As filed with the Securities and Exchange Commission on November 15, 2004
File no. 333-119493
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT No.2
To
FORM SB-2
REGISTRATION STATEMENT
UNDER THE
SECURITIES ACT OF 1933
McKENZIE BAY INTERNATIONAL, LTD.
(Name of small business issuer in its charter)
Delaware 4911
(State or jurisdiction of (Primary Standard Industrial
incorporation or organization) Classification Code Number)
51-0386871
(I.R.S. Employer
Identification No.)
975 Spaulding Avenue SE, Grand Rapids, Michigan, 49546 (616) 940-3800
(Address and telephone number of principal
executive offices and principal place of business)
Gregory N. Bakeman
975 Spaulding Avenue SE
Grand Rapids, Michigan 49546
(616) 940-3800
(name, address and telephone number of agent for service)
Copies to:
Jonathan B. Reisman, Esq.
Reisman & Associates, P.A.
6975 NW 62nd Terrace
Parkland, Florida 33067
Telecopier No.: (928) 569-8195
Approximate Date of Commencement of Proposed Sale To The Public: As soon as
practicable after this Registration Statement becomes effective.
If this Form is filed to register additional securities for an offering pursuant
to 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
The registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
Subject to completion, dated *_______* ,
2004
Prospectus
McKENZIE BAY INTERNATIONAL, LTD.
25,343,244 shares of Common Stock
This prospectus relates to an offering of up to (a) 20,239,968 shares of our
common stock by Cornell Capital Partners, LP ("Cornell Capital Partners") issued
and which may be issued by us to Cornell Capital Partners under a Standby Equity
Distribution Agreement, (b) 2,004,444 shares by Spencer Clarke LLC, ("Spencer
Clarke") of which up to 2,000,000 shares may be acquired by Spencer Clarke upon
exercise of warrants which we may issue to it, (c) 1,413,532 shares of our
common stock underlying convertible promissory notes issued by us, (d) 1,620,300
shares which may be acquired upon exercise of warrants we issued in connection
with the promissory notes, and (e) 65,000 shares to be issued to a creditor.
Until such time, as any, as our shares are listed on the over-the counter
Bulletin Board, the public offering price of the selling stockholders will be
$1.50 per share,
Under the Standby Equity Distribution Agreement, subject to the conditions
described later in this prospectus, Cornell Capital Partners has agreed to
purchase shares of our common stock from us for up to $15 million. Cornell
Capital Partners is not obligated to purchase any of our shares unless at the
time of purchase our shares shall have been authorized for quotation on the
Nasdaq National Market, the Nasdaq SmallCap Market, the American Stock Exchange,
the OTC Bulletin Board or the New York Stock Exchange, whichever is at the time
the principal trading exchange or market for the shares or to the extent that
Cornell Capital Partner's holdings would exceed 9.9% of our then outstanding
common stock. There are certain other conditions to the obligation of Cornell
Capital Partners to purchase our shares. See "The Standby Equity Distribution
Agreement."
Under the agreement, we, at our sole discretion, can require Cornell Capital
Partners to purchase our shares line from time to time over a period of twenty-
four months after the effective date of date of our registration statement of
which this prospectus is a part or until Cornell Capital Partners purchases
shares from us having an aggregate purchase price of $15 million, whichever
comes first. at a price per share of 99% of, which amounts to a 1% discount
from, the lowest volume weighted average price of our common stock as quoted by
Bloomberg, LP during the five consecutive trading day period immediately
following the respective dates we give notice to Cornell Capital Partners of our
intention to sell shares to Cornell Capital Partners. Based upon the number of
shares actually purchased by Cornell Capital Partners, under the assumptions
described and explained elsewhere in this prospectus the effective discount from
such computed price could be as high as 18.48%. If the actual number of shares
purchased are less than the number utilized in the assumptions, the effective
discount could be substantially higher. For example, although highly unlikely,
if we sell only 1 million shares to Cornell Capital Partners, the effective
discount would be approximately 32%.
Because we have also agreed to allow Cornell Capital Partners to retain 5% of
the proceeds from our sale of shares to Cornell Capital Partners, the net cash
price to be paid by Cornell Capital Partners to us will be 94% of the computed
lowest volume weighted average price with respect to each purchase. We have
also agreed to issue to Cornell Capital Partners shares of our common stock
having a market value, similarly determined, of $540,000 as a commitment fee for
the Standby Equity Distribution Agreement which we will satisfy through the
issuance of 239,968 shares, 119,984 of which were issued to Cornell Capital
Partners on April 6, 2004. The issuance of the shares effectively reduces the
per share price we receive from Cornell Capital Partners. We have entered into a
Placement Agent Agreement with Spencer Clarke under which Spencer Clarke agreed
to review the terms of the Standby Equity Distribution Agreement and advise us
with respect to the terms. Spencer Clarke's fee for these services was $10,000
which we satisfied by the issuance to Spencer Clarke of 4,444 shares of our
common stock. We will also pay Spencer Clarke for its services as a placement
agent in introducing us to Cornell Capital Partners an amount equal to 10% of
the gross proceeds of each purchase of our shares by Cornell Capital Partners
under the Standby Equity Distribution Agreement of which we have paid $25,000
and the balance will be paid at the time or times that Cornell Capital Partners
purchases shares from us. We will also issue to Spencer Clarke warrants to
purchase shares of our common stock in an amount equal to 10% of the number of
shares sold to Cornell Capital Partners. Although the exercise price of the
warrants has not yet been determined, it will not be less than the weighted
average price computed as described above.
After giving effect to the 10% fee payable to Spencer Clarke, the net cash price
we will retain on purchases by Cornell Capital Partners, without regard to the
additional issuances of shares and warrants to Cornell Capital Partners and
Spencer Clarke, will be 84% of the computed lowest volume weighted average price
with respect to each purchase.
There is no cap on the number of shares that can be issued under the Standby
Equity Distribution Agreement. Based upon our current capital needs and the
market price of our common stock, we presently have no intention of drawing
down the entire $15 million amount. Accordingly, our estimate of the number of
shares that we will issue pursuant to the equity line is 10 million shares. If
our circumstances change and we have no other source of financing, we may
ultimately have to draw down the entire $15 million assuming that we will then
be in a position to satisfy all of the relevant conditions.
There is a large number of shares of common stock underlying the Standby Equity
Distribution Agreement that will be available for future sale and the sale of
these shares will cause dilution to our existing shareholders. The resale of
such shares can be expected to depress the market price of our shares.
In connection with the issuance of the promissory notes and warrants described
above, we paid a commission to Spencer Clarke of $109,375.
We are not selling any securities in this offering and therefore will not
receive any proceeds from this offering. As more fully described in this
prospectus however, we will receive proceeds from any sale of common stock under
the Standby Equity Distribution Agreement and upon any exercise of the warrants.
Subsequent to the time, if any, that are shares are listed on the over-the
counter Bulletin Board, the selling stockholders may sell their shares in one or
more transactions on the over-the-counter market, in negotiated transactions, or
through a combination of those methods of distribution, at prices related to
prevailing market prices or at negotiated prices.
Each of the selling stockholders may be deemed to be an "underwriter" as that
term is defined in the Securities Act of 1933.
AN INVESTMENT IN THE SHARES INVOLVES SUBSTANTIAL RISKS AND IS HIGHLY
SPECULATIVE. SEE "RISK FACTORS" BEGINNING ON PAGE 15 OF THIS PROSPECTUS.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE
SELLING STOCKHOLDERS MAY NOT PUBLICLY SELL THE SECURITIES INCLUDED IN THIS
PROSPECTUS UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL ANY
SECURITIES BY THE SELLING STOCKHOLDERS AND THE SELLING STOCKHOLDERS ARE NOT
SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE
IS NOT PERMITTED.
The date of this prospectus is 2004.
IN MAKING A DECISION WHETHER TO BUY OUR COMMON STOCK, YOU SHOULD ONLY RELY ON
THE INFORMATION CONTAINED IN THIS PROSPECTUS. THE INFORMATION IN THIS PROSPECTUS
MAY ONLY BE ACCURATE ON THE DATE OF THIS PROSPECTUS.
