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 ended December 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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
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:
Title of Each Class Outstanding at December 31, 2004
Common Shares Without Par Value 93,129,798
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[ ]
1
Indicate by check mark which financial statement item the registrant has
elected to follow. Item 17 [X] Item 18 [ ]
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING
THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed 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 [ ] Not
applicable [X]
This report contains statements of a forward-looking nature relating to
future events or our future performance. These statements are only
predictions and actual events or results may differ materially. In
evaluating such statements, you should carefully consider the various
factors identified in this report which could cause actual results to
differ materially from those expressed in or implied by, any forward-
looking statements, including those set forth in "Risk Factors" See
"Cautionary Note Regarding Forward-Looking Statements".
2
TABLE OF CONTENTS
Page
PART I 4
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 4
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 4
ITEM 3. KEY INFORMATION 4
ITEM 4. INFORMATION ON THE COMPANY 8
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 17
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 26
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 33
ITEM 8. FINANCIAL INFORMATION 34
ITEM 9. THE OFFER AND LISTING 35
ITEM 10. ADDITIONAL INFORMATION 36
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 46
PART II 48
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 48
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHT OF SECURITY HOLDERS
AND USE OF PROCEEDS 48
ITEM 15. CONTROLS AND PROCEDURES 48
ITEM 16. [RESERVED] 49
PART III 50
ITEM 17. FINANCIAL STATEMENTS 50
ITEM 18. FINANCIAL STATEMENTS 95
ITEM 19. EXHIBITS 95
3
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 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
2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------
(US Dollars)
Results of operations:
Revenue -- -- 68,569 274,360 907,744
Loss from operations (9,917,889)(4,995,624)(3,733,499)(5,798,827)(4,863,482)
Loss from continuing
operations (9,916,215)(4,921,650)(4,366,454)(6,437,461)(4,756,873)
Net loss per Cdn GAAP (9,916,215)(4,984,681)(5,261,607)(6,838,264)(4,756,873)
Net loss per US GAAP (8,405,184)(4,984,681)(5,264,469)(6,602,892)(6,103,362)
Net loss per share Cdn GAAP (0.12) (0.09) (0.12) (0.19) (0.15)
Net loss per share US GAAP (0.10) (0.09) (0.12) (0.18) (0.12)
Net loss from continuing
operation per share (0.12) (0.09) (0.10) (0.18) (0.15)
Financial position at year-end:
Total assets, Cdn GAAP 13,198,698 3,759,605 1,285,813 6,454,399 4,469,120
US GAAP 13,198,698 3,759,605 1,285,813 6,457,263 4,390,740
Total liabilities, Cdn GAAP 8,911,500 2,035,168 1,957,625 5,179,271 898,374
US GAAP 8,911,500 2,035,168 1,957,625 5,179,271 898,374
Shareholder's equity,
Cdn GAAP 4,287,198 1,724,437 (671,812) 1,275,128 3,570,746
Shareholder's equity,
US GAAP 4,287,198 1,724,437 (671,812) 1,277,992 3,492,366
Common shares issued 93,129,798 69,915,654 49,941,000 40,942,115 35,851,060
During 2004, significant impacts to results of operations and financial
condition and comparability of results of operations and financial
condition in 2004 versus 2003 occurred principally due to the
commencement of construction of the Company's 100tpd commercial
scale plant in West Lorne, Ontario. The Company is now solely
focused on BioOil related activities.
4
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. This Risk Factors section
is written in accordance with U.S. Securities and Exchange Commission's
"plain English" guidelines. In this section, the words "we," "us,"
"our" and "ours" refer only to the Company and its subsidiaries and not
any other person.
RISKS RELATED TO OUR OPERATIONS
WE HAVE INCURRED NET LOSSES SINCE COMMENCING BUSINESS AND EXPECT FUTURE
LOSSES
We have had limited revenues to date and have not shown a profit since
inception. The Company had a net loss of $9,916,215 for the year ended
December 31, 2004 as well as a net loss of $4,984,681 for the year
ended December 31, 2003. As at December 31, 2004, the Company has a
working capital deficit of $7,062,062. 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
2005. We do not expect revenues to increase 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 Company is in the process of raising additional capital financing
in order to continue its operations, fund its research and development
activities, and ensure orderly realization of its assets and
liabilities. While the Company is expending its best efforts to
achieve the above plans, there is no assurance that any such activity
will generate sufficient funds for operations.
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 likely
have to obtain additional capital either through debt or equity
financing to continue our research and development strategies. 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
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.
5
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
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 TECHNOLOGY HAS NOT YET BEEN COMMERCIALIZED
To date, our technology has been tested only at a pre-commercial scale.
Full commercialization may expose operational flaws and unanticipated
costs that may inhibit market acceptance.
OUR MARKET IS VERY COMPETITIVE
The markets for our products and technologies are traditionally highly
competitive, and other providers of products and technologies have various
advantages and disadvantages 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. Most 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 and products have gained only limited market acceptance and
have generated no 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
6
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 Chief Technology Officer. 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
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.
RISKS RELATED TO OUR COMMON SHARES
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 exchange.
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 MAY 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.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements, within the meaning of
Section 21E of the Securities Exchange Act of 1934 and Section 27A of the
Securities Act of 1933 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. The forward-looking
statements are subject to significant risks, uncertainties and other
factors including those identified in the "Risk Factors" section of this
Form 20-F, which may cause actual results to differ materially from those
7
expressed in or implied by, these statements. 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.
Item 4. Information On The Company
A. History and development of the Company
DynaMotive Energy Systems Corporation (the "Company" and or "DynaMotive")
is a leader in biomass-to-liquid fuel conversion, a process known as "Fast
Pyrolysis". Its principal business is the development and
commercialisation of its renewable energy process called "Fast Pyrolysis",
which is a fast pyrolysis process that produces liquid BioOil fuel from
biomass or biomass waste feedstocks. BioOil is a clean, renewable fuel
which can replace natural gas, diesel and other fossil fuels to produce
power, mechanical energy and heat in industrial boilers, fuel gas turbines
and fuel reciprocating engines. The Company aims to unleash significant
amounts of energy production, in the form of BioOil fuels, based upon
utilization of abundant 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.
Information for the total revenues by category of activity and geographic
market for each of the last three years is detailed in Note 18 to the
Consolidated Financial Statements.
DynaMotive is attempting to establish its patented technology as the
industry standard for the production of liquid biomass based fuels, in
competition with other pyrolysis technologies, and other biomass to energy
applications. The Company's fast pyrolysis process efficiently converts
raw biomass or biomass wastes 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 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.
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.
As of December 31, 2004 the Company had six wholly-owned subsidiaries plus
99.9% ownership of a limited partnership: DynaMotive Corporation
(incorporated in the State of Rhode Island in 1990), DynaMotive Europe
Limited (formerly known as DynaMotive Technologies (UK) Ltd., incorporated
in the United Kingdom in 1996), and DynaMotive Canada, Inc. (incorporated
in Canada in November 2000), the West Lorne BioOil Co-Generation Limited
Partnership formed under the laws of Ontario, DynaMotive ElectroChem
Corporation (incorporated in the Province of British Columbia in 1993),
DynaMill(TM) Systems Limited (incorporated in the Province of British
Columbia in 1996) and DynaMotive Puerto Rico, Inc. (incorporated in Puerto
Rico in 1997). The latter three are currently inactive. The Company's
wholly-owned subsidiary, DynaMotive Europe Ltd., purchased 75% of the
shares of Border Biofuels Ltd. (BBL), a United Kingdom company, in April,
8
2001. In 2002, BBL became insolvent and the Company treats it as a
discontinued operation.
In this report, unless the context otherwise requires, the terms the
"Company" and "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 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
Financial information concerning the Company's industry segments is
summarized in Note 18 to the Consolidated Financial Statements. 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").
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 licensee's 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 wastes 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 2004 the Company began
construction of its first 100 tpd commercial scale plant, located
adjacent to the Erie Flooring and Wood Products manufacturing plant in
West Lorne, Ontario, Canada. The Company expects to complete
commissioning of the plant and bring the facility into full operation in
Q3 of 2005.
In April 2002, the Company completed the sale of the operating assets of
DynaPower, its metal cleaning subsidiary to former employees to focus
exclusively in the bioenergy field and in the development of BioOil and
derivative products. The Company retains ownership in all of DynaPower's
intellectual property and expects to receive on-going royalties from its
patents. DynaPower produces industrial metal cleaning systems that
eliminate the need for toxic chemicals traditionally used by the wire
manufacturing industry to clean their products. DynaPower systems have
been sold in North and South America, Europe and Asia
I. CORE TECHNOLOGIES
The Company develops and markets the Fast Pyrolysis process which
efficiently converts forest and agricultural biomass waste into BioOil,
char and non-condensable gases. There is zero waste from the process.
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 non-condensable gases
are re-cycled in the Fast Pyrolysis process and provide the majority of
the energy required for the process. DynaMotive aims to position its
technology as the worldwide industry standard for the production of BioOil
clean, renewable fuel.
9
The Company has demonstrated a high level of success from its Fast
Pyrolysis and BioOil commercialisation program in recent years.
DynaMotive has six phases to its commercialisation 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. In 1999, Stone & Webster
Engineering, a major US based power engineering company, completed
technical due diligence and concluded that the process was "reliable and
scaleable."
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. The plant has been built to industrial specifications
complete with a state-of-the-art distributed control system (DCS). The
plant has a production capacity of 6,000 litres of BioOil per day. In
January 2003, DynaMotive completed its pilot plant program having
confirmed the technology's scalability and reliability as well as the
capacity to replicate the technology enhancements achieved. The plant has
exceeded design parameters operating on a continuous basis at 50% above
its nominal design capacity. The Company also announced full focus of its
resources to the construction of a 100 tpd commercial plant in Canada.
Phase 5: Following successful operation of the 10 tpd pilot, DynaMotive
has begun construction of a 100 tpd commercial scale plant, with
commissioning forecast to be completed by Q3 2005. This plant will use the
same design, and will process wood residues to demonstrate continuous 24-
hour production at commercial scale. This project is also intended to
demonstrate continuous operation of end use applications (boilers/kilns
and gas turbines). The principal goal of the commercial scale
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.
Phases 6/7: On completion of the field demonstration stage, DynaMotive and
partners plan to develop multiple commercial plants at the 100-400 tpd
scale. The Company is presently seeking to secure rights to multiple 'high
disposal cost' biomass waste streams around the world, in order to launch
its final 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.
BioOil can also be used as the basis for a range of derivative products
including, but not limited to, blended fuels for transportation, slow
10
release fertilizers and specialty chemicals. The Company continues to
pursue its strategy to secure industrial partners to develop commercial
products from BioOil derivatives, based upon prototypes developed by
DynaMotive allowing the Company to leverage its resources.
By virtue of being derived from biomass waste, 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 diesel fuel, therefore having
significant environmental advantages over fossil fuels with respect to
atmospheric pollution.
1) BIOOIL PRODUCTION PROCESS
BioOil is produced using a patented fast pyrolysis process trade named
Fast Pyrolysis that converts forest and agricultural biomass wastes such
as sawdust, sugar cane bagasse, rice husks and wheat straw amongst others
into commercial fuels (BioOil, char and non-condensable gases). 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.
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
waste. 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
scale-up to commercial plant capacities.
In January 2003, the Company announced that it successfully completed its
pilot plant program confirming the technology's scalability and
reliability as well as the capacity to replicate the technology
enhancements achieved. As a result, the Company closed its test facilities
and consolidated its operations at its corporate headquarters in
11
Vancouver. In 2003 and 2004, the Company focused its resources on
construction of a 100 tpd commercial scale plant in West Lorne,
Ontario and entered into agreements for the development and construction
of the 100tpd pyrolysis reactor for the plant and completed engineering
review of the design with UMA Engineering Ltd.
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. The integrated plant is to utilize wood residue from Erie
flooring's operations and will be 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 is to provide wood residue
for the project and will receive electricity and process heat for its
operations. The project is expected to export green power to Ontario's
grid system beginning in Q3, 2005. The project is expected to be operating
cash flow positive in 2006 and to prove the commercial viability of the
technology.
The Company has entered into lease, wood supply, steam and electricity
supply 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.
Commissioning of the plant is proceeding under the supervision of the
Company.
In June 2003, the Company announced that it was approved to receive a
funding contribution for the Erie Flooring Project from Sustainable
Development Technology Canada (SDTC). On March 5, 2004 the Company signed
the Contribution Agreement with SDTC, confirming their C$5,000,000 (US$
4.1 million) 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"). If the Company sells the project or otherwise
dispose during the Contract Period of assets financed by the SDTC funding,
SDTC may have a claim on a portion of the proceeds proportionate to their
percentage contribution to the asset.
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, Brazil and
European countries, in addition to sugar producing regions in other parts
of 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 pre-commissioned on BioOil in March 2004
and has been installed at the Erie Flooring site. Orenda has also
identified further commercial scale projects for its turbines and
BioOil, in addition to Erie Flooring 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). Customers for
BioOil fuels could potentially include local, regional and international
power generators and electrical utilities (fuel substitution in large
12
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 in 2004.
The Company also continues to work with Cosan Bon Jesus ("Cosan" is
Brazil's largest sugar and ethanol producer) with which the Company signed
a comprehensive Memoranda of Understanding in March 1998. Cosan and
DynaMotive have tested bagasse and optimized technical design for bagasse-
based BioOil pyrolysis plants. The Company is concentrating on optimizing
the design for a bagasse-fed BioOil pyrolysis plant and further validating
applications, fuel quality and chemical composition of BioOil made from
bagasse.
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. Canada's wood waste alone could
potentially be converted to 15 million barrels of BioOil per year and
represents a significant source of raw materials for DynaMotive.
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
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. RTI and other 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. Char
is a granular solid with properties similar to coal. At 23 - 25 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 does not contain any sulfur.
13
A commercial scale BioOil plant processing 400 tpd of wood residue is
expected to produce approximately 26,000 tons per year of char with a
total energy value of 600,000 - 650,000 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.
In 2003, 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 in 2004.
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. In 2003, the Company was approved to
receive a funding contribution for the Erie Flooring Project from
Sustainable Development Technology Canada (SDTC). On March 5, 2004 the
Company signed the Contribution Agreement with SDTC, confirming their
C$5,000,000 (US$ 4.1 million) 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"). If the Company sells the project
or otherwise disposes during the Contract Period of assets financed by the
SDTC funding, SDTC may have a claim on a portion of the proceeds.
In 2003 and 2004, the Company entered into amendments to its Research and
Development Contribution agreement with the Government of Canada through
Technology Partnerships Canada (TPC). In November 2004, the Company
received an extension to its TPC funding agreement to March 31, 2006. The
agreement confirms a maximum reimbursement cap of C$8.235 million (US$6.8
million). The investment will help the Company further its commercial-
scale demonstration programs, as well as continue its research,
development and testing of DynaMotive's fast pyrolysis technology.
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. DynaMotive originally
entered into the Contribution agreement with TPC in 1997 and as at
December 31, 2004, has drawn US$4.8 million to fund pre-commercial Fast
Pyrolysis research and development. The amended agreement modifies and
expands key terms and conditions placed on the Company. The Company is
required to repay these funds from a percentage of future sales up to a
maximum of US$12.4 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.
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.
14
While the Company has intentionally 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.
