europe Limited and the loss arises from the issue of common share purchase warrants related to this transaction. See additional information in audited Consolidated Financial Statements of the Company Note 9.
Currency exchange gain in 2006 amounted to $88,888 compared to a gain of $33,677 in 2005 due to the appreciation of the US Dollar. Currency exchange gain in 2005 amounted to $33,677 compared to a gain of $53,156 in 2004 due to the depreciation of the US Dollar.
B. LIQUIDITY AND CAPITAL RESOURCES
The principal sources of liquidity during the year ended December 31, 2006 were (i) $27,495,575 in net proceeds after deducting related issue costs and expenses from private placement offerings of the Company’s Common Shares and the exercise of Common Share options and warrants for cash, (ii) $18,091 in deposits for Common Shares to be issued in 2007 pursuant to the exercise of warrants, (iii) $1,500,000 contribution received from joint venture; less (iv) $899,184 decrease in long term loan and (v) $473,451 increase in government grant receivable.
For the previous year ended December 31, 2005 principal sources of liquidity during the year ended December 31, 2005 were (i) $6,398,254 in net proceeds after deducting related issue costs and expenses from private placement offerings of the Company’s Common Shares and the exercise of Common Share options for cash, (ii) $1,957,000 in deposits for Common Shares to be issued in 2006 pursuant to private placement offerings commenced in 2005, (iii) $1,825,000 increase in short-term convertible loan, (iv) $42,331 decrease in repayment of short-term loan and (v) $368,712 increase in government grant receivable.
For the year ended December 31, 2004 the Principal sources of liquidity during the year ended December 31, 2004 were (i) $4,857,699 in net proceeds after deducting related issue costs and expenses from private placement offerings of the Company’s Common Shares and the exercise of Common Share options for cash, (ii) $1,636,408 in deposits for Common Shares to be issued in 2005 pursuant to private placement offerings commenced in 2004, (iii) $830,013 increase in convertible loan, (iv) $816,727 increase in long-term debts and (v) $509,879 decrease in government grant receivable.
Overall cash inflows increased during 2006 due to significantly increased financing activities such as issuance of share capital. During the year ended December 31, 2006, the Company used cash in operating activities and in investing activities of $9,402,744 and $10,339,843 respectively, and generated cash from financing activities of $27,641,031.
During the previous year ended December 31, 2005, overall cash inflows increased during 2005 due to significantly increased financing activities and the completion of constructing of the West Lorne Project in 2005. During the year ended December 31, 2005, the Company used cash in operating activities and in investing activities of $6,734,729 and $1,775,189 respectively, and generated cash from financing activities of $9,769,211. During the year ended December 31, 2004, the Company used cash in operating activities and in investing activities of $2,883,735 and $5,824,645 respectively, and generated cash from financing activities of $8,693,057.
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The net amount of cash used in operating activities during 2006 increased by 40% (over cash used in operating activities during 2005) due to the construction of the Company’s 200 tpd plant and the resulting increase in business development activities. Cash used in operating activities consisted primarily of a net loss for 2006 of $14,252,382 less non-cash expenses of (i) amortization of $124,067, (ii) accretion expense in the amount of $208,022, (iii) loss on settlement of accounts payable of $98,189, (iv) loss on sale of interest in subsidiary of $420,400, and (v) equity compensation expenses of $4,337,590.
The net amount of cash used in operating activities during 2005 increased by 134% (over cash used in operating activities during 2004) due to the commissioning of the Company’s 100 tpd plant and the resulting increase in business development activities. Cash used in operating activities consisted primarily of a net loss for 2005 of $11,997,344 less non-cash expenses of (i) amortization of $148,556, (ii) equity compensation expenses, $3,697,057, (iii) loss on write-down of property, plant and equipment of $200,457, and (iv) accretion expense in the amount of $1,068,192.
The net amount of cash used in operating activities during 2004 increased by 33% of cash used in operating activities during 2003. Cash used in operating activities consisted primarily of a net loss for 2004 of $9,916,215 that was offset by (i) amortization of non-cash items in the sum of $130,912, (ii) non-cash equity compensation expenses, $4,730,604, and (iii) net change in non-cash working capital balances related to operations of $2,087,156.
Financing activities during 2006 generated a net cash inflow of $27,641,031, primarily from the Company’s private placements of Common Shares. Financing activities during 2005 generated a net cash inflow of $9,769,211, primarily from the Company’s private placements of Common Shares and the proceeds from convertible debentures.
Investing activities in 2006 resulted in the use of cash, net of grants, in the amount of $10,339,843 that consisted of $10,496,423 incurred in the acquisition of capital assets (Guelph plant), $21,016 expended on patents, and a $177,596 decrease in restricted cash. Investing activities in 2005 resulted in the use of cash, net of grants and disposal, in the amount of $1,775,189 that consisted of $1,580,195 incurred in the acquisition of capital assets, $22,181 expended on patents and $172,813 increase in restricted cash (funds held in escrow as collateral for short-term convertible debentures). Investing activities in 2004 resulted in the use of cash, net of grants and disposal, in the amount of $5,824,645 that consisted of $5,804,656 that was incurred in the acquisition of capital assets, $19,989 was expended on patents.
As at December 31, 2006, the Company had working capital of $4,938,473 and incurred a net loss of $14,252,382 for the year ended December 31, 2006, and has an accumulated deficit of $73,099,779.
In the year ended December 31, 2006, Dynamotive had no commercial revenue from its core BioOil operations. Sales revenue going forward is uncertain and the Company is therefore dependent on its financing activities to fund its operations. The proceeds from the recent equity financing, together with Technology Partnerships Canada (“TPC”) funding receivable, will be applied to finance the Company’s ongoing research and development and commercial demonstration activities and to support its efforts to obtain the award of customer contracts. Dynamotive will be required to raise sufficient additional funds to finance its commercialization strategy. The raising of additional finance to fund operations is subject to uncertainty. There is no assurance that such financing will be available on commercially reasonable terms, if at all. Dynamotive’s operations are subject to all of the risks inherent in the establishment of a new business enterprise and in particular Dynamotive will require significant additional financing in the future to develop and market its technology to its full potential.
In addition to contemplated equity offerings during 2007, the Company has been able to draw significantly from government grant and loan facilities, including the Government of Canada’s
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TPC program both for expenditures made in 2005 and technical and project related expenditures in 2006. The Company’s agreement with Technology Partnerships Canada pertains to maximum funding of US$7.1 million (C$8.235 million), of which $6.0 million (C$ 7.0 million) has been received as of year end 2006 and $1.1 million is included in government grants receivable.
During the first quarter of 2004, the Company signed a Contribution Agreement with SDTC whereby SDTC will contribute $4.3 million (C$5 million) to the capital cost of the Company’s West Lorne 100 TPD BioOil co-generation project development. This amount is a government grant and is accounted for as a reduction in the capital cost of the project. In 2004, the Company received the three payments of $3.2 million (C$3.7 million) from SDTC. In November 2005, the Company received a payment of $0.7 million (C$0.8 million) from SDTC. In December 2006, the Company received the remaining $0.4 million (C$0.5 million).
During the first quarter of 2006, the Company raised subscription funds of $10.2 million relating to the private placement commenced commencing in the second quarter of 2004 at subscription prices ranging from $0.60 to $1.055 per share. 13 million shares and 2.7 million Common Share Purchase Warrants were issued as a result of this funding.
During the second quarter of 2006, the Company raised total subscription funds of $9.3 million from private placement commenced during the first quarter of 2004 ($0.2 million at subscription prices ranging from $0.81 to $1.35 per share) and from the private placement commenced during the second quarter of 2006 ($9.1 million at subscription prices ranging from $0.86 to $1.33 per share). 8.0 million Shares and 2.0 million Common Share Purchase Warrants were issued as a result of these subscriptions.
During the second quarter of 2005 the Company issued $1.825 million of convertible debentures including $175,000 of debentures issued to officers and directors (or companies controlled by officers and directors) of the Company. The debentures were due between June and September 2006, had an interest rate of 10% payable in shares and were convertible into Company common shares at rates between $0.40 and $0.425 per share. These debentures were collateralized by certain government receivables and guaranteed by the Company. In September and December 2005, $1.15 million of the debentures were converted into 2.7 million common shares and 0.68 million Series U warrants. In 2006, the remaining $675,000 of the debentures were converted into 1,613,969 common shares and 484,787 Series U warrants. In addition, 109,370 shares and 29,493 Series U warrants were issued in 2006 as interest payments on the debentures. As at December 31, 2006, no debentures were outstanding.
During the third and fourth quarter of 2006, the Company did not raise subscription funds relating to the same private placement of the previous quarter.
In total, the Company raised from private placements during 2006 $19.5 million in cash and settled $0.09 million in consulting fees payable by the Company (these shares were valued based on the quoted market price on the date of the settlement agreement) for a total of 21.2 million Common Shares and 4.7 million Common Share Purchase Warrants.
With the current cash on hand, anticipated cash flow from product sales and additional equity and debt financing, the Company anticipates that it will have sufficient cash resources and available financing to satisfy its cash requirements for the next 12 months. The Company expects to require additional funding for the commercial expansion of its technologies through the year 2007 and beyond. Given market conditions and other factors, there can be no guarantee that the Company will be successful in securing additional finance. If adequate funds are not available on acceptable terms when needed, the Company may be required to delay, scaleback or eliminate the manufacturing, marketing or sales of one or more of its products or research and development programs. The outcome of these matters cannot be predicted at this time. The Company’s future operations are dependent on the market’s acceptance of its products in order to ultimately generate future profitable operations, and the Company’s ability to secure sufficient financing to fund
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future operations. There can be no assurance that the Company’s products will be able to secure market acceptance. Management plans to raise additional equity financing to enable the company to complete its development plans.
In recognition of our liquidity and capital resources, our independent public accountants have included a comment in their report on our accompanying consolidated financial statements for the year ended December 2006, that express substantial doubt as to our ability to continue as a going concern.
Subsequent to the year end, during the period from January 1 to April 17, 2007, the Company issued 2,280,259 common shares for total proceeds of $2,480,900, relating to a private placement commencing during the first quarter of 2007. In addition during the period from January 1 to April 17, 2007, the Company received $4.37 million on the exercise of 744,166 options and 6,851,049 warrants.
The Company’s 2007 financing plan is structured to enable completion, commissioning and ramp-up of the Company’s first 200 tonne per day (“tpd”) BioOil manufacturing facility in Guelph. The plant is to be owned 100% by the Company and leased to Evolution Biofuels Inc., a company owned 20% by the Dynamotive. As well the Company expected to spend approximately $5 million on an upgrade and expansion of the plant in West Lorne. The core of the strategy surrounds market and project based equity financing that minimizes equity dilution while raising sufficient capital for operations and projects. In addition, the Company will seek asset backed debt financing if such facilities are available on reasonable commercial terms.
In connection with the Company’s West Lorne project upgrade and construction advances related to the 200 tpd plants, the Company has committed to outstanding construction commitments of approximately $8.2 million at December 31, 2006.
The Company’s funding plan for 2007 is structured so that equity placements explained above will maintain Company and project operations. Additionally, the Company contemplates a private placement and project finance strategy which, with other project funding and sales, are expected to fund the 200 tpd project(s) which are expected to be developed during 2007. Any delay in securing project funding for a project will delay the construction and commissioning of that project.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared based on the accounting policies described in Note 2 to our consolidated financial statements included herein. The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. Actual results could differ from these estimates.
Revenue Recognition
[a] Product Sales
The Company recognizes revenue from the sale of products, including BioOil, char, and other byproducts, upon shipment of the product when the risk and reward of ownership has been transferred to the customer, provided that the amount is fixed or determinable and collection is reasonably assured.
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[b] Licenses and royalties
Revenue from license agreements may include multiple elements within a single contract. Payments received under license agreements may include the following: non-refundable fees at inception of the contract, fees for services to be performed, milestone payments for specific achievements, and royalty payments based upon resulting sales of products. Agreements with multiple elements are separated into significant discrete units of accounting based on the relative fair value of each element. Revenue recognized for each element when all significant acts have been completed and delivery has occurred with no substantial risk of return and collectibility is reasonably assured. When the fair value cannot be determined, revenue is deferred until objective evidence exists or recognized as the final elements are delivered.
Deferred revenue is comprised of amounts received prior to the satisfaction of the revenue recognition criteria described above and includes non-refundable amounts related to sales of master license and plant license agreements. Master license agreements grant the licensee the exclusive right and license to use and commercially exploit the Company’s BioOil technology including the rights to manufacture, market, distribute, and sub-license the technology for the production of BioOil within a specific territory. Plant license agreements grant a licensee the right to use and commercially exploit the Company’s BioOil technology for the development of one or more pyrolysis plant facilities.
In 2006, the Company received a total of $950,000 in payments from three unrelated companies as licensing fees. $500,000 from Rika Ltd. as payment for a Master License to develop project opportunities in the Ukraine and the Baltic republics using Dynamotive’s patented pyrolysis technology; $150,000 from Classic Power Inc. as an initial payment on a Plant License for Guelph, Ontario, Canada; $200,000 from Renewable Oil Corporation Pty Ltd. (“ROC”) for a Master License to develop project opportunities in Australia and $100,000 from ROC as a deposit on an initial plant license.
Deferred revenue is net of $330,000 advanced to entities controlled by Rika Ltd. and a $100,000 long-term investment in ROC.
All the above funds are non-refundable and have been recorded as deferred revenue.
Government Assistance and Investment Tax Credits
Government assistance towards current expenses is included in the determination of income for the period as a reduction of the expenses to which it relates. Amounts received for future expenditures are recorded as a current liability. Government assistance towards the acquisition and construction of property, plant and equipment is deducted from the cost of the related property, plant and equipment. Government grants receivable are recorded when the Company has incurred the qualifying expenditure and there is reasonable assurance the receipts will be recovered.
Repayment of contribution is contingent solely upon the Company’s ability to generate revenue from the sale of specified products or technology. Accordingly, liability of repayment will only be accrued when sales of the products or technology have been generated.
Investment tax credits are accounted for under the cost reduction method whereby they are netted against the expense or capital asset to which they relate. Investment tax credits are recorded when the Company has incurred the qualifying expenditures and there is reasonable assurance the tax credits will be realized. As at December 31, 2006 and 2005, no investment tax credits have been recognized.
23
Research and Development Costs
Research costs are expensed in the period incurred. Development costs are expensed in the period incurred unless the Company believes the development project meets Canadian generally accepted accounting criteria for deferral and amortization. In evaluating these criteria the Company considers technological feasibility to be established only when a product demonstrates it operates under conditions which are acceptable to target customers. If management determines that the development of products to which such costs have been capitalized is not reasonably certain, or that costs exceed recoverable value, such costs are charged to operations. The Company has not capitalized any development costs for any of the year ends presented.
During the year ended December 31, 2006, the Company netted $154,560 (2005 - $nil; 2004 - $nil) of product sales against research and development expenses, which are considered incidental sales of BioOil until such time as the Company’s plant has reached commercial production levels.
Projects Under Development
The Company expenses all preliminary stage costs incurred with respect to a potential capital project, including costs related to the consideration of alternatives, feasibility studies, and activities occurring prior to the decision to proceed with the project until the capital project meets the Company’s capitalization policy and is considered a project under development. The Company begins to capitalize costs for projects under development when it has determined that it is more likely than not that the financing for the capital project is available and it is more likely than not that the Company will be able to meet the requisite local and other governmental regulations to develop the capital project.
For those capital projects that meet the Company’s capitalization policy, the Company capitalizes incremental costs that are directly identifiable with the specific capital project until the capital project is substantially complete and ready for its intended use. Financing costs, including interest, are capitalized when they arise from indebtedness incurred, directly or indirectly, to finance the construction of the capital project. Capitalization of financing costs will cease when a capital project is considered to be substantially complete and ready for its intended use.
Annually, or whenever events and circumstances indicate that the carrying value of the assets might be impaired and the carrying value may not be recoverable, the Company performs evaluations to assess the recoverability of its projects under development. When the carrying value of projects under development is determined to exceed its recoverable amount, an impairment loss is recorded to reduce the carrying value of the projects under development to its fair value.
Stock Based Compensation Plan
The Company has two stock based compensation plans - a stock appreciation rights (“SA Rights”) plan and a stock option plan for directors and employees, which are described in note 15. Under the terms of the stock option plan the Company may grant fixed options or options whose vesting is contingent on future performance. Compensation is recognized under the fair value based method when fixed or performance based stock options are granted to employees and directors. Compensation is recognized using the fair value based method for SA Rights when the performance criteria have been met and amortized over the service period.
The Company may also issue stock options and warrants to employees or as consideration for services rendered by non-employees. As a result of the change in accounting policy (note 3), such equity awards are recorded at their fair value using the Black Scholes option pricing model, as compensation expense or capitalized to long-term assets under construction when the Company receives the related services and the equity awards vest. No compensation is recognized in connection with options and warrants awarded in connection with private placements, since the
24
share issue costs are netted against the proceeds raised. All unvested or modified options for non-employees are re-measured on each balance sheet date until such options vest, are exercised or forfeited.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES, ETC.
The Company considers patents to be an important aspect of the Company’s business. The Company protects its intellectual property such as trademarks, patents, product designs, manufacturing processes and new product research and concepts. These rights are protected through patents and trademark registrations, the maintenance of trade secrets and, when necessary and appropriate. The Company also maintains stringent procedures to maintain the secrecy of its confidential business information. These procedures include the establishment of "need to know" criteria for the dissemination of certain information and the use of written confidentiality agreements in cases where the sharing of proprietary information with third parties is necessary.
As of May 24, 2007, the Company’s key patent is protected in 11 countries, patent applications pending in 5 countries and is scheduled to expire between years 2016 and 2018. A US Patent was granted in February 2006 to expire in year 2024 with respect to an enhancement of the key patent and based on this, a US PCT application was filed in February 2005; a Eurasian patent application was filed in March 2006
Research costs are expensed in the year incurred and are recorded net of incidental product sales. Development costs are expensed in the year incurred unless the Company believes the development project meets Canadian generally accepted accounting criteria for deferral and amortization. In evaluating these criteria the Company considers technological feasibility to be established only when a product demonstrates it operates under conditions, which are acceptable to target customers.
If management determines that the development of products to which such costs have been capitalized is not reasonably certain, or that costs exceed recoverable value, such costs are charged to operations
Please refer to the Item 5.A. Results of operations for additional information on research and development.
D. TREND INFORMATION
The Company’s Fast Pyrolysis technology produces BioOil, a fuel that will compete with conventional energy sources and other alternative energy industrial fuels. Therefore, price trends in the broad energy industry and developments in the alternative energy sector will affect the commercial viability and attractiveness of BioOil. The economic attractiveness of BioOil production is significantly affected by the availability of suitable biomass feedstock, the price of which may be effected on a regional basis by competing uses for the feedstock from other industries. The price of emissions credits, which can result from combustion of BioOil which displaces hydrocarbon fuels, may be affected by many outside factors including legislated requirements and international agreements.
E. OFF-BALANCE SHEET ARRANGEMENTS
Nil
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table provides as of December 31, 2006 the known long term obligations and commitments of the Company:
25
Contractual Obligations
| Total
| Less than 1
year | 1 – 3 years
| 3 – 5 years
| More than 5
years |
Operating lease obligations –
Office equipment |
30,000 |
10,000 |
17,000 |
3,000 |
Nil |
| Premise lease obligations | 471,000 | 242,000 | 229,000 | Nil | Nil |
| Business development contract | 150,000 | 140,000 | 10,000 | Nil | Nil |
| Construction commitments | 8,191,000 | 8,191,000 | Nil | Nil | Nil |
| Total | 8,842,000 | 8,583,000 | 256,000 | 3,000 | Nil |
Note: On April 5, 2007 the Company entered into certain amended agreements with Erie Flooring and Wood Products (“Erie”) regarding the supply by Erie of wood to the West Lorne BioOil plant (“BioOil plant”) over the next 12 years at no charge and the provision of char from the BioOil plant to Erie at no charge. In relation to these agreements, Dynamotive agreed to pay for the purchase and installation of a char based boiler system and related char delivery infrastructure. The terms include an immediate payment of $500,000 to Erie and a further $359,000 to Erie in equal monthly payments plus 8% interest, over the next 10 years for the purchase of the boiler.
We have an operating lease for office facilities of our head office.
G. SAFE HARBOR
Item 6. Directors, Senior Management and Employees
A. Directors and Senior Management
As at May 16, 2007, the Company’s directors and executive officers are:
| Name | Age | Position |
| Richard Chen-Hsing Lin(2)(3) | 63 | Chairman, President, Operations-China and Director |
| R. Andrew Kingston(3) | 47 | President, Chief Executive Officer and Director |
| Curtin Winsor, Jr., Ph.D.(1)(2) | 67 | Director |
| Desmond Radlein, Ph.D.(1)(2)(3) | 58 | Director |
| Shing-Cheng Hong(1) | 73 | Director |
| Chih-Lin Chu | 39 | Director |
| George J. Terwilliger III | 57 | Director |
| Brian Richardson | 44 | Chief Financial Officer |
| Jan Barynin, Ph.D. | 69 | Vice President, Engineering |
| Laura Santos | 57 | Corporate Secretary |
| Jeffrey Lin | 37 | Vice President, Business Development-China and Japan |
| Anton Kuipers | 53 | Vice President of Business Development |
| Robert Nigel Horsley | 59 | Executive Director of Marketing |
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-------
| (1) | Member of the Audit and Corporate Governance Committee of the Board of Directors. |
| | |
| (2) | Member of the Compensation Committee of the Board of Directors. |
| | |
| (3) | Member of the Executive Committee of the Board of Directors. |
All Directors are elected annually at the Company's Annual Meeting of Shareholders. The executive officers of the Company are appointed annually at the first meeting of the Company's Board of Directors held after each annual meeting of shareholders. Each director and executive officer of the Company holds office until his or her successor is duly elected and qualified or until his or her death or resignation or until he or she shall be removed in the manner provided by the Company's by-laws. There is no arrangement or understanding between any director or executive officer and any other person pursuant to which any director or executive officer is selected.
Richard Chen Hsing Lin. Mr. Lin has been a Director of the Company since 1992 and Chairman of the Company since May of 1995. He is the past President of the Taiwan Chamber of Commerce in Canada. Mr. Lin is also co-founder, Vice President and Secretary of Neoventi Technology Corporation since 1991 and Neoventi Investment Corporation since 1992, and has been a Director of Concert Industries Ltd. since December 1992. Mr. Lin was also President of the Taiwan Chamber of Commerce in B.C., and Vice President of R.C.A. Taiwan. Mr. Lin’s son, Jeffrey Lin, is the Company’s Vice President, Business Development for China and Japan. (See Jeffrey Lin’s affiliations below)
Robert Andrew Kingston. Mr. Kingston was appointed President and CEO in April 1999. Mr. Kingston has held senior positions in multi-national oil companies, property and investment corporations and financial institutions in Europe, the USA and South America. From 1996 to 1999, Mr. Kingston was advisor to public and private companies in the U.S. Canada and the U.K. From 1995 to 1996, Mr. Kingston was senior advisor to the Chairman of Rotch Property Group Ltd., a UK property investment and development company with assets in excess of US $7 billion. From 1992 to 1995, Mr. Kingston was a financial advisor on corporate restructuring for Interpetrol S.A., a South American oil trading company that at the time was partly owned by the Argentine National Oil Company (NYSE: YPF). He held a number of positions with the Gatoil Group of Companies from 1986 to 1990,: a fully integrated, privately owned oil conglomerate, including Managing Director of Gatoil Services (UK) Limited and Financial Vice President of Gatoil Enterprises Inc. (USA). He also worked for Price Waterhouse & Co. and Ducilo S.A., a subsidiary to E.1. DuPont de Nemours & Co.
Curtin Winsor, Jr., Ph.D. Dr. Winsor has been a Director of the Company since June 1996. He received his MA and Ph.D. in Latin American Area Studies and History of Diplomacy from the School of International Service of American University in 1979. He served at the Department of State's Office of Congressional Relations until 1971. Dr. Winsor became Special Assistant to Senator Bob Dole, Chairman of the Republican National Committee, from June 1971 to May 1973. Moving to the private sector, he served as Manager for International Affairs at the Washington office of Chase Manhattan Bank from 1973 to 1979. He helped to found the Alliance for Free Enterprise in 1979 and served as its Deputy Director until 1983. Dr. Winsor served as US Ambassador to Costa Rica from 1983 to 1985. He continued to serve as Consultant on Central America to the Under Secretary of Defense from 1985 to 1987. Dr. Winsor is a Governor of the Donner Canadian Foundation of Toronto, and a Trustee of the Pan-American Development Foundation (of the Organization of American States) in Washington, DC. He has been the owner of the American Chemical Services Company of Marmet, WV, which provides chemical blending, storage and distribution services for larger chemical companies servicing the coal industry for more than the past five years.