TABLE OF CONTENTS
PROSPECTUS SUMMARY............................................................10
Our proposed business........................................................10
Corporate information........................................................11
The offering by the Selling Stockholders.....................................11
Summary Financial Information................................................14
RISK FACTORS..................................................................15
FORWARD LOOKING STATEMENTS....................................................22
USE OF PROCEEDS...............................................................22
MANAGEMENT'S PLAN OF OPERATION................................................24
WindStor.....................................................................24
Lac Dore Mining Inc..........................................................26
Cash Requirements for 2004 Fiscal Year Administrative Costs..................27
Additional Employees.........................................................27
Revenues.....................................................................28
Expenses.....................................................................28
Net Loss.....................................................................28
Liquidity and Capital Resources..............................................29
Off-balance sheet arrangements...............................................29
<page>3
PROPOSED BUSINESS.............................................................29
Background...................................................................29
Wind Powered Alternative Energy Systems......................................30
Acquisition of Dermond Inc...................................................30
Wind Turbine Technology......................................................30
Potential Wind Turbine Markets...............................................32
Off-Grid (Islands & Remote Access)...........................................32
Urban User Market............................................................33
Proposed Products............................................................33
Production...................................................................35
Marketing....................................................................35
Competition..................................................................35
Intellectual Property........................................................37
Research and Development.....................................................38
Regulation...................................................................39
Extraction and Refining of Vanadium..........................................43
Acquisition of Lac Dore Mining Inc...........................................43
Properties and Uses of Vanadium..............................................44
Vanadium Supply..............................................................45
Lac Dore Deposit Preliminary Feasibility Study...............................45
Competition..................................................................46
Exploration and commercialization............................................47
Governmental and Environmental Regulations...................................47
Employees....................................................................49
Properties...................................................................49
Offices......................................................................52
<page>4
MANAGEMENT....................................................................52
Executive Officers, Directors and Significant Employees......................52
Executive Compensation.......................................................56
Summary Compensation Table...................................................56
Option Grants Table..........................................................57
Aggregated Option Exercises in Last Fiscal
Year and Fiscal Year-End Option Values.......................................58
Long-Term Incentive Plans - Awards in Last Fiscal Year.......................58
Compensation of Directors....................................................58
Employment Contracts and Termination of Employment
and Change in Control Arrangements...........................................59
Equity Securities Authorized for Issuance
With Respect to Compensation Plans...........................................61
THE STANDBY EQUITY DISTRIBUTION AGREEMENT.....................................62
Summary......................................................................62
Certain Terms of the Standby Equity Distribution Agreement Explained.........64
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................68
MARKET FOR COMMON EQUITY AND CERTAIN RELATED STOCKHOLDER MATTERS..............71
DESCRIPTION OF COMMON STOCK...................................................71
CERTAIN TRANSACTIONS..........................................................72
SHARES ELIGIBLE FOR FUTURE SALE...............................................73
THE SELLING STOCKHOLDERS......................................................74
<page>5
PLAN OF DISTRIBUTION..........................................................77
INDEMNIFICATION...............................................................78
LEGALITY OF SHARES............................................................78
CHANGES IN ACCOUNTANTS........................................................78
LEGAL PROCEEDINGS.............................................................79
EXPERTS.......................................................................79
ADDITIONAL INFORMATION........................................................80
FINANCIAL STATEMENTS.........................................................F-1
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY US. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE WILL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN OUR AFFAIRS SINCE THE
DATE OF THIS PROSPECTUS OR THAT THE INFORMATION CONTAINED IN THIS PROSPECTUS IS
CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES
OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
PROSPECTUS SUMMARY
This summary may not contain all the information you should consider before
investing in our shares. You should read the entire prospectus carefully before
making an investment decision. In this prospectus, unless the context otherwise
requires, references to "we" "us" and "our" refer to McKenzie Bay International,
Ltd., a Delaware corporation.
Our proposed business
We intend to concentrate our efforts on the development and sale of wind powered
alternative energy systems. The systems are designed to utilize vertical axis
wind turbines which we refer to as Dermond Wind Turbine or DWT and an energy
system which is intended to integrate and manage DWTs and other electricity
generating sources with an energy storage device which we refer to as
"WindStor." Our products are presently in the design stage. We have recently
installed a prototype DWT, although no meaningful testing has yet been
accomplished. No other prototypes of our products have been built.
We believe that vertical axis wind turbines have the potential to provide
building owners, real estate developers, property managers and other users in
urban locations a means to reduce the overall cost of electricity.
<page>6
We further believe that vertical axis wind turbines may provide a cost-effective
and efficient alternative power supply in commercial buildings, schools,
multistory residential dwellings, light industrial businesses and off-grid
areas. In addition, we believe that vertical axis wind turbines may also be
suitable for peak shaving and load leveling applications. We also believe that
WindStor can provide a higher quality, lower cost and environmentally friendly
alternative electricity source than is presently available for off-grid
electricity users dependent upon diesel and gasoline generators.
Because, both DWT and WindStor are presently in the design and development
stage, there can be no assurance that the technology will work as expected or
that they will perform to the extent that we anticipate or will be commercially
viable.
Although we have claims to a vanadium/titanium deposit in Chibougamau, Quebec
which we refer to as the Lac Dore deposit, except for expenditures on
preliminary exploration and our vanadium refining technology, we believe that it
is highly unlikely that, at least in the foreseeable future, we will receive the
requisite amount of at least $330 million to engage in any material activities
in connection with the deposit. Accordingly, we have deferred our plans to
engage in those activities and, unless the context otherwise requires, the
discussion of our proposed business and related risks in this prospectus relate
solely to the development and sale of wind powered alternative energy systems.
We do not have the capital to further fund or develop any of our proposed
business activities. We are in a developmental stage with respect to wind
powered alternative energy systems and were in the preliminary evaluation part
of the exploration stage with respect to the vanadium deposit. We have never
realized any meaningful revenues. As stated in the notes to our consolidated
financial statements, because we have suffered recurring losses and a have a
deficiency in assets and working capital, there is substantial doubt about our
ability to continue as a going concern. Our former auditors have included that
statement in their report dated December 23, 2003 (April 6, 2004 as to note 17).
Corporate information
We were incorporated in Delaware on August 17, 1998. Our principal office is
located at 975 Spaulding Avenue SE, Grand Rapids, Michigan 49546 and our
telephone number is (616) 940-3800. The information contained in, or that can be
accessed through, our website is not part of this prospectus.
The offering by the Selling Stockholders
This prospectus relates to an offering of up to (a) 20,239,968 shares of our
common stock by Cornell Capital Partners, LP, issued and which may be issued by
us to Cornell Capital Partners under a Standby Equity Distribution Agreement,
(b) 2,004,444 shares by Spencer Clarke LLC of which up to 2,000,000 shares of
which may be acquired by Spencer Clarke upon exercise of warrants which we may
issue to it, (c) 1,413,532 shares which may be acquired upon conversion of
promissory notes we issued in August and September 2004, (d) 1,620,300 shares
which may be acquired upon exercise of warrants we issued in connection with the
promissory notes, and (e) 65,000 shares to be issued to a creditor.
<page>7
We have entered into a Standby Equity Distribution Agreement with Cornell
Capital Partners which provides that, we may, at our discretion, periodically
issue and sell to Cornell Capital Partners shares of our common stock for a
total purchase price of $15 million. The maximum amount of each sale is
$625,000, and we may not notify Cornell Capital Partners of any sale to be made
by us to Cornell Capital Partners within seven trading days of a prior such
notice. Cornell Capital Partners has agreed to pay us an amount per share of
99% of, which amounts to a 1% discount on, the lowest volume weighted average
price of our common stock as quoted by Bloomberg, LP during the five consecutive
trading day period immediately following the respective dates we give notice to
Cornell Capital Partners of our intention to sell shares to Cornell Capital
Partners under the Standby Equity Distribution Agreement. Because we have also
agreed to allow Cornell Capital Partners to retain 5% of the proceeds from our
sale of shares to Cornell Capital Partners, the net cash price to be paid by
Cornell Capital Partners to us will be 94% of the computed lowest volume
weighted average price with respect to each purchase. We have also agreed to
issue to Cornell Capital Partners shares of our common stock having a market
value, similarly determined, of $540,000 which we will satisfy by the issuance
of 239,968 shares, 119,984 of which were issued on April 6, 2004. The issuance
of the shares effectively reduces the per share price we receive from Cornell
Capital Partners. See "The Standby Equity Distribution Agreement."
We will also pay Spencer Clarke for its services as a placement agent in
introducing us to Cornell Capital Partners an amount equal to 10% of the gross
proceeds of each purchase of our shares by Cornell Capital Partners under the
Standby Equity Distribution Agreement of which we have paid $25,000 and the
balance will be paid at the time or times that Cornell Capital Partners
purchases shares from us. We will also issue to Spencer Clarke warrants to
purchase shares of our common stock in an amount equal to 10% of the number of
shares sold to Cornell Capital Partners. Although the exercise price of the
warrants has not yet been determined, it will not be less than the weighted
average price computed as described above. After giving effect to the 10% fee
payable to Spencer Clarke, the net cash price we will retain on purchases by
Cornell Capital Partners, without regard to the additional issuances of shares
and warrants to Cornell Capital Partners and Spencer Clarke, will be 84% of the
computed lowest volume weighted average price with respect to each purchase.
Based upon the number of shares actually purchased by Cornell Capital Partners,
under the assumptions described and explained elsewhere in this prospectus the
effective discount from such computed price could be as high as 18.48%. If the
actual number of shares purchased are less than the number utilized in the
assumptions, the effective discount could be substantially higher. For example,
although highly unlikely, if we sell only 1 million shares to Cornell Capital
Partners, the effective discount would be approximately 32%.