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
The Company may be subject to material federal, provincial, state or
foreign environmental laws. If full commercial use of BioOil in power
generation, heat and other applications commences, the Company believes
that it may 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 environment. The Company believes that it will be
able to fully comply in all material aspects with all such laws and
regulations to the extent that they be deemed applicable to the Company's
product with only limited resources expected to be required by the Company
in so complying.
The Company believes that the environmental regulations currently imposed
upon the targeted consumers of the Company's primary technologies are
likely to be maintained if not expanded upon for the foreseeable future.
The Company believes that the imposition of such regulations upon these
targeted customers will provide significant assistance to the Company's
ability to sell its products. Any stringent environmental protection laws
enacted in an area in which a targeted customer is located could further
enhance the Company's ability to attract customers to use these products.
15
C. Organizational Structure
(Please refer to PDF file)
As of December 31, 2004, the Company had six wholly-owned subsidiaries
plus 99.9% ownership of a limited partnership: DynaMotive Corporation
(incorporated in the State of Rhode Island in 1990), DynaMotive Europe
Limited (formerly known as DynaMotive Technologies (UK) Ltd., incorporated
in the United Kingdom in 1996), DynaMotive Canada, Inc. (incorporated in
Canada in November 2000), DynaMotive ElectroChem Corporation (incorporated
in the Province of British Columbia in 1993), DynaMill(TM) Systems Limited
(incorporated in the Province of British Columbia in 1996), DynaMotive
Puerto Rico, Inc. (incorporated in Puerto Rico in 1997) and the West Lorne
BioOil Co-Generation Limited Partnership (the "Limited Partnership") which
was formed in Ontario, Canada in September 2003. The latter three
corporations are currently inactive. DynaMotive Canada Inc. acts as the
General Partner of the Limited Partnership, which will develop and operate
the Erie Flooring Project. In April 2001, DynaMotive Europe Ltd.,
purchased 75% of the shares of Border Biofuels Ltd. (BBL), a United
Kingdom company. In December 2002, BBL was placed into liquidation and the
Company now accounts for it as a discontinued operation (see note 4 of the
Company's audited financial statements).
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 June 2004,
are located in a business park complex in Vancouver, BC, Canada with
approximately 8,000 square feet of office space.
Since December 2002, the Company's 10 tpd pilot plant has been in storage
and is intended for use to demonstrate the feasibility of new biomass waste
streams.
The majority of the Company's capital assets consist of capital assets
under construction for the Erie Flooring Project and initial amounts paid
for the 200 tpd plant.
16
Item 5. Operating and Financial Review and Prospects
THE FOREGOING DISCUSSION IN "OPERATING AND FINANCIAL REVIEW AND PROSPECTS"
CONTAINS FORWARD-LOOKING STATEMENTS CONCERNING, AMONG OTHER THINGS, FUTURE
ENERGY PRICES, THE AMOUNT OF SAVINGS DUE TO THE COMPANY'S COST CUTTING
PROGRAM AND THE LEVEL OF FUTURE CAPITAL EXPENDITURES. THESE STATEMENTS
REFLECT MANAGEMENT'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND
FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON MANY
ASSUMPTIONS AND FACTORS INCLUDING COMPETITIVE PRICING FOR PRODUCTS,
COMMODITY PRICES, ECONOMIC CONDITIONS IN COUNTRIES WHERE THE COMPANY DOES
BUSINESS, THE EFFECTS OF CURRENCY FLUCTUATIONS AND THE EFFECTS OF
GOVERNMENT REGULATIONS. ANY CHANGES IN SUCH ASSUMPTIONS OR FACTORS COULD
PRODUCE SIGNIFICANTLY DIFFERENT RESULTS.
OVERVIEW
This section should be read in conjunction with the Company's financial
statements included under Item 17 of this Form 20-F.
In 2004, DynaMotive 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
For the years 2004, 2003 and 2002, the Company had expended on an annual
basis $3,455,511, $969,419 and $453,710 respectively, on research and
development. Of these amounts, $765,106, $456,438 and $288,445
respectively, were reimbursed by government funding. The remainder of the
respective annual expenditures were paid by the Company. The level of
research and development expenditure has increased in the current year 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 2003 and
technical and project related expenditures in 2004. The Company's
agreement with Technology Partnerships Canada pertains to maximum funding
of US$6.8 million (C$8.235 million), of which $4.8 million (C$ 5.7
million) has been received as of year end 2004.
General and administrative salaries and benefits increased to $5,267,756
in 2004 from $2,693,430 in 2003. The increase in 2004 was mainly due to
increased activity in the general and administrative area, an increase in
non-cash compensation and management of the Company's development
activities with its 100 TPD commercial scale plant. Due to the change in
accounting policy for stock option compensation effective January 1, 2004,
pursuant to which, the Company is required to use fair value method of
calculating stock option compensation for all options granted subsequent
to January 1, 2002, modifications on the term of the employee stock
options, stock based compensation expense recognized has increased during
the year. General and administrative salaries and benefits increased to
$2,693,430 in 2003 from $1,483,443 in 2002. The increase in 2003 was
17
mainly due to the higher market price of the company's stock resulting in
higher recorded stock based compensation expenses.
Professional fees increased to $1,010,802 (comprised of legal & accounting
and audit fees of $240,955 and consulting fees of $769,847) in 2004 from
$954,223 (comprised of legal & accounting and audit fees of $297,349 and
consulting fees of $656,874) in 2003. The increase was due mainly to the
increase of hiring external consultants during the year. Professional
fees increased to $954,223 (comprised of legal & accounting and audit fees
of $297,349 and consulting fees of $656,874) in 2003 from $861,199
(comprised of legal & accounting and audit fees of $322,876 and consulting
fees of $538,323) in 2002. The increase was due mainly to the higher
market price of the company's stock resulting in higher recorded stock
based compensation expenses.
Amortization and depreciation increased to $130,912 in 2004 from $125,580
in 2003 due to the replacement of certain computer equipment. Amortization
and depreciation decreased to $125,580 in 2003 from $313,474 in 2002 due
to the write-down of assets in 2002.
Interest and other income decreased to $8,766 in 2004 from $73,974 in 2003
due mainly to decrease of miscellaneous revenue in 2004. Interest and
other income increased to $73,974 in 2003 from $982 in 2002 due mainly to
increase of miscellaneous revenue in 2003.
Interest expense decreased in 2004 to $151,758 from $320,643 in 2003 due
mainly to the repayment of interest bearing debt. Interest expense
increased in 2003 to $320,643 from $123,013 in 2002 due mainly to the
increase in total liabilities and interest accretion on convertible loan.
Marketing expense increased to $283,322 in 2004 from $155,914 in 2003 due
to an increase in business development activities and participation in an
environmental conference during the year. Marketing expense decreased to
$155,914 in 2003 from $183,294 in 2002 due to a reduction in the use of
external assistance.
Office supplies, telephone and insurance increased to $328,286 in 2004
from $300,751 in 2003 due to the increased activities in the general and
administrative area. Office supplies, telephone and insurance increased to
$300,751 in 2003 from $230,808 in 2002 due mainly to the increase of
insurance costs.
Rent for leased premises decreased to $107,804 in 2004 from $109,653 in
2003 due to the change in office and storage space. Rent for leased
premises decreased to $109,653 in 2003 from $515,446 in 2002 due to the
elimination of the pilot plant space and U.K. lease.
Currency exchange gain in 2004 amounted to $53,156 compared to a gain of
$177,551 in 2003 due to the depreciation of the US Dollar. Currency
exchange gain in 2003 amounted to $177,551 compared to a gain of $80,461
in 2002 due to the depreciation of the US Dollar.
No write-down occurred in 2004 and 2003. Loss on the write-down of long-
term assets was decreased to $nil in 2003 from $872,114 in 2002. In 2002,
DynaMill assets in the amount of $46,944 and Wire Die Cleaning assets in
the amount of $31,303 were written off because the Company is focused on
the application of BioOil for energy. The Company wrote-off its 2 TPD
pilot plant of $159,096 as it completed its testing. Amounts related to
the 10 TPD pilot plant assets totaling $237,913 were partially written-
down, as the Company intends to keep the 10 TPD plant for testing and
market development purposes. The 50 TPD UK pilot plant development assets
of $212,749 were written-off due to the Company focusing on the 100 plant
in Canada. Other assets of $65,377 were written off. Patents for DynaPower
of $118,732 were written-down.
Overall capital expenditures, net of government grants and disposal, used
for developing and patenting the Company's technologies increased to
18
$9,106,450 in 2004 from $1,502,100 in 2003. Capital expenditures for the
Fast Pyrolysis technology increased to $8,982,857 in 2004 from $1,497,398
in 2003. The increase in the Fast Pyrolysis capital expenditures in 2004
was due mainly to construction of the 100 tpd industrial plant in Ontario,
Canada and initial payments on the 200 tpd plant to be constructed at a
Canadian site.
Overall capital expenditures, net of government grants and disposal, used
for developing and patenting the Company's technologies increased to
$1,502,100 in 2003 from $183,473 in 2002. Capital expenditures for the
Fast Pyrolysis technology increased to $1,497,398 in 2003 from $182,637 in
2002. The increase in the Fast Pyrolysis capital expenditures in 2003 was
due to commencement of the 100 tpd industrial plant in Ontario, Canada and
initial payments on the 200 tpd plant to be constructed at a Canadian
site.
The Company's total assets increased to $13,198,698 at the end of 2004
from $3,759,605 at the end of 2003, due mainly to the building of the 100
tpd commercial scale plant. Property, plant and equipment increased to
$12,154,153 in 2004 from $2,293,422 in 2003 due to the building of the 100
tpd commercial scale plant. The total liabilities increased to $8,911,500
at the end of 2004 from $2,035,168 at the end of 2003, due mainly to the
increase of long-term debts and accounts payable of the 100 tpd industrial
plant. Current Liabilities increased to $7,843,828 at the end of 2004 from
$2,035,168 at the end of 2003 due almost entirely to an increase in
accounts payable and accrued liabilities of the 100 tpd commercial scale
plant.
During the year ended December 31, 2004, the Company recorded a net
operating loss of $9,916,215, compared to a net operating loss of
$4,984,681 for the year 2003. The increase in operating loss in 2004 as
compared to 2003 was primarily attributable to (i) an increase in general
and administrative salaries and benefits (ii) an increase in marketing
expense, (iii) an increase in professional fees and (iv) an increase in
research and development. The net operating loss in 2004 reflected
professional fees totaling $1,010,802, of which, $235,845 was non-cash
amounts paid in shares. The non-cash professional fees in 2003 were
$655,416. During the year ended December 31, 2003, the Company recorded a
net operating loss of $4,984,681, compared to a net operating loss of
$5,261,607 for the year 2002. The decrease in operating loss in 2003 as
compared to 2002 was primarily attributable to (i) a decrease in
amortization and depreciation, (ii) a decrease in rent, (iii) a decrease
in loss on write-down of long-term assets, and (iv) a decrease in loss
from discontinued operations.
The basic and diluted loss per common share increased to twelve cents
($0.12) for the year 2004 from nine cents ($0.09) for the year 2003. The
loss per common share for the year 2002 was twelve cents ($0.12). The
increase in basic and diluted loss per share for 2004 and 2003 was due to
both the increase in the loss for each year and the increase in the
weighted average number of Common Shares outstanding from 45,104,978
shares in 2002 to in 56,617,490 in 2003 and 80,979,299 in 2004.
B. LIQUIDITY AND CAPITAL RESOURCES
Principal sources of liquidity during the year ended December 31, 2004
were (i) $4,857,699 in net proceeds ($5,242,734 gross) 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.
For the previous year ended December 31, 2003 the principal sources of
liquidity were (i) $2,321,852 in net proceeds ($2,413,473 gross) after
deducting related issue costs and expenses from private placement
offerings of the Company's Common Shares and the exercise of Common Share
19
options for cash, (ii) $1,476,012 in deposits for Common Shares to be
issued in 2004 pursuant to private placement offerings commenced in 2003,
and (iii) $154,488 in project deposit received. For the previous year
ended December 31, 2002, the principal sources of liquidity were (i)
$1,545,400 in net proceeds ($1,546,036 gross) 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)
$352,376 in deposits for Common Shares to be issued in 2003 pursuant to
private placement offerings commenced in 2002 and (iii) convertible loans
from the existing shareholders in the amount of $263,416, and (iv)
$196,596 from short-term bank indebtedness.
Overall cash flows decreased during 2004 as there were significant
increased activities in 2004 as a result of the construction and
development of the West Lorne Project. During the year ended December 31,
2004, the Company used cash in investing activities of $5,824,645, and
used cash in operating activities of $2,883,735 and generated cash from
financing activities of $8,693,057.
During the previous year ended December 31, 2003, the Company used cash in
operating activities and in investing activities of $2,169,755 and
$530,209 respectively, and generated cash from financing activities of
$3,221,353. During the previous year ended December 31, 2002, the Company
used cash in operating activities and in investing activities of
$2,187,480 and $64,902 respectively, and generated cash from financing
activities of $2,197,472.
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, $4,827,804,
and (iv) net change in non-cash working capital balances related to
operations of $2,087,156.
The net amount of cash used in operating activities during 2003 increased
by 1% of cash used in operating activities during 2002. Cash generated in
operating activities consisted primarily of a net loss for 2003 of
$4,984,681 that was offset by (i) amortization of non-cash items in the
sum of $125,580, (ii) non-cash equity compensation expenses, $2,427,857,
(iii) accretion of interest on convertible debt of $239,245 and (iv) net
change in non-cash working capital balances related to operations of
$199,795.
Financing activities during 2004 generated a net increase in cash of
$8,693,057, primarily from the Company's private placements of Common
Shares. Financing activities during 2003 generated a net increase in cash
of $3,221,353, primarily from the Company's private placements of Common
Shares
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. Investing activities in 2003 resulted in use of cash,
net of grants and disposal, in the amount of $530,209 that consisted of
$491,057 that was incurred in the acquisition of capital assets, $6,479
was expended on patents and $32,673 expended other long-term assets.
Investing activities in 2002 resulted in use of cash, net of grants and
disposal, in the amount of $64,902 that consisted of $70,071 was incurred
in the acquisition of capital assets, $7,946 expended on patents and
offset by proceeds of $13,115 on the sale of equipment.
During the first quarter, the Board approved an increase in the private
placement funding from $2 million to $4 million to further assist the
Company in the completion of its first commercial plant. As a result, the
Company received subscription funds of $1,602,397 relating to the second
tranche of the private placement which commenced during the third quarter
of 2003, including $1,313,760 in cash and cancellation of $288,637 in
consulting fees payable by the Company at subscription prices ranging from
20
$0.35 to $0.485 per share for a total of 3,698,234 Common Shares issued,
including 1,149,116 warrants to purchase the Company's Common
Share at prices ranging from $0.65 to $0.75 per share.
During the second quarter, the Company commenced a $2 million private
placement at a share price based on a discount of up to 15% to the five-
day average market closing price of the Company's stock, plus two-year
warrants to purchase a quarter of a share of the Company's common stock at
25% above market. During the third quarter, the Board approved an increase
in the private placement funding from $2 million to $3.5 million to
further assist the Company in the completion of its first commercial
plant. At September 30, 2004, the Company has received $2,021,500 towards
this financing at share prices ranging from $0.36 to $0.427 per share.