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Desmond Radlein, Ph.D.Dr. Radlein became a Director of the Company in December 1997, retired in August 2002 and was re-appointed in August 2003. Dr. Radlein has been the President of RTI - Resource Transforms International, Ltd., an R&D company specializing in pyrolysis technology and applications, since 1994. Dr. Radlein received a B.Sc: in Chemistry (1986) from the Alcan Scholar University of the West Indies in Jamaica and M.Sc. in Theoretical Chemistry (1970) from the University of Calgary in Alberta. He received his Ph.D. from the University of Cambridge, England (1975) in Physical Chemistry. He was a member of the Board of the Waterloo Region Community Legal Services from 1994 to 1995. Dr. Radlein was also an Associate Research Professor at the Chemical Engineering Department of the University of Waterloo from 1987 to 1994. He is an inventor or co-inventor of 10 patents on pyrolysis and petroleum processing and has also authored over 20 publications in various scientific journals. Some of his research activities include: pyrolytic production of fermentable sugars, fundamental studies on biomass pyrolysis mechanisms, catalytic hydropyrolysis for hydrocarbon production and catalyst development for gasification.
Shing-Cheng Hong. Mr. Hong became a Director of the Company in December 1997. With 40 years of financial and industrial background, Mr. Hong led a 42-member management team of Hotung Venture Capital Corp. where he served as its President since 1987. Hotung is the leading venture capital group in Taiwan and currently manages total funds of US$7 billion. Thirty-three additional venture capital funds were also established under his leadership; including Daitung VC; Yuantung VC; Litung VC; Futung VC and Wantung VC. Mr. Hong retired in 2001 from Hotung and now serves as Chairman of Giga Venture Partners & Co.
Chih-Lin Chu. Mr. Chu became a Director of the Company in June 2001. He is General Manager for Business Development at China Strategic Holdings Limited (CSH) since March 2000. CSH is a public company listed on Hong Kong Exchange with investments in energy, tire manufacturing, breweries, paper, pharmaceuticals and other light and heavy industries including power plants, diesel engine manufacturing, cement,. chemical plants, electrical machinery and auto parts as well as information technology and e-commerce related projects. From 1999 to 2000, Mr. Chu was Vice Chairman and President, China Operation for Tricom Holdings Limited, also a public company in Hong Kong with a focus on telecommunication products. Since 1994, Mr. Chu has been involved in business development and government relationship in China for various companies including Cathay Pacific Airline O.B.C. G.S.A., Shanghai E&T Wako Express Co. Ltd and Shanghai Tricom Limited. Mr. Chu received his MBA from the China Europe International Business School in China.
George J. Terwilliger III.Mr. Terwilliger became a Director of the Company in November 2006. He was Deputy Attorney General of the United States from 1991 to 1993 and served as the number two official and chief operating officer of the Department of Justice. He was Principal Associate Deputy Attorney General from 1990 to 1991, and a U.S. Attorney for the District of Vermont from 1986 to 1991. His public service career dates back to 1978 when he was appointed Assistant U.S. Attorney for the District of Columbia. From 1993 to 2000, Mr. Terwilliger was a Managing Partner and member of the Partnership’s Executive Committee at McGuire Woods’ Washington, DC office and led the corporate defense and white collar practice group. He is currently, a senior partner and head of corporate defense and special projects with White & Case LLP, of Washington DC, where he leads teams of lawyers on behalf of major corporate clients, including oil companies. His business and financial experience includes matters of corporate governance, financial management and controls, public relations and management of business projects and initiatives.
Brian Richardson, C.A., MBA Mr. Richardson was appointed Chief Financial Officer of the Company in August 2003. From 1993 - 2002, Mr. Richardson was a financial consultant in a variety of industries, including working for four years as a project manager for Westcoast Energy on gas and electric infrastructure projects in Latin America. In the early 1990's, he was CFO of a publicly traded venture capital firm, helping to bring it onto the TSE via a reverse take-over. Mr. Richardson also worked in investment banking, and as CFO of a biotech start-up. He has
28
significant experience in project planning, management and control and in working with early stage technology companies. Mr. Richardson received his designation as a Chartered Accountant in 1987, and in 1990, graduated with a MBA degree from IMD in Switzerland.
Jan Barynin, PhD., P.Eng. Dr. Barynin was appointed Vice President, Engineering in June 2004. Dr. Barynin spent almost 30 years of his professional career in steam, power, and boiler engineering; from 1970 to 1980 with Combustion Engineering (CE-Canada), from 1980 to 1986 with Babcock and Wilcox and from 1986 to 1999 with H.A. Simons. He oversaw the development of the Company’s 10 tpd BioOil demonstration plant and lately, has been responsible for the completion and commissioning of the 100 tpd BioOil plant in West Lorne, Ontario. His latest endeavours have been dedicated to renewable energy and use of agricultural and forestry residues. Dr. Barynin graduated as a Chemical Engineer in 1961 from the Royal Technology University of Denmark and in 1970 received his doctorate in Chemical Engineering and Chemical Technology from the Imperial College, UK.
Laura Santos, BFA. Mrs. Santos has been Secretary of the Company since March 1998, Assistant Secretary and Executive Assistant from 1994 to 1998. Prior to joining the Company, she was Accounting Supervisor with Everex Systems from 1990 to 1993; Senior Accounting Assistant with Walbar, Canada from 1989 to 1990 and with CitiBank, N.A. and Chemical Bank in New York from 1983 to 1988. She was also Assistant to the Executive Secretary of the Philippine American Chamber of Commerce in New York from 1982 to 1983. Mrs. Santos graduated with a Bachelor of Fine Arts degree from the University of the East, Philippines.
Jeffrey Lin, B.Sc. MBA, CMA.Mr. Lin joined Dynamotive in 1994 and has been appointed VP Business Development to lead the Company’s expansion efforts in Japan and China. Before joining the business development team, Mr. Lin previously held positions as the Director of Finance and Project Manager with the Company. Mr. Lin has the technical knowledge, business and financial experience as well as the cultural background and the language skills to open new business opportunities in Asia.
Anton Kuipers. Mr. Kuipers joined Dynamotive in January 2007 and has been appointed Vice President Strategic Initiatives with specific responsibilities to oversee new business development initiatives in Canada. Before joining Dynamotive, Mr. Kuipers was Vice President of Business Development, Marketing and Trade with Leading Edge British Columbia, a technology marketing society created by the Government of British Columbia to promote the technology industry sectors in British Columbia. Prior to Leading Edge BC, Mr. Kuipers worked for BC Trade Development Corporation and the BC Trade and Investment Office. Mr. Kuipers worked extensively with British Columbia energy and environmental technology industry sectors, facilitated and structured contracts with major multinationals and government agencies in Canada and abroad.
Robert Nigel Horsley.Mr. Horsley was appointed Executive Director of Communications and Investor Relations in October 2006. He was Vice-President and General Manager of Isee3D from April, 1993 to 1998 and was also a board member until December 2000. Mr. Horsley was a co-founder of Railpower Technologies Inc. in 2000, and was on Railpower’s board from November 2000 until his resignation in December 2003. He continued in consulting and senior management roles until August 2005 at which time he again, took up consulting and later employment with General Hydrogen Corporation, a company he helped co-found in 1999. He relinquished his final position as Director of Investor and Public Relations with General Hydrogen on September 2006, prior to joining Dynamotive.
B. Compensation of Directors and Senior Management
The following table contains a summary of compensation paid or payable to directors and senior management during the year ended December 31, 2006(1):
29
Name |
Salary
($) |
Bonus
($) | Long-term
Incentive Plan
($) |
| Richard Chen-Hsing Lin | 209,965 | 302,970 | 169,400(3) |
| Robert Andrew Kingston | 326,612 | 468,227 | 242,000(4) |
| Curtin Winsor, Jr., Ph.D | 13,044(2) | - | - |
| Shing-Cheng Hong | 17,451(2) | - | - |
| Desmond Radlein | 17,187(2) | - | - |
| Chih-Lin Chu | 8,814(2) | - | - |
| George Terwillger | 1,058(2) | - | - |
| Paul Hughes | 215,935(6) | - | - |
| Brian Richardson | 193,901 | 49,577 | 36,300(5) |
| Jan Barynin | 123,392 | - | - |
| Laura Santos | 105,764 | 88,798 | - |
| Jeffrey Lin | 105,764 | 88,798 | - |
| Robert Nigel Horsley | 30,848 | - | - |
Notes:
| (1) | Except as otherwise noted, all compensation are disclosed in U.S. dollars based upon 2006’s average exchange rate of $0.8814 per dollar. |
| (2) | 50% to be paid in cash ($28,777) and 50% in shares (total of 22,187 restricted common shares) |
| (3) | Unissued bonus share option earned pursuant to milestone achievement calculated at 700 shares per ton of capacity per 200 tpd plant contracted, priced at $1.21 per share determined on September 29, 2006 |
| (4) | Unissued bonus share option earned pursuant to milestone achievement calculated at 1,000 shares per ton of capacity per 200 tpd plant contracted, priced at $1.21 per share determined on September 29, 2006 |
| (5) | Unissued bonus share option earned pursuant to milestone achievement calculated at 150 shares per ton of capacity per 200 tpd plant contracted, priced at $1.21per share determined on September 29, 2006 |
| (6) | Mr. Hughes resigned from the Company on December 7, 2006 |
The following table lists stock options outstanding at December 31, 2006 to purchase common shares of the Company for directors and senior management:
| Name | Number of Shares | Exercise Price | Expiry Date |
| Richard Chen Hsing Lin | 750,000 | $0.50 | 02-Feb-10 to 29-Apr-12 |
| Richard Chen Hsing Lin | 300,000 | $0.23 | 30-Aug-13 |
| Richard Chen Hsing Lin | 605,660 | $0.20 | 30-Aug 13 to 31-Mar-14 |
| Richard Chen Hsing Lin | 2,000,000 | $0.45 | 31-Jul-14 to 31-Jul-16 |
| Richard Chen Hsing Lin | 150,000 | $1.60 | 12-Jul-09 |
| Robert Andrew Kingston | 775,000 | $0.50 | 02-Feb-10 to 23-Feb-12 |
| Robert Andrew Kingston | 907,649 | $0.20 | 30-Aug-13 to 14-Mar-14 |
| Robert Andrew Kingston | 300,000 | $0.23 | 30-Aug-13 |
| Robert Andrew Kingston | 2,400,000 | $0.22 | 30-Aug-13 to 22-Dec-13 |
| Robert Andrew Kingston | 2,000,000 | $0.45 | 31-Jul-14 to 31-Jul-16 |
30
| Name | Number of Shares | Exercise Price | Expiry Date |
| Robert Andrew Kingston | 150,000 | $1.60 | 12-Jul-09 |
| Curtin Winsor, Jr., Ph.D | 24,000 | $0.33 | 22-Dec-08 |
| Curtin Winsor, Jr., Ph.D | 45,000 | $0.45 | 05-Aug-08 to 01-Jul-10 |
| Desmond Radlein, Ph.D | 24,000 | $0.33 | 22-Dec-08 |
| Desmond Radlein, Ph.D | 69,000 | $0.45 | 05-Aug-08 to 01-Jul-10 |
| Shing-Cheng Hong | 23,000 | $0.45 | 01-Jul-10 |
| Chih-Lin Chu | 16,000 | $0.33 | 22-Dec-08 |
| Chih-Lin Chu | 45,000 | $0.45 | 05-Aug-08 to 01-Jul-10 |
| Paul Hughes | 400,000 | $0.49 | 31-May-08 to 31-May-09 |
| Brian Richardson | 600,000 | $0.48 | 01-Nov-08 to 30-Sep-09 |
| Brian Richardson | 300,000 | $0.58 | 01-Nov-08 to 30-Sep-09 |
| Brian Richardson | 100,000 | $1.60 | 12-Jul-09 |
| Jan Barynin | 600,000 | $0.48 | 21-Jan-09 to 08-Dec-10 |
| Jan Barynin | 50,000 | $1.60 | 12-Jul-09 |
| Laura Santos | 10,000 | $1.00 | 2-Feb-10 |
| Laura Santos | 80,000 | $1.50 | 14-Jun-10 to 31-Jan-11 |
| Laura Santos | 15,000 | $0.50 | 28-Apr-12 |
| Laura Santos | 100,000 | $0.23 | 30-Aug-13 |
| Laura Santos | 122,308 | $0.20 | 30-Aug-13 to 14-Mar-14 |
| Laura Santos | 400,000 | $0.49 | 31-Dec-09 to 31-Dec-10 |
| Laura Santos | 100,000 | $1.60 | 12-Jul-09 |
| Jeffrey Lin | 110,000 | $1.00 | 02-Feb-10 |
| Jeffrey Lin | 15,000 | $0.50 | 28-Apr-12 |
| Jeffrey Lin | 400,000 | $0.49 | 31-Dec-09 to 31-Dec-10 |
| Jeffrey Lin | 100,000 | $1.60 | 12-Jul-09 |
| Robert Nigel Horsley | 400,000 | $1.35 | 30-Sep-12 |
C.Board Practices
Members of the Board of Directors have served in their respective capacities since their election. Each director elected will hold office until the conclusion of the next Annual General Meeting of the Company at which a director is elected, unless the director’s office is earlier vacated in accordance with the Articles of the Company or the provisions of the Business Corporations Act (British Columbia).
The Company maintains standing Executive, Compensation and Audit and Corporate Governance Committees, but does not have a nominating committee. The Executive Committee is comprised of Dr. Desmond Radlein, Messrs. R. Andrew Kingston and Richard Chen-Hsing Lin. The purpose of the Committee is to act on behalf of the Board to provide direction to management and to
31
authorize and approve expenditures in excess of the authority delegated by the Board to management, with such approvals to be ratified by the Board at the next regular scheduled Meeting.
The Company’s Audit and Corporate Governance Committee, whose members include Mr. Shing-Cheng Hong, Drs. Curtin Winsor, Jr. and Desmond Radlein and Mr. George Terwilliger III, reviews the financial reporting process of the Company on behalf of the Board by reviewing the independence of the Company’s independent auditors, the adequacy of internal controls, the quality of financial reporting, and accounting estimates involving the use of significant management judgment.
The Compensation Committee of the Board of Directors makes recommendations to the Board of Directors on compensation issues, including (i) salary levels for officers; (ii) executive compensation plans; (iii) the review of employee benefit programs; (iv) the review of proposed compensation plans applicable to the Company’s officers and employees; and (v) the administration of the Company’s stock option plans as authorized by the Board. The Committee is comprised of Drs. Desmond Radlein and Curtin Winsor, Jr. and Mr. Richard Chen-Hsing Lin.
The Board approved in May 2004 a new compensation plan as proposed by the Compensation Committee for non-management Board members and Committee chairs, as follows: a) annual retainer of $8,814, and $4,407 for Board members and Committee chairs respectively, payable in 50% cash and 50% in common stock priced at the market closing price on the day of the AGM or the average of the five trading days prior to the AGM, whichever is lower; b) 15,000 and 8,000 stock options for Board members, and Committee chairs, respectively; the term of the stock options is for four (4) years and priced at $0.45 per share for years 2004-2006; c) Board and Committee meeting fees – $264 per meeting under two (2) hours and $1,058 per meeting over two (2) hours, payable in 50% cash and 50% in common stock priced on the last trading day of the respective quarter at the lower of the price on such day or the average of the previous five trading days. Shares when issued with respect to these fees are restricted for a twelve-month period and subject to Rule 144 of the Securities Act of 1933. The Compensation Committee of the Board regularly reviews the appropriateness of Director’s compensation. The directors are also reimbursed for out-of-pocket expenses such as reasonable traveling, hotel and other expenses incurred in and about the business of the Company.
Executive officers of the Company who also act as directors of the Company do not receive any additional compensation for services rendered in their capacity as directors, other than as paid by the Company to such executive officers in their capacity as executive officers.
D. Employees
The following table lists the number of employees at the end of the period for each of the past three financial years broken down by geographic location.
| | 2006 | 2005 | 2004 |
| Canada | 36 | 25 | 24 |
| US | 0 | 0 | 0 |
| UK | 0 | 0 | 0 |
| Total | 36 | 25 | 24 |
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E. Share ownership
The following table sets out the names of directors and senior management, the period of time during which each has been a director or senior manager of the Company, and the number of common shares of the Company beneficially owned by each of them, directly or indirectly, or over which control or direction is exercised and percentage of ownership as at May 16, 2007:
Name | Periods during which Has
Served as a Director or
Senior Manager |
Shares Owned and % of
Ownership |
Richard Chen-Hsing Lin(2)
Chairman, President, Operations-China and
Director | Since 1992
| 2,245,370 Common shares(2)
1.21%
|
Robert Andrew Kingston(3)
President, Chief Executive Officer and Director | Since 1999
| 900,468 Common shares(3)
0.49% |
Curtin Winsor, Jr., Ph.D.(4)
Director | Since 1996
| 1,541,393 Common shares(4)
0.83% |
Shing-Cheng Hong(5)
Director | Since 1997
| 130,226 Common shares(5)
0.07% |
Chih-Lin Chu(6)
Director | Since 2001
| 10,206 Common shares(6)
0.006% |
Desmond Radlein, Ph.D.
Director | 1997 – 2002 and 2003 to
present | 57,223 Common shares(7)
0.03% |
George J. Terwilliger III
Director | Since 2006
| 5,463 Common shares
0.003% |
Brian Richardson
Chief Financial Officer | Since 2003
| 152,000 Common shares
0.08% |
Jan Barynin, Ph.D., P.Eng
Vice President, Engineering | Since 2004
| nil
|
Laura Santos
Corporate Secretary | Since 1998
| 6,016 Common shares
0.003% |
Jeffrey Lin
Vice President, Business Development – China
and Japan | Since 2005
| nil
|
Robert Nigel Horsley
Executive Director of Marketing | October 2006
| nil
|
Anton Kuipers
Vice President of Business Development | January 2007
| nil
|
Notes:
| (1) | The information as to Shares beneficially owned or controlled is not within the knowledge of the management of the Company and has been furnished by the respective nominees. |
| | |
| (2) | Includes 2,245,370 Common Shares, of which 423,746 Common Shares are held by Cantai Property Limited (Cantai), a company controlled by Mr. Lin and includes 1,648,712 Common Shares held by Leede Financial – 354,218 common shares on behalf of Mr. Lin and 1,294,494 on behalf of Cantai; also includes 172,912 Common Shares held by Neoventi Technology Corporation over which Mr. Lin has |
33
| voting and disposition powers. Mr. Lin also holds options to purchase up to an aggregate of 5,805,660 Common Shares (3,000,000 Common Shares (1,000,000 common shares non-vested) at an exercise price of $0.45, expiring from July 31, 2014 to July 31, 2018; 1,000,000 Common Shares (1,000,000 common shares non-vested) at an exercise price of $0.58, expiring from July 31, 2019 to July 31, 2020; 750,000 Common Shares at an exercise price of $0.50, expiring from February 2, 2010 to April 28, 2012, 300,000 Common Shares at an exercise price of $0.23, expiring on August 30, 2013; 605,660 Common Shares at an exercise price of $0.20, expiring from August 30, 2013 to March 31, 2014 and 150,000 Common Shares at an exercise price of $1.60, expiring July 12, 2009). |
| | |
| (3) | Includes 900,468 Common Shares; 761,912 of these Shares are held in the name of Cape Fear Limited, an Isle of Man company which all shares are held by an arm’s length trustee of a discretionary trust of which Mr. Kingston is a beneficiary. Mr. Kingston also holds options to purchase up to an aggregate of 8,532,649 Common Shares (3,000,000 Common Shares (1,000,000 common shares non-vested) at an exercise price of $0.45, expiring from July 31, 2014 to July 31, 2018; 1,000,000 Common Shares (1,000,000 common shares non-vested) at an exercise price of $0.58, expiring from July 31, 2019 to July 31, 2020; 300,000 Common Shares at an exercise price of $0.23, expiring on August 30, 2013; 2,400,000 Common Shares at an exercise price of $0.22, expiring from August 30, 2013 to December 22, 2013; 907,649 Common Shares at an exercise price of $0.20, expiring from August 30, 2013 to March 14, 2014, 775,000 Common Shares at an exercise price of $0.50, expiring from February 2, 2010 to February 23, 2012, and 150,000 Common Shares at an exercise price of $1.60, expiring on July 12, 2009). |
| | |
| (4) | Includes 1,541,393 Common Shares of which 1,273,262 Common Shares are held by Legacy Trust. Dr. Winsor also holds options to purchase up to an aggregate of 69,000 Common Shares (24,000 Common Shares at an exercise price of $0.33, expiring on December 22, 2008; 45,000 Common Shares at an exercise price of $0.45, expiring from August 5, 2008 to July 1, 2010). |
| | |
| (5) | Mr. Hong also holds options to purchase up to 23,000 Common Shares at an exercise price of $0.45, expiring on July 1, 2010. |
| | |
| (6) | Mr. Chu also holds options to purchase up to an aggregate of 61,000 Common Shares (16,000 Common Shares at an exercise price of $0.33, expiring on December 22, 2008; 45,000 Common Shares at an exercise price of $0.45, expiring from August 5, 2008 to July 1, 2010). |
| | |
| (7) | Dr. Desmond Radlein also holds options to purchase up to an aggregate of 93,000 Common Shares (24,000 Common Shares at an exercise price of $0.33, expiring on December 22, 2008; 69,000 Common Shares at an exercise price of $0.45, expiring from August 5, 2008 to July 1, 2010). |
The number of shares beneficially owned by the directors and senior management, directly or indirectly, are based on information furnished by Computershare Trust Company of Canada, the registrar and transfer agent of the Company, and by the nominees themselves. The Directors and Officers beneficially own or effectively control as a group a total of 5,685,166 shares which represent 3.07% of the total issued and outstanding shares of the Company.
The Directors and Senior Management hold a total of 15,286,617 options. 4,799,617 options are exercisable between $0.20 and $0.33 each; 8,837,000 are exercisable between $0.45 and $0.58 each; and 1,650,000 options are exercisable between $1.00 and $1.60 each. 13,756,617 unexercised options were in the money and 1,530,000 unexercised options were out of the money based on the average trading price of $1.13 per Common share as listed on the OTC BB as at May 16, 2007.
Percentage of class is calculated based on the outstanding common shares as at May 16, 2007 of 185,348,245.
The Company has a Stock Option Plan (the “Plan”), enabling the Company to provide its directors, officers and employees with an opportunity to share in increases in the value of the Company’s shares. The Plan is intended to attract and retain the services of directors, officers, employees and consultants to the Company for the benefit of the Company and its shareholders and to provide additional incentive for such directors, officers and employees to continue to work in the best interests of the Company and its shareholders through continuing ownership of its Common Stock. At May 16, 2007, 11,077,315 options were issuable under the Plan and 16,845,367 options were outstanding at exercise prices ranging from $0.20 to $1.60 per common share.
34
Item 7. Major Shareholders and Related Party Transactions
A. Major Shareholders
To the Company’s knowledge, it is not directly or indirectly owned or controlled by another corporation or by any foreign government, nor is it aware of any person who owns more than 5% of the Company’s common stock (the only outstanding class of the Company’s voting securities).
The Company knows of no arrangements which may, at a subsequent date, result in a change of control.
Computershare Trust Company of Canada (Computershare) is the Company's registrar and transfer agent for the Company's shares. Computershare’s records as of May 16, 2007 indicate 186,051,212 shares of common stock issued and outstanding as follows:
| Residence of Shareholder | Number of Holders | Number of Shares(1) | Percent |
| Canada | 73 | 73,390,578 | 39.45% |
| U.S.A. | 204 | 86,889,566 | 46.70% |
| Other | 138 | 25,771,068 | 13.85% |
| Total | 415 | 186,051,212 | 100.00% |
(1) Includes the total number of shares held by registered and beneficial shareholders.
B. Related Party Transactions
Except as disclosed herein, the Company has not, since the beginning of its last fiscal year ended December 31, 2006, and does not propose to:
| (1) | enter into any transactions which are material to the Company or a related party or any transactions unusual in their nature or conditions involving goods, services or tangible or intangible assets to which the Company or any its former subsidiaries was a party; |
| | | |
| (2) | make any loans or guarantees directly or through any of its former subsidiaries to or for the benefit of any of the following persons: |
| | | |
| (a) | enterprises that directly or indirectly through one or more intermediaries, control or controlled by or are under common control with the Company; |
| | | |
| (b) | associates of the Company (unconsolidated enterprises in which the Company has significant influence or which has significant influence over the Company) including shareholders beneficially owning 10% or more of the outstanding shares of the Company; |
| | | |
| (c) | individuals owning, directly or indirectly, shares of the Company that gives them significant influence over the Company and close members of such individuals families; |
| | | |
| (d) | key management personnel (persons having authority in responsibility for planning, directing and controlling the activities of the Company including directors and senior management and close family members of such directors and senior management); or |
35
| | (e) | enterprises in which a substantial voting interest is owned, directly or indirectly, by any person described in (c) or (d) or over which such a person is able to exercise significant influence. |
The following transactions with related parties are in the normal course of operations and are recorded at amounts established and agreed between the related parties. The Company had the following transactions with related parties since December 31, 2005:
Consulting fees and salaries of $1,763,575 for the year ended December 31, 2006 (2005 - $1,940,421; 2004 - $3,053,332) have been paid to Directors (or companies controlled by Directors) of the Company. Included in the amount above, is $543,122 (2005 - $974,392; 2004 - $2,288,556) paid by stock based compensation.