There is no cap on the number of shares that can be issued under the Standby
Equity Distribution Agreement. Based upon our current capital needs and the
market price of our common stock, we presently have no intention of drawing
down the entire $15 million amount. Accordingly, our estimate of the number of
shares that we will issue pursuant to the equity line is 10 million shares. If
our circumstances change and we have no other source of financing, we may
ultimately have to draw down the entire $15 million assuming that we will then
be in a position to satisfy all of the relevant conditions.
There is a large number of shares of common stock underlying the Standby
Equity Distribution Agreement that will be available for future sale and the
sale of these shares will cause dilution to our existing shareholders. The
resale of such shares can be expected to depress the market price of our shares.
We are not selling any securities in this offering and therefore will not
receive any proceeds from the sale by the selling stockholders. As more fully
described in this prospectus however, we expect to receive proceeds from the
sale of common stock to Cornell Capital Partners under the Standby Equity
Distribution Agreement and upon exercise of the warrants referred to above.
<page>8
The terms of the Standby Equity Distribution Agreement, the effective price we
will receive and our arrangements with Spencer Clarke are more fully described
below in this prospectus.
Common Stock to be offered by the selling stockholders 25,343,244 shares (1)(2)
Common Stock outstanding before the offering 26,408,255 shares (2)
Common Stock outstanding after the offering 51,751,499 shares (3)
Initial Public offering price of the selling stockholders $1.50 per share
Proceeds We will not receive any
proceeds from the sale
of the shares by the
selling stockholders.
Any proceeds we receive
from the sale of shares
to Cornell Capital
Partners under the
Standby Equity
Distribution
Agreement, and Spencer
Clarke and the holders
of our Convertible
promissory notes
upon exercise
of warrants, will be
used as descried under
the caption "Use of
Proceeds" in this
prospectus.
Risk Factors The securities offered
by this prospectus
involve a high degree
of risk. See
"Risk Factors."
(1) Represents the number of shares that we have registered with the SEC in our
registration statement of which this prospectus is a part. The number of
shares that we may actually sell to Cornell Capital Partners depends upon,
among other things, the prevailing market prices at the times of the sales.
If the number of shares we have registered with the SEC becomes
insufficient, we may register additional shares.
(2) Does not include 16,164,414 shares which may be issued upon exercise of
presently outstanding warrants and options.
(3) Includes (a) 119,984 shares to be issued to Cornell Capital Partners as of
the date of this prospectus, (b) 20,000,000 shares which we may sell to
Cornell Capital Partners under the Standby Equity Distribution Agreement,
(c) 4,444 shares to be issued to Spencer Clarke as of the date of this
prospectus, (d) 2,000,000 shares which we may sell to Spencer Clarke upon
exercise of warrants. (e) 1,413,532 shares that we may issue upon conversion
of outstanding promissory notes, and (f) 1,630,000 shares which we may issue
upon exercise of warrants issued in connection with the promissory notes.
<page>8
Summary Financial Information
The following table summarizes our statements of loss and balance sheet data for
and as of the periods indicated. The summary should be read in conjunction with
Management's Plan of Operation and our financial statements and notes thereto
included elsewhere in this prospectus. The amounts for the fiscal years ended
September 30, 2002 and 2003 have been derived from our audited financial
statements.
<table>
<s> <c> <c> <c>
Nine months ended Fiscal Year ended From inception
June 30, September 30, to June 30,
2003 2004 2003 2002 2004
(unaudited) (unaudited) (unaudited)
------------- ------------- ------------- ------------ ---------------
Revenues $ - $ - $ - $ 12,825 $ 12,825
Loss before cumulative
effect of change
in accounting principle
for SFAS 142 $ (2,337,497) $(2,929,964) $(3,545,420) $(5,970,574) $(20,569,270)
Net loss $ (2,337,497) $(3,076,936) $(3,692,392) $(5,970,574) $(20,716,242)
------------- ------------ -------------- ---------- ---------------
Net loss attributable to
stockholders $ (2,337,497) $(3,076,936) $(3,692,392) $(5,970,574) $(20,716,242)
============= ============ ============== ============ ===============
Basic and diluted net loss
per share $(0.09) $(0.13) $(0.15) $(0.29)
========== ============ ============ ===========
Weighted average shares
outstanding used in
basic and diluted net
loss per share
calculations 25,691,524 23,916,382 24,186,803 20,940,128
============= ============ =========== ==========
June 30, 2004
Balance Sheet Data (unaudited)
--------------
Cash $ 47,571
Working capital (deficiency) $(1,853,196)
Total assets $888,407
Total liabilities $ 3,599,465
Total stockholders' capital deficiency $(2,711,058)
</table>
<page>9
RISK FACTORS
An investment in our common stock involves substantial risks. You should
consider carefully the following information about these risks, together with
the financial and other information, including risks, contained elsewhere in
this prospectus, before you decide whether to buy our common stock. If any of
the described events actually occur, our business, financial condition and
results of operations would likely suffer and the market price, if any, of our
common stock would decline. In such case, you may lose all or part of your
investment.
BECAUSE WE HAVE NO OPERATING HISTORY, THERE IS NO BASIS ON WHICH YOU CAN
EVALUATE OUR PROPOSED BUSINESS AND PROSPECTS. Prospective investors customarily
consider a company's operating history as a factor in determining whether to
make an investment. Prospective investors who decide to purchase our shares may
have decided not to purchase the shares if they had an operating history to
review.
WE HAVE HAD LOSSES SINCE INCEPTION AND EXPECT LOSSES TO CONTINUE FOR THE
FORESEEABLE FUTURE. We incurred net losses of $3,692,392, $5,970,574 and
$4,933,244 during the fiscal years ended September 30, 2003, 2002 and 2001,
respectively. We incurred net losses of $2,337,497 and $3,076,936 during the
nine month periods ended June 30, 2004 and 2003, respectively. Since our
inception through June 30, 2004, we have incurred aggregate net losses of
$20,716,242. Any future operations may not be sufficient to generate the
revenues necessary to reach profitability.
UNLESS WE OBTAIN ADDITIONAL CAPITAL, WE WILL NOT BE ABLE TO PAY OUR AUDITORS TO
CONDUCT THE AUDIT FOR OUR FISCAL YEAR ENDED SEPTEMBER 30, 2004. If the audit is
not completed, we will be unable to file our Annual Report with the SEC. The
timely filing of the Annual Report is one of the conditions to the obligation of
Cornell Capital Partners to purchase our shares under the Standby Equity
Distribution Agreement. In addition, if we fail to timely file the Annual
Report, we will have violated the reporting requirements of the Securities
Exchange Act of 1934.
BECAUSE OF OUR LIMITED CAPITAL, UNLESS WE OBTAIN SUBSTANTIAL ADDITIONAL CAPITAL
WE MAY NOT HAVE SUFFICIENT CAPITAL TO ENGAGE IN OUR PROPOSED BUSINESS
ACTIVITIES. On June 30, 2004, we had current assets of $472,020 and current
liabilities of $2,325,216. We do not have adequate capital to further fund,
develop or explore our proposed business activities.
There can be no assurance that Cornell Capital Partners will comply or that we
will be able to comply with the terms or satisfy the conditions of the Standby
Equity Distribution Agreement or that the conditions to Cornell Capital
Partner's obligations will be satisfied. Furthermore there can be no assurance
that Cornell Capital Partners will have the financial resources to comply with
the Agreement. Furthermore, Cornell Capital Partners is not obligated to
purchase any shares from us to the extent that its holdings would exceed 9.9% of
our then outstanding common stock. Even if Cornell Capital Partners does
purchase the full amount of shares from us under the Standby Equity Distribution
Agreement and Spencer Clarke exercises all of the warrants that we may issue to
it, we will still require substantial additional capital to implement our
business plan.
<page>10
There can be no assurance that the holders of convertible promissory notes
aggregating approximately $1,100,000 will convert the shares. See Note 11 of
Notes to Condensed Interim Consolidated Financial Statements.
In order for us to begin to engage in continuous improvement and marketing of
DWTs and WindStor energy systems, we will require additional capital of
approximately $7 million. In order for us to engage in any material activities
in connection with the Lac Dore deposit, we will require additional capital of
at least $330 million. There can be no assurance that our preliminary estimate
is not too low.
Neither we nor our subsidiaries will be able to continue development,
exploratory or administrative functions for more than a few months unless
substantial additional funding from Cornell Capital Partners or otherwise
becomes available. There can be no assurance we will obtain adequate funding, if
any, or that the terms of any such funding will not be unfavorable to us. Our
ability to engage in the business activities described below is dependant upon
our acquisition of significant funds.
BECAUSE OF OUR LIMITED CAPITAL, UNLESS WE OBTAIN SUBSTANTIAL ADDITIONAL CAPITAL
WE MAY NOT HAVE SUFFICIENT CAPITAL TO CONTINUE AS A GOING CONCERN. As stated in
the notes to our consolidated financial statements, because we have suffered
recurring losses and a have a deficiency in assets and working capital, there is
substantial doubt about our ability to continue as a going concern. Our former
auditors have included that statement in their report dated December 23, 2003
(April 6, 2004 as to note 17).