During the fourth quarter, the Company has raised further $3,350,466
towards the private placements commencing in the second quarter at a share
prices ranging from $0.346 to $0.40 per share.
Subsequent to year-end, the Board approved a tranched funding of up to $20
million to meet its objectives for additional working capital, general
corporate purposes and to assist the Company in the completion of its
first commercial plant. As a result, the Company raised further
subscription funds of $2.1 million relating to the private placement
commenced during the first quarter of 2005 at subscription prices ranging
from $0.30 to $0.523 per share. 6.1 million shares and 2.3 million Common
Share Purchase Warrants remain to be issued as a result of this funding.
In total, the Company raised during the year an aggregate of $7,417,448,
including $6,685,726 in cash which includes $731,721 in consulting fees
payable by the Company for a total of 17,640,593 Common Shares and
6,667,942 Common Share Purchase Warrants.
With the current cash on hand and anticipated sales revenue, the Company
anticipates that it will require additional funding for its continued
operations and the commercialization of its Fast Pyrolysis technologies
through the year 2005. 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, scale-back or eliminate the
manufacturing, marketing or sales of one or more of its products or research
and development programs.
The Company's 2005 financing plan is structured to enable construction of
the Company's first commercial scale BioOil manufacturing
facility. 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 addition to contemplated equity and debt offerings, the Company expects to
be able to draw significantly from government grant and loan facilities,
including the Government of Canada's Technology Partnerships program and
from the approved SDTC funding towards the West Lorne Project. The
Company expects to draw in 2005 a significant portion of the remaining TPC
and SDTC funding.
In connection with the Company's West Lorne project, the Company is
committed to outstanding construction commitments of approximately $6.4
million and expects the project to be completed in the summer of 2005, of
which a vender has committed to provide a $3.0 million (C$3.64 million) 7-
year lease financing on equipment purchased.
The Company's funding plan for 2004 was 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 government contributions and other project
funding, are expected to fund the commercial demonstration projects which
21
are expected to be operational during Q3, 2005. Any delay in securing
project funding for a project will delay the construction and
commissioning of that project.
The West Lorne Project has committed to a seven year $3 million (C$3.6
million) turbine financing agreement which will be secured by the turbine
and other power island assets. The Project has also entered into a three
year loan agreement for up to $0.8 million (C$1.0 million) of which $816,727
(C$1,000,000) has been advanced as at December 31, 2004. This loan is
secured by a first charge on all of the project's assets aside from the
power island assets. For detail, please see note 9 of the Audited
Consolidated Financial Statements 2004.
The Company has entered into an agreement to pay for equipment and services
in exchange for an $830,013 (C$1 million) convertible debenture. The
debenture is convertible into common shares of the Company at the market
price at time of conversion, subject to a minimum conversion price of
US$0.40 per share and a maximum conversion price of US$0.60 per share. The
debenture bears no interest and the principal is due December 10, 2009. For
detail, please see note 10 of the Audited Consolidated Financial Statements
2004.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared based on the accounting
policies described in Note 2 to our consolidated financial statements in
"Item 17. Financial Statements" in this Annual Report on Form 20-F. 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.
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 for
property, plant and equipment is deducted from the cost of the related
property, plant and equipment.
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, 2004 and 2003, no investment
tax credits have been recorded.
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
22
which such costs have been capitalized is not reasonably certain, or that
costs exceed recoverable value, such costs are charged to operations.
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 11. Under the terms of the stock
option plan the Company may grant fixed options or options whose vesting
is contingent on future performance. Under Canadian GAAP, 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, under the Canadian
GAAP, when the performance criteria have been met and amortized over the
service period.
In addition, the Company has entered into compensation arrangements, which
entitle certain non-employees to receive specific amounts for their
services. These amounts can only be settled by applying them to the
exercising of outstanding options to purchase common shares each month
over a period of up to twelve months. The Company recognizes compensation
expense based on the fair value of the common stock issuable under the
arrangement, when related services are performed. The common shares
issuable under these arrangements are generally issued in the quarter
following the period in which they are earned.
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, 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,
23
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.
Effective January 1, 2004, the Company adopted the Canadian GAAP fair-value-
based method for all stock-based awards granted on or after January 1, 2004
and retroactively applied this method without restatement. For US GAAP
purposes, the Company continues to follow SFAS No. 123.("SFAS 123")
"Accounting for Stock Based Compensation" in accounting for options granted
to non-employees and Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees" (APB 25) and related interpretations, in
accounting for stock options granted to officers, directors, and employees.
Compensation expense is calculated based on the difference, on the measurement
date, between the fair market value of the Company's stock and the exercise
price and is recorded over the vesting period of the options. During 2004,
315,813 [2003 - 1,595,456; 2002 - nil] fixed employee stock options granted
with exercise prices less than the market price of the underlying stock on the
date of the grant. For U.S. GAAP purposes, the stock appreciation rights
("SA Rights") and performance-based stock options are accounted for as a
variable compensation plan under APB 25. Compensation relating to variable
plans is recorded in the reconciliation when it becomes probable that the
award will be earned.
Prior to January 1, 2002, the Company did not record stock-based compensation
for Canadian GAAP purposes and as such there was a difference between Canadian
and U.S. GAAP. For the years ended December 31, 2003 and 2002,, the Company
adopted the guidance under CICA Handbook Section 3870 [note 3] which required
that all stock-based awards made to non-employees and direct awards of stock,
stock appreciation rights and awards that call for settlement in cash or ther
assets that are outstanding or granted for fiscal years beginning on or after
January 1, 2002 are to be measured and recognized using a fair value based
method. For stock based awards granted to employees, the Company had
previously elected to use the intrinsic method as permitted under Canadian
GAAP, which is consistent with U.S. GAAP.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES, ETC.
The Company considers patents to be an important aspect of the Company's
business. The Company aggressively protects its intellectual property such
as trademarks, patents, product designs, manufacturing processes and new
product research and concepts. These rights are protected through the
development and acquisition of utility and design patents and trademark
registrations, the maintenance of trade secrets and, when necessary and
appropriate, litigation against those who, in the Company's opinion, are
competing unfairly with the Company. 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 December 31, 2004, the Company has active inventions protected by
patents issued and patents pending via in-house development or license.
The Company's key U.S. patents are scheduled to expire in year 2016.
The key Fast Pyrolysis patents expire in years 2016, 2017 and 2018 in all
jurisdictions.
Research costs are expensed in the year incurred. 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
24
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. Therefore, price trends in the
broad energy industry and developments in the alternative energy sector
will effect the commercial viability and attractiveness of BioOil. Early
technical development and market acceptance of BioOil is significantly
effected by the availability of ongoing governmental financial support for
the alternative energy industry in general and for the Company's BioOil
process in particular.
E. OFF-BALANCE SHEET ARRANGEMENTS
Nil
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table provides as of December 31, 2004 the known long term
obligations and commitments of the Company:
|========================================================================|
| | | | | | |
|Contractual Obligations| Total | Less | 1 - 3 | 3 - 5 | More |
| | | than 1 | years | years | than 5 |
| | | year | | | years |
|------------------------------------------------------------------------|
|Operating lease | | | | | |
|obligations - Office | Nil | Nil | Nil | Nil | Nil |
|equipment | | | | | |
|------------------------------------------------------------------------|
|Premise lease | | | | | |
|obligations - Head | 592,492 | 125,132 | 280,641 | 186,719 | Nil |
|office | | | | | |
|------------------------------------------------------------------------|
|Total | 592,492 | 125,132 | 280,641 | 186,719 | Nil |
|========================================================================|
We have an operating lease for office facilities of our head office.
G. Safe Harbor
Forward Looking Statement
Statements in this report concerning the company's business outlook or
future economic performance; anticipated profitability, revenues,
expenses, or other financial items; and statements concerning assumptions
made or expectations as to any future events, conditions, performance or
other matters, are "forward-looking statements" as that term is defined
under the Federal Securities Laws. Forward-looking statements are subject
to risks, uncertainties and other factors which could cause actual results
to differ materially from those stored in 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
Company's filings with the Securities and Exchange Commission
25
Item 6. Directors, Senior Management and Employees
A. Directors and Senior Management
As at April 30, 2005, the Company's directors and executive officers are:
Name Age Position
Richard Chen-Hsing Lin (2)(3) 61 Chairman, President, Operations-
China and Director
R. Andrew Kingston (3) 45 President, Chief Executive
Officer and Director
Curtin Winsor, Jr., Ph.D. (1)(2) 65 Director
Desmond Radlein, Ph.D. (1)(2)(3) 56 Director
Shing-Cheng Hong (1) 71 Director
Chih-Lin Chu 37 Director
Brian Richardson 42 Chief Financial Officer
Jan Barynin, Ph.D. 68 Vice President, Engineering
Laura Santos 55 Corporate Secretary
Jeffrey Lin 35 Vice President, Business
Development- China and Japan
- -----
(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 elected 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.
26
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 was President of
the Taiwan Entrepreneurs and Investors Association 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 President of the Taiwan Entrepreneurs Association in B.C., Vice
President of R.C.A. Taiwan and a Director of Consolidated Peritronics
Medical Inc. from February 1992 to April 1994.
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 $1.8 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.I. 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.
Desmond Radlein, Ph.D. Dr. Radlein became a Director of the Company in
December 1997. 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.
27
Shing-Cheng Hong. Mr. Hong became a Director of the Company in December
1997. With 40 years of industrial and financial background, Mr. Hong led a
42-member management team of Hotung Venture Capital Corp. where he served
as President until his retirement in 2001. Hotung is the leading venture
capital group in Taiwan. Mr. Hong still serves as Chairman of Honho
Consulting Corp. which manages the Hong Tung VC, a subsidiary of Hotung,
with funds of US$55 million. He is also President of Taiwan based Giga
Venture Partners & Co. Mr. Hong is also Advisor to Taiwan based Acer
SoftCapital Incorporated.
Chih-Lin Chu. Mr. Chu became a Director of the Company in June 2001. He
is currently President of Hong Kong based China Development and Investment
Holdings Ltd. From 2000 to 2004, Mr. Chu was General Manager for Business
Development at China Strategic Holdings Limited (CSH). CSH is a public
company listed on the Hong Kong Exchange with investments in energy, tire
manufacturing, breweries, 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.
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 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. Mrs. Santos has been Secretary of the Company since March
1998, Assistant Secretary and Executive Assistant since 1994. Prior to
joining the Company, she was Accounting Supervisor with Everex Systems
from 1990 to 1993; Senior Accounting Clerk 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 recently 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
28
knowledge, business and financial experience as well as the cultural
background and the language skills to open new business opportunities in
Asia.
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, 2004*:
|=======================================================================|
| | | | | |
| | | |Long-term |Long-term |
| |Salary |Bonus |Incentive |Incentive |
|Name |($) |($) |Plan |Plan |
| | | |($) |($) |
|-----------------------------------------------------------------------|
|Richard Chen-Hsing | 172,864** | 86,432 | - | - |
|Lin | | | | |
|-----------------------------------------------------------------------|
|Robert Andrew | 268,900 | 134,450 | - | - |
|Kingston | | | | |
|-----------------------------------------------------------------------|
|Curtin Window, Jr., | 7,913** | - | - | - |
|Ph.D | | | | |
|-----------------------------------------------------------------------|
|Shing-Cheng Hong | 11,755** | - | - | - |
|-----------------------------------------------------------------------|
|Desmond Radlein | 12,216** | - | - | - |
|-----------------------------------------------------------------------|
|Chih-Lin Chu | 7,683 | | | |
|-----------------------------------------------------------------------|
|Brian Richardson | 121,005 | - | - | - |
|-----------------------------------------------------------------------|
|Warren Johnson | 121,005 | - | - | - |
|-----------------------------------------------------------------------|
|Jan Barynin | 67,872 | - | - | - |
|-----------------------------------------------------------------------|
|Laura Santos | 69,146 | - | - | - |
|-----------------------------------------------------------------------|
|Jeffrey Lin | 66,149 | - | - | - |
|=======================================================================|
*Except as otherwise noted, all compensation are disclosed in U.S. dollars
based upon 2004's average exchange rate of $0.7683 per dollar.
**Salary includes both cash and share compensation. Please refer to Item
7-B for details of Mr. Lin's compensation.
Mr. Johnson's employment contract terminated in January 31, 2005.
The following table lists stock options outstanding at December 31, 2004
to purchase common shares of the Company for directors and senior
management:
|========================================================================|
| | | | |
|Name |Number of |Exercise |Expiry Date |
| |Shares |Price | |
|------------------------------------------------------------------------|
|Richard Chen Hsing Lin | 750,000 |$0.50 |02-Feb-10 to 29-Apr-12|
|------------------------------------------------------------------------|
|Richard Chen Hsing Lin | 300,000 |$0.23 |11-Apr-13 |
|------------------------------------------------------------------------|
|Richard Chen Hsing Lin | 605,660 |$0.20 |01-Feb-13 |
|------------------------------------------------------------------------|
|Richard Chen Hsing Lin |1,000,000 |$0.45 |31-Jul-09 |
|------------------------------------------------------------------------|
|Robert Andrew Kingston | 775,000 |$0.50 |02-Feb-10 to 23-Feb-12|
|------------------------------------------------------------------------|
|Robert Andrew Kingston | 907,649 |$0.20 |31-Jan-13 |
|------------------------------------------------------------------------|
|Robert Andrew Kingston | 300,000 |$0.23 |10-Apr-13 |
|------------------------------------------------------------------------|
|Robert Andrew Kingston |2,400,000 |$0.22 |10-Apr-13 |
|------------------------------------------------------------------------|
|Robert Andrew Kingston |1,000,000 |$0.45 |31-Jul-09 |
|------------------------------------------------------------------------|
|Curtin Winsor, Jr., Ph.D| 24,000 |$0.90 |09-Dec-06 |
|------------------------------------------------------------------------|
29
|------------------------------------------------------------------------|
|Name |Number of |Exercise |Expiry Date |
| |Shares |Price | |
|------------------------------------------------------------------------|
|Curtin Winsor, Jr., Ph.D| 24,000 |$0.33 |22-Dec-08 |
|------------------------------------------------------------------------|
|Curtin Winsor, Jr., Ph.D| 15,000 |$0.45 |05-Aug-08 |
|------------------------------------------------------------------------|
|Desmond Radlein, Ph.D | 20,000 |$0.90 |10-Dec-06 |
|------------------------------------------------------------------------|
|Desmond Radlein, Ph.D | 24,000 |$0.33 |22-Dec-08 |
|------------------------------------------------------------------------|
|Desmond Radlein, Ph.D | 23,000 |$0.45 |05-Aug-08 |
|------------------------------------------------------------------------|
|Shing-Cheng Hong | 16,000 |$0.90 |10-Dec-06 |
|------------------------------------------------------------------------|
|Shing-Cheng Hong | 16,000 |$0.33 |22-Dec-08 |
|------------------------------------------------------------------------|
|Shing-Cheng Hong | 23,000 |$0.45 |05-Aug-08 |
|------------------------------------------------------------------------|
|Chih-Lin Chu | 16,000 |$0.90 |09-Dec-06 |
|------------------------------------------------------------------------|
|Chih-Lin Chu | 16,000 |$0.33 |22-Dec-08 |
|------------------------------------------------------------------------|
|Chih-Lin Chu | 15,000 |$0.45 |05-Aug-08 |
|------------------------------------------------------------------------|
|Brian Richardson | 240,000 |$0.23 |06-May-06 |
|------------------------------------------------------------------------|
|Brian Richardson | 100,000 |$0.45 |30-Aug-06 |
|------------------------------------------------------------------------|
|Brian Richardson | 128,067 |$0.20 |14-Mar-06 |
|------------------------------------------------------------------------|
|Warren Johnson | 150,000 |$0.50 |31-Mar-06 to 28-Apr-06|
|------------------------------------------------------------------------|
|Warren Johnson | 100,000 |$0.23 |31-Mar-06 |
|------------------------------------------------------------------------|
|Laura Santos | 80,000 |$1.50 |14-Jun-05 to 31-Jan-06|
|------------------------------------------------------------------------|
|Laura Santos | 10,000 |$1.00 | 2-Feb-05 |
|------------------------------------------------------------------------|
|Laura Santos | 15,000 |$0.50 |28-Apr-06 |
|------------------------------------------------------------------------|
|Laura Santos | 100,000 |$0.23 |30-Aug-07 |
|------------------------------------------------------------------------|
|Laura Santos | 122,308 |$0.20 |30-Aug-05 to 14-Mar-06|
|------------------------------------------------------------------------|
|Jeffrey Lin | 110,000 |$1.00 |02-Feb-05 |
|------------------------------------------------------------------------|
|Jeffrey Lin | 15,000 |$0.50 |28-Apr-06 |
|------------------------------------------------------------------------|
|Jeffrey Lin | 100,000 |$0.23 |30-Aug-07 |
|========================================================================|
C. Board Practices and Share Ownership
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 Company Act (British Columbia).