Consulting fees and share issue costs of $nil for the year ended December 31, 2006 (2005 - $87,395; 2004 - $574,326) have been paid to a shareholder of the Company. Included in the amount above, is $nil (2005 - $1,113; 2004 - $513,958) paid by stock based compensation.
As at December 31, 2006, $nil (2005 - $82,529; 2004 - $136,370) was advanced to a Director of the Company in connection with the formation of a joint venture for the development of the Company’s BioOil technology and related products. The joint venture did not proceed and the advance was written-off on December 31, 2005.
As at December 31, 2006, there was $5,925 (2005 - $11,926) due from related parties and $1,218,932 (2005 - $1,005,447) due to related parties, which amounts are non-interest bearing, unsecured and due on demand.
During 2006, $150,000 of convertible debentures plus interest issued to a former officer were converted into 468,820 common shares and 200,650 Series U warrants.
C. Interest of Experts and Counsel
Not applicable.
Item 8. Financial Information
A. Consolidated Statements and Other Financial Information
See Item 17 of this Annual Report for the Company’s Consolidated Financial Statements for the years ended December 31, 2006, 2005 and 2004.
B. Significant Changes
There have been no significant changes in the Company’s business since December 31, 2006 except as disclosed in this Annual Report.
Item 9. The Offer and Listing
Dynamotive Energy Systems Corporation’s Common Shares is traded on the Over the Counter Bulletin Board (OTCBB) under the symbol DYMTF.OB. As at December 31, 2006, the closing market sales price on the OTC BB for the Company’s Common Share was $1.12 per share. The following table shows the annual High and Low market prices for the securities traded on the NASD OTC Bulletin Board for the five most recent full financial years; the high and low market prices for each financial quarter for the two most recent full financial years and any subsequent period; and the monthly high and low market prices for the most recent six months:
36
| Year Ended | High | Low |
| 2002 | 0.67 | 0.18 |
| 2003 | 0.79 | 0.14 |
| 2004 | 0.80 | 0.41 |
| 2005 | 1.00 | 0.43 |
| 2006 | 1.76 | 0.76 |
| | | |
| Quarter Ended | High | Low |
| | | |
| March 31, 2005 | 0.66 | 0.47 |
| June 30, 2005 | 0.59 | 0.43 |
| September 30, 2005 | 0.63 | 0.49 |
| December 31, 2005 | 1.00 | 0.53 |
| | | |
| March 31, 2006 | 1.76 | 0.76 |
| June 30, 2006 | 1.70 | 1.01 |
| September 30, 2006 | 1.40 | 1.09 |
| December 31, 2006 | 1.22 | 0.88 |
| | | |
| March 31, 2007 | 1.36 | 0.97 |
| | | |
| Month Ended | High | Low |
| December 2006 | 1.22 | 0.93 |
| January 2007 | 1.35 | 0.97 |
| February 2007 | 1.29 | 1.15 |
| March 2007 | 1.36 | 1.15 |
| April 2007 | 1.34 | 1.17 |
| May 2007 | 1.21 | 1.00 |
The Company has never declared or paid cash dividends on its Common Shares. The Company currently intends to retain its earnings, if any, to provide funds for the operation and expansion of its business and, therefore, does not anticipate declaring or paying cash dividends in the foreseeable future.
Item 10. Additional Information
A. Share capital
Not applicable
B. Business Corporations Act Memorandum, Amendments and Articles of Incorporation
Articles of Association
The Company was incorporated on April 11, 1991 pursuant to theCompanies Act (British Columbia), later theCompany Act. The Company's corporate constituting documents were then comprised of its Notice of Articles and its Articles of Association ("Articles").
The Business Corporations Act (British Columbia) ("BCA") was adopted in British Columbia in 2004 and is now in effect. The Business Corporations Act replaces the Company Act (British
37
Columbia) and adopts many provisions similar to those contained in corporate legislation elsewhere in Canada. There was a mandatory transition process under the Business Corporations Act, so that all companies had to comply with the new regulations. As part of its transition, the Company adopted new Articles in June 2005.
Under the Business Corporations Act, every "pre-existing company" remained subject to certain "Pre-existing Company Provisions" contained in the Company Act (British Columbia) unless such provisions are removed with the approval of shareholders by way of a special resolution. Such Pre-existing Company Provisions include the following provisions that were relevant to the Company:
The majority required to pass a special resolution is three-quarters of those votes cast at a properly constituted meeting of shareholders. Under the BCA, a special resolution may be passed with a minimum two-thirds vote; and
A repurchase or redemption of shares can only be offered pro-rata to all shareholders. This provision has been removed under the BCA.
In order to take full advantage of the flexibility offered by the BCA, the Company's board of directors proposed removal of the Pre-existing Company Provisions in connection with the adoption by the Company of a new form of Articles that incorporates provisions permitted under the BCA. The removal of the Pre-existing Company Provisions required the affirmative vote of not less than three-quarters of the votes cast at a meeting of the shareholders of the Company, present in person or by proxy. This approval of the shareholders by special resolution was obtained at the annual general meeting of the shareholders of the Company held on June 27, 2005. The removal of the Pre-existing Company Provisions became effective upon the filing of a Notice of Alteration to the Company's Articles with the British Columbia Registrar of Companies on October 5, 2005. The Company's shareholders also approved by special resolution the adoption of a new form of Articles (the "Articles"). The Articles were adopted by the Company with a view to updating its charter documents to bring them into line with theBusiness Corporations Act and incorporating some of the new provisions of theBusiness Corporations Act. These Articles were filed with the Registrar of Companies on October 5, 2005.
The following is a summary of certain material provisions of (i) the Company's Notice of Articles, as amended by the Notice of Alteration approved by shareholders, (ii) the Company's new Articles, as adopted by shareholders, and (iii) certain provisions of theBusiness Corporations Act and related laws applicable to the Company:
1. Objects and Purposes
The Company's Memorandum and Articles do not specify objects or purposes. The Company is entitled under theBusiness Corporations Act to carry on all lawful businesses which can be carried on by a natural person.
2. Directors
Generally
The Directors of the Company are generally empowered, by majority vote, to manage the business and to bind the Company to all manners of agreements and transactions as they see fit, acting in the best interests of the Company. So long as the Preferred Shares are outstanding, the Company directors are restricted from effecting certain kinds of dividends and distributions on the common shares.
38
Director's power to vote on a proposal, arrangement or contract in which the director is interested.
According to theBusiness Corporations Act, a director holds a disclosable interest in a contract or transaction if:
| 1. | the contract or transaction is material to the company; |
| | | |
| 2. | the company has entered, or proposes to enter, into the contract or transaction, and |
| | | |
| 3. | either of the following applies to the director: |
| | | |
| a. | the director has a material interest in the contract or transaction; |
| | | |
| b. | the director is a director or senior officer of, or has a material interest in, a person who has a material interest in the contract or transaction. |
However, theBusiness Corporations Act also provides that in the following circumstances, a director does not hold a disclosable interest in a contract or transaction if:
| 1. | the situation that would otherwise constitute a disclosable interest arose before the coming into force of theBusiness Corporations Actor, if the company was recognized under theBusiness Corporations Act, before that recognition, and was disclosed and approved under, or was not required to be disclosed under, the legislation that: |
| | | |
| a. | applied to the company on or after the date on which the situation arose; and |
| | | |
| b. | is comparable in scope and intent to the provisions of theBusiness Corporations Act; |
| | | |
| 2. | both the company and the other party to the contract or transaction are wholly-owned subsidiaries of the same corporation; |
| | | |
| 3. | the company is a wholly-owned subsidiary of the other party to the contract or transaction; |
| | | |
| 4. | the other party to the contract or transaction is a wholly-owned subsidiary of the company; or |
| | | |
| 5. | where the director or senior officer is the sole shareholder of the company or of a corporation of which the company is a wholly-owned subsidiary. |
TheBusiness Corporations Act further provides that a director of a company does not hold a disclosable interest in a contract or transaction merely because:
| 1. | the contract or transaction is an arrangement by way of security granted by the company for money loaned to, or obligations undertaken by, the director or senior officer, or a person in whom the director or senior officer has a material interest, for the benefit of the company or an affiliate of the company; |
| | |
| 2. | the contract or transaction relates to an indemnity or insurance; |
| | |
| 3. | the contract or transaction relates to the remuneration of the director or senior officer in that person's capacity as director, officer, employee or agent of the company or of an affiliate of the company; |
| | |
| 4. | the contract or transaction relates to a loan to the company, and the director or senior officer, or a person in whom the director or senior officer has a material interest, is or is to be a guarantor of some or all of the loan; or |
39
| 5. | the contract or transaction has been or will be made with or for the benefit of a corporation that is affiliated with the company and the director or senior officer is also a director or senior officer of that corporation or an affiliate of that corporation. |
Under the Company's Articles, a director or senior officer who holds a disclosable interest (as that term is used in theBusiness Corporations Act) in a contract or transaction into which the Company has entered or proposes to enter:
| 1. | is liable to account to the Company for any profit that accrues to the director or senior officer under or as a result of the contract or transaction only if and to the extent provided in the Act; |
| | |
| 2. | is not entitled to vote on any directors' resolution to approve that contract or transaction, unless all the directors have a disclosable interest in that contract or transaction, in which case any or all of those directors may vote on such resolution; |
| | |
| 3. | and who is present at the meeting of directors at which the contract or transaction is considered for approval may be counted in the quorum at the meeting whether or not the director votes on any or all of the resolutions considered at the meeting. |
A director or senior officer who holds any office or possesses any property, right or interest that could result, directly or indirectly, in the creation of a duty or interest that materially conflicts with that individual's duty or interest as a director or senior officer, must disclose the nature and extent of the conflict as required by theBusiness Corporations Act. No director or intended director is disqualified by his or her office from contracting with the Company either with regard to the holding of any office or place of profit the director holds with the Company or as vendor, purchaser or otherwise, and no contract or transaction entered into by or on behalf of the Company in which a director is in any way interested is liable to be voided for that reason
Directors' power, in the absence of an independent quorum, to vote compensation to themselves or any members of their body.
The compensation of the directors is decided by the directors unless the board of directors requests approval to the compensation from the shareholders by ordinary resolution. TheBusiness Corporations Act provides that a director of a company does not hold a disclosable interest in a contract or transaction merely because the contract or transaction relates to the remuneration of the director or senior officer in that person's capacity as director, officer, employee or agent of the Company or of an affiliate of the Company.
Borrowing powers exercisable by the directors.
Under the Articles, the directors may, on behalf of the Company:
1. Borrow money in such manner and amount, on such security, from such sources and upon such terms, and conditions as they consider appropriate;
2. Issue bonds, debentures, and other debt obligations either outright or as a security for any liability or obligation of the Company or any other person and at such discounts or premiums and on such other terms as they consider appropriate;
3. guarantee the repayment of money by any other person or the performance of any obligation of any other person; and
4. mortgage, charge, whether by way of specific or floating charge, grant a security interest in, or give other security on, the whole or any part of the present and future assets and undertaking of the Company.
40
Retirement and non-retirement of directors under an age limit requirement.
There are no such provisions applicable to the Company under its Memorandum or its Articles or theBusiness Corporations Act.
Number of shares required for a director's qualification.
Directors need not own any shares of the Company in order to qualify as directors.
3. Rights, Preferences and Restrictions Attaching to Each Class of Shares
Classes of Shares
The Company has two classes of shares, namely common without par value and Class “A” Preferred Shares (the "Preferred Shares") with special rights and restrictions. The common shares and preferred shares are unlimited in number. Notice of Alteration of the Company’s Articles of Incorporation to cancel the existing special rights and restrictions attached to the Class “A” Preferred shares and to adopt a new special rights and restrictions attached to the Class “A” Preferred shares as approved at the Company’s Special Meeting of Shareholders on November 21, 2005. The Company’s Articles was altered to change all of the unissued Class “A” Preferred shares each with a par value of $5.00 into Class ”A” Preferred with no par value; to delete the existing Article 26 which sets out the special rights and restrictions attached to the Class “A” Preferred shares; and to add to the Articles of the Company, revised Article 26, which will govern the Class “A” Preferred shares and authorizes directors in the future to issue them in series and attach specific rights and restrictions to each such series within the requirements of Article 26.
Dividends
Dividends may be declared by the board out of available assets and are paid rateably to holders of common shares subject to the rights attached to the Preferred Shares. No dividend may be paid if the Company is, or would thereby become, insolvent.
Voting Rights
Subject to the special rights and restrictions of the Preferred Shares, as set out in Article 26, shares are entitled to one vote on matters to which shares ordinarily vote including the annual election of directors, appointment of auditors and approval of corporate changes. Directors automatically retire at each annual meeting, and may be elected thereat. There are no staggered directorships among the Company's directors. There are no cumulative voting rights applicable to the Company.
Rights to Profits and Liquidation Rights
The holders of Class “A” Preferred shares shall be entitled, on the liquidation or dissolution of the Company, whether voluntary or involuntary, or on any other distribution of its assets among its shareholders for the purpose of winding up its affairs, to receive, before any distribution is made to the holders of Common shares or any other shares of the Company ranking junior to the Class “A” Preferred shares with respect to repayment of capital on the liquidation or dissolution of the Company, whether voluntary or involuntary, or on any other distribution of its assets among its shareholders for the purpose of winding up its affairs, the amount paid up with respect to each Class “A” Preferred share held by them, together with any liquidation or other applicable premium (if any) thereon, all accrued and unpaid cumulative dividends (if any and if preferential) thereon, which for such purpose shall be calculated as if such dividends were accruing on a day-to-day basis up to the date of such distribution, and all declared and unpaid non-cumulative dividends (if any and if preferential) thereon. After payment to the holders of Class “A” Preferred shares of the amounts so payable to them, they shall not, as such, be entitled to share in any further distribution of the property or assets of the Company except as specifically provided in the special rights and restrictions attached to any particular series.
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Redemption
Sinking Fund Provisions
The Company has no sinking fund provisions or similar obligations which require it to, restrict its assets except for as set out in Article 26 of the Articles.
Shares Fully Paid
All the Company shares must, by applicable law, be issued as fully paid for cash, property or services. They are therefore non-assessable and not subject to further calls for payment.
Pre-emptive Rights
There are no pre-emptive rights as a consequence of the Company's Articles or the BCA which provide a right to any person to participate in offerings of the Company's equity or other securities, except as noted below.
With respect to the rights, preferences and restrictions attaching to the Company's common shares, there are generally no significant differences between Canadian and United States law as the shareholders, or the applicable corporate statute, will determine the rights, preferences and restrictions attaching to each class of the Company's shares.
4. Changes to Rights and Restrictions to Shares
TheBusiness Corporations Act provides that a company may, by the type of shareholders' resolution specified by the articles, or, if the articles do not specify the type of resolution, by a special resolution:
| | i) | create special rights or restrictions for, and attach those special rights or restrictions to, the shares of any class or series of shares, whether or not any or all of those shares have been issued; or |
| | | |
| | ii) | vary or delete any special rights or restrictions attached to the shares of any class or series of shares, whether or not any or all of those shares have been issued. |
The Company's Articles provide that, subject to theBusiness Corporations Act, the Company may by ordinary resolution:
| | (a) | create one or more classes or series of shares or, if none of the shares of a class or series of shares are allotted or issued, eliminate that class or series of shares; |
| | | |
| | (b) | increase, reduce or eliminate the maximum number of shares that the Company is authorized to issue out of any class or series of shares or establish a maximum number of shares that the Company is authorized to issue out of any class or series of shares for which no maximum is established; |
| | | |
| | (c) | subdivide or consolidate all or any of its unissued, or fully paid, issued, shares; |
| | | |
| | (d) | if the Company is authorized to issue shares of a class of shares with par value: |
| | (i) | decrease the par value of those shares; or |
42
| | (ii) | if none of the shares of that class of shares are allotted or issued, increase the par value of those shares; |
| | (e) | change all or any of its unissued, or fully paid issued, shares with par value into shares without par value or any of its unissued shares without par value into shares with par value; |
| | | |
| | (f) | alter the identifying name of any of its shares; or |
| | | |
| | (g) | otherwise alter its shares or authorized share structure when required or permitted to do so by the Act where it does not specify a special resolution. |
An ordinary resolution is a resolution of shareholders that is approved by a majority of those votes cast at a properly constituted meeting of shareholders.
If special rights and restrictions are altered and any right or special right attached to issued shares is prejudiced or interfered with, then the consent of the holders of shares of that class by a special separate resolution will be required.
TheBusiness Corporations Act also provides that a company may reduce its capital if it is authorized to do so by a court order, or, if the capital is reduced to an amount that is not less than the realizable value of the company's assets less its liabilities, by a special resolution or court order.
Generally, there are no significant differences between British Columbia and United States law with respect to changing the rights of shareholders as most state corporation statutes require shareholder approval (usually a majority) for any such changes that affect the rights of shareholders.
5. Meetings of Shareholders
The Articles provide that the Company must hold its annual general meeting once in every calendar year (and being a date not more than 15 months from the last annual general meeting) at such time and place to be determined by the directors of the Company. Shareholders meetings are governed by the Articles of the Company but many important shareholder protections are also contained in theSecurities Act (British Columbia) (the "Securities Act") and theBritish Columbia Corporations Act. The Articles provide that the Company will provide at least 21 days advance written notice if the Company is a public company, and 10 days otherwise, of any meeting of shareholders and will provide for certain procedural matters and rules of order with respect to conduct of the meeting. The directors may fix in advance a date, which is no fewer than 21 days if the company is a public company, and 10 days otherwise, prior to the date of the meeting for the purpose of determining shareholders entitled to receive notice of and to attend and vote at a general meeting.
TheSecurities Act and theBritish Columbia Corporations Actsuperimpose requirements provide that shareholders meetings generally require about a 60 day notice period from initial public notice and that The Company makes a thorough advanced search of intermediary and brokerage registered shareholdings to facilitate communication with beneficial shareholders so that meeting proxy and information materials can be sent via the brokerages to unregistered but beneficial shareholders. The form and content of information circulars and proxies and like matters are governed by theSecurities Actand theBritish Columbia Corporations Act. This legislation specifies the disclosure requirements for the proxy materials and various corporate actions, background information on the nominees for election for director, executive compensation paid in the previous year and full details of any unusual matters or related party transactions. The
43
Company must hold an annual shareholders meeting open to all shareholders for personal attendance or by proxy at each shareholder's determination.
Most state corporation statutes require a public company to hold an annual meeting for the election of directors and for the consideration of other appropriate matters. The state statutes also include general provisions relating to shareholder voting and meetings. Apart from the timing of when an annual meeting must be held and the percentage of shareholders required to call an annual meeting or an extraordinary meeting, there are generally no material differences between Canadian and United States law respecting annual meetings and extraordinary meetings.
6. Rights to Own Securities
There are no limitations under the Company's Articles or in theBusiness Corporations Act on the right of persons who are not citizens of Canada to hold or vote common shares.
7. Restrictions on Changes in Control, Mergers, Acquisitions or Corporate Restructuring of the Company
The Company's Articles do not contain any provisions that would have the effect of delaying, deferring or preventing a change of control of the Company. The Company has not implemented any shareholders' rights or other "poison pill" protection against possible take-overs. The Company does not have any agreements which are triggered by a take-over or other change of control. There are no provisions in its Articles triggered by or affected by a change in outstanding shares which gives rise to a change in control. There are no provisions in the Company's material agreements giving special rights to any person on a change in control.
TheBusiness Corporations Act does not contain any provisions that would have the effect of delaying, deferring or preventing a change of control of a company. Securities legislation and stock exchange policies applicable to the Company however do require shareholder's approval's for change of control transactions.
Generally, there are no significant differences between British Columbia and United States law in this regard, as many state corporation statutes also do not contain such provisions and only empower a company's board of directors to adopt such provisions.
8. Ownership Threshold Requiring Public Disclosure
The Articles of the Company do not require disclosure of share ownership. Share ownership of director nominees must be reported annually in proxy materials sent to the Company's shareholders. There are no requirements under British Columbia corporate law to report ownership of shares of the Company but theSecurities Act requires disclosure of trading by insiders (generally officers, directors and holders of 10% of voting shares) within 10 days of the trade. Controlling shareholders (generally those in excess of 20% of outstanding shares) must provide seven days advance notice of share sales. All insider trading reports filed by the Company's insiders pursuant to Canadian securities legislation are available on the internet atwww.sedi.ca.
Most state corporation statutes do not contain provisions governing the threshold above which shareholder ownership must be disclosed. United States federal securities laws require a company that is subject to the reporting requirements of the Securities Exchange Act of 1934 to disclose, in its annual reports filed with the Securities and Exchange Commission those shareholders who own more than 5% of a corporation's issued and outstanding shares.
9. Differences in Law between the US and British Columbia
Differences in the law between United States and British Columbia, where applicable, have been explained above within each category.
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10. Changes in the Capital of the Company
There are no conditions imposed by the Company's Notice of Articles or Articles which are more stringent than those required by theBusiness Corporations Act.
C. Material contracts
There have been no material contracts entered into, other than contracts entered into in the ordinary course of business, to which the Company or any member of the group is a party, for the two years immediately preceding publication of this document.
The following are the material contracts entered into during the period January 1, 2005 to date (included as exhibits):
- Executive Services Agreement with B. Richardson dated October 1, 2005;
- Heads of Agreement with Consensus Business Group and Joint Venture Proposal dated February 20, 2006
- Engineering, and Construction Management Agreements with Tecna S.A. dated July 7, 2006
- DT2 Engineering, Development Agreements with Tecna S.A. dated July 7, 2006
- Shareholder Agreement with Pendana and Dynamotive Biomass Resource Corporation dated September 22, 2006;
- Joint Venture Agreement with Pendana and Dynamotive Europe Limited dated September 22, 2006;
- Loan Agreement with Dynamotive Biomass Resource Corporation dated September 30, 2006
- Loan Agreement with Dynamotive Europe Limited dated September 30, 2006
- Consulting Agreement with D. Radlein dated December 8, 2006;
- Executive Services Agreement with A. Kuipers dated January 16, 2007;
- Umberlla Amending Agreement by and amongst Erie Flooring & Wood Products and West Lorne BioOil Co-generation LP and Dynamotive Energy Systems Corporation dated April 5, 2007
D. Exchange controls
The Company is a Province of British Columbia, Canada corporation. There is no law or governmental decree or regulation in Canada that restricts the export or import of capital, or affects the remittance of dividends, interest or other payments to a non-resident holder of common shares, other than withholding tax requirements and British Columbia corporate laws which restrict the Company from paying dividends where the Company is or as a result of paying the dividend will become insolvent. Any remittances to United States residents are generally subject to withholding tax, however no such remittances are likely in the foreseeable future. See "Taxation" below.
There is no limitation imposed by the laws of Canada or by the charter or other constituent documents of the Company on the right of a non-resident to hold or vote its common shares, other than as provided in theInvestment Canada Act (Canada) (the "Investment Act"). The following discussion summarizes the material features of theInvestment Act for a non-resident who proposes to acquire a controlling number of the Company's common shares. It is general only, it is not a substitute for independent advice from an investor's own advisor, and it does not anticipate statutory or regulatory amendments. The Company does not believe theInvestment Act will have any affect on it or on its non-Canadian shareholders due to a number of factors including the nature of its operations and the Company's relatively small capitalization.
TheInvestment Act generally prohibits implementation of a "reviewable" investment by an individual, government or agency thereof, corporation, partnership, trust or joint venture (each an
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"entity") that is not a "Canadian" as defined in theInvestment Act (ie. a "non-Canadian"), unless after review the Director of Investments appointed by the Minister responsible for theInvestment Act is satisfied that the investment is likely to be of net benefit to Canada. An investment in the Company's common shares by a non-Canadian (other than a "WTO investor" as that term is defined in theInvestment Act and which term includes entities which are nationals of or are controlled by nationals of member states of the World Trade Organization) when the Company was not controlled by a WTO investor, would be reviewable under theInvestment Act if it was an investment to acquire control of the Company and the value of the assets of the Company, as determined in accordance with the regulations promulgated under theInvestment Act, was over CDN$5 million, or if an order for review was made by the federal cabinet on the grounds that the investment related to Canada's cultural heritage or national identity, regardless of the value of the assets of the Company. An investment in the common shares by a WTO investor, or by a non-Canadian when the Company was controlled by a WTO investor, would be reviewable under theInvestment Act if it was an investment to acquire control of the Company and the value of the assets of the Company, as determined in accordance with the regulations promulgated under theInvestment Act, was not less than a specified amount, for 2007 is CDN$281 million. A non-Canadian would acquire control of the Company for the purposes of theInvestment Act if the non-Canadian acquired a majority of the common shares. The acquisition of less than a majority but one-third or more of the common shares would be presumed to be an acquisition of control of the Company unless it could be established that, on the acquisition, the Company was not controlled in fact by the acquiror through the ownership of the common shares.