ALTHOUGH WE INTEND TO OBTAIN ADDITIONAL CAPITAL PRIMARILY THROUGH THE SALE OF
EQUITY SECURITIES TO BE ISSUED BY US, WE CANNOT ASSURE YOU THAT ADDITIONAL
FINANCING WILL BE AVAILABLE ON TERMS NOT UNFAVORABLE TO US, IF AT ALL. It is
difficult and very often impossible for development stage companies to obtain
adequate financing on any terms.
IF WE RAISE ADDITIONAL FUNDS THROUGH THE ISSUANCE OF OUR EQUITY SECURITIES, THE
PERCENTAGE OWNERSHIP OF OUR STOCKHOLDERS WILL BE REDUCED, WE MAY UNDERGO A
CHANGE IN CONTROL AND STOCKHOLDERS MAY EXPERIENCE DILUTION WHICH COULD
SUBSTANTIALLY DIMINISH THE VALUE OF THEIR COMMON STOCK. One of the factors which
generally affects the market price of publicly traded equity securities is the
number of shares outstanding in relationship to assets, net worth, earnings or
anticipated earnings and other financial items. If a public market is sustained
for our shares, a material amount of dilution can be expected to cause the
market price of our shares to decline. Furthermore, the public perception of
future dilution can have the same effect even if the actual dilution does not
occur.
WE MAY HAVE INCURRED SIGNIFICANT CONTINGENT LIABILITIES THROUGH OFFERS AND SALES
OF OUR EQUITY SECURITIES. Since September 30, 2003, we sold 1,088,297 shares of
our common stock for both cash and non cash consideration at prices ranging from
$0.82 to $2.50 per share. The weighted average price per share was $1.69. During
the same period, we sold convertible promissory notes, options and warrants
which permit the holders to obtain an aggregate of 3,356,756 shares of our
common stock at conversion or exercise prices ranging from $.75 to $3.00 per
share. If we did not comply with applicable securities laws in connection with
the offer and sale of securities during the period, as well as prior periods, we
could incur civil, administrative and criminal liabilities and we could be
required to refund the purchase price, plus interest.
<page>11
IF WE VIOLATED CERTAIN SECURITIES LAWS, WE MAY NOT NOW BE ABLE TO PRIVATELY
OFFER OUR EQUITY SECURITIES FOR SALE. Any offering of our equity securities in
or from the United States must be registered with the SEC or be exempt from
registration. If our prior offers and sales were not exempt from registration,
it is likely that they would be deemed integrated with future offerings unless
we do not offer equity securities for at least six months. In the event of such
integration, we would only be permitted to offer and sell equity securities
after we file a registration statement with the SEC and the registration
statement has become effective. The registration process is both expensive and
can be expected to take at least several months and would substantially hinder
our efforts to obtain funds.
BECAUSE OUR PROPRIETARY TECHNOLOGIES PROCESSES MAY PROVE INEFFECTIVE OR
UNFEASIBLE, WE ARE UNABLE TO DETERMINE IF OUR ENGINEERING AND TEST RESULTS CAN
BE DUPLICATED IN COMMERCIAL PRODUCTION. We intend to rely heavily on the success
of our proprietary technologies. We have conducted and plan to continue to
conduct limited laboratory and practical testing of the technologies. If our
proprietary technologies ultimately prove ineffective or unfeasible, we may not
be able to engage in commercial production of our products or we may become
liable to our customers in amounts that we will be unable to sustain.
WE HAVE NOT BEEN ISSUED ANY PATENTS AND WILL NOT FILE FOR PATENTS ON CERTAIN
CAPABILITIES AND PROCESSES THAT WE CONSIDER INTELLECTUAL PROPERTY. IN THE
ABSENCE OF PATENT PROTECTION, SIMILAR TECHNOLOGY COULD BE DEVELOPED
INDEPENDENTLY BY A THIRD PARTY WHICH COULD MATERIALLY HARM US. Alternatively, if
we successfully establish a commercially viable position in any market, third
parties may independently develop similar technology which could undercut our
market position, particularly if the third party has greater experience and
resources than we do. In addition, any measures that we may take to protect our
technology may prove inadequate, which could result in the eventual use of our
proprietary technology by competitors.
IF OUR PROPRIETARY TECHNOLOGIES ARE SUCCESSFUL, CURRENT AND NEW COMPETITORS
COULD ENTER THE MARKET(S) WHICH WOULD MATERIALLY DIMINISH THE VALUE OF OUR
TECHNOLOGIES. Any success of our technologies can be expected to generate
greater interest, which would likely lead to increased competition. Increased
competition would lessen the benefits we may derive from our proprietary
processes. If other products enter the marketplace that are technologically
superior to our products, the then value, if any, of our products will be
diminished.
IF WE FAIL TO OBTAIN NEEDED GOVERNMENTAL APPROVALS OR ENCOUNTER SIGNIFICANT
DELAYS IN OBTAINING OR RENEWING GOVERNMENTAL PERMITS OR APPROVALS, WE MAY NOT BE
ABLE TO ENGAGE IN OUR PROPOSED BUSINESS ACTIVITIES. Obtaining necessary permits
and approvals could be a complex and time-consuming process involving numerous
local, state, provincial and federal agencies. The duration and success of each
permit and/or approval effort may be contingent on many variables not within our
control, such as new permit requirements or a change in governmental policy or
government leadership. There can be no assurance that governmental permits
and/or approvals will be issued and/or retained or be issued without conditions
that could materially harm our business operations.
<page>12
Compliance with laws and regulations may require significant capital outlays or
delays, which may negatively affect operations or may cause material changes or
delays in our intended operations. Further, new or different standards
(environmental or otherwise) imposed by governmental authorities in the future
could materially harm our business operations.
In addition, governmental regulations may negatively impact us indirectly. For
instance, wind turbine site locations and products using high-purity vanadium
may become subject to new regulations. These regulations may curb the market
appeal for our products if the regulations make the purchase or use of such
products so expensive or complex that other products gain a competitive
advantage because they are not subject to such regulatory constraints and are
therefore less expensive or less burdensome to purchase or use. We are not able
to predict whether new governmental regulations will arise and, if so, what form
these regulations will take.
BECAUSE WE HAVE ONLY ENGAGED IN THE PRELIMINARY EVALUATION PART OF THE
EXPLORATION STAGE FOR THE LAC DORE DEPOSIT, THERE CAN BE NO ASSURANCE THAT A
COMMERCIALLY VIABLE MINERAL DEPOSIT EXISTS ON ANY OR ALL OF THE PROPERTY.
Further exploration, for which we do not have the funds, will be required before
a final evaluation as to the economic and legal feasibility of the deposit is
determined. Furthermore, if we ever make the determination, there can be no
assurance that it will be accurate.
OUR COMMON STOCK MAY BE ADVERSELY AFFECTED BY LIMITED TRADING VOLUME AND THE
MARKET PRICE MAY FLUCTUATE SIGNIFICANTLY, WHICH MAY NEGATIVELY AFFECT OUR
STOCKHOLDERS' ABILITY TO SELL THEIR SHARES. Prior to this offering, there has
been a limited public market for our common stock and there can be no assurance
that an active trading market will develop or be sustained. An absence of an
active trading market can be expected to adversely affect our stockholders'
ability to sell their shares. Our common stock has experienced, and is likely to
experience in the future, significant price and volume fluctuations, which could
adversely affect the market price without regard to our operating performance.
In addition, we believe that factors such as quarterly fluctuations in our
financial results and changes in the overall economy or the condition of the
financial markets could cause the price of our common stock to fluctuate
substantially. These fluctuations may also cause short sellers to enter the
market from time to time in the belief that our share price will decline. We
cannot predict whether the market for our shares will be stable or appreciate
over time.
BECAUSE OUR COMMON STOCK IS CONSIDERED TO BE A "PENNY STOCK," OUR STOCKHOLDERS'
ABILITY TO SELL THEIR SHARES IN A PUBLIC MARKET MAY BE SIGNIFICANTLY IMPAIRED BY
THE SEC'S PENNY STOCK RULES. The penny stock rules require a broker-dealer,
prior to a transaction in a penny stock not otherwise exempt from the rules, to
deliver a standardized risk disclosure document that provides information about
penny stocks and the risks in the penny stock market. The broker-dealer also
must 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 prior to a transaction in a penny stock the broker-dealer
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 or
becomes subject to the penny stock rules. In addition the burdens imposed upon
broker dealers by the penny stock rules may discourage broker dealers from
effecting transactions in our common stock, which could severely limit its
liquidity.
<page>13
BECAUSE OF THE CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK BY A SMALL NUMBER
OF STOCKHOLDERS, IT IS UNLIKELY THAT ANY OTHER HOLDER OF COMMON STOCK WILL BE
ABLE TO AFFECT OUR MANAGEMENT OR DIRECTION. On November 15, 2004, our directors,
officers and certain of their affiliates were deemed to beneficially own
approximately 58% of our outstanding common stock. Accordingly, if these
stockholders act together as a group, they would most likely be able to control
the outcome of stockholder votes, including votes concerning the election of
directors, the adoption or amendment of provisions in our certificate of
incorporation and bylaws and the approval of significant corporate transactions.