The Company maintains standing Executive, Compensation and Audit
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 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.
30
The Company's Audit and Corporate Governance Committee, whose members
include Mr. Shing-Cheng Hong, Drs. Curtin Winsor, Jr. and Desmond Radlein
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.
In May 2004, the Board approved a new compensation plan as proposed by the
Compensation Committee for non-management Board members and Committee
chairs, as follows: a) annual retainer of $7,683, and $3,841 for Board
members and Committee chairs respectively, payable in 50% cash and 50% in
common stock priced at $0.60 per share for year 2004; 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 year 2004; c) Board and Committee meeting fees - $230 per
meeting under two (2) hours and $921 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.
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 April
30, 2005:
|=======================================================================|
| | | |
| |Periods during which|Shares Owned and % |
| |Has Served as a |of Ownership |
|Name |Director or Senior | |
| |Manager | |
|-----------------------------------------------------------------------|
|Richard Chen-Hsing Lin(2)(3) |Since 1992 |2,184,169 Common |
|Chairman, President, | |shares(4) |
|Operations-China and Director | |2.08% |
|-----------------------------------------------------------------------|
|Robert Andrew Kingston (3) |Since 1999 |830,853 Common |
|President, Chief Executive | |shares(5) |
|Officer and Director | |0.798% |
|-----------------------------------------------------------------------|
|Curtin Winsor, Jr., Ph.D.(1) |Since 1996 |255,236 Common |
|(2) | |shares |
|Director | |0.243% |
|-----------------------------------------------------------------------|
31
|-----------------------------------------------------------------------|
| |Periods during which|Shares Owned and % |
| |Has Served as a |of Ownership |
|Name |Director or Senior | |
| |Manager | |
|-----------------------------------------------------------------------|
|Desmond Radlein, Ph.D.(1) |1997 - 2002 and 2003|44,563 Common |
|(2)(3) |to present |shares |
|Director | |0.0425% |
|-----------------------------------------------------------------------|
|Shing-Cheng Hong(1) |Since 1997 |50,369 Common |
| | |shares |
|Director | |0.0481% |
|-----------------------------------------------------------------------|
|Chih-Lin Chu |Since 2001 |6,194 Common Shares|
|Director | |0.00591% |
|-----------------------------------------------------------------------|
|Brian Richardson |Since 2003 |50,000 Common |
|Chief Financial Officer | |shares |
| | |0.0477% |
|-----------------------------------------------------------------------|
|Jan Barynin, Ph.D., P.Eng |Since 2004 |nil |
|Vice President, Engineering | | |
|-----------------------------------------------------------------------|
|Laura Santos |Since 1998 |24,172 Common |
|Corporate Secretary | |shares |
| | |0.00023% |
|-----------------------------------------------------------------------|
|Jeffrey Lin |January 2005 |84,283 Common |
|Vice President, Business | |shares |
|Development - China and Japan | |0.0805% |
|=======================================================================|
Notes:
(1) Member of the Audit and Corporate Governance Committee of the Board.
(2) Member of the Compensation Committee of the Board.
(3) Member of the Executive Committee of the Board.
(4) Includes 2,184,169 Common Shares, of which 1,567,202 Common Shares
are held by Cantai Property Limited, a company controlled by Mr. Lin of
which 60,000 Common Shares are held in escrow subject to the Company's
attainment of certain performance criteria; also includes 172,912 Common
Shares held by Neoventi Technology Corporation over which Shares Mr. Lin
has voting and disposition powers.
(5) Includes 830,853 Common Shares held by Cape Fear Limited a UK
company whereby Mr. Kingston serves as a director.
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 3,529,839
shares which represent 3.37% of the total issued and outstanding shares of
the Company.
The Directors and Senior Management hold a total of 10,040,684 options.
5,233,684 options are exercisable between $0.20 and $0.33 each; 4,531,000
are exercisable between $0.45 and $0.50 each; and 276,000 options are
exercisable between $0.90 and $1.50 each. 7,409,684 unexercised options
were in the money based on the average trading price of $0.48 per Common
share as listed on the OTC BB as at April 30, 2005.
Percentage of class is calculated based on the outstanding common shares
as at April 30, 2005 of 104,663,130.
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
32
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 April 30, 2005, 2,459,452 options were issuable under the Plan
and 13,240,018 options were outstanding at exercise prices ranging from
$0.20 to $1.50 per common share.
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.
|==================================================================|
| | | | |
| |2004 |2003 |2002 |
|------------------------------------------------------------------|
|Canada |24 |16 |17 |
|------------------------------------------------------------------|
|US |0 |1 |2 |
|------------------------------------------------------------------|
|UK |0 |1 |2 |
|------------------------------------------------------------------|
| |24 |18 |21 |
|==================================================================|
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) except as
noted below:
Shareholder Name and Address Number of Percentage of
Shares Held Issued Shares
Cede & Co.(1) 36,884,235 35.24%
Box 20
Bowling Green Station
New York, New York, 10274
The Canadian Depository for Securities 32,149,095 30.71%
("CDS")(1)
85 Richmond Street West
Toronto, Ontario M5H 2C9
(1) Cede & Co. and CDS are brokerage clearing houses and hold shares on
behalf of brokerage firms. Management of the Company is unaware of the
beneficial ownership of the shares although certain of these figures may
include shares of management held in their brokerage accounts.
The above information was supplied by Computershare Trust Company of
Canada, the Company's registrar and transfer agent.
Canadian law does not permit disclosure of the beneficial shareholders of
a company's voting securities.
Major shareholders do not have different voting rights.
The Company knows of no arrangements which may, at a subsequent date,
result in a change of control.
33
Computershare Trust Company of Canada (Computershare) is the Company's
registrar and transfer agent for the Company's shares. Computershare's
records as of April 30, 2005 indicate 104,663,130 shares of common stock
issued and outstanding as follows:
|=======================================================================|
| | | | |
|Residence of |Number of Holders|Number of Shares |Percent |
|Shareholders | |(1) | |
|-----------------------------------------------------------------------|
|Canada |99 | 40,830,301 |39.01% |
|-----------------------------------------------------------------------|
|U.S.A. |203 | 37,522,406 |35.85% |
|-----------------------------------------------------------------------|
|Other |130 | 26,280,423 |25.14% |
|-----------------------------------------------------------------------|
|Total |432 | 104,663,130 |100.00% |
|=======================================================================|
(1) Includes the total number of shares held by registered and beneficial
shareholders.
B. Related Party Transactions
Pursuant to a Consulting Agreement that commenced July 1, 2003 until July
31, 2004 with Cantai Property Ltd. ("Cantai"), a company controlled by
Richard Lin, the Company paid Cantai $118,100 for the services of Mr. Lin
during the period. As part of this agreement, Mr. Lin can also earn a bonus
of up to 50% of his base compensation if certain milestones are achieved
plus reimbursement of out-of-pocket expenses. Subsequent to this
agreement, Mr. Lin signed a new employment agreement with the Company
commencing August 1, 2004 for a period of five years. Under the new
agreement, Mr. Lin receives a monthly remuneration of $14,405 less
statutory withholdings.
Consulting fees and share issue costs of $574,336 for the year ended
December 31, 2004 have been paid to a shareholder of the Company. Included
in the amount above, is $513,958 paid by stock based compensation.
As at December 31, 2004, $72,988 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. As
the joint venture had not been formalized, the advance was written-off on
December 31, 2004.
Item 8. Financial Information
A. Consolidated Statements and Other Financial Information
See Item 17 and 18 for the Company's Consolidated Financial Statements for
the year ended December 31, 2004.
B. Significant Changes
Operations
34
The Company focused its efforts during 2004 on the development of its core
Fast Pyrolysis technology and the construction of its first commercial
scale (100 tpd) BioOil production facility located in West Lorne, Ontario,
Canada.
In Canada, the Company's R&D efforts are focused on completion of its West
Lorne 100 tpd plant and on the design of its proposed 200 tpd plant.
Opportunities in British Columbia continue to be pursued and additional
projects were investigated including promising opportunities in Ontario and
elsewhere.
In March 2004, the Company signed a Contribution Agreement with Sustainable
Development Technology Canada ("SDTC") that provides C$5 million (US$4
million) of financial support for its West Lorne BioOil Co-generation
project based in Ontario, Canada. The project is being developed in
partnership with Orenda division of Magellan Aerospace, Ontario Power
Generation, UMA Engineering and Erie Flooring and Wood Products.
Financing Activities
The Company's financing efforts were successful to a limited degree 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.
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, 2004, the closing market sales price on the OTC BB for the
Company's Common Share was $0.48 per share. The following table shows the
High and Low sales prices for the securities traded on the NASD OTC
Bulletin Board for the five most recent full financial years; two most
recent full financial years and any subsequent period for each full
financial quarter; and the most recent six months:
Year Ended High Low
---------- ---- ----
2000 4.11 0.28
2001 1.69 0.49
2002 0.67 0.18
2003 0.79 0.14
2004 0.80 0.41
Quarter Ended High Low
------------- ---- ----
March 31, 2003 0.22 0.14
June 30, 2003 0.70 0.15
September 30, 2003 0.79 0.36
December 31, 2003 0.64 0.31
March 31, 2004 0.80 0.51
June 30, 2004 0.67 0.46
September 30, 2004 0.62 0.41
December 31, 2004 0.52 0.46
March 31, 2005 0.66 0.47
35
Month Ended High Low
----------- ---- ----
November 2004 0.52 0.46
December 2004 0.49 0.46
January 2005 0.49 0.47
February 2005 0.66 0.48
March 2005 0.60 0.50
April 2005 0.52 0.44
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
In June 2004, the Company changed its authorized capital to an unlimited
number of common shares with no par value and an unlimited Class A
preferred shares with a par value of $5.00 each, having attached special
rights and restrictions. The Notice of Alteration became effective as filed
with the British Columbia's Registrar's office on October 28, 2004.
B. Company Act Memorandum, Amendments and Articles of Incorporation
Notice of Alteration of the Company's Articles of Incorporation to increase
the Company's authorized capital to an unlimited number of common shares
with no par value and an unlimited Class A preferred shares with a par
value of $5.00 each, having attached special rights and restrictions which
became effective British Columbia's Registrar's office on October 28, 2004.
Please see Exhibit 3.3 for details of the Notice of Alteration.
Previously filed as exhibits to the Company's Quarterly Report on Form 10-
QSB dated August 15, 2000 and Form 10-Q dated August 14, 2001. (Commission
File No. 0-27524).
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.
D. Exchange controls
Nil
36
There are no Canadian laws, decrees or regulations applicable to the
Company that restrict the export or import of capital or that affect the
remittance of dividends or other payments, if any, to non-resident holders
of the Company's Common Shares, other than 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.
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 (in this summary, a "U.S. 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 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, and has not held or used (and does not hold or use)
Common Shares in connection with a permanent establishment or fixed base in
Canada. 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,
the regulations and the Treaty publicly announced by the Government of Canada
to the date hereof, and the current administrative practices of the Canada
Customs and 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 or administrative practice, although no
assurances can be given in these respects. The immediately following summary
does not take into account Canadian provincial, U.S. federal (which follows
further below), 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 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.
Dividends
- ---------
Dividends paid or deemed to be paid 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
37
dividend and remit it to the Canadian government for the U.S. Holder's account.
Disposition
- -----------
A U.S. Holder is not subject to tax under the Tax Act in respect of a capital
gain realized on the disposition of a Common Share in the open market unless
the share is "taxable Canadian property" to the holder thereof and the U.S.
Holder is not entitled to relief under the Treaty. A common share will be
taxable Canadian property to a U.S. Holder if, at any time during the 60
months preceding the disposition, the U.S. Holder or persons with whom the
U.S. Holder did not deal at arm's length alone or together owned, or had
rights to acquire, 25% or more of DynaMotive's issued shares of any
class or series. If the shares of DynaMotive constitute taxable Canadian
property to the holder, the holder may be subject to Canadian income tax
on the gain. The taxpayer's capital gain or loss from a disposition of
the share is the amount, in any, by which the proceeds of disposition exceed
(or are exceeded by) the aggregate of the adjusted cost base and reasonable
expenses of disposition. One-half of the capital gain is included in income
and one-half of the capital loss is deductible from capital gains realized
in the same year. Unused capital losses may carried back three taxation
years or forward indefinitely and applied to reduce capital gains realized
in those years. It should be noted that Canada requires a withholding tax
on the gross proceeds of a sale of taxable Canadian property by a non-resident.
The withholding tax may be reduced on completion of a Clearance Certificate
request. If the disposition of the share is subject to tax in Canada, the
non-resident must also file a Canadian income tax return reporting the
disposition.
A U.S. Holder whose common shares do constitute taxable Canadian property,
and who might therefore be liable for Canadian income tax under the Tax
Act, will generally be relieved from such liability under the Treaty unless
the value of such shares at the time of disposition is derived principally
from real property situated in Canada. The value of DynaMotive's common
shares is not currently derived principally from real property situated in
Canada.
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
38
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 the summary 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 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
39
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 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,
40
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 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
41
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, 2004 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 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.
42
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.
43
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)
44
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 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.
45
F. Dividends and paying agents
Not applicable.
G. Statements by experts
Not applicable.
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
Not applicable
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 Canada, the U.S. and the United Kingdom, and
therefore the Company is subject to 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. Accordingly, the
Company's future results could be materially adversely affected by changes
in these or other factors.
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'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.
46
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.
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, 2004, 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.