The foregoing assumes the Company will not engage in the production of uranium or own an interest in a producing uranium property in Canada, or provide any financial service or transportation service or is a cultural business, as the rules under theInvestment Act governing those businesses are different.
Certain transactions relating to the common shares of the Company would be exempt from the
Investment Act, including:
| | (a) | an acquisition of the common shares by a person in the ordinary course of that person's business as a trader or dealer in securities, |
| | | |
| | (b) | an acquisition of control of the Company in connection with the realization of security granted for a loan or other financial assistance and not for a purpose related to the provisions of theInvestment Act, and |
| | | |
| | (c) | an acquisition of control of the Company by reason of an amalgamation, merger, consolidation or corporate reorganization following which the ultimate direct or indirect control in fact of the Company, through the ownership of the common shares, remained unchanged. |
E. Taxation
ALL PROSPECTIVE INVESTORS ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES OF PURCHASING THE COMMON SHARES.
Material Canadian Federal Income Tax Consequences for United States Residents
The following summarizes the material Canadian federal income tax consequences generally applicable to the holding and disposition of Common Shares by a holder who, (a) for the purposes of the Income Tax Act (Canada) (the "Tax Act"), is not resident in Canada, deals at arm's length with Dynamotive, holds the Common Shares as capital property and does not use or hold the Common Shares in the course of carrying on, or otherwise in connection with, a business in
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Canada, and (b) for the purposes of the Canada-United States Income Tax Convention, 1980 (the "Treaty"), is a resident solely of the United States, has never been a resident of Canada, has not held or used (and does not hold or use) Common Shares in connection with a permanent establishment or fixed base in Canada, and is entitled to the benefits of the Treaty. A holder meeting all of the foregoing requirements is referred to in this summary as a “U.S. Holder”, and this summary only addresses such U.S. Holders. This summary does not apply to traders or dealers in securities, limited liability companies, tax-exempt entities, insurers, financial institutions (including those to which the mark-to-market provisions of the Tax Act apply), or any other U.S. Holder to which special considerations apply.
This summary is based on the current provisions of the Tax Act including all regulations thereunder, the Treaty, all proposed amendments to the Tax Act and the regulations publicly announced by the Minister of Finance to the date hereof, and the current administrative practice of the Canada Revenue Agency. It has been assumed that all currently proposed amendments will be enacted as proposed and that there will be no other relevant change in any governing law, judicial interpretation or administrative practice, although no assurances can be given in these respects. The summary does not take into account Canadian provincial, U.S. federal (which follows further below under the heading “Material United States Tax Consequences”), state or other foreign income tax law or practice. The tax consequences to any particular U.S. Holder will vary according to the status of that holder as an individual, trust, corporation, partnership or other entity, the jurisdictions in which that U.S. Holder is subject to taxation, and generally according to that holder's particular circumstances. Accordingly, this summary is not, and is not to be construed as, Canadian tax advice to any particular U.S. Holder. All holders or prospective holders should consult with their own tax and legal advisors regarding their particular circumstances. The discussion below is qualified accordingly.
Dividends
Dividends paid or credited, or deemed to be paid or credited to a U.S. Holder by Dynamotive will be subject to Canadian withholding tax. Under the Treaty, the rate of withholding tax on dividends paid to a U.S. Holder is generally limited to 15% of the gross amount of the dividend (or 5% if the U.S. Holder is a corporation and beneficially owns at least 10% of Dynamotive's voting shares). Dynamotive will be required to withhold the applicable withholding tax from any such dividend and remit it to the Canadian government.
Disposition
A U.S. Holder is subject to tax under the Tax Act in respect of a capital gain realized on the disposition or deemed disposition of a Common Share unless the U.S. Holder is entitled to relief under the Treaty. For this purpose, the U.S. Holder's capital gain (or loss) from a disposition or deemed disposition of a Common Share is the amount by which the proceeds of disposition exceed (or are exceeded by) the aggregate of the U.S. Holder's adjusted cost base of the Common Share for purposes of the Tax Act and any reasonable expenses of disposition. Absent Treaty relief, one-half of any capital gain so realized is included in computing the U.S. Holder's income for purposes of the Tax Act.
A qualifying U.S. Holder may generally qualify for relief under the Treaty in respect of such tax on such capital gain if and provided that the value of shares of Dynamotive is not derived principally from real property situated in Canada at the relevant time.Management believes that the value of Dynamotive's common shares is not currently derived principally from real property situated in Canada.
A U.S. Holder wishing to claim any such applicable Treaty relief should consult with the U.S. Holder's own tax advisors regarding the procedure for claiming the relief in a relevant Canadian tax return reporting the disposition or deemed disposition. In addition, notwithstanding any potentially applicable Treaty relief, a disposition or deemed disposition of Common Shares is
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subject to certain tax clearance certificate and withholding procedures that should also be discussed with the U.S. Holder's own tax advisors in advance of a disposition.
United States Tax Consequences
United States Federal Income Tax Consequences
The following is a discussion of all material United States federal income tax consequences, under current law, generally applicable to a U.S. Holder (as hereinafter defined) of common shares of Dynamotive. This discussion does not address all potentially relevant federal income tax matters and it does not address consequences peculiar to persons subject to special provisions of federal income tax law, such as those described below as excluded from the definition of a U.S. Holder. In addition, this discussion does not cover any state, local or foreign tax consequences. (see "Taxation - Canadian Federal Income Tax Consequences" above). Accordingly, we urge holders and prospective holders of common shares of Dynamotive to consult their own tax advisors about the specific federal, state, local, and foreign tax consequences to them of purchasing, owning and disposing of common shares of Dynamotive, based upon their individual circumstances.
The following discussion is based upon the sections of the Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations, published Internal Revenue Service ("IRS") rulings, published administrative positions of the IRS and court decisions that are currently applicable, any or all of which could be materially and adversely changed, possibly on a retroactive basis, at any time and which are subject to differing interpretations. This discussion does not consider the potential effects, both adverse and beneficial, of any proposed legislation which, if enacted, could be applied, possibly on a retroactive basis, at any time.
U.S. Holders
As used herein, a "U.S. Holder" means a holder of common shares of Dynamotive who is a citizen or individual resident of the United States, a corporation or partnership created or organized in or under the laws of the United States or of any political subdivision thereof, an estate whose income is taxable in the United States irrespective of source or a trust subject to the primary supervision of a court within the United States and control of a United States fiduciary as described Section 7701(a)(30) of the Code. This summary does not address the tax consequences to, and U.S. Holder does not include, persons subject to specific provisions of federal income tax law, such as tax-exempt organizations, qualified retirement plans, individual retirement accounts and other tax-deferred accounts, financial institutions, insurance companies, real estate investment trusts, regulated investment companies, broker-dealers, non-resident alien individuals, persons or entities that have a "functional currency" other than the U.S. dollar, shareholders subject to the alternative minimum tax, shareholders who hold common shares as part of a straddle, hedging or conversion transaction, and shareholders who acquired their common shares through the exercise of employee stock options or otherwise as compensation for services. This summary is limited to U.S. Holders who own common shares as capital assets and thesummary does not address the consequences to a person or entity holding an interest in a shareholder or the consequences to a person of the ownership, exercise or disposition of any options, warrants or other rights to acquire common shares. In addition, this summary does not address special rules applicable to United States persons (as defined in Section 7701(a)(30) of the Code) holding common shares through a foreign partnership or to foreign persons holding common shares through a domestic partnership.
Distribution on Common Shares of Dynamotive
In general, U.S. Holders receiving dividend distributions (including constructive dividends) with respect to common shares of Dynamotive are required to include in gross income for United States federal income tax purposes the gross amount of such distributions, equal to the U.S. dollar value of such distributions on the date of receipt (based on the exchange rate on such date), to the extent that Dynamotive has current or accumulated earnings and profits, without reduction for any
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Canadian income tax withheld from such distributions. Such Canadian tax withheld may be credited, subject to certain limitations, against the U.S. Holder's federal income tax liability or, alternatively, may be deducted in computing the U.S. Holder's federal taxable income by those who itemize deductions. (See more detailed discussion at "Foreign Tax Credit" below). To the extent that distributions exceed current or accumulated earnings and profits of Dynamotive, they will be treated first as a return of capital up to the U.S. Holder's adjusted basis in the common shares and thereafter as gain from the sale or exchange of property. Preferential tax rates for long-term capital gains are applicable to a U.S. Holder which is an individual, estate or trust. There are currently no preferential tax rates for long-term capital gains for a U.S. Holder which is a corporation.
In the case of foreign currency received as a dividend that is not converted by the recipient into U.S. dollars on the date of receipt, a U.S. Holder will have a tax basis in the foreign currency equal to its U.S. dollar value on the date of receipt. Generally any gain or loss recognized upon a subsequent sale or other disposition of the foreign currency, including the exchange for U.S. dollars, will be ordinary income or loss. However, an individual whose realized gain does not exceed $200 will not recognize that gain, provided that there are no expenses associated with the transaction that meet the requirements for deductibility as a trade or business expense (other than travel expenses in connection with a business trip) or as an expense for the production of income.
Dividends paid on the common shares of Dynamotive generally will not be eligible for the dividends received deduction provided to corporations receiving dividends from certain United States corporations. A U.S. Holder which is a corporation and which owns shares representing at least 10% of the voting power and value of Dynamotive may, under certain circumstances, be entitled to a 70% (or 80% if the U.S. Holder owns shares representing at least 20% of the voting power and value of Dynamotive) deduction of the United States source portion of dividends received from Dynamotive (unless Dynamotive qualifies as a "foreign personal holding company" or a "passive foreign investment company," as defined below). Dynamotive does not anticipate that it will earn any United States income, however, and therefore does not anticipate that any U.S. Holder will be eligible for the dividends received deduction.
Under current Treasury Regulations, dividends paid on Dynamotive's common shares, if any, generally will not be subject to information reporting and generally will not be subject to U.S. backup withholding tax. However, dividends and the proceeds from a sale of Dynamotive's common shares paid in the U.S. through a U.S. or U.S. related paying agent (including a broker) will be subject to U.S. information reporting requirements and may also be subject to the 31% U.S. backup withholding tax, unless the paying agent is furnished with a duly completed and signed Form W-9. Any amounts withheld under the U.S. backup withholding tax rules will be allowed as a refund or a credit against the U.S. Holder's U.S. federal income tax liability, provided the required information is furnished to the IRS.
Foreign Tax Credit
A U.S. Holder who pays (or has withheld from distributions) Canadian income tax with respect to the ownership of common shares of Dynamotive may be entitled, at the option of the U.S. Holder, to either receive a deduction or a tax credit for such foreign tax paid or withheld. Generally, it will be more advantageous to claim a credit because a credit reduces United States federal income taxes on a dollar-for-dollar basis, while a deduction merely reduces the taxpayer's income subject to tax. This election is made on a year-by-year basis and generally applies to all foreign taxes paid by (or withheld from) the U.S. Holder during that year. There are significant and complex limitations which apply to the credit, among which is the general limitation that the credit cannot exceed the proportionate share of the U.S. Holder's United States income tax liability that the U.S. Holder's foreign source income bears to his or its worldwide taxable income. In the determination of the application of this limitation, the various items of income and deduction must be classified into foreign and domestic sources. Complex rules govern this classification process. In addition, this limitation is calculated separately with respect to specific classes of income such as "passive
49
income, " "high withholding tax interest," "financial services income," "shipping income," and certain other classifications of income. Dividends distributed by Dynamotive will generally constitute "passive income" or, in the case of certain U.S. Holders, "financial services income" for these purposes. The availability of the foreign tax credit and the application of the limitations on the credit are fact specific, and U.S. Holders of common shares of Dynamotive should consult their own tax advisors regarding their individual circumstances.
Disposition of Common Shares of Dynamotive
In general, U.S. Holders will recognize gain or loss upon the sale of common shares of Dynamotive equal to the difference, if any, between (i) the amount of cash plus the fair market value of any property received, and (ii) the shareholder's tax basis in the common shares of Dynamotive. Preferential tax rates apply to long-term capital gains of U.S. Holders which are individuals, estates or trusts. In general, gain or loss on the sale of common shares of Dynamotive will be long-term capital gain or loss if the common shares are a capital asset in the hands of the U.S. Holder and are held for more than one year. Deductions for net capital losses are subject to significant limitations. For U.S. Holders which are not corporations, any unused portion of such net capital loss may be carried over to be used in later tax years until such net capital loss is thereby exhausted.
For U.S. Holders that are corporations (other than corporations subject to Subchapter S of the Code), an unused net capital loss may be carried back three years and carried forward five years from the loss year to be offset against capital gains until such net capital loss is thereby exhausted.
Other Considerations
Set forth below are certain material exceptions to the above-described general rules describing the United States federal income tax consequences resulting from the holding and disposition of common shares:
Foreign Personal Holding Company
If at any time during a taxable year more than 50% of the total combined voting power or the total value of Dynamotive's outstanding shares is owned, directly or indirectly (pursuant to applicable rules of constructive ownership), by five or fewer individuals who are citizens or residents of the United States and 60% or more of Dynamotive's gross income for such year is derived from certain passive sources (e.g., from certain interest and dividends), Dynamotive may be treated as a "foreign personal holding company." In that event, U.S. Holders that hold common shares would be required to include in gross income for such year their allocable portions of such passive income to the extent Dynamotive does not actually distribute such income. Dynamotive does not believe that it currently qualifies as a foreign personal holding company. However, there can be no assurance that Dynamotive will not be considered a foreign personal holding company for the current or any future taxable year.
Foreign Investment Company
If 50% or more of the combined voting power or total value of Dynamotive's outstanding shares is held, directly or indirectly, by citizens or residents of the United States, United States domestic partnerships or corporations, or estates or trusts other than foreign estates or trusts (as defined by the Code Section 7701(a)(31)), and Dynamotive is found to be engaged primarily in the business of investing, reinvesting, or trading in securities, commodities, or any interest therein, it is possible that Dynamotive may be treated as a "foreign investment company" as defined in Section 1246 of the Code, causing all or part of any gain realized by a U.S. Holder selling or exchanging common shares to be treated as ordinary income rather than capital gain. Dynamotive does not believe that it currently qualifies as a foreign investment company. However, there can be no assurance that
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Dynamotive will not be considered a foreign investment company for the current or any future taxable year.
Passive Foreign Investment Company
United States income tax law contains rules governing "passive foreign investment companies" ("PFIC") which can have significant tax effects on U.S. Holders of foreign corporations. These rules do not apply to non-U.S. Holders. Section 1297 of the Code defines a PFIC as a corporation that is not formed in the United States if, for any taxable year, either (i) 75% or more of its gross income is "passive income," which includes interest, dividends and certain rents and royalties or (ii) the average percentage, by fair market value (or, if the corporation is not publicly traded and either is a controlled foreign corporation or makes an election, by adjusted tax basis), of its assets that produce or are held for the production of "passive income" is 50% or more. Dynamotive appears to have been a PFIC for the fiscal year ended December 31,2003, and at least certain prior fiscal years. In addition, Dynamotive expects to qualify as a PFIC for the fiscal year ending December 31, 2006 and may also qualify as a PFIC in future fiscal years. Each U.S. Holder of Dynamotive is urged to consult a tax advisor with respect to how the PFIC rules affect such U.S. Holder's tax situation.
Each U.S. Holder who holds stock in a foreign corporation during any year in which such corporation qualifies as a PFIC is subject to United States federal income taxation under one of three alternative tax regimes at the election of such U.S. Holder. The following is a discussion of such alternative tax regimes applied to such U.S. Holders of Dynamotive. In addition, special rules apply if a foreign corporation qualifies as both a PFIC and a "controlled foreign corporation" (as defined below) and a U.S. Holder owns, actually or constructively, 10% or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation (See more detailed discussion at "Controlled Foreign Corporation" below).
A U.S. Holder who elects to treat Dynamotive as a qualified electing fund ("QEF") will be subject, under Section 1293 of the Code, to current federal income tax for any taxable year to which the election applies in which Dynamotive qualifies as a PFIC on his pro rata share of Dynamotive's (i) "net capital gain" (the excess of net long-term capital gain over net short-term capital loss), which will be taxed as long-term capital gain, and (ii) "ordinary earnings" (the excess of earnings and profits over net capital gain), which will be taxed as ordinary income, in each case, for the shareholder's taxable year in which (or with which) Dynamotive's taxable year ends, regardless of whether such amounts are actually distributed. A U.S. Holder's tax basis in the common shares will be increased by any such amount that is included in income but not distributed.
The procedure a U.S. Holder must comply with in making an effective QEF election, and the consequences of such election, will depend on whether the year of the election is the first year in the U.S. Holder's holding period in which Dynamotive is a PFIC. If the U.S. Holder makes a QEF election in such first year, i.e., a "timely" QEF election, then the U.S. Holder may make the QEF election by simply filing the appropriate documents at the time the U.S. Holder files his tax return for such first year. If, however, Dynamotive qualified as a PFIC in a prior year during the U.S. Holder's holding period, then, in order to avoid the Section 1291 rules discussed below, in addition to filing documents, the U.S. Holder must elect to recognize under the rules of Section 1291 of the Code (discussed herein), (i) any gain that he would otherwise recognize if the U.S. Holder sold his stock on the qualification date or (ii) if Dynamotive is a controlled foreign corporation, the U.S. Holder's pro rata share of Dynamotive's post-1986 earnings and profits as of the qualification date. The qualification date is the first day of Dynamotive's first tax year in which Dynamotive qualified as a QEF with respect to such U.S. Holder. For purposes of this discussion, a U.S. Holder who makes (i) a timely QEF election, or (ii) an untimely QEF election and either of the above-described gain-recognition elections under Section 1291 is referred to herein as an "Electing U.S. Holder." A U.S. Holder who holds common shares at any time during a year of Dynamotive in which Dynamotive is a PFIC and who is not an Electing U.S. Holder (including a U.S. Holder who makes an untimely QEF election and makes neither of the above-described gain-recognition
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elections) is referred to herein as a "Non-Electing U.S. Holder." An Electing U.S. Holder (i) generally treats any gain realized on the disposition of his Dynamotive common shares as capital gain; and (ii) may either avoid interest charges resulting from PFIC status altogether, or make an annual election, subject to certain limitations, to defer payment of current taxes on his share of Dynamotive's annual realized net capital gain and ordinary earnings subject, however, to an interest charge. If the U.S. Holder is not a corporation, any interest charge imposed under the PFIC regime would be treated as "personal interest" that is not deductible.
In order for a U.S. Holder to make (or maintain) a valid QEF election, Dynamotive must provide certain information regarding its net capital gains and ordinary earnings and permit its books and records to be examined to verify such information. Dynamotive intends to make the necessary information available to U.S. Holders to permit them to make (and maintain) QEF elections with respect to Dynamotive. Dynamotive urges each U.S. Holder to consult a tax advisor regarding the availability of, and procedure for making, the QEF election.
A QEF election, once made with respect to Dynamotive, applies to the tax year for which it was made and to all subsequent tax years, unless the election is invalidated or terminated, or the IRS consents to revocation of the election. If a QEF election is made by a U.S. Holder and Dynamotive ceases to qualify as a PFIC in a subsequent tax year, the QEF election will remain in effect, although not applicable, during those tax years in which Dynamotive does not qualify as a PFIC. Therefore, if Dynamotive again qualifies as a PFIC in a subsequent tax year, the QEF election will be effective and the U.S. Holder will be subject to the rules described above for Electing U.S. Holders in such tax year and any subsequent tax years in which Dynamotive qualifies as a PFIC. In addition, the QEF election remains in effect, although not applicable, with respect to an Electing U.S. Holder even after such U.S. Holder disposes of all of his or its direct and indirect interest in the shares of Dynamotive. Therefore, if such U.S. Holder reacquires an interest in Dynamotive, that U.S. Holder will be subject to the rules described above for Electing U.S. Holders for each tax year in which Dynamotive qualifies as a PFIC.
In the case of a Non-Electing U.S. Holder, special taxation rules under Section 1291 of the Code will apply to (i) gains realized on the disposition (or deemed to be realized by reasons of a pledge) of his Dynamotive common shares and (ii) certain "excess distributions," as defined in Section 1291(b), by Dynamotive.
A Non-Electing U.S. Holder generally would be required to pro rate all gains realized on the disposition of his Dynamotive common shares and all excess distributions on his Dynamotive common shares over the entire holding period for the common shares. All gains or excess distributions allocated to prior years of the U.S. Holder (excluding any portion of the holder's period prior to the first day of the first year of Dynamotive (i) which began after December 31, 1986, and (ii) for which Dynamotive was a PFIC) would be taxed at the highest tax rate for each such prior year applicable to ordinary income. The Non-Electing U.S. Holder also would be liable for interest on the foregoing tax liability for each such prior year calculated as if such liability had been due with respect to each such prior year. A Non-Electing U.S. Holder that is not a corporation must treat this interest charge as "personal interest" which, as discussed above, is wholly non-deductible. The balance, if any, of the gain or the excess distribution will be treated as ordinary income in the year of the disposition or distribution, and no interest charge will be incurred with respect to such balance. In certain circumstances, the sum of the tax and the PFIC interest charge may exceed the amount of the excess distribution received, or the amount of proceeds of disposition realized, by the U.S. Holder.
If Dynamotive is a PFIC for any taxable year during which a Non-Electing U.S. Holder holds Dynamotive common shares, then Dynamotive will continue to be treated as a PFIC with respect to such Dynamotive common shares, even if it is no longer definitionally a PFIC. A Non-Electing U.S. Holder may terminate this deemed PFIC status by electing to recognize gain (which will be taxed under the rules discussed above for Non-Electing U.S. Holders) as if such Dynamotive common shares had been sold on the last day of the last taxable year for which it was a PFIC.
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Effective for tax years of U.S. Holders beginning after December 31, 1997, U.S. Holders who hold (actually or constructively) marketable stock of a foreign corporation that qualifies as a PFIC may elect to mark such stock to the market annually (a "mark-to-market election"). If such an election is made, such U.S. Holder will generally not be subject to the special taxation rules of Section 1291 discussed above. However, if the mark-to-market election is made by a Non-Electing U.S. Holder after the beginning of the holding period for the PFIC stock, then the Section 1291 rules will apply to certain dispositions of, distributions on and other amounts taxable with respect to Dynamotive common shares. A U.S. Holder who makes the mark-to-market election will include in income for each taxable year for which the election is in effect an amount equal to the excess, if any, of the fair market value of the common shares of Dynamotive as of the close of such tax year over such U.S. Holder's adjusted basis in such common shares. In addition, the U.S. Holder is allowed a deduction for the lesser of (i) the excess, if any, of such U.S. Holder's adjusted tax basis in the common shares over the fair market value of such shares as of the close of the tax year, or (ii) the excess, if any, of (A) the mark-to-market gains for the common shares in Dynamotive included by such U.S. Holder for prior tax years, including any amount which would have been treated as a mark-to-market gain for any prior tax year but for the Section 1291 rules discussed above with respect to Non-Electing U.S. Holders, over (B) the mark-to-market losses for shares that were allowed as deductions for prior tax years. A U.S. Holder's adjusted tax basis in the common shares of Dynamotive will be adjusted to reflect the amount included in or deducted from income as a result of a mark-to-market election. A mark-to-market election applies to the taxable year in which the election is made and to each subsequent taxable year, unless Dynamotive common shares cease to be marketable, as specifically defined, or the IRS consents to revocation of the election. Because the IRS has not established procedures for making a mark-to-market election, U.S. Holders should consult their tax advisor regarding the manner of making such an election. No view is expressed regarding whether common shares of Dynamotive are marketable for these purposes or whether the election will be available.
Under Section 1291(f) of the Code, the IRS has issued Proposed Treasury Regulations that, subject to certain exceptions, would treat as taxable certain transfers of PFIC stock by Non-Electing U.S. Holders that are generally not otherwise taxed, such as gifts, exchanges pursuant to corporate reorganizations, and transfers at death. Generally, in such cases the basis of Dynamotive common shares in the hands of the transferee and the basis of any property received in the exchange for those common shares would be increased by the amount of gain recognized. Under the Proposed Treasury Regulations, an Electing U.S. Holder would not be taxed on certain transfers of PFIC stock, such as gifts, exchanges pursuant to corporate reorganizations, and transfers at death. The transferee's basis in this case will depend on the manner of the transfer. In the case of a transfer by an Electing U.S. Holder upon death, for example, the transferee's basis is generally equal to the fair market value of the Electing U.S. Holder's common shares as of the date of death under Section 1014 of the Code. The specific tax effect to the U.S. Holder and the transferee may vary based on the manner in which the common shares are transferred. Each U.S. Holder of Dynamotive is urged to consult a tax advisor with respect to how the PFIC rules affect his or its tax situation.