The existence of ownership concentrated in a few persons may have the effect of
delaying or preventing a change in management or voting control. Furthermore,
the interests of our controlling stockholders could conflict with those of our
other stockholders.
BECAUSE CERTAIN STOCKHOLDERS HAVE THE RIGHT TO REQUIRE US TO REPURCHASE THEIR
SHARES IN THE AGGREGATE AMOUNT OF APPROXIMATELY $92,000, OUR FINANCIAL POSITION
COULD BE MATERIALLY, ADVERSELY AFFECTED. The existence of the repurchase rights
may, among other things, also impair our ability to obtain funds.
BECAUSE NONE OF OUR OFFICERS HAS HAD ANY PRIOR EXPERIENCE IN OUR PROPOSED
BUSINESS ACTIVITIES, THEIR JUDGMENT AS IT RELATES TO THOSE ACTIVITIES MAY NOT BE
SOUND. Our proposed business activities are of a highly technical nature. The
success of technical businesses is generally determined in substantial part by
the prior experience of its executive personnel.
BECAUSE WE ARE IN ARREARS IN THE PAYMENT OF SALARIES TO OUR EXECUTIVE OFFICERS
AND EMPLOYEES OF OUR SUBSIDIARIES, ANY OR ALL OF THEM MAY RESIGN AND WE MAY BE
LIABLE FOR ADDITIONAL PAYMENTS IN WHICH CASE WE COULD BE MATERIALLY ADVERSELY
AFFECTED. The aggregate arrearage on November 15, 2004 was approximately
$216,000. Our employment agreements with our executive officers provide that if
we breach any provision of a respective agreement and the breach is not cured by
us within 15 days after receipt of written notice of the breach, the officer
shall be entitled to receive his base salary for a period of three years and all
other rights and benefits the employee may have under our senior executive
benefit, bonus and/or stock option plans and programs shall be determined in
accordance with the terms and conditions of such plans and programs.
BECAUSE EACH OF OUR EXECUTIVE OFFICERS MAY VOLUNTARILY TERMINATE HIS EMPLOYMENT
WITH US AT ANY TIME ON AT LEAST 30 DAYS PRIOR WRITTEN NOTICE TO US, WE CAN NOT
BE SURE IF ANY OF THEM WILL MAINTAIN THEIR POSITION WITH US FOR THE FORESEEABLE
FUTURE. In the event any of our executive officers terminate their employment
with us, we may not be able to find suitable replacements on similar terms, if
at all.
BECAUSE OUR BUSINESS PLAN IS HEAVILY DEPENDENT ON THE SUCCESS OF NEW AND UNTRIED
PRODUCTS SUCCESSFULLY ENTERING THE MARKET PLACE, WE CAN NOT BE SURE THAT THEY
WILL PERFORM AS WE ANTICIPATE. No determination can be made with reasonable
certainty until the products have been produced, installed and utilized in the
field in significant quantities.
<page>14
ALTHOUGH WE PLAN ON ACQUIRING AND MAINTAINING COMMERCIAL INSURANCE TO REDUCE
SOME OPERATING HAZARD RISKS, SUCH INSURANCE MAY NOT BE AVAILABLE TO US AT
ECONOMICALLY FEASIBLE RATES, IF AT ALL. In the absence of suitable insurance, we
may be exposed to claims and litigation which we will not be financially able to
defend or we may be subject to judgments which may be for amounts greater than
our ability to pay.
BECAUSE WE PLAN TO RELY ON INDEPENDENT THIRD-PARTY MANUFACTURERS TO FABRICATE
THE DWT AND WINDSTOR PRODUCTS, SUPPLIER CAPACITY, SHORTAGES IN NECESSARY RAW
MATERIALS, WORK STOPPAGES AND TRANSPORTATION PROBLEMS COULD MATERIALLY,
ADVERSELY AFFECT OUR BUSINESS. Any delay in initiating production at third-party
facilities, any inability to have new products manufactured at these facilities
or any failure to meet our customers' demands could damage our relationships
with our customers and may decrease our sales.
WE HAVE BROAD DISCRETION IN THE APPLICATION OF PROCEEDS WHICH WE RECEIVE IN
CONNECTION WITH THE STANDBY EQUITY DISTRIBUTION AGREEMENT AND THE EXERCISE OF
THE WARRANTS, WHICH MAY INCREASE THE RISK THAT THE PROCEEDS WILL NOT BE APPLIED
EFFECTIVELY. Because of the uncertainty of the timing of our receipt and the
amount, if any, of the proceeds, we have not definitively determined specific
uses for them. Accordingly, investors will be relying on our management's
judgment with only limited information about our specific intentions regarding
the use of proceeds. Our failure to apply the funds effectively could have a
material adverse effect on our business, results of operations and financial
condition.
FUTURE SALES BY OUR STOCKHOLDERS MAY ADVERSELY AFFECT OUR STOCK PRICE AND OUR
ABILITY TO RAISE FUNDS IN FUTURE EQUITY OFFERINGS. Sales of our common stock in
the public market during and following this offering, including sales made by
the selling stockholders, can be expected to lower the market price of our
common stock. Sales may also make it more difficult for us to sell equity
securities or equity-related securities in the future at a time and price that
our management deems acceptable or at all. Of the 14,753,486 shares held by
persons who are not our affiliates on November 15, 2004, approximately
11,913,240 shares were freely tradable without restriction or further
registration under the Securities Act of 1933. In addition, approximately
2,184,198 additional shares were then eligible to be sold in accordance with
Rule 144 under that Act and approximately 637,748 more shares will be able to be
sold within the ensuing twelve month period. All of the shares to be sold by the
selling stockholders in this offering will be freely tradable without
restriction or further registration under the Securities Act of 1933.
ANTI-TAKEOVER PROVISIONS COULD MAKE A THIRD PARTY ACQUISITION OF US DIFFICULT
WHICH MAY ADVERSELY AFFECT THE MARKET PRICE AND THE VOTING AND OTHER RIGHTS OF
THE HOLDERS OF OUR COMMON STOCK. Certain provisions of the Delaware General
Corporation Law may delay, discourage or prevent a change in control. The
provisions may discourage bids for our common stock at a premium over the market
price. Furthermore, the authorized but unissued shares of our common stock are
available for future issuance by us without our stockholders' approval. These
additional shares may be utilized for a variety of corporate purposes including
but not limited to future public or direct offerings to raise additional
capital, corporate acquisitions and employee incentive plans. The issuance of
such shares may also be used to deter a potential takeover of us that may
otherwise be beneficial to our stockholders. A takeover may be beneficial to
stockholders because, among other reasons, a potential suitor may offer
stockholders a premium for their shares above the then market price.
The existence of authorized but unissued and unreserved shares of preferred
stock may enable the Board of Directors to issue shares to persons friendly to
current management which would render more difficult or discourage an attempt to
obtain control of us by means of a proxy contest, tender offer, merger or
otherwise, and thereby protect the continuity of our management.
<page>15
FORWARD LOOKING STATEMENTS
Information included or incorporated by reference in this prospectus may contain
forward-looking statements. This information may involve known and unknown
risks, uncertainties and other factors which may cause our actual results,
performance or achievements to be materially different from the results,
performance or achievements expressed or implied by any forward-looking
statements. Forward-looking statements, which involve assumptions and describe
our future plans, strategies and expectations, are generally identifiable by use
of the words "may," "will," "should," "expect," "anticipate," "estimate,"
"believe," "intend" or "project" or the negative of these words or other
variations on these words or comparable terminology.
Forward-looking statements in this prospectus, including statements regarding,
among other things, (a) our projected sales and profitability, (b) our growth
strategies, (c) anticipated trends in our industry, (d) our future financing
plans, (e) outcome of regulatory matters and (f) our anticipated needs for
funds. The statements may be found under "Management's Plan of Operation" and
"Proposed Business," as well as elsewhere in this prospectus. Actual events or
results may differ materially from those discussed in forward-looking statements
as a result of various factors, including, without limitation, the risks
outlined under "Risk Factors" and matters described in this prospectus
generally. In light of these risks and uncertainties, there can be no assurance
that the events expressed or implied by the forward-looking statements will in
fact occur.
The forward looking statements in this prospectus reflect what we currently
anticipate will happen. What actually happens could differ materially from what
we currently anticipate will happen. We are not promising to make any public
announcement when we think forward looking statements in this prospectus are no
longer accurate whether as a result of new information, what actually happens in
the future or for any other reason.
USE OF PROCEEDS
We are not selling any securities in this offering and therefore will not
receive any proceeds from this offering. As more fully described in this
prospectus however, we expect to receive proceeds from the sale of common stock
under the Standby Equity Distribution Agreement and upon exercise of warrants.