- ------------------------------------------------------------------------
47
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 15. Controls And Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the
"Exchange Act"), we carried out an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures as of December
31, 2004 being the date of our most recently completed fiscal year. This
evaluation was carried out under the supervision and with the participation
of our chief executive officer, and our chief financial officer. Based upon
that evaluation, our chief executive officer and our chief financial officer
concluded that our disclosure controls and procedures are effective in timely
alerting management to material information relating to us required to be
included in our periodic SEC filings.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in our 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 our reports filed under the Exchange
Act is accumulated and communicated to management, including our chief
executive officer and chief financial officer to allow timely decisions
regarding required disclosure.
During our most recently completed fiscal year ended December 31, 2004,
there were no changes in our internal control over financial reporting that
have materially affected, or are reasonably likely to affect, our internal
control over financial reporting.
The term "internal control over financial reporting" is defined as a process
designed by, or under the supervision of, the registrant's principal executive
and principal financial officers, or persons performing similar functions, and
effected by the registrant's board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:
Pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the assets of the
registrant;
Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
registrant are being made only in accordance with authorizations of management
and directors of the registrant; and
48
Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the registrant's assets that
could have a material effect on the financial statements.
Item 16. [Reserved]
ITEM 16A. Audit committee financial expert
Our board of directors has determined that Mr. Shing-Cheng Hong 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.
ITEM 16C Principal accountant fees and services
A summary of accountant fees and services are provided in a table below:
Total Fees
--------------------------
2004 2003
---- ----
Audit Fees (1) 100,615 122,698
Audit-Related Fees - -
(2)
Tax Fees (3) 845 7,923
All Other Fees (4) - -
- -------------------------------------------------
Total (5) 101,460 130,621
- -------------------------------------------------
(1) Audit fees are the aggregate fees billed by our external auditors for
the audit of our annual consolidated financial statements and services that
are normally provided by external auditors in connection with statutory and
regulatory filings.
(2) Audit-related fees in 2004 and 2003 include fees related to services
that are reasonably related to the performance of the audit or review of
our financial statements but not included under "Audit Fees".
(3) Tax fees in 2004 and 2003 include fees related to services for tax
compliance and tax planning.
(4) All other fees include miscellaneous financial advises other than above
categories.
(5) In 2004, total fees of $101,460 were paid to the current auditor. In 2003,
the amount of $129,836 was paid to the predecessor auditor and $785 was
paid to the current auditor.
- ------------------------------------------------------------------------
49
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
Consolidated Balance Sheets as at
December 31, 2004 and December 31, 2003
Consolidated Statements of Loss for the years ended
December 31, 2004, December 31, 2003 and December 31, 2002
Consolidated Statements of Deficit for the years ended
December 31, 2004, December 31, 2003 and December 31, 2002
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, December 31, 2003 and December 31, 2002
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------
50
Consolidated Financial Statements (in U.S. dollars)
DynaMotive Energy Systems Corporation
December 31, 2004 and 2003
51
BDO [LOGO]
- ---
BDO Dunwoody LLP 600 Cathedral Place
Chartered Accountants 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 sheet of DynaMotive Energy Systems
Corporation as at December 31, 2004 and the consolidated statements of loss,
deficit and cash flows for the year then ended. 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 audit.
We conducted our audit 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 present fairly, in all
material respects, the financial position of the Company as at December 31,
2004 and the results of its operations and its cash flows for the year then
ended in accordance with Canadian generally accepted accounting principles.
The comparative figures were reported upon by other auditors. Their report
covered the years ended December 31, 2003 and 2002, contained no reservations
and was dated April 16, 2004.
On March 22, 2005, we reported separately to the shareholders of DynaMotive
Energy Systems Corporation on financial statements for the same period
prepared in accordance with the Canadian generally accepted accounting
principles, excluding Note 20, Reconciliation of General Accepted Accounting
Principles, included in the accompanying financial statements.
/S/ BDO Dunwoody LLP
Chartered Accountants
Vancouver, Canada,
March 22, 2005.
52
BDO [LOGO]
- ---
BDO Dunwoody LLP 600 Cathedral Place
Chartered Accountants 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
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 (following the opinion paragraph)
when changes in an accounting policy, such as those involving 2004 stock-based
compensation, 2004 asset retirement obligations described in Note 3, 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 March
22, 2005 is expressed in accordance with Canadian reporting standards which do
not permit a reference to such conditions and events in the auditors' report
hen these are adequately disclosed in the financial statements.
/S/ BDO Dunwoody LLP
Chartered Accountants
Vancouver, Canada,
March 22, 2005.
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of DynaMotive Energy Systems Corporation
We have audited the consolidated balance sheet of DynaMotive Energy Systems
Corporation as at December 31, 2003 and the consolidated statements of loss,
deficit and cash flows for the years in the two year period December 31, 2003.
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 the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Company as at December 31,
2003 and the results of its operations and its cash flows for each of the
years in the two year period ended December 31, 2003 in accordance with
Canadian generally accepted accounting principles.
/S/ Ernst & Young LLP
Chartered Accountants
Vancouver, Canada,
April 16, 2004.
Comments by Auditors for U.S. Readers
on Canada-United States Reporting Difference
United States reporting standards for auditors require the addition of an
explanatory 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.
Although we conducted our audits 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 16, 2004 is expressed in accordance with Canadian reporting standards
which do not permit a reference to such conditions and events in the report
of independent registered public accounting firm when these are adequately
disclosed in the financial statements.
/S/ Ernst & Young LLP
Chartered Accountants
Vancouver, Canada,
April 16, 2004.
54
DynaMotive Energy Systems Corporation
Incorporated under the laws of British Columbia, Canada
CONSOLIDATED BALANCE SHEETS
(See Nature of Business and Going Concern Uncertainty - Note 1)
As at December 31 (in U.S. dollars)
2004 2003
$ $
- -----------------------------------------------------------------------------------
ASSETS
Current
Cash 136,971 283,514
Receivables 230,280 97,501
Government grants receivable [note 17] 236,548 732,776
Prepaid expenses and deposits 177,967 74,280
- -----------------------------------------------------------------------------------
Total current assets 781,766 1,188,071
Other long-term assets -- 32,673
Property, plant and equipment [note 5] 12,154,153 2,293,422
Patents [note 6] 262,779 245,439
- -----------------------------------------------------------------------------------
13,198,698 3,759,605
===================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current
Short-term loans [note 7] 42,331 --
Accounts payable and accrued liabilities [note 8] 7,635,494 1,880,680
Project advance [note 19] 166,003 154,488
- -----------------------------------------------------------------------------------
Total current liabilities 7,843,828 2,035,168
Convertible debenture [note 9] 307,463 --
Long-term debt [note 10] 760,209 --
- -----------------------------------------------------------------------------------
Total liabilities 8,911,500 2,035,168
- -----------------------------------------------------------------------------------
Commitments and contingencies [notes 1, 13, 14 and 17]
Shareholders' Equity
Share capital [note 11(b)] 39,866,465 30,907,990
Shares to be issued [note 11(c)] 2,340,894 2,827,111
Contributed surplus [note 11(h)] 9,584,266 4,815,679
Cumulative translation adjustment (654,374) (690,107)
Deficit (46,850,053) (36,136,236)
- -----------------------------------------------------------------------------------
Total shareholders' equity 4,287,198 1,724,437
- -----------------------------------------------------------------------------------
13,198,698 3,759,605
===================================================================================
See accompanying notes
On behalf of the Board:
"Richard Lin" "Andrew Kingston"
Director Director
55
DynaMotive Energy Systems Corporation
Incorporated under the laws of British Columbia
CONSOLIDATED STATEMENTS OF LOSS
For the Year Ended December 31 (in U.S. dollars)
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------------
REVENUE
Sales -- -- 68,569
- -----------------------------------------------------------------------------------
EXPENSES
Cost of sales -- -- 6,587
Amortization and depreciation 130,912 125,580 313,474
Interest expense [note 11(i)] 151,758 320,643 123,013
Marketing [note 11(i)] 283,322 155,914 183,294
Office supplies, telephone and insurance 328,286 300,751 230,808
Professional fees [note 11(i)] 1,010,802 954,223 861,199
Rent [note 11(i)] 107,804 109,653 515,446
Research and development [notes 11(i) and 17] 2,690,405 512,981 165,265
General and administrative salaries
and benefits [note 11(i)] 5,267,756 2,693,430 1,483,443
Foreign Exchange gain (53,156) (177,551) (80,461)
- -----------------------------------------------------------------------------------
(9,917,889) 4,995,624 3,802,068
- -----------------------------------------------------------------------------------
Loss from operations (9,917,889) (4,995,624) (3,733,499)
OTHER REVENUE AND EXPENSES
Interest and other income 8,766 73,974 982
Loss on asset disposals (7,092) -- (31,615)
Loss on write-down of long-term assets
[notes 5 and 6] -- -- (872,114)
Gain on recovery of government grants [note 17] -- -- 269,792
- -----------------------------------------------------------------------------------
1,674 73,974 (632,955)
- -----------------------------------------------------------------------------------
Loss from continuing operations (9,916,215) (4,921,650) (4,366,454)
Loss from discontinued operations [note 4(a)] -- (63,031) (895,153)
- -----------------------------------------------------------------------------------
Loss for the year (9,916,215) (4,984,681) (5,261,607)
===================================================================================
Weighted average number of common shares
outstanding [note 11[j]] 80,979,299 56,617,490 45,104,978
===================================================================================
Basic and diluted loss per common share
Continuing operations [note 11[j]] (0.12) (0.09) (0.10)
Discontinued operations [note 11[j]] -- (0.00) (0.02)
- -----------------------------------------------------------------------------------
Loss per share (0.12) (0.09) (0.12)
===================================================================================
See accompanying notes
56
DynaMotive Energy Systems Corporation
Incorporated under the laws of British Columbia
CONSOLIDATED STATEMENTS OF DEFICIT
As at December 31 (in U.S. dollars)
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------------
Deficit, beginning of year (36,136,236) (31,151,555) (25,773,048)
Effect of change in accounting
policy [note 3] (797,602) -- (116,900)
- -----------------------------------------------------------------------------------
Deficit, beginning of year restated (36,933,838) (31,151,555) (25,889,948)
Loss for the year (9,916,215) (4,984,681) (5,261,607)
- -----------------------------------------------------------------------------------
Deficit, end of year (46,850,053) (36,136,236) (31,151,555)
===================================================================================
See accompanying notes
57
DynaMotive Energy Systems Corporation
Incorporated under the laws of British Columbia
CONSOLIDATED STATEMENTS OF CASH FLOWS
As at December 31 (in U.S. dollars)
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------------
OPERATING ACTIVITIES
Loss for the year (9,916,215) (4,984,681) (5,261,607)
Add items not involving cash:
Amortization and depreciation 130,912 125,580 313,474
Interest expense-non cash -- 239,245 --
Loss on write-down of property,
plant and equipment -- -- 753,382
Loss on write-down of patents -- -- 118,732
Stock based compensation [note 11(i)] 4,827,804 2,427,857 1,326,010
Foreign exchange gain and other items (13,392) (177,551) (48,846)
Net change in non-cash working capital
balances related to operations [note 16] 2,087,156 199,795 611,375
- -----------------------------------------------------------------------------------
Cash used in operating activities (2,883,735) (2,169,755) (2,187,480)
- -----------------------------------------------------------------------------------
FINANCING ACTIVITIES
Increase (decrease) in bank
indebtedness - short-term -- (158,539) 196,596
Proceeds from convertible debenture 830,013 -- 263,416
Proceeds from long-term debt 816,727 -- --
Proceeds from short term loan 42,331 265,000 --
Repayment of short term loan -- (265,000) --
Increase in project advance -- 154,488 --
(Increase) decrease in government
grant receivables 509,879 (572,460) (160,316)
Share capital issued 4,857,699 2,321,852 1,545,400
Shares to be issued 1,636,408 1,476,012 352,376
- -----------------------------------------------------------------------------------
Cash provided by financing activities 8,693,057 3,221,353 2,197,472
- -----------------------------------------------------------------------------------
INVESTING ACTIVITIES
Increase in other long-term assets -- (32,673) --
Increase in patent costs (19,989) (6,479) (7,946)
Purchase of property, plant and equipment
(net of government grants) (5,804,656) (491,057) (70,071)
Proceeds on sale of equipment -- -- 13,115
- -----------------------------------------------------------------------------------
Cash used in investing activities (5,824,645) (530,209) (64,902)
- -----------------------------------------------------------------------------------
Increase (decrease) in cash and cash
equivalents from operations (15,323) 521,389 (54,910)
Effects of foreign exchange rate
changes on cash (131,220) (262,968) 18,462
- -----------------------------------------------------------------------------------
Increase (decrease) in cash and
cash equivalents during year (146,543) 258,421 (36,448)
Cash and cash equivalents, beginning of year 283,514 25,093 61,541
- -----------------------------------------------------------------------------------
Cash and cash equivalents, end of year 136,971 283,514 25,093
===================================================================================
See accompanying notes
58
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
1. NATURE OF BUSINESS AND GOING CONCERN UNCERTAINTY
[a] Nature of business
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.
In April 2001, the Company acquired Border Biofuels Limited ("BBL"), in the
U.K. In December 2002, BBL was petitioned into bankruptcy by creditors and
became insolvent [note 4]. In April 2002, the Company sold all tangible assets
in its metal cleaning subsidiary, DynaPower, Inc. to focus all of its
resources on its BioOil production technology [note 12].
[b] Going concern uncertainty
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 in the normal course of operations for the foreseeable future. As
at December 31, 2004, the Company has a working capital deficiency of
$7,062,062, and has incurred a loss of $9,916,215 for the year ended December
31, 2004.
The ability of the Company to continue as a going concern is in substantial
doubt and 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 is in the process of raising additional capital
financing in order to continue its operations, fund its research and
development activities, and ensure orderly realization of its assets and
discharge of its liabilities. While the Company is expending its best efforts
to achieve the above plans, there is no assurance that any such activity will
generate sufficient funds for operations.
59
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
1. NATURE OF BUSINESS AND GOING CONCERN UNCERTAINTY (cont'd.)
The Company is not expected to be profitable during the ensuing twelve months
and therefore must rely on securing additional funds from government sources
and by the issuance of shares of the Company for cash consideration.
Subsequent to the year-end, the Company has received additional equity
financing (Note 21(a)).
The consolidated financial statements do not reflect adjustments in carrying
values and classifications of assets and liabilities that would be necessary
should the Company not be able to continue its operations.
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 Corporation, incorporated under
the laws of Rhode Island, U.S.A.; DynaMotive Europe Limited, incorporated
under the laws of the United Kingdom; DynaMotive Canada Inc., federally
incorporated under the laws of Canada; DynaPower Inc., incorporated under the
laws of British Columbia (for 2002 only); DynaMotive Puerto Rico, Inc.,
incorporated under the laws of Puerto Rico; DynaMill Systems Ltd.,
incorporated under the law of British Columbia; and DynaMotive Electrochem
Corporation, incorporated under the laws of British Columbia. DynaMotive
Electrochem Corporation, DynaMill Systems Ltd. and DynaMotive Puerto Rico,
Inc. are companies with no significant net assets or operations. DynaPower
Inc. sold all tangible assets to the management of DynaPower in a management
buyout in 2002 [note 12]. In addition, the Company owns 99.9% of the West
Lorne BioOil Co-Generation LP formed under the law of Ontario and has
accounted for its proportionate share of the partnership.