Whether or not a U.S. Holder makes a timely QEF election with respect to common shares of Dynamotive, certain adverse rules may apply in the event that both Dynamotive and any foreign corporation in which Dynamotive directly or indirectly holds shares is a PFIC (a "lower-tier PFIC"). Pursuant to certain Proposed Treasury Regulations, a U.S. Holder would be treated as owning his or its proportionate amount of any lower-tier PFIC shares, and generally would be subject to the PFIC rules with respect to such indirectly-held PFIC shares unless such U.S. Holder makes a timely QEF election with respect thereto. Dynamotive intends to make the necessary information available to U.S. Holders to permit them to make (and maintain) QEF elections with respect to each subsidiary of Dynamotive that is a PFIC.
Under the Proposed Treasury Regulations, a U.S. Holder who does not make a timely QEF election with respect to a lower-tier PFIC generally would be subject to tax (and the PFIC interest charge) on (i) any excess distribution deemed to have been received with respect to his or its
53
lower-tier PFIC shares and (ii) any gain deemed to arise from a so-called "indirect disposition" of such shares. For this purpose, an indirect disposition of lower-tier PFIC shares would generally include (i) a disposition by Dynamotive (or an intermediate entity) of lower-tier PFIC shares, and (ii) any other transaction resulting in a diminution of the U.S. Holder's proportionate ownership of the lower-tier PFIC, including an issuance of additional common shares by Dynamotive (or an intermediate entity). Accordingly, each prospective U.S. Holder should be aware that he or it could be subject to tax even if such U.S. Holder receives no distributions from Dynamotive and does not dispose of its common shares. Dynamotive strongly urges each prospective U.S. Holder to consult a tax advisor with respect to the adverse rules applicable, under the Proposed Treasury Regulations, to U.S. Holders of lower-tier PFIC shares.
Certain special, generally adverse, rules will apply with respect to Dynamotive common shares while Dynamotive is a PFIC unless the U.S. Holder makes a timely QEF election. For example under Section 1298(b)(6) of the Code, a U.S. Holder who uses PFIC stock as security for a loan (including a margin loan) will, except as may be provided in regulations, be treated as having made a taxable disposition of such shares.
Controlled Foreign Corporation
If more than 50% of the total combined voting power of all classes of shares entitled to vote or the total value of the shares of Dynamotive is owned, actually or constructively, by citizens or residents of the United States, United States domestic partnerships or corporation, or estates or trusts other than foreign estates or trusts (as defined by the Code Section 7701(a)(31)), each of which own, actually or constructively, 10% or more of the total combined voting power of all classes of shares entitled to vote of Dynamotive ("United States Shareholder"), Dynamotive could be treated as a controlled foreign corporation ("CFC") under Subpart F of the Code. This classification would effect many complex results, one of which is the inclusion of certain income of a CFC which is subject to current U.S. tax. The United States generally taxes United States Shareholders of a CFC currently on their pro rata shares of the Subpart F income of the CFC. Such United States Shareholders are generally treated as having received a current distribution out of the CFC's Subpart F income and are also subject to current U.S. tax on their pro rata shares of increases in the CFC's earnings invested in U.S. property. The foreign tax credit described above may reduce the U.S. tax on these amounts. In addition, under Section 1248 of the Code, gain from the sale or exchange of shares by a U.S. Holder of common shares of Dynamotive which is or was a United States Shareholder at any time during the five-year period ending on the date of the sale or exchange is treated as ordinary income to the extent of earnings and profits of Dynamotive attributable to the shares sold or exchanged. If a foreign corporation is both a PFIC and a CFC, the foreign corporation generally will not be treated as a PFIC with respect to United States Shareholders of the CFC. This rule generally will be effective for taxable years of United States Shareholders beginning after 1997 and for taxable years of foreign corporations ending with or within such taxable years of United States Shareholders. Special rules apply to United States Shareholders who are subject to the special taxation rules under Section 1291 discussed above with respect to a PFIC. Because of the complexity of Subpart F, a more detailed review of these rules is outside of the scope of this discussion. Dynamotive does not believe that it currently qualifies as a CFC. However, there can be no assurance that Dynamotive will not be considered a CFC for the current or any future taxable year.
F. Dividends and paying agents
Not applicable.
G. Statements by experts
Not applicable.
54
H. Documents on display
Documents and exhibits referred to in this document may be inspected at the offices of the Securities and Exchange Commission or obtained from the Company by telephoning (604)267-6013 or in writing at Suite 230 – 1700 West 75th Avenue, Vancouver, BC, V6P 6G2.
I. Subsidiary Information
The Company operates the Erie Plant through a principal subsidiary which is a Canadian registered limited partnership (“LP”). The Company holds all the equity and controls all aspects of the LP. A copy of the LP agreement is part of the Consortium master Agreement filed as Exhibit 4.6.
The Company’s other subsidiaries were not active in 2006 and are not material to Company at this time.
Item 11. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to financial market risks, including changes in interest rates and foreign currencies.
FOREIGN CURRENCY RISK
The Company has operations in primarily in Canada with some limited activities in the U.S. and the United Kingdom, and therefore the Company is subject to some risks typical of an international business including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility.
The Company can be adversely affected when the Canadian currency appreciates. Management has the ability, to some extent, to time the exchange and enter into forward exchange contracts in an attempt to mitigate such risk. The Company has not entered into any forward exchange contracts during the reporting period. The Company’s financial statements are reported in U.S. currency. The extent of the Company’s exposure depends on the degree of fluctuation in foreign currencies. Due to the nature of foreign currency exchange, the exact exposure is difficult to estimate.
The Company’s sales, corresponding receivables and the majority of its expenses are in Canadian and U.S. dollars. The Company holds cash in U.S., Canadian and U.K. funds, and exchanges from U.S. currency to Canadian and U.K. currency as necessary. Through operations in Canada and the U.S., the Company incurs research and development and administrative expenses in Canadian dollars and U.S. dollars and potentially other foreign currencies. The Company is exposed, in the normal course of business, to foreign currency risks on any non-Canadian dollar expenditures. The Company has evaluated its exposure to these risks and has determined that the only significant foreign currency exposure at this time is to the U.S. dollar, through receipt of proceeds of U.S. dollar denominated share offerings. At this time, the Company does not believe the exposure to other currency fluctuations is material.
INTEREST RATE RISK
The Company invests its cash in a variety of short-term financial instruments, including bank deposits. These deposits are typically denominated in U.S. and Canadian dollars. Cash balances in other foreign currencies are operating balances and are only invested in demand or short-term deposits of the local operating bank.
55
Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted because of a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company’s future investment income may fall short of expectations because of changes in interest rates or we may suffer losses in principal if forced to sell securities which have seen a decline in market value because of changes in interest rates.
The Company’s investments are made in accordance with an investment policy approved by our Board of Directors. Under this policy, all short-term investments must be made in investment grade securities with original maturities of less than one year at the time of acquisition.
The Company does not attempt to reduce or eliminate its investment exposure to interest rate risk through the use of derivative financial instruments due to the short-term nature of the Company’s investments. Based on a sensitivity analysis performed on the balances as of December 31, 2005, the fair value of short term investments would not be significantly impacted by either a 100 basis point increase or decrease in interest rates.
The Company has no bank loans outstanding.
Item 12. Description Of Securities Other Than Equity Securities
Not applicable.
56
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Not applicable.
Item 14. Material Modifications To The Right Of Security Holders and Use Of Proceeds
Not applicable.
Item 15T. Controls and Procedures
A. Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the "Exchange Act"), the Company carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of December 31, 2006. This evaluation was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Robert Andrew Kingston, and the Company's Chief Financial Officer, Brian Richardson. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Securities and Exchange Commission (the “SEC”). There have been no changes in the Company's internal controls, or in other factors that significantly affected or could significantly affect internal controls, subsequent to the date the Company carried out the evaluation.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the Company's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the Company's reports filed under the Exchange Act is accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
B. Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes policies and procedures pertaining to maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; providing reasonable assurance that receipts and expenditures of the Company are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of Company
57
assets that could have a material effect on our financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company's internal control over financial reporting was effective as of December 31, 2006.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this Annual Report (Form 20-F).
C. Changes in Internal Control Over Financial Reporting
There have occurred no changes in our internal control over financial reporting (as defined in Rule 13a-15 or 15d-15 under the Exchange Act) during the period covered by this Annual Report (Form 20-F) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The information furnished pursuant to Item 15T of this Annual Report (Form 20-F) shall not be deemed “filed” for purposes of the Securities Exchange Act of 1934, as amended, nor shall it be incorporated by reference into any of the Company’s filings under the Securities Act of 1933, as amended, unless otherwise expressly stated in such filing.
Item 16. [Reserved]
ITEM 16A. Audit committee financial expert
Our board of directors has determined that Mr. Shing-Cheng Hong is an independent member of the board and is the committee financial expert on our audit committee. For details on his professional career see “Item 6. Directors, Senior Management and Employees”.
ITEM 16B Code of Ethics
The Company has adopted a code of ethics which requires all employees to acknowledge a responsibility for honest, fair and respectful dealings between the Company and its employees, customers and suppliers. The Code requires observance of high standards of respect for the laws applicable to the Company's business activities and precludes offering or accepting any benefit from a customer or supplier which could be construed as an improper inducement to do business. The Company's insiders acknowledge their responsibility for careful compliance with corporate disclosure and securities trading laws. The Code is available for review on the Company's website at www.dynamotive.com.
58
ITEM 16C Principal accountant fees and services
A summary of accountant fees and services are provided in a table below:
| | Total Fees |
| | 2006 | 2005 |
| Audit Fees(1) | 186,245 | 125,347 |
| Audit-Related Fees(2) | — | — |
| Tax Fees(3) | 9,878 | — |
| All Other Fees(4) | — | — |
| Total | 196,123 | 125,347 |
(1) “Audit Fees” include fees necessary to perform the annual audit and quarterly reviews of the Company’s consolidated financial statements. Audit Fees include fees for review of tax provisions and for accounting consultations on matters reflected in the financial statements. Audit Fees also include audit or other attest services required by legislation or regulation, such as comfort letters, consents, reviews of securities filings and statutory audits.
(2) “Audit-Related Fees” include services that are traditionally performed by the auditor. These audit-related services include employee benefit audits, due diligence assistance, accounting consultations on proposed transactions, internal control reviews and audit or attest services not required by legislation or regulation.
(3) “Tax Fees” include fees for all tax services other than those included in “Audit Fees” and “Audit-Related Fees”. This category includes fees for tax compliance, tax planning and tax advice. Tax planning and tax advice includes assistance with tax audits and appeals, tax advice related to mergers and acquisitions, and requests for rulings or technical advice from tax authorities.
(4) “All Other Fees” include all other non-audit services.
ITEM 16D Exemptions from the Listing Standards for Audit Committees
Not Applicable
ITEM 16E Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Not Applicable
59
PART III
Item 17. Financial Statements
Financial Statements required under this item are filed herewith and attached to this Form 20-F and form part of this Annual Report.
Index to Financial Statements
| Auditors’ Report |
| |
| Comments by Auditors for U.S. Readers on Canada-United States Reporting Difference |
| |
| Consolidated Balance Sheets as at December 31, 2006 and December 31, 2005 |
| |
| Consolidated Statements of Loss for the years ended December 31, 2006, December 31, 2005 and December 31, 2004 |
| |
| Consolidated Statements of Deficit for the years ended December 31, 2006, December 31, 2005 and December 31, 2004 |
| |
| Consolidated Statements of Cash Flows for the years ended December 31, 2006, December 31, 2005 and December 31, 2004 |
| |
| Notes to Consolidated Financial Statements |
60
Consolidated Financial Statements (in U.S. dollars)
Dynamotive Energy Systems Corporation
December 31, 2006 and 2005
61
 | BDO Dunwoody LLP
Chartered Accountants
| 600 Cathedral Place
925 West Georgia Street
Vancouver, BC, Canada V6C 3L2
Telephone: (604) 688-5421
Telefax: (604) 688-5132
E-mail: vancouver@bdo.ca
www.bdo.ca |
AUDITORS’ REPORT
To the Shareholders of
Dynamotive Energy Systems Corporation
We have audited the consolidated balance sheets of Dynamotive Energy Systems Corporation as at December 31, 2006 and 2005 and the consolidated statements of loss, deficit and cash flows for each of the years in the three-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as at December 31, 2006 and 2005 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006 in accordance with Canadian generally accepted accounting principles.
/s/ BDO Dunwoody LLP
Chartered Accountants
Vancouver, Canada
April 17, 2007
62
| BDO Dunwoody LLP
Chartered Accountants
| 600 Cathedral Place
925 West Georgia Street
Vancouver, BC, Canada V6C 3L2
Telephone: (604) 688-5421
Telefax: (604) 688-5132
E-mail: vancouver@bdo.ca
www.bdo.ca |
Comments by Auditors for U.S. Readers
on Canada-United States Reporting Difference
The reporting standards of the Public Company Accounting Oversight Board (United States) for auditors require the addition of an explanatory paragraph (following the opinion paragraph) when the financial statements are affected by conditions and events that cast substantial doubt on the Company’s ability to continue as a going concern, such as those described in Note 1 to the financial statements. Public Company Accounting Oversight Board (United States) reporting standards also require the addition of an explanatory paragraph when changes in an accounting policy, such as those described in notes 3 and 23, have a material effect on the consolidated financial statements. Although we conducted our audit in accordance with both Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States), our report to the shareholders dated April 17, 2007 is expressed in accordance with Canadian reporting standards which do not permit a reference to such conditions and events in the auditors’ report when these are adequately disclosed in the financial statements.
/s/ BDO Dunwoody LLP
Chartered Accountants
Vancouver, Canada
April 17, 2007
63
Dynamotive Energy Systems Corporation
Incorporated under the laws of British Columbia, Canada
CONSOLIDATED BALANCE SHEETS
As at December 31 (in U.S. dollars)
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| | | | | | | |
| ASSETS | | | | | | |
| Current | | | | | | |
| Cash and cash equivalents[note 2] | | 9,346,534 | | | 1,428,468 | |
| Restricted cash[note 12] | | — | | | 172,813 | |
| Receivables[note 4] | | 474,903 | | | 40,326 | |
| Government grants receivable[note 20] | | 1,087,910 | | | 627,582 | |
| Prepaid expenses and deposits | | 467,413 | | | 235,127 | |
| Total current assets | | 11,376,760 | | | 2,504,316 | |
| Property, plant and equipment[note 6] | | 26,362,390 | | | 14,199,148 | |
| Patents[note 7] | | 253,912 | | | 259,109 | |
| Other assets | | 100,637 | | | — | |
| | | 38,093,699 | | | 16,962,573 | |
| | | | | | | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | |
| Current | | | | | | |
| Accounts payable and accrued liabilities[note 11] | | 6,438,287 | | | 7,314,856 | |
| Convertible debenture[note 12] | | — | | | 546,461 | |
| Total current liabilities | | 6,438,287 | | | 7,861,317 | |
| Long-term debt[note 13] | | — | | | 808,848 | |
| Deferred revenue[notes 5, 10, and 14] | | 520,000 | | | — | |
| Total liabilities | | 6,958,287 | | | 8,670,165 | |
| Commitments and contingencies[notes 1, 16, and 20] | | | | | | |
| Non-controlling interest[note 8] | | 1,354,923 | | | — | |
| Shareholders’ Equity | | | | | | |
| Share capital[note 15(b)] | | 85,127,873 | | | 51,849,476 | |
| Shares to be issued[note 15(c)] | | 1,741,339 | | | 2,677,832 | |
| Contributed surplus[note 15(h)] | | 16,800,527 | | | 13,047,158 | |
| Cumulative translation adjustment | | (789,471 | ) | | (434,661 | ) |
| Deficit | | (73,099,779 | ) | | (58,847,397 | ) |
| Total shareholders’ equity | | 29,780,489 | | | 8,292,408 | |
| | | 38,093,699 | | | 16,962,573 | |
See accompanying notes
On behalf of the Board:
| | “Richard Lin” | “Andrew Kingston” |
| | Director | Director |
64
Dynamotive Energy Systems Corporation
Incorporated under the laws of British Columbia, Canada
CONSOLIDATED STATEMENTS OF LOSS
For the Year Ended December 31 (in U.S. dollars)
| | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| | | | | | | | | | |
| EXPENSES | | | | | | | | | |
| Marketing and business development | | 1,768,063 | | | 1,199,959 | | | 466,435 | |
| Research and development[notes 15(i), 20 and 21] | | 4,247,784 | | | 2,804,432 | | | 2,905,830 | |
| General and administrative[note 15(i)] | | 7,763,275 | | | 6,257,086 | | | 6,316,110 | |
| Amortization and depreciation | | 124,067 | | | 148,556 | | | 130,912 | |
| Interest expense[note 15(i)] | | 505,340 | | | 1,445,918 | | | 151,758 | |
| Foreign exchange gain | | (88,888 | ) | | (33,677 | ) | | (53,156 | ) |
| | | 14,319,641 | | | 11,822,274 | | | (9,917,889 | ) |
| Loss from operations | | (14,319,641 | ) | | (11,822,274 | ) | | (9,917,889 | ) |
| | | | | | | | | | |
| OTHER INCOME AND EXPENSES | | | | | | | | | |
| Interest and other income | | 493,610 | | | 5,614 | | | 8,766 | |
| Gain/(loss) on asset disposals | | — | | | 19,773 | | | (7,092 | ) |
| Loss on settlement of accounts payable[note 15(i)] | | (98,189 | ) | | — | | | — | |
| Loss on sale of interest in subsidiary[note 9] | | (420,400 | ) | | — | | | — | |
| Loss on write-down of long-term assets[note 6] | | — | | | (200,457 | ) | | — | |
| | | (24,979 | ) | | (175,070 | ) | | 1,674 | |
| Loss before non-controlling interest | | (14,344,620 | ) | | (11,997,344 | ) | | (9,916,215 | ) |
| | | | | | | | | | |
| Non-controlling interest | | 92,238 | | | — | | | — | |
| Net loss for the year | | (14,252,382 | ) | | (11,997,344 | ) | | (9,916,215 | ) |
| | | | | | | | | | |
| Weighted average number of common | | | | | | | | | |
| shares outstanding[note 15[j]] | | 153,685,553 | | | 108,009,185 | | | 80,979,299 | |
| | | | | | | | | | |
| Basic and diluted loss per common share | | (0.09 | ) | | (0.11 | ) | | (0.12 | ) |
See accompanying notes
Dynamotive Energy Systems Corporation
Incorporated under the laws of British Columbia, Canada
CONSOLIDATED STATEMENTS OF DEFICIT
As at December 31 (in U.S. dollars)
| | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| Deficit, beginning of year | | (58,847,397 | ) | | (46,850,053 | ) | | (36,136,236 | ) |
| Effect of change in accounting policy[note 3] | | — | | | — | | | (797,602 | ) |
| Deficit, beginning of year restated | | (58,847,397 | ) | | (46,850,053 | ) | | (36,933,838 | ) |
| Loss for the year | | (14,252,382 | ) | | (11,997,344 | ) | | (9,916,215 | ) |
| Deficit, end of year | | (73,099,779 | ) | | (58,847,397 | ) | | (46,850,053 | ) |
See accompanying notes
65
Dynamotive Energy Systems Corporation
Incorporated under the laws of British Columbia, Canada
CONSOLIDATED STATEMENTS OF CASH FLOWS
As at December 31 (in U.S. dollars)
| | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| | | | | | | | | | |
| OPERATING ACTIVITIES | | | | | | | | | |
| Net loss for the year | | (14,252,382 | ) | | (11,997,344 | ) | | (9,916,215 | ) |
| Add items not involving cash: | | | | | | | | | |
| Amortization and depreciation | | 124,067 | | | 148,556 | | | 130,912 | |
| Accretion expense | | 208,022 | | | 1,068,192 | | | — | |
| Non-controlling interest | | (92,238 | ) | | — | | | — | |
| Interest expense non-cash | | 14,408 | | | 67,970 | | | 97,200 | |
| (Gain) Loss on asset disposals | | — | | | (19,773 | ) | | 7,092 | |
| Loss on write-down of long-term assets | | — | | | 200,457 | | | — | |
| Loss on settlement of accounts payable | | 98,189 | | | — | | | — | |
| Loss on sale of interest in subsidiary | | 420,400 | | | — | | | — | |
| Stock based compensation[note 15(i)] | | 4,337,590 | | | 3,697,057 | | | 4,730,604 | |
| Foreign exchange gain and other items | | (88,888 | ) | | (33,677 | ) | | (20,484 | ) |
| Net change in non-cash working capital balances | | | | | | | | | |
| related to operations[note 19] | | (171,912 | ) | | 133,833 | | | 2,087,156 | |
| Cash used in operating activities | | (9,402,744 | ) | | (6,734,729 | ) | | (2,883,735 | ) |
| | | | | | | | | | |
| FINANCING ACTIVITIES | | | | | | | | | |
| Contribution received from joint venture[note 8] | | 1,500,000 | | | — | | | — | |
| Proceeds from convertible debenture | | — | | | 1,825,000 | | | 830,013 | |
| Proceeds from long-term debt | | — | | | — | | | 816,727 | |
| Proceeds from short term loan | | — | | | — | | | 42,331 | |
| Decrease in long-term debt | | (899,184 | ) | | — | | | — | |
| Repayment of short term loan | | — | | | (42,331 | ) | | — | |
| (Increase) decrease in government grant | | | | | | | | | |
| receivables | | (473,451 | ) | | (368,712 | ) | | 509,879 | |
| Share capital issued | | 27,495,575 | | | 6,398,254 | | | 4,857,699 | |
| Shares to be issued | | 18,091 | | | 1,957,000 | | | 1,636,408 | |
| Cash provided by financing activities | | 27,641,031 | | | 9,769,211 | | | 8,693,057 | |
| | | | | | | | | | |
| INVESTING ACTIVITIES | | | | | | | | | |
| Increase in patent costs | | (21,016 | ) | | (22,181 | ) | | (19,989 | ) |
| Purchase of property, plant and equipment (net of | | | | | | | | | |
| government grants received) | | (10,496,423 | ) | | (1,580,195 | ) | | (5,804,656 | ) |
| Decrease (increase) in restricted cash | | 177,596 | | | (172,813 | ) | | — | |
| Cash used in investing activities | | (10,339,843 | ) | | (1,775,189 | ) | | (5,824,645 | ) |
| | | | | | | | | | |
| Increase (decrease) in cash and cash | | | | | | | | | |
| equivalents | | 7,898,444 | | | 1,259,293 | | | (15,323 | ) |
| Effects of foreign exchange rate changes on cash | | 19,622 | | | 32,204 | | | (131,220 | ) |
| Increase (decrease) in cash and cash | | | | | | | | | |
| equivalents during year | | 7,918,066 | | | 1,291,497 | | | (146,543 | ) |
| Cash and cash equivalents, beginning of year | | 1,428,468 | | | 136,971 | | | 283,514 | |
| Cash and cash equivalents, end of year | | 9,346,534 | | | 1,428,468 | | | 136,971 | |
| | | | | | | | | | |
| Supplemental cash flow information [notes 15(i) and 19] | | | | | | | |
See accompanying notes
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
1. NATURE OF BUSINESS AND FUTURE OPERATIONS
Dynamotive Energy Systems Corporation (“the Company” or “Dynamotive”) was incorporated on April 11, 1991 under the laws of the Province of British Columbia. Dynamotive is focused on the development of innovative energy solutions based on its patented fast pyrolysis system. The Company’s focus is to commercialize its patented BioOil production technology and establish this technology for production of BioOil clean fuels.
These financial statements have been prepared in accordance with Canadian generally accepted accounting principles on a going concern basis, which presumes the Company will be able to realize its assets and discharge its liabilities and commitments in the normal course of operations for the foreseeable future. As at December 31, 2006, the Company has working capital of $4,938,473 (2005 - working capital deficiency of $5,357,001), and has incurred a loss of $14,252,382 (2005 - $11,997,344; 2004 - $9,916,215) for the year ended December 31, 2006.
The ability of the Company to continue as a going concern is in substantial doubt and is dependent on achieving profitable operations, commercializing its BioOil production technology and obtaining the necessary financing in order to develop this technology. The outcome of these matters cannot be predicted at this time. The Company’s future operations are dependent on the market’s acceptance of its products in order to ultimately generate future profitable operations, and the Company’s ability to secure sufficient financing to fund future operations. There can be no assurance that the Company’s products will be able to secure market acceptance. Management plans to raise additional equity financing to enable the Company to complete its development plans. These financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Management is of the opinion that expected future financing along with expected sales will provide sufficient working capital to meet the Company’s liabilities and commitments as they become due.
2. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles.
The following is a summary of significant accounting policies used in the preparation of these consolidated financial statements:
Principles of consolidation
These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries Dynamotive Canada Inc., federally incorporated under the laws of Canada; Dynamotive Corporation, incorporated under the laws of Rhode Island, U.S.A.; Dynamotive USA Inc. incorporated under the laws of Delaware, U.S.A.; Dynamotive Latinoamericana S.A., incorporated under the laws of Buenos Aires, Argentina; First Resources Corporation, incorporated under the laws of British Columbia.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
In September 2006, the Company entered into an agreement to sell-off a 20% interest of its then wholly owned subsidiary Dynamotive Europe Limited (“DEL”) (note 9). The Company maintains the remaining 80% ownership interest in DEL. The Company continues to fully consolidate DEL for each of the years presented.