Pursuant to the Standby Equity Distribution Agreement, we may, at our
discretion, periodically issue and sell to Cornell Capital Partners shares of
common stock for a total purchase price of $15 million. The maximum amount of
each sale is $625,000, and we may not notify Cornell Capital Partners of any
sale to be made by us to Cornell Capital Partners within seven trading days of a
prior such notice.
<page>16
For illustrative purposes only, we have set forth below our intended use of
proceeds for the range of net proceeds indicated below which we may receive
under the Standby Equity Distribution Agreement and upon exercise of warrants in
the order of priority. Although the exercise price of warrants which may be
issued to Spencer Clarke has not yet been determined, it will not be less than
the weighted average price computed under the Standby Equity Distribution
Agreement. The amounts in table below are based upon the assumption that the
exercise price will be the price so computed.
The amounts in the tables are based upon estimated offering expenses of
$125,500. The amounts are estimates only, and may be changed due to various
factors, including the timing of the receipt of the proceeds. For purposes of
the table, we have assumed that the exercise price of the warrants is the
weighted average price computed as described above.
Gross proceeds $4,770,000 $9,450,000 $18,500,000
- ---------------------------------------------------------------------
Net proceeds $4,080,000 $8,290,000 $16,175,000
USE OF PROCEEDS
USE AMOUNT AMOUNT AMOUNT
- ------------------- ------------ ------------ ------------
Payment to auditors
for September 30,
2004 fiscal year
audit $ 60,0000 $ 60,000 $ 60,000
Repayment of
promissory notes,
including interest $1,125,000 $1,125,000 $ 1,125,000
Test 100 kW
DWT/WindStor
prototype $ 359,000 $ 359,000 $ 359,000
Build 200 kW DWT
prototype $ 500,000 $ 500,000 $ 500,000
Continuous
improvement and
marketing of
DWT/WindStor $1,136,000 $4,346,000 $12,231,000
Exploration Lac
Dore deposit,
vanadium
refining $ 0 $1,000,000 $ 1,000,000
Working capital and
other corporate
purposes $ 900,000 $ 900,000 $ 900,000
---------- ---------- -----------
Total $4,080,000 $8,290,000 $16,175,000
========== ========== ===========
To the extent that the promissory notes held by selling stockholders are
converted into shares of our common stock, the amount allocated to working
capital and other corporate purposes will be increased.
<page>17
We received net proceeds of approximately $984,000 in connection with our
issuance of the 12% promissory notes and warrants in August and September 2004.
We allocated those proceeds as follows:
USE AMOUNT
- -----------------------------------------
Payment of accounts payable $600,000
WindStor development $100,000
Working Capital $284,000
Because we have broad discretion in the application of proceeds, the risk that
the proceeds will not be applied effectively is increased. Pending use, we may
invest the net proceeds in short term, investment grade debt instruments,
certificates of deposit or direct or guaranteed obligations of the United
States.
MANAGEMENT'S PLAN OF OPERATION
The following should be read in conjunction with our financial statements and
the related notes that appear elsewhere in this prospectus. The discussion
contains forward looking statements that reflect our plans, estimates and
beliefs. Our actual results could differ materially from those discussed in the
forward looking statements. Factors that could cause or contribute to these
differences include, but are not limited to, those discussed below and elsewhere
in this prospectus, particularly under the caption "Risk Factors."
WindStor
With adequate funding, we intend to build and install prototypes, and bring to
market WindStor, a "Green Energy" electricity management system that is intended
to provide customers with electricity at fixed, long-term, rates by generating
electricity at the customer's location with a DERMOND Wind Turbine "DWT" and
storing excess electricity in a battery for controlled distribution, via our
proprietary "System Integrator". We believe the planned markets for WindStor
exist in adequate size to provide the opportunity for penetration of our
products leading to profitable operations.
On October 30, 2004, installation of a 100kW DWT prototype was completed at the
Universite du Quebec en Abitibi-Temiscamingue, in Rouyn-Noranda, Quebec Canada,
our long term research and development site. Over the ensuing several months,
installation of a battery and diesel generator are also planned, completing a
WindStor test installation. Rouyn-Noranda is the home of, or near, several of
our key engineering and specialty component manufacturing companies. The
WindStor system will be donated to the Universitie at the earliest of the end of
our testing or May 31, 2015.
We intend to develop WindStor systems as "Projects." WindStor system(s) within
a Project will be built according to the electricity power needs of the user. A
wide variety of Project configurations are expected. For example, one Project
installation may require a 200 kilowatt (kW) DWT and 200 kWs of energy storage,
a System Integrator and other components and costs to install the system; while
another WindStor Project may require multiple DWTs, a larger battery and a
System Integrator. Consequently, WindStor Projects will have different
installed costs and performance matrices.
<page>18
We plan to retain ownership of all commercial WindStor systems which may be
installed in customers' locations. Our plan is that a McKenzie Bay company will
own at least a majority of each Project. We intend to retain control of the
technology and benefit from the long term revenue generation anticipated by each
WindStor Project. WindStor Project majority ownership will require additional
capital beyond any proceeds we may receive under the Standby Equity Distribution
Agreement and exercise of the warrants. We intend to arrange for debt to be
borrowed to fund a portion of each Project. There can be no assurance that we
will be successful in obtaining debt financing on terms not unfavorable to us,
if at all.
We have formed WindStor Power Co. (WPC) as a wholly owned subsidiary of McKenzie
Bay International Ltd., to conduct the marketing, WindStor system assembly and
installation coordination, and system operation and administration of each
WindStor Project. WPC will be funded by McKenzie Bay International Ltd.
initially, with expectations that revenues from WindStor Projects will exceed
the costs of Project operations and allow WPC to fund ongoing Project
development.
The cost to engineer, build, install and test a 100kW DWT and WindStor was
projected at approximately $2,000,000. Approximately $627,000 in grants and
loans from Canadian governmental agencies have been received and we have
provided funding of approximately $674,000. DERMOND INC. has received a
commitment for an additional $340,000 in grants and loans, requiring us to fund
$359,000 to complete the expected project costs and ongoing testing. Certain of
the Canadian funding programs require that we co-invest or provide a commitment
to fund. We may not be able to satisfy our funding requirements to induce the
Canadian governmental agencies to provide additional monies for DWT and WindStor
development. Therefore, we do not know if we will receive the additional funds
necessary or planned.
If the results of WindStor testing are positive, the next DWT engineering phase,
being bid now, will be for a 200kW DWT prototype which will be the standard size
DWT for WindStor systems. We expect that development costs for the enlarged
version of the 100kW DWT to be approximately $200,000 and DWT fabrication costs
to be another $300,000. We plan to have a prototype of the 200kW DWT ready for
installation by May 2005. In addition, we intend to fund continuous improvement
engineering of the DWT as operating results from the test site are received and
analyzed. Both the 200kW development and continuous improvement costs are part
of the DERMOND INC. business plan and we expect them to be partially offset by
grants and loans from Canadian funding sources. Because the funds have not been
committed to by any funding source, there can be no assurance that we will
obtain them.
We have conditional agreements with twelve entities for commercial installations
of WindStor, dependent upon satisfactory testing of wind power at the respective
location to provide sufficient electricity production from a DWT to create an
economically feasible WindStor facility. While wind testing is being conducted,
zoning, permitting and site location issues will be addressed. If wind power is
sufficient, all regulatory issues are resolved, site plans are approved, we are
able to obtain adequate financial resources, we successfully obtain working
prototypes and pricing terms are agreed upon by prospective customers, we intend
to begin to install WindStor systems.
<page>19
Lac Dore Mining Inc.
If funding becomes available, we intend to continue research and development of
the vanadium recovery and refining technology developed for McKenzie Bay during
the preliminary feasibility study of the Lac Dore deposit. The next planned
step is operation of a Sample Product Unit (SPU) planned for construction by SGS
Lakefield Research at its facilities in Lakefield, Ontario, Canada. This
facility would be used to advance vanadium refining processes and produce and
provide small samples of high-purity vanadium chemicals to potential customers.
The planned cost to operate the SPU is $1 million over a 16-month period.
Although grants and/or loans may be available to us for part of the cost, we
have not assumed or relied upon their availability.
If results from the SPU project are successful and demand for the chemicals
provided to potential customers of Lac Dore Mining Inc. are sufficient to
warrant additional development, we intend to build a larger production facility,
called the Development Production Pilot Plant (DPPP). If feasible and also
largely dependent upon adequate funding being available, this project would take
place after the end of the fiscal year ending September 30, 2004. The cost to
build the DPPP has been estimated to be approximately $10 million. No funds for
building the DPPP have been allocated.
Our plans for Lac Dore are dependent upon a number of events coming together
successfully, including, but not limited to, an adequate demand for high-purity
vanadium, our ability to raise at least $330 million to build and operate the
mine and refinery, our ability to find and hire management and employees to
operate the mine and refinery and successful permitting of the mine and refinery
to be built and operated. At a minimum, we believe contemplation of the
building of Lac Dore is several years into the future.