The consolidated financial statements include the results of operations of BBL
as discontinued operations [note 4]. DynaMotive Electrochem Corporation,
DynaMill Systems Ltd. and DynaMotive Puerto Rico, Inc. are inactive companies
with no significant net assets or operations.
60
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
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 translation or settlement of foreign currency denominated monetary
items are included in the determination of net income.
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 process are
recorded in shareholders' equity as an adjustment to the cumulative
translation adjustment account.
Revenue recognition
[a] Revenue from the sale of products is recognized upon shipment of the
product and 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] Revenue from contracts relating to implementation of the Company's metal
cleaning systems in a commercial application (2002) is recognized on a
completed contract basis, except for those which are greater than three
months in duration, for which revenue is recognized on a percentage of
completion basis where the basis of measure of performance is based on
engineering estimates of completion. Losses on contracts are fully
provided for when they become known.
[c] Revenue from services contracts is recognized when the services are
provided.
61
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
[d] Royalty revenue is recognized when the Company has earned the right to
collect payment pursuant to the terms of the relevant agreement and when
the amount is reasonably determinable and collectible.
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 for property, plant
and equipment is deducted from the cost of the related property, plant and
equipment.
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, 2004 and 2003, no investment tax credits have
been recorded.
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.
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 commencing with commercial
production. 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.
62
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express 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)
Motor vehicles 50% the first year and 25% thereafter
declining balance
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. In 2002, the Company determined that write-downs of the carrying values
of certain assets were required [notes 5 and 6].
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.
63
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
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.
Income taxes
The Company accounts for income taxes using the 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 11. 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 has a compensation arrangement with several officers of the
Company whereby the officers receive a fixed number of common shares per
month. The Company records compensation expense monthly based on the month-end
quoted market price of the Company's stock.
64
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
In addition, the Company has entered into compensation arrangements, which
entitle certain non-employees to receive specific amounts for their services.
These amounts can only be settled by applying them to the exercising of
outstanding options to purchase common shares each month over a period of up
to twelve months. The Company recognizes compensation expense based on the
fair value of the common stock issuable under the arrangement, when related
services are performed. The common shares issuable under these arrangements
are generally issued in the quarter following the period in which they are
earned.
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, 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.
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. The effect
of potential issues of shares under share option, share purchase warrants and
conversion agreements are antidilutive. Therefore, diluted loss per common
share is equivalent to basic loss per common share.
Financial instruments
The fair values of the financial instruments approximate their carrying value
due to their short term or demand nature, except for the convertible debenture
and long-term debt. The fair values of the convertible debenture and long-term
debt were calculated using discounted cash flow analysis and approximate their
carrying value as the effective interest rates implicit in these financial
instruments are similar to current market rates.
65
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
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.
3. CHANGE IN ACCOUNTING PRINCIPLES
[a] Stock based compensation
Effective January 1, 2004, the Company has 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.
Prior to 2004, effective January 1, 2002, the Company followed the
recommendations of the CICA 3870 which required that all stock-based awards
made to non-employees and direct awards of stock, stock appreciation rights
and awards that call for settlement in cash or other assets that were
outstanding or granted for fiscal years beginning on or after January 1, 2002
were to be measured and recognized using a fair value based method. Awards
that an entity had the ability to settle in stock were recorded as equity,
whereas awards that the entity was required to or had a practice of settling
in cash were recorded as liabilities. The fair value method was encouraged for
all other employee stock based compensation but other methods of accounting
such as the intrinsic method were permitted. If the fair value method was not
adopted, then pro-forma disclosure for net loss and loss per share was
required to show the effects as if the fair value method has been used. The
Company elected to use the intrinsic method to account for awards granted to
employees and directors in 2002 and 2003. As a result of adopting this
standard, opening deficit as at January 1, 2002 was increased by $116,900 and
contributed surplus was increased by $116,900 to reflect certain SA Rights
that were outstanding.
66
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
3. CHANGE IN ACCOUNTING PRINCIPLES - (cont'd)
[b] Asset Retirement Obligations
Effective January 1, 2004, the Company adopted CICA Handbook Section 3110,
"Asset Retirement Obligations" which requires the Company to retroactively
record 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 will be 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, 2004, for various reasons, including the fact that the BioOil
plant is still under construction, the Company can not make a reasonable
estimate of the fair value of the asset retirement obligations and
consequently, no liability was accrued.
4. BORDER BIOFUELS LTD.
[a] Liquidation of BBL
In April 2001, the Company acquired 75% of the outstanding common shares of
Border Biofuels Limited ("BBL"), a United Kingdom Green Power project
development company for a nominal cash consideration of $2 (GBP 1) plus
acquisition cost of $70,241 (GBP 49,537).
On December 13, 2002, BBL was placed into liquidation when a petition was made
by creditors under the Insolvency Act of 1986 of the United Kingdom.
Substantially all of its assets will be liquidated by a bank appointed
receiver. The Company does not expect to recover any proceeds from the sale of
BBL's assets.
As BBL remains in liquidation at December 31, 2004, the Company no longer
controls the operating, financing and investing decisions of BBL. As such, the
financial position and results of operations have been deconsolidated from the
date that BBL was petitioned into bankruptcy. Accordingly, the results of
operations of BBL for the prior periods have been accounted for as
discontinued operations.
67
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
4. BORDER BIOFUELS LTD. (cont'd.)
The results of the discontinued operations are as follows:
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------
Sales - - -
- -----------------------------------------------------------------------------
Net loss from discontinued operations - (63,031) (1,508,189)
Gain on disposal - - 613,036
- -----------------------------------------------------------------------------
- (63,031) (895,153)
- -----------------------------------------------------------------------------
[b] Guarantee provided by Dynamotive
In 2001, BBL entered into a credit facility with Bank of Scotland for a
maximum of $385,320 (GBP 200,000). The credit facility is denominated in
British Pounds Sterling. Interest is charged at the bank's base rate (as at
December 31, 2001 - 4%) plus 3%. The credit facility 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 has recognized the full amount of the
guarantee as a current liability in 2002 and included the impact as part of
the 2002 loss from discontinued operations. As BBL remains in liquidation at
December 31, 2004, there has been no change in status regarding the
settlement of the credit facility.
5. PROPERTY, PLANT AND EQUIPMENT
2004 2003
------------------------------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
$ $ $ $
- ------------------------------------------------------------------------------------
Furniture and fixtures 166,649 127,064 172,248 119,926
Computer equipment and software 395,616 306,745 299,811 258,917
Equipment 647,960 408,916 603,015 324,938
Projects under development:
Construction in Progress
- West Lorne 10,958,107 - 1,235,510 -
Pre-construction advances 766,035 - 664,057 -
Leasehold improvements 153,106 100,476 88,065 88,065
Motor vehicles 57,446 47,565 53,462 30,900
- ------------------------------------------------------------------------------------
13,144,919 990,766 3,116,168 822,746
- ------------------------------------------------------------------------------------
Net book value 12,154,153 2,293,422
- ------------------------------------------------------------------------------------
68
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
5. PROPERTY, PLANT AND EQUIPMENT (cont'd.)
The Company is constructing a 100 tonne per day BioOil co-generation project
at the site of Erie Flooring in West Lorne, Ontario. At December 31, 2004,
the Company had recorded pre-construction advances of $766,035 [2003 -
$664,057] representing initial payments on a proposed 200 tonne per day plant.
All of the pre-construction advances were paid in cash or shares.
During 2004, government grants of $2,829,117 [2003 - $416,708] have been
applied to reduce the cost of property, plant and equipment under
construction. For 2004 and 2003, construction in progress comprises the costs
to construct a 100 tonne per day BioOil plant.
In 2002, the Company recorded write-downs of certain property, plant and
equipment totaling $753,382, pertaining to the BioOil Power Generation
segment. The Company determined that the net realizable value of certain test
equipment was below their carrying values.
6. PATENTS
2004 2003
------------------------------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
$ $ $ $
- ------------------------------------------------------------------------------------
Patents 365,715 102,936 320,250 74,811
- ------------------------------------------------------------------------------------
Net book value 262,779 245,439
====================================================================================
In 2002, the Company recorded a write-down on patents pertaining to the
DynaPower metal cleaning technology of $118,732. The Company determined that
the future cash flows from these licenses granted upon the management buyout
[note 12] of DynaPower were insufficient to support the carrying value of
these patents. Therefore, these patents were written down to management's best
estimates of the future discounted cash flows from the licenses on these
patents.
Patents are recorded at cost and amortized on a straight line basis over the
estimated useful life of the related technology of 16 years. The annual
amortization expense of these patents for the next five years is estimated to
be $23,000 per annum.
69
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
7. SHORT-TERM LOANS
[a] On December 24, 2004 the Company entered into a loan agreement with an
officer of the Company for $42,331 [2003 - $nil]. The loan bore interest
at 2% per month and had a 1-month term and was repaid in January 2005.
[b] On June 3, 2003 the Company entered into a loan agreement with a U.S.
based Trust for $200,000 and an officer of the Company for $50,000. The
loans bore interest at 2% per month and had a 12-month term. The loan
agreement also called for the Company to issue 2.5 million warrants
exercisable at $0.20 each for a period of five years as part of the loan
financings.
The proceeds of the loan were allocated to the loan and warrants based on
their relative fair values. Accordingly, $104,167 was initially allocated
to the loan and $145,833 was allocated to the warrants. The carrying
value of the debt was accreted up to its face value over the term to
maturity. Accretion of $12,153 was recognized in the year ended December
31, 2003. The Company provided the lenders with a general security
agreement and other undertakings in regard to the loan.
In December 2003, the Company repaid the loan and the lender released the
Company from the general security agreement.
[c] During the year ended December 31, 2003 the Company was advanced $15,000
by a director which was non-interest bearing and was repaid in August
2003.
8. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
2004 2003
$ $
- ------------------------------------------------------------------------------
Trade accounts payable 3,157,724 911,949
Accrued compensation 34,808 --
Accrued liabilities 4,057,642 613,023
Bank of Scotland guarantee [note 4(b)] 385,320 355,708
- ------------------------------------------------------------------------------
7,635,494 1,880,680
==============================================================================
70
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
9. CONVERTIBLE DEBENTURE
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 debenture is convertible
into common shares of the Company at the market price at time of conversion,
subject to a minimum conversion price of $0.40 per share and a maximum
conversion price of $0.60 per share. The debenture bears no interest and the
principal is due December 10, 2009. The agreement calls for the Company to
enter into a marketing agreement with the Vendor and to issue to the Vendor
500,000 warrants to purchase common shares of the Company, exercisable at
$0.49 per share during the period to December 31, 2006. As at December 31,
2004, the Company has not entered into any marketing agreement with the Vendor
and no warrants have been issued as the convertible debenture agreement has
only became effective shortly before year end.
The proceeds of the debenture have been allocated to the debenture and
warrants based on their relative fair values. Accordingly, $307,463 was
allocated to the debenture and $522,550 was allocated to the conversion
feature and warrants. The carrying value of the debt will be 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 will begin in January 2005.
10. 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, based on
exchange rate at December 31, 2004) loan. The loan bears interest at 1.25% per
month with interest due monthly and the principal due August 11, 2007. The LP
may repay the loan at any time without penalty. The loan agreement also calls
for the Company to issue 312,500 warrants to purchase common shares of the
Company, exercisable at $0.50 per share for a period of three years, as part
of the loan financing. The loan is collateralized by the assets of the LP and
is guaranteed by the Company.
The proceeds of the loan have been allocated to the debt and warrants based on
their relative fair values. Accordingly, $760,209 was allocated to the loan
and $69,804 was allocated to the warrants. The carrying value of the debt
will be 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 shortly before year end. The accretion of the debt discount will
begin in January 2005.
71
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL
[a] Authorized share capital
The Company's authorized capital consists of an unlimited number of common
shares [2003 - 100,000,000 common shares] with no par value and 100,000,000
Class A preferred shares [2003 - 100,000,000] with a par value of $5.00 each
having attached special rights and restrictions. No preferred shares were
issued and outstanding at December 31, 2004 and 2003.
[b] Issued and outstanding common shares
Issued
# $
- ----------------------------------------------------------------------------------
Balance, December 31, 2001 40,942,115 24,617,914
Issued for cash
Pursuant to private placement 4,503,872 1,545,400
Issued on conversion of convertible loan 856,551 200,000
Issued for settlement of fees payable and severances 479,025 145,598
Issued for services (i) 3,159,437 1,136,507
Shares to be redeemed and cancelled (ii) -- (92,379)
- ----------------------------------------------------------------------------------
Balance, December 31, 2002 49,941,000 27,553,040
Issued for cash
Pursuant to private placement 12,863,895 1,544,715
Pursuant to exercise of stock options 580,100 183,050
Issued on conversion of convertible loan 1,389,746 182,254
Issued for settlement of fees payable 2,206,966 699,037
Issued for services (i) 2,973,947 745,894
Shares redeemed and cancelled (ii) (40,000) --
- ----------------------------------------------------------------------------------
Balance, December 31, 2003 69,915,654 30,907,990
Issued for cash
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 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 (ii) -- 76,688
- ----------------------------------------------------------------------------------
Balance, December 31, 2004 93,129,798 39,866,465
==================================================================================
72
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. 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.
a. The Company has entered into compensation arrangements with non-
employees for specified amounts, which can only be settled by applying
the amounts to exercise outstanding options to purchase common shares
monthly over a period of up to twelve months. Included in issued for
services are $nil [2003 - 1,536,141; 2002- 1,379,447] shares, fair
valued at $nil [2003 - $321,082; 2002 - $552,387].
b. In addition, the Company issued 2,393,459 [2003 - 980,753; 2002 -
675,486] restricted shares to non-employees for services, fair valued
at $1,303,005 [2003 - $363,764; 2002 - $217,269]. The shares have a 12-
month restriction from the issue date.
C. The Company has issued $nil [2003 - 455,794; 2002 - 1,054,916] shares
to employees, directors and officers for services rendered, recorded at
fair value of $nil [2003 - $60,922; 2002 - $349,901].
d. In addition, the Company issued 32,182 [2003 - 8,590; 2002 - 49,588]
restricted shares to employees and directors for services, fair valued
at $19,140 [2003 - $2,686; 2002 - $16,950]. The shares have a 12 month
restriction from the issue date. During 2003, 7,331 common shares
previously issued to a director of the Company were cancelled and
returned to Treasury with a fair value of $2,560.
[ii] At December 31, 2004, the Company had nil [December 31, 2003 - 306,748]
common shares to be redeemed. The remaining balance of the previously
accrued redemption was cancelled as a result of the Company using the
shares as a deposit on the next development project. These shares, which
were included as outstanding at December 31, 2003, were issued for
services in relation to the termination of agreements with non-employees
and to be redeemed upon satisfying conditions of the termination
agreements which were fully settled in 2003.
[iii] During the year ended December 31, 2004, the Company completed several
private placements for gross proceeds of $6,491,511. Share issuance
costs related to these private placements totaled $665,820, of which,
$385,035 was paid in cash and $280,785 was paid in shares [note 11(i)].
Pursuant to the private placement agreements in 2004 and 2003, 4,479,559
Series Q warrants and 4,227,739 Series S warrants were issued in 2004
[note 11(c)].
The Company also issued 2,999,113 fully vested shares for services
performed in 2004. These shares were valued based on the quoted market
price on the date of the agreement.