Effective January 1, 2005, the Company adopted CICA Accounting Guideline 15, Consolidation of Variable Interest Entities (“AcG-15). The guidance establishes when a company should consolidate a variable interest entity in its financial statements. AcG-15 provides the definition of variable interest entity and requires a variable interest entity to be consolidated if a company is at risk of absorbing the majority of the variable interest entity’s expected losses, is entitled to receive a majority of the variable interest entity’s residual returns, or both. As a result, the Company has applied the guidance of AcG-15, and has consolidated the accounts of its joint venture Dynamotive Biomass Resource Corporation (“DBRC”), in which the Company has a 51% ownership interest (note 8). In addition, the Company owns 99.98% of the West Lorne BioOil Co-Generation LP formed under the laws of Ontario and has accounted for its proportionate share of the partnership.
All inter-company balances and transactions have been eliminated on consolidation.
Use of estimates
The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Foreign currency translation
The accounts of the Company and its consolidated subsidiaries are measured using the Canadian dollar as the functional currency. Monetary items denominated in foreign currencies are translated into Canadian dollars using exchange rates in effect at the balance sheet date and non-monetary items are translated using historical exchange rates. Exchange gains or losses arising on the transaction or settlement of foreign currency denominated monetary items are included in the determination of net loss.
The Company uses the U.S. dollar as the reporting currency for its consolidated financial statements. Assets and liabilities are translated into U.S. dollars using current exchange rates in effect at the balance sheet date and revenue and expense accounts are translated using the average exchange rate during the period. Gains and losses resulting from this translation are recorded in shareholders’ equity as an adjustment to the cumulative translation adjustment account.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
Revenue recognition
[a]Product Sales
The Company recognizes revenue from the sale of products, including BioOil, char, and other byproducts, upon shipment of the product when the risk and reward of ownership has been transferred to the customer, provided that the amount is fixed or determinable and collection is reasonably assured.
[b]Licenses and royalties
Revenue from license agreements may include multiple elements within a single contract. Payments received under license agreements may include the following: non-refundable fees at inception of the contract, fees for services to be performed, milestone payments for specific achievements, and royalty payments based upon resulting sales of products. Agreements with multiple elements are separated into significant discrete units of accounting based on the relative fair value of each element. Revenue recognized for each element when all significant acts have been completed and delivery has occurred with no substantial risk of return and collectibility is reasonably assured. When the fair value cannot be determined, revenue is deferred until objective evidence exists or recognized as the final elements are delivered.
Deferred revenue is comprised of amounts received prior to the satisfaction of the revenue recognition criteria described above and includes non-refundable amounts related to sales of master license and plant license agreements. Master license agreements grant the licensee the exclusive right and license to use and commercially exploit the Company’s BioOil technology including the rights to manufacture, market, distribute, and sub-license the technology for the production of BioOil within a specific territory. Plant license agreements grant a licensee the right to use and commercially exploit the Company’s BioOil technology for the development of one or more pyrolysis plant facilities.
Government assistance and investment tax credits
Government assistance towards current expenses is included in the determination of income for the period as a reduction of the expenses to which it relates. Amounts received for future expenditures are recorded as a current liability. Government assistance towards the acquisition and construction of property, plant and equipment is deducted from the cost of the related property, plant and equipment. Government grants receivable are recorded when the Company has incurred the qualifying expenditure and there is reasonable assurance the receipts will be recovered.
Repayment of contribution is contingent solely upon the Company’s ability to generate revenue from the sale of specified products or technology. Accordingly, liability of repayment will only be accrued when sales of the products or technology have been generated.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
Investment tax credits are accounted for under the cost reduction method whereby they are netted against the expense or capital asset to which they relate. Investment tax credits are recorded when the Company has incurred the qualifying expenditures and there is reasonable assurance the tax credits will be realized. As at December 31, 2006 and 2005, no investment tax credits have been recognized.
Research and development costs
Research costs are expensed in the period incurred. Development costs are expensed in the period incurred unless the Company believes the development project meets Canadian generally accepted accounting criteria for deferral and amortization. In evaluating these criteria the Company considers technological feasibility to be established only when a product demonstrates it operates under conditions which are acceptable to target customers. If management determines that the development of products to which such costs have been capitalized is not reasonably certain, or that costs exceed recoverable value, such costs are charged to operations. The Company has not capitalized any development costs for any of the year ends presented.
During the year ended December 31, 2006, the Company netted $154,560 (2005 - $nil; 2004 - $nil) of product sales against research and development expenses, which are considered incidental sales of BioOil until such time as the Company’s plant has reached commercial production levels.
Patents
Patents are recorded at cost, including related legal costs, and are amortized on a straight-line basis over the lesser of the estimated useful life of the related technology and the life of the patent. If management determines that development of products to which patent costs relate is not reasonably certain, or that costs exceed recoverable value, such costs are charged to operations. Due to the long-term nature of estimates inherent in determining future cash flows, it is possible that the future cash flows or the estimated useful life of such assets could be reduced in the future.
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
Property, plant and equipment
Property, plant and equipment are recorded at cost, net of government assistance, and amortized using the following methods and annual rates:
| | Furniture and fixtures | 20% declining balance |
| | Computer equipment | 30% declining balance |
| | Computer software | 100% declining balance |
| | Equipment | 20% declining balance |
| | Leasehold improvements | Straight line over the term of the lease
(which approximates its estimated life) |
Annually, or whenever events and circumstances indicate that the carrying value of the assets might be impaired and the carrying value may not be recoverable, the Company performs evaluations to assess the recoverability of its property, plant and equipment. When the carrying value of property, plant and equipment is determined to exceed its recoverable amount, an impairment loss is recorded to reduce the carrying value of the capital asset to its fair value.
Projects under development
The Company expenses all preliminary stage costs incurred with respect to a potential capital project, including costs related to the consideration of alternatives, feasibility studies, and activities occurring prior to the decision to proceed with the project until the capital project meets the Company’s capitalization policy and is considered a project under development. The Company begins to capitalize costs for projects under development when it has determined that it is more likely than not that the financing for the capital project is available and it is more likely than not that the Company will be able to meet the requisite local and other governmental regulations to develop the capital project.
For those capital projects that meet the Company’s capitalization policy, the Company capitalizes incremental costs that are directly identifiable with the specific capital project until the capital project is substantially complete and ready for its intended use. Financing costs, including interest, are capitalized when they arise from indebtedness incurred, directly or indirectly, to finance the construction of the capital project. Capitalization of financing costs will cease when a capital project is considered to be substantially complete and ready for its intended use.
Annually, or whenever events and circumstances indicate that the carrying value of the assets might be impaired and the carrying value may not be recoverable, the Company performs evaluations to assess the recoverability of its projects under development. When the carrying value of projects under development is determined to exceed its recoverable amount, an impairment loss is recorded to reduce the carrying value of the projects under development to its fair value.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
Income taxes
The Company accounts for income taxes using the asset and liability method of tax allocation. Future income taxes are recognized for the future income tax consequences attributable to differences between the carrying values of assets and liabilities and their respective income tax bases. Future income tax assets and liabilities are measured using substantively enacted income tax rates expected to apply to taxable income in the periods in which temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in rates is included in earnings in the period that includes the substantial enactment date. Future income tax assets are recorded in the consolidated financial statements if realization is considered more likely than not. A valuation allowance is recorded to reduce future income tax assets recognized by the amount of any future income tax benefits that, based on available evidence, are not expected to be realized.
Stock based compensation
The Company has two stock based compensation plans - a stock appreciation rights (“SA Rights”) plan and a stock option plan for directors and employees, which are described in note 15. Under the terms of the stock option plan the Company may grant fixed options or options whose vesting is contingent on future performance. Compensation is recognized under the fair value based method when fixed or performance based stock options are granted to employees and directors. Compensation is recognized using the fair value based method for SA Rights when the performance criteria have been met and amortized over the service period.
The Company may also issue stock options and warrants to employees or as consideration for services rendered by non-employees. As a result of the change in accounting policy (note 3), such equity awards are recorded at their fair value using the Black Scholes option pricing model, as compensation expense or capitalized to long-term assets under construction when the Company receives the related services and the equity awards vest. No compensation is recognized in connection with options and warrants awarded in connection with private placements, since the share issue costs are netted against the proceeds raised. All unvested or modified options for non-employees are re-measured on each balance sheet date until such options vest, are exercised or forfeited.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
Loss per common share
Basic loss per common share is based on the weighted average number of shares outstanding for the period excluding contingently issuable shares and excluding escrowed shares. For the years ended December 31, 2006, potentially dilutive common shares (relating to shares to be issued, options and warrants outstanding, and convertible instrument agreements outstanding at year end) totaling 45,003,779 (2005 – 55,107,401, 2004 – 39,342,607) were not included in the computation of loss per share because their effect was anti-dilutive.
Financial instruments
The fair values of the financial instruments approximate their carrying value due to their short term or demand nature. In 2005, the fair values of the convertible debenture and long-term debt were calculated using discounted cash flow analysis and approximated their carrying value as the effective interest rates implicit in these financial instruments were similar to current market rates.
Management has assessed that it is not practical to determine the fair value of the long-term investment, which represents 2,658,994 common shares of Renewable Energy Corp., a company incorporated in Australia, as these shares are not traded in an organized financial market.
Leases
Leases are classified as either capital or operating leases. Leases which transfer substantially all the benefits and risks of ownership of the property to the Company are accounted for as capital leases. Capital lease obligations reflect the present value of future minimum lease payments, discounted at the appropriate interest rate. All other leases are accounted for as operating leases wherein rental payments are expensed as incurred.
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and balances invested in short-term money market deposits with an original maturity less than 90 days from the date of purchase. For the year ended December 31, 2006, the weighted average interest rate earned on cash equivalent balances was 4.77% (2005 – 3.51%) . As at December 31, 2006, the Company had $409,810 (2005 - $328,468) in cash, which includes $203,400 in Canadian currency (converted to US dollars based on the year end foreign exchange rate), $6,650,000 (2005 - $1,100,000) in short-term US dollar money market deposits and $2,286,724 (2005 – nil) in Canadian dollar (converted to US dollars based on the year end foreign exchange rate) T-bill mutual funds.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
2. SIGNIFICANT ACCOUNTING POLICIES (cont’d.)
Asset retirement obligations
The Company records the fair value of an asset retirement obligation as a liability in the period in which it incurred a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets and when a reasonable estimate of the fair value can be made. The obligation is measured initially at fair value using present value methodology, and the resulting costs capitalized into the carrying amount of the related asset. In subsequent periods, the liability will be adjusted for any changes in the amount or timing of the underlying future cash flows. Capitalized asset retirement costs will be depreciated on the same basis as the related asset and the discount accretion of the liability is included in determining the results of operations. As at December 31, 2006 and 2005, the Company estimated the fair value of the asset retirement obligations was $nil and consequently, no liability was accrued.
Long-term investment
The Company’s long-term investment is accounted for on a cost basis. The investment is written-down to its estimated net realizable value when there is evidence of a decline in value below carried cost that is other than temporary.
3. CHANGE IN ACCOUNTING POLICY
Stock based compensation
Effective January 1, 2004, the Company adopted, on a retroactive basis without restatement, the recommendations of revised CICA Handbook Section 3870 (“CICA 3870”), “Stock-based compensation and other stock-based payments”, which now requires companies to adopt the fair value based method for all stock-based awards granted on or after January 1, 2002. Previously, companies were only required to disclose the pro-forma effect of stock options issued to employees and directors in the notes to the financial statements. The effect of this change in accounting policy was to increase the deficit at January 1, 2004 by $797,602 with a corresponding increase to contributed surplus.
4. RECEIVABLES
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| | | | | | | |
| Receivables from sales of BioOil | | 96,337 | | | 1,955 | |
| Government taxes recoverable | | 318,416 | | | 19,144 | |
| Sundry receivables | | 60,150 | | | 19,227 | |
| | | 474,903 | | | 40,326 | |
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
5. Long-term advance
On April 7, 2006, the Company loaned $250,000 to Rika Ukraina Ltd to fund its wholly owned subsidiary’s (Rika Biofuels Ltd.) biomass development activities. The loan is unsecured and bears interest at 6% per annum and the principal and interest was originally due no later than July 15, 2006. The repayment was extended to March 15, 2007 and subsequently extended again to May 17, 2007. On December 18, 2006, an additional $80,000 loan with the same terms was advanced to Rika Ukraina Ltd. from DBRC. Under the terms of the agreement, the Company has the option to convert the principal and any accrued interest into a 50% ownership interest in Rika Biofuels Ltd. at any time the loan is outstanding. For the year ended December 31, 2006, the entire long-term advance of $330,000 has been offset against amounts received from Rika Ltd. and recorded as deferred revenue (note 14).
6. PROPERTY, PLANT AND EQUIPMENT
| | | 2006 | | | 2005 | |
| | | | | | Accumulated | | | | | | Accumulated | |
| | | Cost | | | Amortization | | | Cost | | | Amortization | |
| | | $ | | | $ | | | $ | | | $ | |
| | | | | | | | | | | | | |
| Furniture and fixtures | | 155,358 | | | 129,257 | | | 148,243 | | | 123,669 | |
| Computer equipment and software | | 552,498 | | | 426,057 | | | 461,123 | | | 366,765 | |
| Equipment | | 119,786 | | | 28,511 | | | 24,499 | | | 15,858 | |
| Projects under development: | | | | | | | | | | | | |
| West Lorne | | 13,271,968 | | | — | | | 12,832,393 | | | — | |
| Construction advances – 200 tpd plant | | 12,765,393 | | | — | | | 1,196,885 | | | — | |
| Leasehold improvements | | 214,503 | | | 133,291 | | | 158,200 | | | 115,903 | |
| | | 27,079,506 | | | 717,116 | | | 14,821,343 | | | 622,195 | |
| Net book value | | 26,362,390 | | | 14,199,148 | |
The Company has constructed a 100 tonne per day BioOil co-generation project at the site of Erie Flooring in West Lorne, Ontario. At December 31, 2006, the Company has also recorded $12,765,393 [2005 - $1,196,885] as plant and equipment representing initial payments on a 200 tonne per day (“tpd”) plant at Guelph, Ontario. All of the construction payments were paid in cash or shares.
During 2006, government grants of $1,331,964 [2005 - $873,583] have been applied to reduce the cost of property, plant and equipment under construction.
In 2005, the Company recorded write-downs of certain property, plant and equipment totaling $190,146, pertaining to certain BioOil Power Generation testing equipment. The Company determined that the net recoverable amount of certain test equipment was below its carrying value.
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
7. PATENTS
| | | 2006 | | | 2005 | |
| | | | | | Accumulated | | | | | | Accumulated | |
| | | Cost | | | Amortization | | | Cost | | | Amortization | |
| | | $ | | | $ | | | $ | | | $ | |
| | | | | | | | | | | | | |
| Patents | | 410,530 | | | 156,618 | | | 390,220 | | | 131,111 | |
| Net book value | | 253,912 | | | 259,109 | |
Patents are recorded at cost, including related legal costs, and are amortized on a straight-line basis over the lesser of the estimated useful life of the related technology and the life of the patent. The annual amortization expense of these patents for the next five years is estimated to be approximately $25,000 per annum.
In 2005, the Company recorded write-downs of certain patents the Company is no longer pursuing totaling $10,311. The Company determined that the net recoverable amount of these patents was below their carrying values.
8. BIOMASS JOINT VENTURE
In September 2006, the Company and Pedana Limited BVI (“Pendana”) entered into joint venture agreement to establish DBRC (a company incorporated federally in Canada) with the purpose of securing biomass and to source project development opportunities and additional biofuel and green credit pipeline opportunities. The agreement expires on December 31, 2016.
Pursuant to terms of the agreement, the Company earned a 51% interest in DBRC by contributing cash of $500,000 and granting DBRC certain rights associated with specific biomass development opportunities in Canada, South America, and Europe. In return for a 49% ownership in DBRC, Pendana’s contribution amounted to cash payments of $2,000,000 ($1.5 million was received in DBRC as at December 31, 2006 and $500,000 received subsequent to year end). In addition to the above, the Company has agreed to lend DBRC up to $1 million, with terms to be entered into at a later date. Pendana has also further agreed to provide a $20 million revolving line of credit to DBRC. Any sums advanced under this credit facility shall at Pendana’s sole discretion, be repayable on demand and shall bear interest at 4% above the rate of the Royal Bank of Scotland. Pendana shall be entitled to security in the projects or assets funded under this clause of the credit facility. As at December 31, 2006, no funds have been advanced by Pendana under this credit facility.
Management has determined that DBRC meets the criteria of a variable interest entity (“VIE”) under AcG-15 and accordingly has consolidated the accounts of DBRC into these financial statements. The non-controlling interest represents Pendana’s share of the carrying value of DBRC as a result of Pendana’s 49% interest.
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
9. DYNAMOTIVE EUROPE LIMITED
In September 2006, the Company and Pendana Limited BVI (“Pendana”) entered into an agreement in connection with the Company’s then wholly-owned subsidiary DEL. The agreement was made in an effort to establish DEL as a permanent presence in Europe to develop European projects. Under the terms of the agreement, Pendana completed a private placement with the Company, whereby the Company issued 2,332,361 common shares and 583,090 share purchase warrants for gross cash proceeds of $2,000,000. The warrants are exercisable at $1.26 and expire on August 2, 2008. In addition, the Company issued a total of 3,000,000 warrants, with an exercise price of $1.2375, to Pendana, 1,000,000 of these warrants expire on April 24, 2007 and the remaining 2,000,000 warrants expire on February 28, 2007. The additional warrants were valued using the Black-Scholes option pricing model using the following assumptions: risk free interest rate of 4.17%; dividend yield of 0%, volatility factors of 35.23%; and an expected life of 0.5 years. Pendana also received a 20% interest in DEL, with Dynamotive maintaining the remaining 80% interest. The Company further agreed to loan DEL $2,000,000 on commercial terms.
Pursuant to the terms of the agreement, 20% of the net cash generated by DEL will be distributed to Pendana’s agent and 80% to the Company in settlement of the intercompany debt. In the event DEL wishes to seek further debt or equity funding to finance specific projects at any time following the date of the agreement, Pendana shall have the right of first refusal.
At the date of acquisition, DEL was substantially inactive and no non-controlling interest was recorded as a result of this transaction, as the net asset value at that date was in a deficit position and DEL has not yet obtained profitable operations. As a result of the sale of this 20% interest in DEL, the Company has recorded a loss of $420,400 in its operations for the year ended December 31, 2006. The Company continues to consolidate the accounts of DEL as the Company maintains its remaining 80% ownership interest.
10. LONG TERM INVESTMENT
As at December 31, 2006, Dynamotive holds 2,658,994 (2005 – Nil) common shares of Renewable Energy Corp (“ROC”) incorporated in Victoria, Australia, a subsidiary of Enecon Pyrolysis Pty Limited. It represents a 6.6% interest in the entity. For the year ended December 31, 2006, the entire long-term investment of $100,000 has been offset against amounts received from ROC and recorded as deferred revenue (note 14).
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
11. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| | | | | | | |
| Trade accounts payable | | 3,141,341 | | | 5,499,062 | |
| Accrued compensation | | 239,287 | | | 41,692 | |
| Accrued liabilities | | 2,665,838 | | | 1,429,942 | |
| Bank of Scotland guarantee(i) | | 391,821 | | | 344,160 | |
| | | 6,438,287 | | | 7,314,856 | |
| (i) | In 2001, Border Biofuels Ltd. (“BBL”, a company in liquidation which was 75% owned by the Company) entered into a credit facility with the Bank of Scotland for a maximum of $391,821 (2005 - $344,100) (£200,000). The credit facility is denominated in British Pounds Sterling and is guaranteed by the Company. During 2002, BBL became insolvent. If the Bank is unable to realize on its collateral with BBL, it has the right to seek settlement from the Company for payment. Although there is currently no indication that the Bank will pursue the Company, the Company in 2002 recognized the full amount of the guarantee as a current liability. BBL remains in liquidation at December 31, 2006, there has been no change in status regarding the settlement of the credit facility. |
12. CONVERTIBLE DEBENTURES
| (a) | In 2005, the Company issued $1,825,000 of convertible debentures including $175,000 of debentures issued to officers and directors (or companies controlled by officers and directors) of the Company. These debentures were due between June and September 2006, had an interest rate of 10% payable in shares and were convertible into Company common shares at rates between $0.40 and $0.425 per share. These debentures were collateralized by certain government grant receivables and guaranteed by the Company. In September and December 2005, $1,150,000 of debentures were converted into 2,727,941 common shares and 681,985 Series U warrants. In addition, 101,071 shares and 25,267 Series U warrants were issued in 2005 as an interest payment on the debenture. During the first six months of 2006, the remaining $675,000 of the debentures were converted into 1,613,969 common shares and 484,787 Series U warrants. In addition, 109,370 shares and 29,493 Series U warrants were issued in 2006 as an interest payment on the debenture. As at December 31, 2006, no debentures were outstanding. |
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
12. CONVERTIBLE DEBENTURES (cont’d)
| The original proceeds of the debenture were allocated to the debenture and the conversion feature at December 31, 2005 based on their relative fair values. Accordingly, $1,173,409 was originally allocated to the debenture and $651,591 was allocated to the conversion feature. The carrying value of the debt was being accreted up to its face value over the term to maturity. The accretion of the debt discount began in June 2005 and $96,695 was accreted during the period to December 31, 2005. The amount of $426,357 was expensed in 2005 due to the conversion of the debentures. During the first six months of 2006, $20,645 of the debt discount was accreted and $107,894 was expensed due to conversion of the remaining debentures. |
| | |
| As at December 31, 2005, restricted cash of $172,813 was held by the Company’s lawyer as collateral for short-term convertible debentures. In January 2006, debenture holders converted the same amount into Company’s common shares and these funds became non-restricted. |
| | |
| (b) | In December 2004 the Company entered into an agreement with an Ontario corporation (the “Vendor”) to pay for equipment and services in exchange for an $830,013 (C$1,000,000) convertible debenture (the “Agreement”). The debenture was convertible into common shares of the Company at the market price at the time of conversion, subject to a minimum conversion price of $0.40 per share and a maximum conversion price of $0.60 per share. In addition, for each share issued upon conversion, the debenture holder would receive ½ share purchase warrant. Each whole warrant is exercisable for two years from the date of issue at 5% above the market price at the time of conversion. The debenture bore no interest and the principal was due on December 10, 2009. In September 2005, the Vendor converted the entire debenture into common shares of the Company at a price of $0.54 per share and received 1,535,001 shares and 767,500 two-year Series S warrants exercisable at $0.57 per share. |
| | |
| The Agreement also called for the Company to enter into a marketing agreement with the Vendor. In connection with the marketing agreement, in early 2005 the Company issued to the Vendor 500,000 Series U warrants to purchase common shares of the Company, exercisable at $0.49 per share during the period from January 4, 2005 to December 31, 2006. The Vendor has exercised these warrants subsequent to December 31, 2005. |
| | |
| The proceeds of the debenture have been allocated to the debenture and warrants at December 31, 2004 based on their relative fair values. Accordingly, $307,463 was allocated to the debenture, $440,592 was allocated to the conversion feature and $81,958 was allocated to the warrants. The carrying value of the debt was being accreted up to its face value over the term to maturity. No amount of the discount was accreted in 2004 since the debt agreement only became effective in December 2004. The accretion of the debt discount began in January 2005 and the entire balance of $522,550 ($440,592 related to the conversion feature and $81,958 related to the warrants) was expensed upon conversion in September 2005. |
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
13. LONG-TERM DEBT
In 2004, the West Lorne BioOil Co-Generation LP (the “LP”) entered into a loan agreement with a Bahamas Corporation for an $830,013 (C$1,000,000) loan. The loan bore interest at 1.25% per month with interest due monthly and the principal due on August 11, 2007. The LP could repay the loan at any time without penalty. The loan agreement also called for the Company to issue 312,500 Series T warrants to purchase common shares of the Company, exercisable at $0.49 per share for a period of three years, as part of the loan financing. The loan was collateralized by the assets of the LP and guaranteed by the Company. The debt and accrued interest were fully settled in June 2006.
The proceeds of the loan were allocated to the debt and warrants based on their relative fair values. In 2004, $760,209 was allocated to the loan and $69,804 was allocated to the warrants. The carrying value of the debt was being accreted up to its face value over the term to maturity. The accretion of the debt discount began in January 2005 and $22,591 was accreted in 2005. During first five months of 2006, $9,459 of the debt discount was accreted and $37,754 was expensed due to the repayment of the loan in June 2006.