If the tests from prototype DWTs are successful, we intend to begin marketing
and installation of WindStor systems. We will require significant amounts of
equity and debt funds to build and install WindStor systems, continue Lac Dore
exploration and for general and administrative expenses. If we are successful
in obtaining equity funds to be utilized in connection with WindStor, we intend
to allocate them as follows:
Build 100kW DWT/WindStor Prototype $ 359,000
Design and build 200kW DWT Prototype $ 500,000
Continuous Improvement & Marketing of DWT/WindStor $12,231,000
Exploration of Lac Dore deposit $ 1,000,000
Audit fees, working capital, repayment of
promissory notes and other corporate purposes $ 2,085,000
------------
TOTAL $16,175,000
============
<page>20
Cash Requirements for 2005 Fiscal Year Administrative Costs
To date our activities have been funded primarily through the sale of equity
securities and financial assistance from Canadian governmental agencies in the
form of loans and grants. As noted above, we must obtain substantial additional
capital to engage in our proposed businesses.
Our cash requirements for administrative costs for the fiscal year ending
September 30, 2005 (including direct support of subsidiary operations) follows:
Use Amount
- ------------------------ ----------
Employee salaries $2,476,000
Professional costs (includes
consultants, outside accountants,
independent auditors and legal counsel) $1,276,000
General administrative (includes lease
obligations, travel and other
administrative costs) $ 720,000
Neither we nor our subsidiaries will be able to continue development,
exploratory or administrative functions for more than a few months unless
substantial additional funding from Cornell Capital Partners or otherwise
becomes available.
As stated in the notes to our consolidated financial statements, because we have
suffered recurring losses and a have a deficiency in assets and working capital,
there is substantial doubt about our ability to continue as a going concern.
Our former auditors have included that statement in their report dated December
23, 2003 (April 6, 2004 as to note 17).
We cannot be sure that we will be able to obtain adequate financing from outside
sources to fund our proposed operations. If we are unable to obtain the
necessary funding, we will not be able to continue to operate.
Additional Employees
We will need to add a number of employees to DERMOND in anticipation of
successful DWT and WindStor prototype testing. Additions include, project
managers, mechanical, aeronautic and electrical engineers and administrative
personnel. McKenzie Bay recently hired a senior project manager, to oversee all
vendor relationships and WindStor Power Co. installations, and intends to add
administrative personnel, including a controller. WindStor Power Co. is a wholly
owned subsidiary of McKenzie Bay International, Ltd.
Revenues
For the fiscal year ended September 30, 2003, and nine month period ending June
30, 2004, we did not generate any revenues.
<page>21
Expenses
Expenses, for comparative periods, before amortization and interest expenses
decreased $1,291,685 (from $4,717,823 to $3,426,138) for the year ended
September 30, 2003 as compared to the year ended September 30, 2002. This
decrease resulted primarily from decreases in research, development and
exploration expenses (reduced $1,447,005), wages and benefits (reduced
$251,687), general administration costs (reduced $277,030) and advertising,
promotion and travel (reduced $106,667). Offsetting the reduced costs were
increases in management wages and benefits (increased $271,845) and professional
fees (increased $518,859). For the 9 months ended June 30, 2004, compared to
the same 9 month period ended June 30, 2003, expenses before interest and
amortization decreased $610,927. This decrease in operating expenses occurred
from decreases in research, development and exploration expenses (reduced
$794,846), wages and benefits (reduced $86,933) and professional fees (reduced
$305,087). Offsetting the reduced costs were increases in management wages and
benefits (increased $544,552).
Net Loss
For the year ended September 30, 2003, net loss was approximately ($3,692,000),
compared to net losses of approximately ($5,971,000) for the year ended
September 30, 2002. In addition to reduced operation costs for the year ended
September 30, 2003, marketable securities losses and the write down of
incorporation and reorganization costs added approximately $1,259,000 to the net
loss of September 30, 2002. For the nine months ended June 30, 2004, net loss
was approximately ($2,337,000) compared to a net loss of approximately
($3,077,000) for the nine months ended June 30, 2003. During the nine months
ending June 30, 2003, we wrote down the purchase cost of DERMOND INC. in excess
of the assets purchased ($146,972) in accordance with accounting principle SFAS
142, which contributed to the net loss for that period.
Liquidity and Capital Resources
Our ability to satisfy current obligations depends in part upon our ability to
raise additional capital and, ultimately, the entry of WindStor into the market
and reaching a profitable level of operations. There is no assurance that
capital can be obtained to fulfill our capital needs. Without the sale of
additional common stock, we will be unlikely to continue operations.
An increase in the shortfall of working capital increased from approximately
($1,822,000) as of September 30, 2003, to approximately ($1,853,000) as of June
30, 2004. This shortfall increase for the period resulted from operating
expenses in excess of capital raised to satisfy these expenditures.
Currently, our sole source of internal liquidity is from the sale of equity and
debt.
<page>22
Off-balance sheet arrangements
We have no off-balance sheet financial arrangements and do not foresee any
during the next 12 months.
PROPOSED BUSINESS
Background
Prior to July 2003, we intended to primarily engage in the exploration of our
Lac Dore vanadium deposit in Chibougamau, Quebec. Based upon a market study,
undertaken as part of a preliminary feasibility study by SNC-Lavalin, dated
April 2002, we believe that successful introduction of new vanadium-based bulk-
energy storage devices (large batteries) could generate increased demand for
vanadium, which may make exploitation of the Lac Dore deposit economically
feasible. To date, however, the limited sales growth of vanadium batteries has
not generated the demand for vanadium which we anticipated. We cannot forecast
when, if ever, any meaningful increase in sales for vanadium based batteries may
occur. Except for research and development work relating to vanadium refining
technology, we have deferred engaging in any material exploratory or other
activities in connection with the deposit. We do not have the capital to further
fund any meaningful activities related to the deposit. In order to retain full
rights to the claims in the deposit, we must perform and/or fund certain
exploration and development-related work as specified by applicable regulations
or we must pay a total of approximately $38,000 per year.
Because of our belief in the growing interest in alternative energy generation
devices, we altered our business plan in July 2003 to concentrate on wind
powered alternative energy systems.
We do not have the capital to further fund or develop any of our proposed
business activities related to wind powered alternative energy systems. Although
we have been and are currently seeking funding, there can be no assurance that
we will receive adequate funding, if any, or that the terms of any such funding
will not be unfavorable to us. Other than our agreement with Cornell Capital
Partners, which is subject to conditions we may not be able to satisfy, we have
not received any commitment for funding. Our ability to engage in the business
activities described below is dependant upon our acquisition of significant
funds. We are in the development stage with respect to wind powered alternative
energy systems.
We have never realized any meaningful revenues. As stated in the notes to our
consolidated financial statements, because we have suffered recurring losses and
a have a deficiency in assets and working capital, there is substantial doubt
about our ability to continue as a going concern. Our former auditors have
included that statement in their report dated December 23, 2003 (April 6, 2004
as to note 17).
<page>23
Wind Powered Alternative Energy Systems
Acquisition of Dermond Inc.
On February 12, 2002, we acquired all of the outstanding shares of common stock
of Dermond Inc., a Canadian corporation formed in 1996 from Jacquelin Dery and
Laurent Mondou. Dermond owned the technology referred to as the Dermond Wind
Turbine. The technology relates to improvements to the Darrieus style vertical
axis wind turbine, a generator assembly to produce electricity and a self-
erecting structure for the wind turbine. The purchase price consisted of:
- The issuance to each of the sellers of 50,000 shares of our common
stock;
- The payment to each of the sellers of CDN $25,000.
In connection with the purchase, we entered into an employment agreement and
royalty agreement with each of the sellers. Pursuant to the employment
agreements, the sellers are employed as Vice Presidents of Dermond until
February 12, 2007, subject to additional periods of one year each unless a party
gives requisite notice of termination. Each of the employees is entitled to
receive an annual salary of CDN $65,000 (approximately $48,100 U.S. on September
27, 2004) which will increase to CDN $85,000 (approximately $62,900 U.S. on
September 27, 2004) upon our first sale of a Dermond Wind Generator. On November
15, 2004, we were approximately $12,000 U.S. in arrears in the payment of
salaries to each of Messrs. Dery and Mondou.
Pursuant to the royalty agreements, we will pay each of the sellers a royalty of
1.25% of the net receipts received by us from sales of the Dermond Wind
Generator utilizing the technology developed by Dermond. In the event that a
Dermond Wind Generator is leased rather than sold, the royalty payable to each
of the sellers will be 1.25% of the net lease payment received by us. In the
event of the resale or re-lease of the same wind generator, the sellers shall
each be entitled to a further such royalty of 1.25%. In the event a Dermond Wind
Generator is leased, each of the sellers may elect to receive the royalty in a
lump sum upon execution of the lease agreement and payment of the first lease
payment. The lump sum royalty will be 1.25% of the then present value of the
lease. The royalties will be payable to the sellers on all Dermond Wind
Generator sold or leased during the 10-year period commencing with the first
sales or lease transaction of a Dermond Wind Generator.