73
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
[c] Shares to be issued
At December 31, 2004, the Company has 5,629,859 [2003 - 7,107,160] common
shares to be issued which are comprised of:
[i] 1,403,080 [2003 - 2,783,677] common shares which are to be issued to a
director and non-employees for services rendered under compensation
arrangements with a value of $704,486 [2003 - $1,351,099].
[ii] 4,226,779 common shares relating to a private placement commenced during
the year ended December 31, 2004 [2003 - 4,185,150] and nil [2003 -
138,333] common shares are related to exercise of warrants. The private
placement is for up to $6.0 million at an offering price between $0.355
and $0.414. At December 31, 2004, the Company had received $1,636,408
[2003 - $1,476,012] in cash for these shares to be issued [note 21(a)].
[d] Escrow agreement
At December 31, 2004 and 2003, 556,000 common shares were held in escrow to be
released at a rate of one share for each $0.17 of "cash flow" as defined in
the agreement, generated by the Company.
At December 31, 2004 and 2003, 225,334 common shares were held in escrow from
an original total of 676,000 common shares put into escrow. These common
shares are to be released from escrow upon the Company achieving a capitalized
stock value of $100 million.
During the three-year period ended December 31, 2004, no common shares were
released from escrow and at December 31, 2004, 781,334 [2003 - 781,334] common
shares are held in escrow.
74
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
[e] Stock options
At December 31, 2004, the following stock options to Directors, employees and
others 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
Price 2004 Life Price 2004 Price
- -----------------------------------------------------------------------------------
$0.20 - $0.23 6,051,723 6.93 years $0.21 5,189,698 $0.21
$0.30 - $0.50 5,106,000 3.90 years $0.49 4,618,500 $0.46
$0.60 - $0.90 332,000 1.94 years $0.84 332,000 $0.84
$1.00 120,000 5.09 years $1.00 120,000 $1.00
$1.50 330,000 0.26 years $1.50 309,000 $1.50
- -----------------------------------------------------------------------------------
11,939,723 10,569,198
===================================================================================
From time to time, the Company has provided incentives in the form of share
purchase options to the Company's directors, officers, employees and others.
The Company has reserved 13,969,470 [2003 - 10,487,348] (15%) of its common
shares for issuance upon the exercise of stock options of which at December
31, 2004, 2,029,747 [2003 - 471,360] are available to be granted. The exercise
price and the vesting terms of the options are determined by the Compensation
Committee. The exercise price will generally be at least equal to the market
price of the common shares at the date of the grant and the term may not
exceed five years from the date of the grant.
Subsequent to December 31, 2004, all of the 330,000 stock options with
exercise price of $1.50 expired unexercised.
75
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
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, 2001 5,001,963 1.15
Options granted 4,638,298 0.44
Options forfeited or expired (1,598,725) 0.96
Options exercised (2,213,699) 0.38
- ----------------------------------------------------------------------------------
Balance, December 31, 2002 5,827,837 0.63
Options granted 7,603,409 0.24
Options forfeited or expired (1,299,017) 0.32
Options exercised (2,116,241) 0.52
- ----------------------------------------------------------------------------------
Balance, December 31, 2003 10,015,988 0.41
Options granted 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
==================================================================================
During 2004, the Company extended the expiry date of 6,606,617 options issued
to officers from the original expiry date for a period of five years.
During 2003, the Company repriced 500,000 options issued to a director (or
company controlled by a director) from the original exercise price of $0.50 to
a new exercise price of $0.30. During 2002, the Company repriced 1,800,000
options issued to directors from the original exercise price of $1.50 to a new
exercise price of $0.50.
Included in the options granted in 2004, were 350,000 [2003 - 817,300] options
to non-employees for services rendered recorded at a fair value of $73,750
[2003 - $145,711].
Subsequent to year end, 211,877 options with a weighted average exercise price
of $0.27 were exercised.
76
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
The weighted-average fair value of options granted in 2004 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 $nil (as
there were no stock options granted in 2004 where stock price is equal to the
exercise price of the options), $0.40, and $0.41 respectively [2003 - $0.20,
$0.38, and $0.21; 2002 - $0.37, $0.41, and $0.32].
The fair value of stock options, SA Rights and warrants granted in 2004 is
estimated at the measurement date using the Black Scholes option pricing model
with the following weighted average assumptions: Risk free interest rate of
4.3%; dividend yields of 0%; volatility factors of the expected market price
of the Company's common stock of 92.7%; and weighted average expected life of
the option of 7.9 years.
Pro forma information regarding net income and earnings per share was
previously required by CICA 3870, for all periods presented where the fair
value method was not chosen, as if the Company has accounted for stock
options, SA Rights and warrants granted to employees under the fair value
method [see note 3(a)]. The fair value for these options, SA Rights and
warrants is estimated at the measurement date using the Black Scholes option
pricing model with the following assumptions for 2003 and 2002, respectively:
Risk free interest rate of 4.5% for both years; dividend yields of 0% for both
years; volatility factors of the expected market price of the Company's common
stock of 116% and 113%, and weighted average expected lives of the options of
2.7 years and 4.3 years.
Supplemental disclosure of pro forma loss and loss per share is as follows:
2003 2002
$ $
- --------------------------------------------------------------------------------
Loss for the period as stated (4,984,681) (5,261,607)
Less stock-based compensation 676,354 121,248
- --------------------------------------------------------------------------------
Pro forma loss (5,661,035) (5,382,855)
================================================================================
- --------------------------------------------------------------------------------
Basic and diluted loss per share as stated (0.09) (0.12)
Proforma basic and diluted loss per share (0.10) (0.12)
================================================================================
77
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
[f] Common share purchase warrants
During 2003, the Company repriced 200,000 warrants from the original exercise
price of $0.40 to a new exercise price of $0.15 and compensation expense of
$16,000 was recorded.
At December 31, 2004 the common share purchase warrants outstanding were as
follows:
No. of Common Exercise
Shares Issuable Price Expiration Date
- -----------------------------------------------------------------------------------
Series F Warrants 933,333 $0.70 March 5, 2005
Series M Warrants 102,544 $1.50 January 20, 2005 - May 09, 2005
Series O Warrants 300,000 $0.35 June 10, 2005
Series P Warrants 4,477,147 $0.33 to 0.40 July 29, 2005 - December 23, 2006
Series Q Warrants 11,492,088 $0.20 to $0.75 August 31, 2005 - August 31, 2008
Series R Warrants 2,500,000 $0.20 August 31, 2008
Series S Warrants 4,910,239 $0.47 to $0.69 August 10, 2006 to December 23, 2007
Series T Warrants 312,500 $0.49 November 3, 2007
====================================================================================
As at December 31, 2004, all warrants are vested.
(1) 933,333 of the Series F warrants were issued as part of a private
placement. These warrants vested upon successful completion of the private
placement and expired unexercised subsequent to year end.
(2) The Series M 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. 50,353 Series M warrants
expired and were cancelled during the year.
78
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
(3) The Series N-b warrants expired and were cancelled during the year.
(4) The Series O warrants were issued as a part of a loan agreement [note
14(f)] during the year ended 2002.
(5) 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.
(6) 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 [note 14(e)]. 4,479,559 Series Q warrants were issued during
the year at a weighted average exercise price of $0.59 per share, expiring
on various dates from January 12, 2006 to May 20, 2007. Also in 2004,
188,333 warrants were exercised at a weighted average price of $0.27 per
share.
(7) The Series R warrants were issued as part of a loan agreement. 2,500,000
Series R warrants were issued as part of the loan financings [note 7(b)]
at a weighted average exercise price of $0.59 per share.
(8) The Series S warrants were issued during the year 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.
4,910,239 Series S warrants were issued during the year [note 10].
(9) The Series T warrants were issued as a part of a loan agreement during the
year and the warrants vested immediately upon issue.
Compensation expenses recognized for warrants granted during 2004 was $601,250
[2003 - $1,265,474; 2002 - $45,994].
[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.
79
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
The SA Rights vest as the Company achieves stock value target as defined in
the agreement: the remaining 1/3 of the SA Rights issued may be redeemed upon
the Company achieving a capitalized stock value of $100 million.
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, 2004, 300,000 [December 2003 - 1,468,335] SA Rights were
outstanding and 200,000 [December 2003 - 1,106,668] were vested.
SA Rights transactions and the number of SA Rights outstanding is summarized
as follows:
No. of
SA Rights Issued
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Balance, December 31, 2002 1,471,668
SA Rights forfeited (3,333)
- --------------------------------------------------------------------------------
Balance, December 31, 2003 1,468,335
SA Rights redeemed (766,668)
SA Rights forfeited (401,667)
- --------------------------------------------------------------------------------
Balance, December 31, 2004 300,000
================================================================================
At December 31, 2004, the following SA Rights, all of which were issued to
employees, were outstanding:
SA Rights SA Rights Initial Expiration
Outstanding Vested Value Date
- -------------------------------------------------------------------------------
300,000 200,000 $0.40 December 31, 2008
===============================================================================
In 2004, the Company received redemption notices for 766,668 SA Rights for
$114,433 of which $38,944 was paid in cash and $75,489 was paid in shares.
The Company has an arrangement with a former director of the Company for
300,000 outstanding SA Rights of which 200,000 SA Rights have been vested with
an initial value of $0.40 extending the expiration date to December 31, 2008.
80
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
[h] Contributed surplus
Contributed surplus includes the fair value of stock options and warrants
issued to non-employees for services rendered, the fair value of warrants
issued under short-term loan agreements [note 7], the fair value of warrants
related to convertible debentures [note 9], and the fair value of warrants
related to long-term debt [note 10], and the fair value of equity awards
granted to employees [note 11(i)].
[i] Stock based compensation
The Company has recorded stock based compensation as follows:
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------
Balance sheet items
Property, plant and equipment 350,812 1,004,564 105,455
Share issue costs 280,785 947,202 --
Other 17,893 51,000 11,989
- -----------------------------------------------------------------------------
649,490 2,002,766 117,444
- -----------------------------------------------------------------------------
Income statement items
Professional fees 235,845 655,416 546,286
General and administrative
salaries and benefits 3,707,356 1,712,658 730,245
Marketing -- 51,628 42,385
Research & development 787,403 -- 4,626
Interest expense and other 97,200 8,155 2,468
- -----------------------------------------------------------------------------
4,827,804 2,427,857 1,326,010
- -----------------------------------------------------------------------------
Total stock based compensation 5,477,294 4,430,623 1,443,454
=============================================================================
81
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
11. SHARE CAPITAL (cont'd.)
[j] Basic and diluted loss per common share
2004 2003 2002
- ------------------------------------------------------------------------------
Numerator
Loss from continuing operations $(9,916,215) $(4,921,650) $(4,366,454)
Loss from discontinued operations -- (63,031) (895,153)
- ------------------------------------------------------------------------------
Net loss $(9,916,215) $(4,984,681) $(5,261,607)
- ------------------------------------------------------------------------------
Denominator
Weighted average number of
common shares outstanding 81,760,633 57,398,824 45,886,312
Escrowed shares (781,334) (781,334) (781,334)
- ------------------------------------------------------------------------------
80,979,299 56,617,490 45,104,978
- ------------------------------------------------------------------------------
Basic and diluted loss per common share
Continuing operations $(0.12) $(0.09) $(0.10)
Discontinued operations -- (0.00) (0.02)
- ------------------------------------------------------------------------------
Loss per share $(0.12) $(0.09) $(0.12)
==============================================================================
12. DYNAPOWER MANAGEMENT BUYOUT
In April 2002, the Company sold all tangible assets in its metal cleaning
subsidiary, DynaPower, Inc. to the management of DynaPower for nominal
consideration of $1 plus future royalties. The Company retains ownership of
the intellectual property related to the DynaPower metal cleaning technology
and has licensed the intellectual property to DynaPower for a period of seven
years from the closing of the sales agreement. The royalties over the seven
year period are based on an increasing percentage of the cumulative revenues
generated by DynaPower on sales of DynaPower systems. The intellectual
property will transfer from the Company to DynaPower on the expiration of the
royalty period at March 31, 2009 only if a cumulative sales threshold is
reached. In 2002, the Company recorded write-downs of patents related to
DynaPower for $118,732 [note 6].
82
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
13. COMMITMENTS AND CONTINGENCIES
Commitments
The Company has the following future minimum lease commitments for premises
and equipment:
$
- --------------------------------------------------------------------------
2005 125,000
2006 134,000
2007 147,000
2008 142,000
2009 45,000
- --------------------------------------------------------------------------
593,000
- --------------------------------------------------------------------------
In connection with the Company's West Lorne project [see note 5] the Company
is committed to outstanding construction commitments of approximately $6.4
million, of which a vender has committed to provide a $3.0 million (C$3.64
million) 7-year lease financing on equipment purchases.
Pursuant to employment agreements with certain officers of the Company, which
expire on July 31 and December 31, 2009, the Company is obligated to paid the
full term of contract in the event of the officers' early termination. As at
December 31, 2004 the compensation obligation payable over the next four years
amounts to $3,183,445.
Pursuant to employment agreements with certain officers of the Company, the
Company is obligated to allot and issue 335,000 fully-paid shares and a cash
bonus of $16,600 once the Company's first commercial plant is successfully
commissioned.
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.
83
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
14. 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 notes 7 and 11, the
Company had the following transactions with related parties:
[a] Consulting fees and salaries of $3,053,332 for the year ended December 31,
2004 [years 2003 - $1,591,097; 2002 - $639,910] have been paid to
Directors (or companies controlled by Directors) of the Company. Included
in the amount above, is $2,288,556 [2003 - $1,233,418; 2002 - $447,789]
paid by stock based compensation [note 11(b)(i)].
[b] Consulting fees and share issue costs of $574,326 for the year ended
December 31, 2004 [years 2003 - $1,002,085; 2002 - $nil] have been paid to
a shareholder of the Company. Included in the amount above, is $513,958
[2003 - $1,002,085; 2002 - $nil] paid by stock based compensation [note
11(b)(i)].
[c] As at December 31, 2004, $136,370 [2003 - $32,673; 2002 - $nil] 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, 2004.
[d] In 2002, the Company entered into loan agreements with certain directors
totaling $182,254. The loans comprised $118,839, which was used to settle
amounts owing to certain directors and $63,415 which was received in cash.
The loans and accrued interest were converted in May 2003 into the
Company's common shares at 75% of the 10-day average of the Company's
market share price prior to conversion. A total of 818,418 warrants were
also granted to the lenders in connection with the loans [note 11(f)(6)].
The warrants have exercise prices ranging from $0.20 to $0.44, expire from
May 6, 2006 to December 23, 2006, and are outstanding at December 31,
2004. For the portion of the loans received in cash, interest was charged
at a rate of 1% per month and was included in the converted amount. The
remaining debt was non-interest bearing.
The carrying value of the loans was accreted up to its fair value over the
term to the date of conversion. For the year ended December 31, 2003,
$115,633 of accretion interest has been charged to the Consolidated
Statement of Loss.
84
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
14. RELATED PARTY TRANSACTIONS (cont'd.)
[e] During 2002, the Company entered into a loan agreement with related
parties for $200,000 cash, which was converted in 2002 into the Company's
common shares at 75% of the 10 day average of the Company's market share
price prior to conversion. A total of 300,000 warrants were granted to the
lenders in connection with the loans. The warrants have an exercise price
of $0.35 per common share and expire on June 10, 2005. Interest was
charged at a rate of 1% per month and was payable up to conversion. The
warrants are outstanding at December 31, 2004.