14. DEFERRED REVENUE
In 2006, the Company received a total of $950,000 in payments from three unrelated companies as licensing fees. $500,000 from Rika Ltd. as payment for a Master License to develop project opportunities in the Ukraine and the Baltic republics using Dynamotive’s patented pyrolysis technology; $150,000 from Classic Power Inc. as an initial payment on a Plant License for Guelph, Ontario, Canada; $200,000 from Renewable Oil Corporation Pty Ltd. (“ROC”) for a Master License to develop project opportunities in Australia and $100,000 from ROC as a deposit on an initial plant license.
Deferred revenue is net of $330,000 advanced to entities controlled by Rika Ltd. (note 5) and a $100,000 long-term investment in ROC (note 10).
All the above funds are non-refundable and have been recorded as deferred revenue.
80
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL
[a] Authorized share capital
The Company’s authorized capital consists of an unlimited number of common shares with no par value and unlimited Class A preferred shares with no par value with each having attached special rights and restrictions. No preferred shares were issued and outstanding at December 31, 2006 and 2005.
[b] Issued and outstanding common shares
| | | Issued | |
| | | # | | | $ | |
| Balance, December 31, 2003 | | 69,915,654 | | | 30,907,990 | |
| Issued for cash and proceeds received in prior year | | | | | | |
| Pursuant to private placement(iii) | | 16,906,913 | | | 5,825,691 | |
| Pursuant to exercise of stock options | | 569,284 | | | 180,314 | |
| Pursuant to exercise of warrants | | 188,333 | | | 50,583 | |
| Issued for settlement of fees payable(iii) | | 2,999,113 | | | 1,427,565 | |
| Issued for services(i) | | 2,425,641 | | | 1,322,145 | |
| Issued for SA Rights | | 124,860 | | | 75,489 | |
| Shares redeemed and cancelled | | — | | | 76,688 | |
| Balance, December 31, 2004 | | 93,129,798 | | | 39,866,465 | |
| Issued for cash and proceeds received in prior year | | | | | | |
| Pursuant to private placement, net of issuance costs(iii) | | 17,303,998 | | | 6,071,226 | |
| Pursuant to exercise of stock options | | 1,239,139 | | | 373,277 | |
| Pursuant to exercise of warrants | | 1,873,084 | | | 592,088 | |
| Issued for settlement of fees payable(iii) | | 3,347,869 | | | 1,836,047 | |
| Issued for services(i) | | 1,656,643 | | | 929,199 | |
| Issued on conversion of convertible debentures | | 4,364,013 | | | 2,038,951 | |
| Issued on conversion of project advance | | 342,287 | | | 166,003 | |
| Shares to be redeemed and cancelled(ii) | | (44,956 | ) | | (23,780 | ) |
| Balance, December 31, 2005 | | 123,211,875 | | | 51,849,476 | |
| Issued for cash and proceeds received in prior year | | | | | | |
| Pursuant to private placement, net of issuance costs(iii) | | 24,001,562 | | | 18,670,368 | |
| Pursuant to exercise of stock options | | 1,411,716 | | | 642,098 | |
| Pursuant to exercise of warrants | | 17,574,713 | | | 7,936,096 | |
| Issued for settlement of fees payable(iii) | | 2,394,907 | | | 3,036,562 | |
| Issued for services(i) | | 2,003,664 | | | 2,514,585 | |
| Issued on conversion of convertible debentures | | 1,723,339 | | | 726,056 | |
| Cancellation of Escrow Shares | | (556,000 | ) | | (247,368 | ) |
| Balance, December 31, 2006 | | 171,765,776 | | | 85,127,873 | |
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
| [i] | The Company has entered into various agreements for services with its employees, directors and non-employees to be settled with various stock awards. For awards issued to employees and directors, the fair value is determined using the market price on the date of grant and for non-employees the fair value is determined using the market value on the date of completion of the services. |
| | |
| The Company issued shares issued for services are described below: |
| | | Issued | |
| | | # | | | $ | |
| For the year end December 31, 2004 | | | | | | |
| Shares issued for services: | | | | | | |
| Consulting services | | 2,393,459 | | | 1,303,005 | |
| Employees and directors | | 32,182 | | | 19,140 | |
| Total shares issued for services in 2004 | | 2,425,641 | | | 1,322,145 | |
| | | | | | | |
| For the year end December 31, 2005 | | | | | | |
| Shares issued for services: | | | | | | |
| Consulting services | | 1,078,201 | | | 626,365 | |
| Share issuance costs | | 487,940 | | | 268,444 | |
| Employees, directors and officers | | 90,502 | | | 34,390 | |
| Total shares issued for services in 2005 | | 1,656,643 | | | 929,199 | |
| | | | | | | |
| For the year end December 31, 2006 | | | | | | |
| Shares issued for services: | | | | | | |
| Consulting services | | 1,270,258 | | | 1,667,292 | |
| Share issuance costs | | 676,533 | | | 799,574 | |
| Employees, directors and officers | | 56,873 | | | 47,719 | |
| Total shares issued for services in 2006 | | 2,003,664 | | | 2,514,585 | |
| [ii] | At December 31, 2006, the Company had nil [2005 - 44,956; 2004 - nil] common shares to be redeemed. The redeemable shares had a fair value of $nil [2005 - $23,780; 2004 - nil] which were issued as a partial payment of outstanding invoices returned to the Company as a result of the final settlement with a vendor. |
82
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
| [iii] | During the year ended December 31, 2006, the Company completed private placements for gross proceeds of $21,072,712 [2005 - $7,138,730; 2004 - $6,491,511]. Share issuance costs related to these private placements totaled $2,402,344 [2005 - $1,033,113; 2004 - $665,820], of which $232,722 [2005 - $35,041; 2004 - $385,035] was paid in cash and $2,169,622 [2005 - $998,072; 2004 - $280,785] was paid in shares and warrants. Share issuance costs paid in shares were valued based on the quoted market price on the date of private placements. The fair value of the warrants were estimated using the Black-Scholes option pricing model with the following weighted average assumptions: risk free interest rate of 4.06% (2005 – 3.58%; 2004 – 3.02%); dividend yield of 0% (2005 – 0%; 2004 – 0%); volatility factors of 54.5% (2005 – 61.5%; 2004 – 84.2%); and weighted average expected life of 2 years (2005- 2 years; 2004 – 2years). Pursuant to the private placement agreements in 2006, 9,082,305 Series S warrants [2005 – 7,006,257 series S warrants; 2004 – 4,479,559 series Q warrants and 4,227,739 series S warrants] were issued in 2006 [note 15(f)]. |
| | |
| In 2006, the Company also issued 2,394,907 [2005 - 3,347,869; 2004 - 2,999,113] fully vested shares for settlement of fees payable with a total fair value of $3,036,562 [2005 - 1,836,047; 2004 - 1,427,565]. These shares were valued based on the quoted market price on the date of the settlement agreement. This resulted in a loss on settlement of accounts payable of $98,189 [2005 - $nil; 2004 - $nil] |
[c] Shares to be issued
At December 31, 2006, the Company has 1,836,532 [2005 – 4,673,439] common shares to be issued which are comprised of:
| [i] | 966,023 [2005 – 779,140] common shares which are to be issued to directors and non- employees for services rendered under compensation arrangements in 2006 with a fair value of $1,022,718 [2005 - $502,394]. |
| | |
| [ii] | 838,204 [2005 – 468,204] common shares which are to be issued to directors and officers as bonuses during the year with a fair value of $700,530 [2005 - $252,830]. |
| | |
| [iii] | Nil common shares relating to a private placement commenced during the year ended December 31, 2006 [2005 – 2,826,095] and 32,305 [2005 - 600,000] common shares are related to exercise of warrants for gross proceeds of $18,091 [2005 - $342,000]. At December 31, 2006, the Company had received $nil [2005 - $1,957,000] in cash for these shares to be issued. |
| | |
| [iv] | Subscription receivable of $nil [2005 - $34,392] related to nil [2005 – 90,502] common shares issued to an officer in 2006. |
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
[d] Escrow agreement
In December 1995, the Company placed in escrow 1,232,000 shares, issued for nominal consideration, to be released from such escrow agreement as the Company achieves certain milestones. During 1999, the Board approved an amendment to the escrow agreement’s release provisions that applied to 676,000 of the shares held in escrow above. The amended release provisions were that 1/3 of the common shares in escrow were to be released upon the Company achieving each of a capitalized stock value of $30 million, $50 million and $100 million.
During the year ended December 31, 2000, 450,666 of the common shares were released from escrow as the milestones were reached. In February, 2006 the Company’s market capitalization exceeded $100 million and as a result, the remaining 225,334 shares were released from escrow and were issued to the holders.
In March 2006, 556,000 common shares were cancelled and returned to the Treasury as the milestone (one share for each $0.17 of “cash flow” as defined in the agreement) expired without being reached. Accordingly, the Company has reduced common share capital by $247,368, based on the average per-share amount of the common shares at the date of cancellation, with a corresponding increase to contributed surplus.
As at December 31, 2006, nil [2005 - 781,334] common shares are held in escrow.
[e] Stock options
At December 31, 2006, the following stock options to directors, employees and non-employees were outstanding:
| | | Options Outstanding | Options Exercisable |
| | | Weighted- | | | |
| | Number | Average | Weighted- | Number | Weighted- |
| Range of | Outstanding at | Remaining | Average | Exercisable at | Average |
| Exercise | December 31, | Contractual | Exercise | December 31, | Exercise |
| Prices | 2006 | Life | Price | 2006 | Price |
| | | | | | |
| $0.20 - $0.23 | 4,885,617 | 6.58 years | $0.21 | 4,885,617 | $0.21 |
| $0.33 - $0.50 | 9,536,833 | 5.18 years | $0.47 | 9,406,833 | $0.47 |
| $0.58 - $0.90 | 574,583 | 2.45 years | $0.58 | 574,583 | $0.58 |
| $1.00 - $1.35 | 1,020,000 | 4.93 years | $1.21 | 132,500 | $1.01 |
| $1.50 - $1.60 | 872,500 | 2.63 years | $1.59 | 872,500 | $1.59 |
| | 16,889,533 | 4.81 years | $0.50 | 15,872,033 | $0.46 |
84
| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
From time to time, the Company has provided incentives in the form of stock options to the Company’s directors, officers, employees and others. The Company has reserved 25,764,866 [2005 - 18,488,525] (15%) of its common shares for issuance upon the exercise of stock options of which at December 31, 2006, 8,875,333 [2005 - 4,575,275] are available to be granted. The exercise price and the vesting terms of the options are determined by the Compensation Committee of the Company’s Board of Directors. The exercise price will generally be at least equal to the market price of the common shares at the date of the grant.
Stock option transactions for the respective periods and the number of stock options outstanding are summarized as follows:
| | | No. of Common | | | Weighted Average | |
| | | Shares Issuable | | | Exercise Price | |
| | | # | | | $ | |
| Balance, December 31, 2003 | | 10,015,988 | | | 0.41 | |
| Options issued | | 3,393,769 | | | 0.36 | |
| Options forfeited or expired | | (900,750 | ) | | 0.70 | |
| Options exercised | | (569,284 | ) | | 0.32 | |
| Balance, December 31, 2004 | | 11,939,723 | | | 0.38 | |
| Options issued | | 4,068,916 | | | 0.48 | |
| Options forfeited or expired | | (856,250 | ) | | 0.72 | |
| Options exercised | | (1,239,139 | ) | | 0.30 | |
| Balance, December 31, 2005 | | 13,913,250 | | | 0.39 | |
| Options issued | | 4,665,999 | | | 0.82 | |
| Options forfeited or expired | | (278,000 | ) | | 0.66 | |
| Options exercised | | (1,411,716 | ) | | 0.45 | |
| Balance, December 31, 2006 | | 16,889,533 | | | 0.50 | |
During 2005, the Company reduced the expiry date of 400,000 options issued to officers from the original expiry date of three years to two years.
During 2004, the Company extended the expiry date of 6,606,617 options issued to officers from the original expiry date for an additional period of five years.
85
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
The weighted-average fair value of options granted in 2006 where the stock price is equal to the exercise price of the options, greater than the exercise price of the options and less than the exercise of the options was $0.58, $0.54, and $0.78 respectively [2005 - $0.58, $0.54, and $0.46; 2004 - $nil, $0.40 and $0.41] .
Compensation expense recognized for options granted or modified in 2006 or prior periods was $1,933,233 (2005 - $2,103,328; 2004 - $2,680,175). The fair value of stock options and warrants granted in 2006 is estimated at the measurement date using the Black Scholes option pricing model with the following weighted average assumptions: Risk free interest rate of 4.12% (2005 – 3.7%; 2004 – 4.3%); dividend yields of 0% (2005 – 0%; 2004 – 0%); volatility factors of the expected market price of the Company’s common stock of 60.5% (2005 – 79.9%; 2004 – 92.7%); and weighted average expected life of the option of 3.8 years (2005 – 6.5 years; 2004 – 4.9 years).
Expected volatilities are based on historical volatility of the Company’s stock using available data and other factors. The risk-free interest rate is based on Canadian Treasury Instruments. As the Company does not currently pay cash dividends on common stock and does not anticipate doing so in the foreseeable future, the expected dividend yield is zero. The Company uses historical data to estimate option exercise, forfeiture and employee termination within the valuation model. For non-employees, the expected life of the options approximates the full term of the options.
[f] Common share purchase warrants
At December 31, 2006 the common share purchase warrants outstanding were as follows:
| | No. of Common | Exercise | |
| | Shares Issuable | Price | Expiration Date |
| | | | |
| Series Q Warrants | 3,545,203 | $0.20 to $0.75 | January 12, 2007 to August 31, 2008 (note 24) |
| Series R Warrants | 2,500,000 | $0.20 | August 31, 2008 |
| Series S Warrants | 19,286,163 | $0.44 to $2.06 | January 4, 2007 to May 31, 2011 (note 24) |
| Series U Warrants | 946,348 | $0.46 to $0.53 | September 22, 2008 to January 21, 2009 |
| | | | |
| Total | 26,277,714 | | |
86
| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
Summary of warrants exercised and issued during the year end:
| Number of Common Shares Issuable | |
| | | | | via Warrants | | |
| | | via Warrants | via Warrants | cancelled or | | |
| | | Issued | exercised | expired | at | |
| | at December | during the | during the | during the | December | |
| Series | 31, 2005 | year | year | year | 31, 2006 | Exercise Price |
| P Warrants | 3,735,482 | — | (3,735,482) | — | — | $0.40 |
| Q Warrants | 10,357,295 | — | (6,811,757) | (335) | 3,545,203 | $0.20 to $0.75 |
| R Warrants | 2,500,000 | — | — | — | 2,500,000 | $0.20 |
| S Warrants | 15,998,808 | 9,532,275 | (5,906,032) | (338,888) | 19,286,163 | $0.44 to $2.06 |
| T Warrants | 312,500 | — | (312,500) | — | — | $0.49 |
| U Warrants | 1,207,252 | 548,038 | (808,942) | — | 946,348 | $0.46 to $0.53 |
| | 34,111,337 | 10,080,313 | (17,574,713) | (339,223) | 26,277,714 | |
Of 26,277,714 outstanding warrants, 25,638,047 warrants are vested. 14,086,502 of the Series Q, S, and T warrants are callable by the Company for $0.001 to $0.01 per warrant on 30 days notice. 409,618 of the Series Q warrants are callable by the Company for $0.001 to $0.01 per warrant on 30 days notice. 1,100,000 of the Series S warrants are callable by the Company for $0.001 to $0.01 per warrant on 30 days notice as soon as the Company’s shares have closed at or above $2.00 for 20 consecutive trading days. 8,451,594 of the Series S and U warrants are callable by the Company for $0.001 to $0.01 per warrant on 30 days notice as soon as the Company’s shares have closed at or above $3.00 for 20 consecutive trading days.
| (1) | The Series P warrants were issued as part of a private placement and for services of non- employees. These warrants vested upon successful completion of the private placement and as services were performed respectively. During the year ended December 31, 2004, pursuant to various private placements agreement, the Company issued 2,700,000 Series P warrants with an exercise price of $0.40 per share, expiring on April 1, 2006. In 2006, all Series P warrants were exercised. |
| | |
| (2) | The Series Q warrants were issued as part of a private placement for cash and services. These warrants vested upon successful completion of the private placement and as services were performed. In 2002, 818,418 Series Q warrants were issued as part of a loan agreement to certain directors of the Company. In 2006, 6,811,757 [2005 - 1,134,793] warrants were exercised at a weighted average price of $0.37 [2005 - 0.31] per share. |
| | |
| (3) | The 2,500,000 Series R warrants were issued as part of a loan financing in 2003 at an exercise price of $0.20 per share. As at December 31, 2006, the warrants continue to be exercisable and outstanding. |
87
| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
| (4) | The Series S warrants were issued during the year as part of a private placement for cash and services. Of the 9,532,275 [2005 – 11,088,569] warrants issued, 9,082,305 [2005 – 7,006,257] were issued in relation to private placements. The remainder of the warrants were issued for issuance costs. These warrants vested upon successful completion of the private placement and as services were performed. |
| | |
| (5) | The Series T warrants were issued as a part of a loan agreement in 2004 and the warrants vested immediately upon issue. In 2006, 312,500 [2005 - nil] warrants were exercised at a weighted average price of $0.49 [2005 – nil] per share. In 2006, all Series T warrants were exercised. |
| | |
| (6) | In 2006, 548,038 [2005 - 1,207,252] Series U warrants were issued during the year as a part of conversion of convertible debentures. These warrants vested immediately upon issue with a weighted average exercise price of $0.49 [2005 - $0.51]. |
Compensation expense recognized for warrants issued during 2006 was $1,152,368 [2005 - $707,166; 2004 - $601,250].
[g] Stock appreciation rights
In 1998, the Company established a stock appreciation rights plan whereby the participants will be entitled to require the Company to redeem the stock appreciation rights (“SA Rights”) for an amount equal to the excess of the market value of the underlying common shares over the initial value of the SA Right at the date of grant. The SA Rights have vested as the Company achieved stock value targets as defined in the agreement.
The Company also has the right to redeem the SA Rights at its option under certain circumstances. The Company has the sole exclusive election to redeem the SA Rights in cash, shares or in a combination of cash and shares. The number of SA Rights that can be granted under the plan until December 31, 2008 cannot exceed 2,500,000.
At December 31, 2006, 300,000 [December 2005 - 300,000] SA Rights were outstanding and 300,000 [December 2005 - 200,000] were vested. These 300,000 SA Rights, with an initial value of $0.40, expire on December 31, 2008. There were no SA Rights issued, redeemed or forfeited during the past three year period.
88
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
[h] Contributed surplus
The following is a continuity of contributed surplus for the respective periods:
| | | Contributed | |
| | | Surplus | |
| | | $ | |
| Balance, December 31, 2003 | | 4,815,679 | |
| Effect of change in accounting policy {note 3} | | 797,602 | |
| Fair value of warrants related to convertible debentures | | 522,550 | |
| Fair value of warrants related to long-term debt | | 167,010 | |
| Stock-based compensation expense | | 3,281,425 | |
| Balance, December 31, 2004 | | 9,584,266 | |
| Fair value of warrants related to convertible debentures | | 652,398 | |
| Stock-based compensation expense | | 2,810,494 | |
| Balance, December 31, 2005 | | 13,047,158 | |
| Escrow shares cancelled/forfeited | | 247,368 | |
| Loss on sale of subsidiary | | 420,400 | |
| Stock-based compensation expense | | 3,085,601 | |
| Balance, December 31, 2006 | | 16,800,527 | |
[i] Stock based compensation and payment
The Company has recorded stock based compensation and payment as follows:
| | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| Balance sheet items | | | | | | | | | |
| Property, plant and equipment | | 1,941,324 | | | 327,533 | | | 350,812 | |
| Share issue costs | | 2,169,622 | | | 996,876 | | | 280,785 | |
| Accounts payable | | 969,261 | | | 492,136 | | | 17,893 | |
| Other assets | | 100,637 | | | — | | | — | |
| | | 5,180,844 | | | 1,816,545 | | | 649,490 | |
| Income statement items | | | | | | | | | |
| Marketing and business development | | 179,917 | | | 477,079 | | | 108,000 | |
| General and administrative | | 2,571,175 | | | 2,327,161 | | | 3,835,201 | |
| Loss on settlement of accounts payable | | 98,189 | | | — | | | — | |
| Research and development | | 1,586,498 | | | 892,817 | | | 787,403 | |
| Interest expense and other | | 14,408 | | | 67,970 | | | 97,200 | |
| | | 4,450,187 | | | 3,765,027 | | | 4,827,804 | |
| | | | | | | | | | |
| Total stock based compensation and | | | | | | | | | |
| payment | | 9,631,031 | | | 5,581,572 | | | 5,477,294 | |
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| Dynamotive Energy Systems Corporation |
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| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
15. SHARE CAPITAL (cont’d.)
[j] Basic and diluted loss per common share
| | | 2006 | | | 2005 | | | 2004 | |
| | | | | | | | | | |
| Numerator | | | | | | | | | |
| Net loss | $ | (14,252,382 | ) | $ | (11,997,344 | ) | $ | (9,916,215 | ) |
| | | | | | | | | | |
| Denominator | | | | | | | | | |
| Weighted average number of common shares | | | | | | | | | |
| outstanding | | 153,685,553 | | | 108,790,519 | | | 81,760,633 | |
| Escrowed shares | | — | | | (781,334 | ) | | (781,334 | ) |
| | | 153,685,553 | | | 108,009,185 | | | 80,979,299 | |
| | | | | | | | | | |
| Basic and diluted loss per common share | $ | (0.09 | ) | $ | (0.11 | ) | $ | (0.12 | ) |
16. COMMITMENTS AND CONTINGENCIES
Commitments
The Company has the following future minimum annual lease commitments for premises and equipment:
| | | $ | |
| 2007 | | 932,000 | |
| 2008 | | 244,000 | |
| 2009 | | 132,000 | |
| 2010 | | 58,000 | |
| 2011 | | 53,000 | |
| 2012 and after | | 233,000 | |
| | | 1,652,000 | |
Pursuant to employment agreements with certain officers of the Company, which expire between May 31, 2007 and July 31, 2011, the Company is obligated to pay the full term of contract in the event of the officers’ early termination. As at December 31, 2006, the compensation obligation payable over the next four years amounts to $3,944,913 (2005 - $5,308,806).
In connection with the Company’s West Lorne project upgrade and construction advances related to the 200TPD plants (see note 6), the Company has outstanding construction commitments of approximately $8.2 million.
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
16. COMMITMENTS AND CONTINGENCIES (cont’d)
Contingencies
In the ordinary course of business activities, the Company may be contingently liable for litigation and claims with customers, suppliers and former employees. Management believes that adequate provisions have been recorded in the accounts where required. Although it is not possible to estimate the extent of potential costs and losses, if any, management believes that the ultimate resolution of such contingencies will not have a material adverse effect on the consolidated financial position of the Company.
17. RELATED PARTY TRANSACTIONS
The transactions with related parties are in the normal course of operations and are recorded at amounts established and agreed between the related parties. In addition to the transactions described in note 15, the Company had the following transactions with related parties:
| [a] | Consulting fees and salaries of $1,763,575 for the year ended December 31, 2006 [2005 - $1,940,421; 2004 - $3,053,332] have been paid to Directors (or companies controlled by Directors) of the Company. Included in the amount above, is $543,122 [2005 - $974,392; 2004 - $2,288,556] paid by stock based compensation [note 15(b)(i)]. |
| | |
| [b] | Consulting fees and share issue costs of $nil for the year ended December 31, 2006 [years 2005 - $87,395; 2004 - $574,326] have been paid to a shareholder of the Company. Included in the amount above, is $nil [2005 - $1,113; 2004 - $513,958] paid by stock based compensation [note 15(b)(i)]. |
| | |
| [c] | As at December 31, 2006, $nil [2005 - $82,529; 2004 - $136,370] was advanced to a Director of the Company in connection with the formation of a joint venture for the development of the Company’s BioOil technology and related products. The joint venture had not been formalized and the advance was written-off on December 31, 2005. |
| | |
| [d] | The amounts due from/to related parties, which are non-interest bearing, unsecured and due on demand, are comprised of the following: |
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| Receivable | | | | | | |
| Due from directors and officers | | 5,925 | | | 11,926 | |
| | | | | | | |
| Payable | | | | | | |
| Due to directors and officers | | 1,218,932 | | | 1,005,447 | |
91
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
18. LOSSES AND UNUSED DEDUCTIONS CARRIED FORWARD FOR INCOME TAX PURPOSES
As at December 31, 2006, the Company has loss carryforwards of approximately $44,369,000 to apply against future taxable income in Canada ($40,711,000) and the United Kingdom ($3,658,000) and $1,121,000 and $494,000 of federal and provincial investment tax credits respectively available for future use in Canada. The United Kingdom loss carryforwards can be carried forward indefinitely. The Canadian losses and investment tax credits expire as follows:
| | | Federal Investment | | | Provincial Investment | | | Loss | |
| | | Tax Credits | | | Tax Credits | | | Carryforwards | |
| | | $ | | | $ | | | $ | |
| | | | | | | | | | |
| 2007 | | 115,000 | | | — | | | 4,744,000 | |
| 2008 | | 25,000 | | | — | | | 5,386,000 | |
| 2009 | | 49,000 | | | 8,000 | | | 3,974,000 | |
| 2010 | | 167,000 | | | 94,000 | | | 4,614,000 | |
| 2011 | | 197,000 | | | 109,000 | | | — | |
| 2012 | | 54,000 | | | 30,000 | | | — | |
| 2013 | | 58,000 | | | 32,000 | | | 4,352,000 | |
| 2014 | | 456,000 | | | 221,000 | | | 8,506,000 | |
| 2026 | | — | | | — | | | 9,135,000 | |
| | | 1,121,000 | | | 494,000 | | | 40,711,000 | |
In addition, the Company has scientific research and experimental development expenditures of approximately $5,892,000 [2005 - $4,898,600] that can be carried forward indefinitely to apply against future taxable income in Canada.