[f] On June 3, 2003 the Company entered into a loan agreement with an officer
of the Company for $50,000. The loan bore interest at 2% per month and had
a 12-month term. The loan agreement also calls for the Company to issue
500,000 warrants exercisable at $0.20 each for a period of five years as
part of the loan financings. In December 2003, the Company repaid the loan
and the lenders released the Company from the general security agreement.
15. LOSSES AND UNUSED DEDUCTIONS CARRIED FORWARD FOR INCOME TAX PURPOSES
As at December 31, 2004, the Company has loss carryforwards of approximately
$31,266,000 to apply against future taxable income in Canada ($28,154,000) and
the United Kingdom ($3,112,000) and $1,046,000 and $481,000 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
$ $ $
- -----------------------------------------------------------------------------------
2005 -- -- 2,799,000
2006 12,000 -- 2,643,000
2007 111,000 -- 4,593,000
2008 24,000 -- 5,214,000
2009 47,000 7,000 3,847,000
2010 162,000 91,000 2,610,000
2011 190,000 106,000 --
2012 53,000 29,000 --
2013 166,000 92,000 --
2014 281,000 156,000 6,448,000
- -----------------------------------------------------------------------------------
1,046,000 481,000 28,154,000
===================================================================================
85
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
15. LOSSES AND UNUSED DEDUCTIONS CARRIED FORWARD FOR INCOME TAX PURPOSES
(cont'd.)
In addition, the Company has scientific research and experimental development
expenditures of approximately $5,944,000 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, 2004 and December 31,
2003 are as follows:
2004 2003
$ $
- -----------------------------------------------------------------------------
Loss carryforwards 10,965,000 8,164,000
Research and development deductions and credits 3,102,000 2,588,000
Property, plant and equipment 1,056,000 208,000
Financing costs 514,000 380,000
- -----------------------------------------------------------------------------
Total future tax assets 15,637,000 11,340,000
Valuation allowance (15,637,000) (11,340,000)
- -----------------------------------------------------------------------------
Net future tax assets -- --
- -----------------------------------------------------------------------------
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 liability
method of tax allocation. Accordingly, no future tax assets have been
recognized as at December 31, 2004 and 2003 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 35.62%, 35.62% and 37.62% in 2004, 2003 and 2002,
respectively.
The Company's future tax assets include approximately $261,000 [2003 -
$136,000] 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.
86
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
16. SUPPLEMENTAL CASH FLOW INFORMATION
2004 2003 2002
Net change in non-cash working capital $ $ $
- ------------------------------------------------------------------------------
Accounts receivable (90,890) (38,399) 8,737
Inventory -- -- 10,043
Prepaid expenses and deposits (96,852) 10,566 136,434
Deferred revenue -- -- (51,981)
Accounts payable and
accrued liabilities 2,274,898 227,628 508,142
- ------------------------------------------------------------------------------
2,087,156 199,795 611,375
==============================================================================
Interest paid
Short-term interest paid 26,000 63,522 48,661
==============================================================================
For stock based non-cash investing and financing activities, see note 11 (i).
Also excluded from investing activities were $2,941,567 of additions to
property, plant and equipment which were accrued in accounts payable and
accrued liabilities and will be financed through capital leases.
17. GOVERNMENT ASSISTANCE
Government assistance received during the year ended December 31, 2004 in the
amount of $3,611,412 [2003 - $915,237; 2002 - $467,832] has been recorded as a
reduction of expenditures.
Government assistance applied to: 2004 2003 2002
$ $ $
- ------------------------------------------------------------------------------
Property, plant and equipment and other 2,829,117 422,176 127,144
Research and development 765,106 456,438 288,445
Other expenses 17,189 36,623 52,243
- ------------------------------------------------------------------------------
Total 3,611,412 915,237 467,832
==============================================================================
87
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
17. GOVERNMENT ASSISTANCE (cont'd.)
[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 $6.8 million (Cdn$ 8.2 million) or 37% of
eligible expenditures, as defined in the agreement. The Company has received
extensions to the original contribution agreement with TPC to March 31, 2006
while retaining the original cumulative maximum assistance level of $6.8
million. 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 $13.2 million (Cdn$ 16 million) or until the
expiration of contract on December 31, 2014. The Company has received $4.8
million (Cdn $5.7 million) under these agreements to date. In 2004, the
Company received approximately $800,000, of which, $10,740 was deducted from
patents and the remainder was used to reduce expenditures made during the
current year. As at December 31, 2004, $236,548 [2003 - $695,437] is included
in government grants receivable. In early 2002, subsequent to the original
amendment, the Company recovered $269,792 relating to eligible expenditures
made in 2001.
[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 $4.2
million (Cdn$5 million) to the capital cost of the Company's Erie Flooring 100
tonne per day BioOil co-generation project development. This amount will be a
grant and will be accounted for as a reduction in the capital cost of the
project. During 2004, the Company received payment of $2.8 million (Cdn$ 3.7
million) from SDTC.
[c] Other contribution agreements
The Company had contribution agreements with other Canadian governmental
agencies for a maximum contribution of $196,178 over the 2002 - 2004 period.
In the year ended December 31, 2004, the Company received $24,203 [2003 -
$73,709; 2002 - $98,266] under these agreements. Of these amounts, $nil is
included in government grants receivable as at December 31, 2004 [2003 -
$37,339; 2002 - $20,571].
In the year ended December 31, 2004, $24,203 [2003 - $73,709; 2002 - $98,266]
has been used to reduce expenditures made in the current year. A portion of
these funds, to a maximum of $41,501, are repayable under certain defined
terms of non-performance.
88
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
18. SEGMENTED INFORMATION
In 2004 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 BioTherm
technology. BioOil Power Generation is biomass-to-energy technology that
converts low value forest waste and agricultural by-products into BioOil for
use in power generation or other industrial energy purposes.
In prior years, the Company also had two other reportable segments: DynaPower
and Actuator. In 2002, the Company sold the operating assets of DynaPower to
the management of DynaPower and entered into a licensing arrangement for the
DynaPower intellectual property retained by the Company [note 12]. The
licensing agreement under the Actuator segment expired in 2002 and has not
been renewed.
Corporate includes other corporate related amounts that are not a separately
reportable segment.
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------------
Revenue
Actuator -- -- 47,419
DynaPower -- -- 18,480
BioOil Power Generation -- -- 2,580
Corporate -- -- 90
- -----------------------------------------------------------------------------------
-- -- 68,569
- -----------------------------------------------------------------------------------
Loss for the period from
continuing operations
Actuator -- -- 47,419
DynaPower -- -- (105,074)
BioOil Power Generation (9,916,215) (4,921,650) (856,475)
Corporate -- -- (3,452,324)
- -----------------------------------------------------------------------------------
(9,916,215) (4,921,650) (4,366,454)
- -----------------------------------------------------------------------------------
Capital expenditures, including patents
(net of government grants and disposal)
DynaPower -- -- --
BioOil Power Generation 8,982,857 1,497,398 182,637
Corporate 123,593 4,702 836
- -----------------------------------------------------------------------------------
9,106,450 1,502,100 183,473
- -----------------------------------------------------------------------------------
Amortization and depreciation
Actuator -- -- --
DynaPower -- -- --
BioOil Power Generation 55,317 90,373 197,005
Corporate 75,595 35,207 116,469
- -----------------------------------------------------------------------------------
130,912 125,580 313,474
- -----------------------------------------------------------------------------------
Total assets
BioOil Power Generation 12,472,935 3,211,780
Corporate 725,763 547,825
- ---------------------------------------------------------------------
13,198,698 3,759,605
- ---------------------------------------------------------------------
89
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
18. SEGMENTED INFORMATION (cont'd.)
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------------
Geographic information
Revenue
United States -- -- 47,419
Canada -- -- 21,060
Other -- -- 90
- -----------------------------------------------------------------------------------
-- -- 68,569
- -----------------------------------------------------------------------------------
Property, plant and equipment
United States 540 685
Canada 12,143,732 2,270,176
United Kingdom 9,880 22,561
- --------------------------------------------------------------------
12,154,152 2,293,422
===================================================================
For the year ended December 31, 2004 and 2003 the Company recorded no revenue.
For the year ended December 31, 2002, 69% and 10% of sales were from two
customers. As at December 31, 2004, there were no accounts receivable balances
relating to these customers [2003 - $nil].
19. PROJECT ADVANCE
In June 2003 the Company received $166,003, translated at the rate on the
balance sheet date, (C$200,000) from Ontario Power Generation Inc. ("OPG") as
an initial investment in a proposed Ontario based 100 TPD BioOil co-generation
project (the "Project"). The funds were used for pre-development work related
to the Project and are to be converted into a Project ownership interest or
Company equity upon the decision of whether or not to proceed with the
Project. The Project is now proceeding at the site of Erie Flooring in West
Lorne Ontario, but the Company has agreed with OPG that they may extend the
time until March 31, 2005 to decide whether to convert the Project Advance
into either a Project ownership interest or into Company equity based on then
current market value [note 21(b)].
90
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
20. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
The Company prepares the 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 U.S. GAAP, patent costs are amortized over the life of the patent
commencing with the date the patent is granted. Under Canadian GAAP,
patent costs are amortized over the life of the patent commencing with
commercial production.
[iii] 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.
Effective January 1, 2004, the Company adopted the Canadian GAAP fair-
value-based method for all stock-based awards granted on or after
January 1, 2004 and retroactively applied this method without
restatement. For US GAAP purposes, the Company continues to follow SFAS
No. 123.("SFAS 123") "Accounting for Stock Based Compensation" in
accounting for options granted to non-employees and Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" (APB 25) and related interpretations, in accounting for stock
options granted to officers, directors, and employees. Compensation
expense is calculated based on the difference, on the measurement date,
between the fair market value of the Company's stock and the exercise
price and is recorded over the vesting period of the options. During
2004, 315,813 [2003 - 1,595,456; 2002 - nil] fixed employee stock
options granted with exercise prices less than the market price of the
underlying stock on the date of the grant. For U.S. GAAP purposes, the
stock appreciation rights ("SA Rights") and performance-based stock
options are accounted for as a variable compensation plan under APB 25.
Compensation relating to variable plans is recorded in the
reconciliation when it becomes probable that the award will be earned.
Prior to January 1, 2002, the Company did not record stock-based
compensation for Canadian GAAP purposes and as such there was a
91
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
20. RECONCILIATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (cont'd.)
difference between Canadian and U.S. GAAP. For the years ended December
31, 2003 and 2002, the Company adopted the guidance under CICA Handbook
Section 3870 [note 3] which required that all stock-based awards made to
non-employees and direct awards of stock, stock appreciation rights and
awards that call for settlement in cash or ther assets that are
outstanding or granted for fiscal years beginning on or after January 1,
2002 are to be measured and recognized using a fair value based method.
For stock based awards granted to employees, the Company had previously
elected to use the intrinsic method as permitted under Canadian GAAP,
which is consistent with U.S. GAAP.
[iv] 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.
On December 16, 2004, the Financial Accounting Standards Board ("FASB")
issued ("SFAS") No. 123 (revised 2004), "Share-Based Payment." SFAS No.
123(R) requires the Company to measure all employee stock-based
compensation awards using a fair value method and record such expense in
its consolidated financial statements. In addition, SFAS No. 123(R)
requires additional accounting related to the income tax effects and
additional disclosure regarding the cash flow effects resulting from
share-based payment arrangements. For public entities that do not file
as a small business issuer, SFAS No. 123(R) is effective for annual
reporting periods of the registrant's first fiscal year beginning on or
after December 15, 2005.
92
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
20. 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.
2004 2003 2002
$ $ $
- -----------------------------------------------------------------------------------
Loss for the year, Canadian GAAP 9,916,215 4,984,681 5,261,607
Adjustment for stock based compensation (1,511,031) -- --
Adjust for patent write-down -- -- 2,862
- -----------------------------------------------------------------------------------
Loss for the year, U.S. GAAP 8,405,184 4,984,681 5,264,469
- -----------------------------------------------------------------------------------
Unrealized (gain)/losses on foreign currency
Translation (35,733) 146,363 24,321
- -----------------------------------------------------------------------------------
Comprehensive loss for the year, U.S. GAAP 8,369,451 5,131,044 5,288,790
- -----------------------------------------------------------------------------------
Weighted average number of common shares
Outstanding 80,979,299 56,617,490 45,104,978
- -----------------------------------------------------------------------------------
Basic and diluted loss per common share,
U.S. GAAP (0.10) (0.09) (0.12)
===================================================================================
The consolidated assets and liabilities under accounting principles generally
accepted in Canada are the same as the consolidated assets and liabilities
under the accounting principles generally accepted in the United States..
93
DynaMotive Energy Systems Corporation
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
December 31, 2004 (express in U.S. dollars)
21. SUBSEQUENT EVENTS
[a] As described in note 11(c), during the first 3 months of 2005, the Company
issued 9,453,721 common shares for total proceeds of $3,734,881, inclusive
of $1,636,408 received as at December 31, 2004 relating to a private
placement commencing during second quarter of 2004.
[b] The Company received notice from Ontario Power Generation Inc. that it
wishes to convert its project advance of $166,003 (C$200,000) into common
shares of the Company (see also note 19).
22. COMPARATIVE FIGURES
Certain comparative figures have been reclassified in order to conform with
the presentation adopted in the current year.
94
Item 18. Financial Statements
Not applicable.
Item 19. Exhibits
Exhibit Exhibit Description
3.1(a) Company Act 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.)
3.1(b) Amendment to the Company act 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.)
3.2 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.)
3.3 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
4.1 Sustainable Development Technology Canada
Contribution Agreement dated as of March 5,
2004 (filed on Form 20-F on June 1, 2004).
4.2 Modification No. M1 to the Sustainable
Development Technology Canada Contribution
Agreement dated as of April 6, 2004 (filed
on Form 20-F on June 1, 2004).
4.3 Loan Agreement between Memorial Gift Trust,
James Acheson and the Company dated June 3,
2003 (filed on Form 20-F on June 1, 2004).
4.4 Technology Partnerships Canada Agreement
dated July 29, 1997 including amendments
dated February 2, 1998 to August 29, 2003
(filed on Form 20-F on June 1, 2004).
4.5 Amendment to the Technology Partnerships
Canada Agreement dated November 23, 2004.
4.6 Consortium Master Agreement dated February
11, 2004
4.7 Alliance Agreement with UMA Engineering Ltd.
dated January 29, 2004.
4.8 Loan Agreement between Environmental
Engineering & Consultants Limited and the
Company dated November 3, 2004.
95
4.9 Settlement Agreement between Magellan
Aerospace Limited, West Lorne BioOil Co-
Generation LP and the Company dated December
10, 2004.
10.21 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.)
10.28 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.)
12.1 Certification of chief executive officer
12.2 Certification of chief financial officer
13.1 Certification of chief executive officer and
chief financial officer - Section 906 of the
Sarbanes-Oxley Act of 2002
- ----------------------------------------------------------------------
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: May 30, 2005
By: /s/ R. Andrew Kingston
-------------------------------------
R. Andrew Kingston
President and Chief Executive Officer
By: /s/ Brian Richardson
-------------------------------------
Brian Richardson
Chief Financial Officer
96