Future income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has recognized a valuation allowance for those future tax assets for which it is more likely than not that realization will not occur. Significant components of the Company’s future tax assets as of December 31, 2006 and December 31, 2005 are as follows:
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| | | | | | | |
| Loss carryforwards | | 16,053,000 | | | 13,594,000 | |
| Research and development deductions and credits | | 3,160,000 | | | 2,018,000 | |
| Property, plant and equipment | | 1,492,000 | | | 1,069,000 | |
| Financing costs | | 896,000 | | | 655,000 | |
| Total future tax assets | | 21,601,000 | | | 17,336,000 | |
| Valuation allowance | | (21,601,000 | ) | | (17,336,000 | ) |
| Net future tax assets | | — | | | — | |
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
18. LOSSES AND UNUSED DEDUCTIONS CARRIED FORWARD FOR INCOME TAX PURPOSES (cont’d.)
The tax benefit of net operating losses carried forward and the associated valuation allowance were reduced by $986,000 (2005 - $1,044,000), representing the tax effect of losses which expired during the year.
The potential income tax benefits relating to these future tax assets have not been recognized in the consolidated financial statements as their realization did not meet the requirements of “more likely than not” under the asset and liability method of tax allocation. Accordingly, no future tax assets have been recognized as at December 31, 2006 and 2005 and no income tax provision or benefit has been provided for any of the periods presented. Had a tax benefit been provided, the Company’s expected effective tax rate for the reversal of the tax benefit would be 34.18%, 34.12% and 35.62% in 2006, 2005 and 2004, respectively.
The Company’s future tax assets include approximately $896,000 [2005 - $426,000] related to deductions for share issuance costs, in excess of amounts deducted for financial reporting purposes. If and when the valuation allowance related to these amounts is reversed, the Company will recognize this benefit as an adjustment to share capital as opposed to income tax expense in the Consolidated Statement of Loss.
19. SUPPLEMENTAL CASH FLOW INFORMATION
| | | 2006 | | | 2005 | | | 2004 | |
| Net change in non-cash working capital | | $ | | | $ | | | $ | |
| | | | | | | | | | |
| Receivables | | (442,216 | ) | | 153,693 | | | (90,890 | ) |
| Prepaid expenses and deposits | | (237,452 | ) | | (49,305 | ) | | (96,852 | ) |
| Accounts payable and accrued liabilities | | (12,244 | ) | | 29,445 | | | 2,274,898 | |
| Deferred revenue | | 520,000 | | | — | | | — | |
| | | (171,912 | ) | | 133,833 | | | 2,087,156 | |
| | | | | | | | | | |
| Interest paid | | | | | | | | | |
| Short-term interest paid | | 174,257 | | | 131,971 | | | 26,000 | |
For stock based non-cash investing and financing activities, see note 15(i).
93
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
20. GOVERNMENT ASSISTANCE
Government assistance received during the year ended December 31, 2006 in the amount of $1,559,085 [2005 - $1,664,640; 2004 - $3,611,412] has been recorded as a reduction of expenditures.
| Government assistance applied to: | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| | | | | | | | | | |
| Property, plant and equipment and other | | 1,331,964 | | | 853,673 | | | 2,829,117 | |
| Research and development | | 227,121 | | | 782,423 | | | 765,106 | |
| Other expenses | | — | | | 28,544 | | | 17,189 | |
| Total | | 1,559,085 | | | 1,664,640 | | | 3,611,412 | |
| [a] | Technology Partnerships Canada |
| | |
| During 1997, the Company entered into a contribution agreement with Industry Canada- Technology Partnerships Canada (TPC) whereby the Company is entitled to receive a maximum of approximately $7 million (Cdn$ 8.2 million) or 37% of eligible expenditures, as defined in the agreement. The agreement, as amended, specifies that in the event commercial viability is achieved, then the assistance is repayable, commencing January 1, 2005 based on royalties from sales of specified products resulting from the project to a maximum of $13.7 million (Cdn$16 million) or until the expiration of contract on December 31, 2014. As at December 31, 2006, the Company has received $6.0 million (Cdn$7.0 million) under these agreements. In 2006, the Company received $640,852 [2005 - $1,007,318; 2004 - $800,000] from TPC. As at December 31, 2006, $1,087,910 [2005 - $627,582; 2004 - $236,548] is included in government grants receivable. As the Company has not achieved commercial viability and no revenue has been recorded from the project, no repayment has been made and no amount accrued for TPC assistance as at year end. |
| | |
| [b] | Sustainable Development Technology Canada |
| | |
| On March 5, 2004 the Company signed a Contribution Agreement with Sustainable Development Technology Canada (“SDTC”) whereby SDTC will contribute $4.3 million (Cdn$5 million) to the capital cost of the Company’s West Lorne 100 tonne per day BioOil co-generation project development. This amount is a grant and is accounted for as a reduction in the capital cost of the project. During 2006, the Company received payment of $428,669 (Cdn$ 500,000) [2005 - $657,322 (Cdn$ 796,478); 2004 - $3,056,468 (Cdn$3,703,522)] from SDTC. |
94
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
21. RESEARCH AND DEVELOPMENT
The breakdown of the research and development is as follows:
| | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| Research & development expenditures | | 4,629,465 | | | 3,586,855 | | | 3,670,936 | |
| Less: government assistance | | (227,121 | ) | | (782,423 | ) | | (765,106 | ) |
| Less: Product sales - BioOil | | (123,594 | ) | | — | | | — | |
| Less: Product sales - Electricity | | (30,966 | ) | | — | | | — | |
| Total | | 4,247,784 | | | 2,804,432 | | | 2,905,830 | |
22. SEGMENTED INFORMATION
In 2006 the Company has one reportable segment, BioOil Power Generation. The BioOil Power Generation segment relates to the biomass-to-energy technology. Substantially all of the Company’s operations and assets are in Canada and are solely focused on the development and commercialization of its technology. BioOil Power Generation is biomass-to-energy technology that converts low value forest residues and agricultural by-products into BioOil for use in power generation or other industrial energy purposes.
For the years ended December 31, 2006, 2005 and 2004 the Company recorded no revenue.
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
The Company prepares its consolidated financial statements in accordance with Canadian generally accepted accounting principles (“Canadian GAAP”), which conform in all material respects to those in the United States (“U.S. GAAP”), except as follows:
| [i] | Under U.S. GAAP, the excess, if any, between the fair value of the shares in escrow and the carrying value, will be recorded as compensation expense upon release from escrow. Under Canadian GAAP, shares released from escrow do not give rise to compensation expense. |
| | |
| [ii] | Under Canadian GAAP, prior to the accounting change in 2004 the Company accounted for all stock-based compensation issued on or after January 1, 2002 to non-employees using the fair value based method and recognized no compensation expense for stock-based awards to employees. The effect of retroactively applying, without restatement, the fair value based method of stock-based compensation to options granted to employees rather than the previously noted intrinsic method was to increase the deficit as at January 1, 2004 by $797,602 with the corresponding increase to contributed surplus. |
95
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (CONT’D)
| Beginning January 1, 2006, the Company adopted the recommendations of the Statement of Financial Accounting Standards No. 123R, “Accounting for Stock-based Compensation” (“SFAS 123R”), and has applied the recommendations of this standard using the modified prospective method. Under this application, the Company is required to record compensation expense for all awards granted or modified after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Accordingly, no prior periods were restated or cumulative adjustments recorded upon the adoption of this standard. |
| | |
| Prior to the adoption of SFAS 123R, the Company accounted for stock-based compensation plans under the intrinsic value method of accounting as defined by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and applied the disclosure provisions of Statement No. 123, “Accounting for Stock-based Compensation”, as amended. |
| | |
| For years ending prior to December 31, 2006, if the exercise price of an employee stock option award is not fixed in the functional currency of the Company or in the currency the employee is paid, the award is accounted for as a variable award until the award is exercised, forfeited, or expires unexercised. The Company measures compensation as the amount by which the quoted market value of the common shares of the Company’s stock covered by the grant exceeds the option price, compensation arising from changes in the market price are included in the measurement of loss. |
| | |
| [iii] | Under US GAAP, the conversion feature of the convertible debt issued by the Company meets the criteria to be classified as equity. As a result, the Company follows Emerging Issue Task Force (“EITF”) No. 00-27 and records the proceeds of the convertible debts based on the relative fair value of the convertible debt, the contingent warrants issuable upon conversion and any detachable warrants. In accordance with Issue 15 of EITF 00-27, at the time of conversion, the contingent warrants that were issued upon conversion of the convertible debenture should be recognized. As a result of the difference in the calculation of relative fair value for the allocation of proceeds under Canadian and US GAAP, the carrying value of the convertible debt liability under US GAAP should be increased by $56,077 with a corresponding decrease in shareholders’ equity. Additional interest expense as a result of recognition of contingent warrants less the effect of the reduction of accretion of interest was adjusted to the Consolidated Statements of Loss under US GAAP. In addition, in accordance with Issue 10 of EITF 00-27, the commitment date of the convertible instruments related to the paid-in-kind (PIK) accrued interest should be the date the interest was accrued. As a result, an additional beneficial conversion feature (“BCF”) was calculated on these convertible instruments issued for PIK accrued interest on the convertible debentures that were outstanding as at December 31, 2005, amounting to $14,490 for the year ended December 31, 2005. No accretion on this additional BCF was included in the net |
96
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (CONT’D)
| loss for US GAAP purposes as it is immaterial given the short time period that the convertible debentures were outstanding. Additional BCF on the convertible instruments related to the PIK accrued interest for the convertible debentures that were converted during the fiscal year 2005 was calculated as $27,943. The full amount was charged to interest expense upon the conversion of the debentures. |
| | |
| During the year ended December 31, 2006, the Company settled the remaining convertible debentures as described in note 11. As a result, the Company accreted the remaining debt discount, which under US GAAP, resulted in an additional accretion expense of $81,560, which includes the recognition of the contingent warrants issuable upon conversion of the debenture. The Company has determined there was no additional BCF on the convertible instruments related to the PIK accrued interest for the convertible debentures that were converted during the fiscal year 2006. |
| | |
| [iv] | Under Canadian GAAP, the Company can capitalize start-up or pre-operating costs until commercial production is established. Under US GAAP, any pre-operating costs or deferred expenses related to start-up operations are expensed as incurred. For the year ended December 31, 2006, this difference resulted in write-off of $100,637 (2005 - $nil; 2004 - $nil) under US GAAP. |
| | |
| [v] | For U.S. GAAP purposes, the Company presents the disclosure requirements of Financial Accounting Standard No. 130 (“SFAS 130”) in these consolidated financial statements. SFAS 130 requires the presentation of comprehensive income and its components. Comprehensive income includes all changes in equity during a period except shareholder transactions. Other accumulated comprehensive income comprises only the cumulative translation adjustment. |
| | |
| [vi] | New Accounting Pronouncements |
| | |
| SFAS No. 155 |
| | |
| In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statements No. 133 and 140”. Among other things, SFAS No. 155 permits the election of fair value re-measurement for certain hybrid financial instruments that would otherwise require bifurcation under Statement 133, Accounting for Derivative Instruments and Hedging Activities. These hybrid financial instruments would include both assets and liabilities. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. The Company is currently evaluating the impact of the provisions of SFAS 155. |
97
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (CONT’D)
SFAS No. 154
In June 2005, the FASB issued Statement of Financial Accounting Standard No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements” (“SFAS 154”). The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS 154 requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. Opinion 20 previously required that such a change be reported as a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company has determined the adoption of this pronouncement did not have a material impact on the Company’s financial statements.
SFAS No. 157
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of FAS 157 are effective fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of the provisions of SFAS No. 157.
FIN 48
In June 2006, FASB issued interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (FAS No. 109)” (“FIN 48”). This interpretation prescribes a recognition threshold and measurement attribute for tax positions taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with this interpretation is a two-step process. In the first step, recognition, the Company determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step addresses measurement of a tax position that meets the more-likely-than-not criteria. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in a) an increase in a liability for income taxes
98
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (CONT’D)
payable or a reduction of an income tax refund receivable, b) a reduction in a deferred tax asset or an increase in a deferred tax liability or c) both a and b. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be de-recognized in the first subsequent financial reporting period in which that threshold is no longer met. Use of a valuation allowance as described in FAS No. 109 is not an appropriate substitute for the de-recognition of a tax position. The requirement to assess the need for a valuation allowance for deferred tax assets based on sufficiency of future taxable income is unchanged by this interpretation. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact FIN 48 will have on the Company’s consolidated balance sheet and statement of operations.
SAB 108
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108 requires companies to evaluate the materiality of identified unadjusted errors on each financial statement and related financial statement disclosure using both the rollover approach and the iron curtain approach. The rollover approach quantifies misstatements based on the amount of the error in the current year financial statements whereas the iron curtain approach quantifies misstatements based on the effects of correcting the misstatement existing in the balance sheet at the end of the current year, irrespective of the misstatement’s year(s) of origin. Financial statements would require adjustment when either approach results in quantifying a misstatement that is material. Correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended. SAB 108 is effective for fiscal years ending after November 15, 2006 (the Company's fiscal year ending December 31, 2006). The Company has determined that SAB 108 did not have a material impact on its consolidated financial statements.
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| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (CONT”D)
If US GAAP were followed, the significant variations on the consolidated statements of loss and comprehensive loss would be as summarized in the table below.
| | | 2006 | | | 2005 | | | 2004 | |
| | | $ | | | $ | | | $ | |
| | | | | | | | | | |
| Loss for the year, Canadian GAAP | | (14,252,382 | ) | | (11,997,344 | ) | | (9,916,215 | ) |
| Adjustment for release of escrow shares (i) | | (235,068 | ) | | — | | | — | |
| Adjustment for stock based compensation (ii) | | — | | | (934,131 | ) | | 1,511,031 | |
| Adjustment to accretion of interest expense (iii) | | (81,560 | ) | | (193,249 | ) | | — | |
| Adjustment for other assets (iv) | | (100,637 | ) | | — | | | — | |
| Loss for the year, US GAAP | | (14,669,647 | ) | | (13,124,724 | ) | | (8,405,184 | ) |
| | | | | | | | | | |
| Unrealized gain/(losses) on foreign currency | | | | | | | | | |
| translation | | (354,810 | ) | | 219,713 | | | 35,733 | |
| Comprehensive loss for the year, US GAAP | | (15,024,457 | ) | | (12,905,011 | ) | | (8,369,451 | ) |
| | | | | | | | | | |
| Weighted average number of common shares | | | | | | | | | |
| outstanding | | 153,685,553 | | | 108,009,185 | | | 80,979,299 | |
| | | | | | | | | | |
| Basic and diluted loss per common share, U.S. | | | | | | | | | |
| GAAP | | (0.10 | ) | | (0.12 | ) | | (0.10 | ) |
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| Total assets, Canadian GAAP | | 38,093,699 | | | 16,962,573 | |
| Adjustment for other assets (iv) | | (100,637 | ) | | — | |
| | | | | | | |
| Total assets, US GAAP | | 37,993,062 | | | 16,962,573 | |
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| Total liabilities, Canadian GAAP | | 6,958,287 | | | 8,670,165 | |
| Adjustment for allocation of proceeds of convertible debt (iii) | | — | | | 41,587 | |
| Adjustment for accretion of interest expense (iii) | | — | | | (18,775 | ) |
| | | | | | | |
| Total liabilities, US GAAP | | 6,958,287 | | | 8,692,977 | |
100
| Dynamotive Energy Systems Corporation |
| |
| NOTES TO CONSOLIDATED |
| FINANCIAL STATEMENTS |
| |
| December 31, 2006 | (expressed in U.S. dollars) |
23. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (CONT’D)
| | | 2006 | | | 2005 | |
| | | $ | | | $ | |
| Total shareholders’ equity, Canadian GAAP | | 29,780,489 | | | 8,292,408 | |
| Adjustment for allocation of proceeds of convertible debt (iv) | | (100,637 | ) | | — | |
| Adjustment for allocation of proceeds of convertible debt (iii) | | — | | | (41,587 | ) |
| Adjustment for accretion of interest expense (iii) | | — | | | 18,775 | |
| | | | | | | |
| Total shareholders’ equity, US GAAP | | 29,679,852 | | | 8,269,596 | |
The non-controlling interest, and cash flows under accounting principles generally accepted in Canada are the same as the non-controlling interest, and cash flows under the accounting principles generally accepted in the United States.
24. SUBSEQUENT EVENTS
| a) | Subsequent to the year end, during the period from January 1 to April 17, 2007, the Company issued 2,280,259 common shares for total proceeds of $2,480,900, relating to a private placement commencing during the first quarter of 2007. In addition during the period from January 1 to April 17, 2007, the Company received $4,373,000 on the exercise of 744,166 options and 6,851,049 warrants. |
| | |
| b) | On April 5, 2007 the Company entered into certain amended agreements with Erie Flooring and Wood Products (“Erie”) regarding the supply by Erie of wood to the West Lorne BioOil plant over the next 12 years at no charge and the provision of char from the BioOil plant to Erie at no charge. In relation to these agreements, Dynamotive agreed to pay for the purchase and installation of a char based boiler system and related char delivery infrastructure. The terms include an immediate payment of $500,000 to Erie and a further $359,000 to Erie in equal monthly payments plus 8% interest, over the next 10 years for the purchase of the boiler. |
25. COMPARATIVE FIGURES
Certain comparative figures have been reclassified in order to conform with the presentation adopted in the current year.
101
Item 18. Financial Statements
Not applicable.
Item 19. Exhibits
| Exhibit | Exhibit Description |
| | |
| 1.1 | Memorandum of Dynamotive Technologies Corporation, as amended to August 15, 2000 (filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB filed on August 15, 2000 and incorporated herein by reference.) |
| | |
| 1.2 | Amendment to the Memorandum of Dynamotive Energy Systems Corporation, dated July 3, 2001 (filed as Exhibit 3.1(b) to the Company’s Quarterly Report on Form 10-Q filed on August 14, 2001 and incorporated herein by reference.) |
| | |
| 1.3 | Articles of Dynamotive Technologies Corporation, as amended to date (filed as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-QSB filed on August 15, 2000 and incorporated herein by reference.) |
| | |
| 1.4 | Notice of Alteration to the authorized share structure of the Company as filed with the British Columbia Corporate and Personal Property Registries on October 28, 2004 (filed as an exhibit to the Company’s Form 20-F filed on May 30, 2005 and incorporated herein by reference) |
| | |
| 1.5 | Notice of Alteration to the Articles of the Company as filed with the British Columbia Corporate and Personal Property Registries on November 24, 2005 (filed as an exhibit to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 1.6 | Copy of the Limited partnership Agreement establishing the West Lorne BioOil Co-Generation LP referred to the Consortium Master Agreement filed under 4.6 below |
| | |
| 4.1 | Sustainable Development Technology Canada Contribution Agreement dated as of March 5, 2004 (filed as an exhibit to the Company’s Form 20-F filed on June 1, 2004 and incorporated herein by reference) |
| | |
| 4.2 | Modification No. M1 to the Sustainable Development Technology Canada Contribution Agreement dated as of April 6, 2004 (filed as an exhibit to the Company’s Form 20-F filed on June 1, 2004 and incorporated herein by reference) |
| | |
| 4.3 | Loan Agreement between Memorial Gift Trust, James Acheson and the Company dated June 3, 2003 (filed as an exhibit to the Company’s Form 20-F filed on June 1, 2004 and incorporated herein by reference) |
| | |
| 4.4 | Technology Partnerships Canada Agreement dated July 29, 1997 including amendments dated February 2, 1998 to August 29, 2003 (filed as an exhibit to the Company’s Form 20-F filed on June 1, 2004 and incorporated herein by reference) |
102
| Exhibit | Exhibit Description |
| | |
| 4.5 | Amendment to the Technology Partnerships Canada Agreement dated November 23, 2004 (filed as an exhibit to the Company’s Form 20-F filed on May 30, 2005 and incorporated herein by reference) |
| | |
| 4.6 | Consortium Master Agreement dated February 11, 2004 (filed as an exhibit to the Company’s Form 20-F filed on May 30, 2005 and incorporated herein by reference) |
| | |
| 4.7 | Alliance Agreement with UMA Engineering Ltd. dated January 29, 2004 (filed as an exhibit to the Company’s Form 20-F filed on May 30, 2005 and incorporated herein by reference) |
| | |
| 4.8 | Loan Agreement between Environmental Engineering & Consultants Limited and the Company dated November 3, 2004 (filed as an exhibit to the Company’s Form 20-F filed on May 30, 2005 and incorporated herein by reference) |
| | |
| 4.9 | Settlement Agreement between Magellan Aerospace Limited, West Lorne BioOil Co-Generation LP and the Company dated December 10, 2004 (filed as an exhibit to the Company’s Form 20-F filed on May 30, 2005 and incorporated herein by reference) |
| | |
| 4.10 | Convertible Note Agreement between Paul Hughes, COO and the Company dated May 31, 2005 (filed as an exhibit to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 4.11 | Executive Services Agreement with Andrew Kingston dated August 1, 2004 and Amended Executive Services Agreement with Andrew Kingston dated September 29, 2004 (filed as an exhibit to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 4.12 | Executive Services Agreement with Richard Lin dated August 1, 2004 and Amended Executive Services Agreement with Richard Lin dated September 29, 2004 (filed as an exhibit to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 4.13 | Executive Services Agreement with Brian Richardson dated October 1, 2005 (filed as an exhibit to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 4.14 | Executive Services Agreement with Jan Barynin dated May 17, 2004 (filed as an exhibit to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 4.15 | Shareholder Agreement with Pendana Limited BVI and Dynamotive Biomass Resource Corporation dated September 22, 2006* |
| | |
| 4.16 | Joint Venture Agreement with Pendana Limited BVI and Dynamotive Europe Limited dated September 22, 2006* |
103
| Exhibit | Exhibit Description |
| | |
| 4.17 | Consulting Agreement with Desmond Radlein, Ph. D dated December 8, 2006* |
| | |
| 4.18 | Executive Services Agreement with Anton Kuipers dated January 16, 2007* |
| | |
| 4.19 | Loan Agreement with Dynamotive Biomass Resource Corporation dated September 30, 2006* |
| | |
| 4.20 | Loan Agreement with Dynamotive Europe Limited dated September 30, 2006* |
| | |
| 4.21 | Umberlla Amending Agreement by and amongst Erie Flooring & Wood Products and West Lorne BioOil Co-generation LP and Dynamotive Energy Systems Corporation dated April 5, 2007* |
| | |
| 4.22 | Engineering, and Construction Management Agreements with Tecna S.A. dated July 7, 2006* |
| | |
| 4.23 | DT2 Engineering, Development Agreements with Tecna S.A. dated July 7, 2006* |
| | |
| 4.24 | Escrow Agreement, dated January 10, 1995, by and among the Company, Montreal Trust Company of Canada and the holders of the 3,140,900 escrowed shares (filed as Exhibit 10.21 to the Company’s Registration Statement on Form SB-2, Registration No. 33-98622, and incorporated herein by reference.) |
| | |
| 4.25 | February 9, 2000 Agreement to Purchase Patents and Rights between Dynamotive Technologies Corporation and RTI Resource Transforms International, Ltd., (filed as Exhibit 10.28 to the Company’s Form 10- QSB filed on May 15, 2000, and incorporated herein by reference.) |
| | |
| 4.26 | Heads of Agreement with Consensus Business Group and Joint Venture Proposal for Consensus Business Group dated February 20, 2006 (filed as Exhibit 10.29 to the Company’s Form 20-F filed on June 29, 2006 and incorporated herein by reference) |
| | |
| 12.1 | Certification of chief executive officer |
| | |
| 12.2 | Certification of chief financial officer |
| | |
| 13.1 | Certification of chief executive officer – Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
| 13.2 | Certification of chief financial officer – Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
| 15.1 | Audit Committee Charter* |
*Filed as an exhibit to this Annual Report on Form 20-F for the period ended December 31, 2006.
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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
| | Dynamotive Energy Systems Corporation |
| | | |
| Date: June 27, 2007 | | |
| By: | /s/ R. Andrew Kingston |
| | | R. Andrew Kingston |
| | | President and Chief Executive Officer |
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