Wind Turbine Technology
Differential heating of the earth's surface by the sun causes large air masses
to move continuously about the surface of the earth. The masses move with such
velocity that they possess significant amounts of kinetic energy. Wind turbines
have been used to convert the kinetic energy of the moving air mass to
electricity.
<page>24
According to the American Wind Energy Association, horizontal axis wind turbines
dominate the wind turbine market and are used in more than 95% of wind
generating applications around the world. Power production size of horizontal
axis wind turbines generally ranges from approximately 1 kilowatt (kW) to
approximately four megawatts (MW). The predominant aerodynamic principle
employed by wind turbine technologies for operation is lift. As wind attempts to
pass by the wind turbine, its blade design causes the wind to accelerate over
one surface of the blade, creating a low pressure area on that surface which
tends to pull the blade in its direction. Typical wind turbine blade design
varies the lift-pulling action over the blade surface causing rotation, the
basis for wind power functionality.
Several natural factors affect a wind turbine's production of electricity,
including temperature, wind direction consistency and wind speed, the most
important turbine performance criteria. Typically, at the same location, wind
speeds will be greater as the height from ground level increases. Configured in
single to multi-blade propellers, horizontal axis wind turbine design requires
the turbines to be elevated into the air to allow propeller rotation. Vertical
axis wind turbine designs have historically been primarily ground mounted.
Horizontal axis wind turbines' dominance of the market today is based on
superior performance from their ability to access higher velocity winds at
elevation. A horizontal axis wind turbine, however, must incorporate a "yaw"
mechanism, which generally consists of an electric motor that turns the
propeller section into the direction of the wind to adjust to shifts in wind
direction.
French inventor Georges Jean Marie Darrieus filed the first patent for a modern
type of vertical axis wind turbine in France in 1925 and in the United States in
1931. His name is synonymous with the majority of vertical axis wind turbine
designs of today which are referred to as "Darrieus" style. Vertical axis wind
turbines are very difficult to mount high on a tower to capture the higher level
winds. Accordingly, they are usually forced to accept the lower, more turbulent
winds and produce less in possibly more damaging winds.
At the onset of the Arab oil embargo in 1973, the U.S. Atomic Energy Commission,
a predecessor to the current Department of Energy, asked Sandia National
Laboratories, a national United States laboratory devoted to engineering
research and development, to investigate and develop alternative energy sources.
Sandia's engineers began to look into the feasibility of developing an efficient
wind turbine that industry could manufacture. National Research Council Canada
shared its development work with Sandia and a North American effort to develop
the Darrieus technology began.
In the late 1970's, five companies, including FloWind Corporation, began
production, commercialization and installation of modern Darrieus wind turbines,
culminating in a fleet of nearly 900 vertical axis wind turbines, primarily
located in the Altamont and Tehachapi passes of California, and India. All of
the vertical axis wind turbine commercial enterprises have since ceased
production. We are not aware of the reasons why production ceased.
<page>25
Potential Wind Turbine Markets
Approximately 6,868 MW of new wind power capacity was installed worldwide in
2002, increasing generating capacity by 28% and increasing total wind power
installation to over 31,000 MW, enough to power 7.5 million average American
homes. Global wind power capacity quadrupled over the five-year period from 1998
to 2002, growing from 7,600 MW to more than 31,000 MW.
Wind is the world's fastest-growing energy source, with installed generating
capacity increasing by an average of 32% annually during that five-year period.
Approximately 93% of the additional wind power capacity installed in 2002 was in
Europe and the United States, and worldwide, 90% of capacity is in those two
regions.
Substantially all of the wind energy described above is sold to utilities
providing electricity to their customers. In addition to adding supply to a
utility grid, which is the primary market for wind generated electricity, we
believe that supplying power to off-grid communities and urban, commercial rate
paying buildings may constitute potential market opportunities for wind
generated power.
The factual data under this sub caption was compiled by the American Wind Energy
Association and European Wind Energy Association.
There can be no assurance that our wind turbines, if built, will achieve a
meaningful amount of commercial acceptance, if any, in any of the potential
markets.
Off-Grid (Islands & Remote Access)
The prohibitive cost of connecting small, remote communities to a utility grid
or, in the case of islands, the lack of a typical power generation resource such
as coal or nuclear energy, causes thousands of locations worldwide to be
dependent upon diesel and gasoline powered generators for electricity. The fuel,
operating and maintenance expenses for these generators are extremely high,
causing electricity generating costs to be significantly greater than in urban
"in-grid" locations.
A document titled "Le Developpement de l'Energie Eolienne au Quebec" ("the
development of wind energy in Quebec") dated April 30, 1998, was presented by
Hydro-Quebec at a Quebec Government public hearing on the future of wind energy
in May 1998. Hydro-Quebec estimated at that time that the potential world
wind/diesel (wind generated electricity with diesel generator backup) market
outside Canada was estimated at 25,000 MW, with 11,400 MW of existing diesel
installations and 13,000 MW to come.
Wind turbines have been introduced to off-grid communities in various locations
around the world. We believe the following sites constitute viable off-grid
markets;
<page>26
- - Thousands of island and remote mining, logging and other off-grid
locations;
- - More than 200 Canadian communities;
- - Approximately 250 off-grid communities in Alaska.
Urban User Market
We believe that vertical axis wind turbines have the potential to provide
building owners, real estate developers, property managers and other users in
urban locations a means to reduce the overall cost of electricity. Based upon
information compiled by the U.S. Department of Energy, commercial retail rate
users in the U. S. alone consume more than 1.4 million MW of electricity
annually.
We further believe that vertical axis wind turbines may provide a cost-effective
and efficient alternative power supply in commercial buildings, schools,
multistory residential dwellings, light industrial businesses and off-grid
areas. In addition, we believe that vertical axis wind turbines may also be
suitable for peak shaving and load leveling applications.
Proposed Products
DWTSM
Subject to obtaining sufficient funds, we intend to contract with others for the
manufacture of prototype vertical axis wind turbines which we refer to as
Dermond Wind Turbine or DWT. The DWT has been designed to utilize the following
technology which we have included in our patent application which may result in
the following:
- - Simplification of installation by reducing the number of onsite elevated
assembly steps;
- - Improvement in quality of workmanship by allowing more "in factory"
assembly;
- - Reduction in overall cost of installation; and
- - Relative ease of installation where certain assembly equipment may be
unavailable.
A prototype DWT was installed in October 2004. Until the prototype has been
fully tested, there can be no assurance that the technology will work as
expected or that any DWT will perform to the extent that we anticipate or will
be commercially viable. No meaningful testing has yet been accomplished If the
prototype meets our expectations and we obtain the requisite funding, we intend
to have DWTs manufactured for commercial introduction.
<page>27
The "wind cage," or blade rotating space, will be approximately 40 feet high and
56 feet wide and is expected to weigh approximately 10,000 pounds. We initially
selected the 100 kW size because the configuration meets our initial market
focus for the remote, limited access and extreme climatic environment markets.
We now believe that a 200kW configuration of the DWT will be a better match for
the largest of our potential markets, urban areas, and be a good electricity
energy generation size for off-grid markets as well. Subject to our obtaining
sufficient capital, we intend to immediately engineer and build a 200 kW DWT
and, if testing of the 100 kW and 200 kW devices is successful, begin
construction of 200 kW DWTs for commercial introduction.
We believe that we will require funds of approximately $700,000 to complete the
design, construct, install the 200kW DWT and $360,000 to test the DWT and
WindStor system prototypes. If we are able to obtain the funds, we intend to
utilize them as follows:
ANTICIPATED TIME
USE REQUIRED FUNDS PERIOD FOR USE OF FUNDS
- ---------------- --------------- -----------------------
Design Completion $ 200,000 5 months
Prototype Construction
and Installation $ 500,000 7 months
Testing $ 360,000 12 months
WindStor(SM)
We are completing development of WindStor, an energy system which is intended to
integrate and manage DWTs and other electricity generating sources with an
energy storage device. Because WindStor has neither been built nor tested,
there can be no assurance that the technology will work as expected or that any
WindStor will perform to the extent that we anticipate or will be commercially
viable.
WindStor is an electricity management system which will use the Dermond Vertical
Axis Wind Turbine to generate electricity. This electricity will be used by the
customer as generated or stored in a battery. WindStor's proprietary "System
Integrator" will be programmed to distribute electricity to the customer's
facility from the lowest cost source at each moment to provide to the customer
the least costly source of electricity.
WindStor is designed to constantly monitor electricity demand and supply. We
anticipate that, because of the monitoring, WindStor will be able to provide for
instant shifting from one power source to another, such as the Vertical Axis
Wind Turbine, a battery and either the grid or a backup diesel generator, in
order to select the lowest cost source of electricity available at any moment in
time and to immediately switch to battery power if other means of power are
interrupted from the supply source.
<page>28
We believe that WindStor can provide a higher quality, lower cost and
environmentally friendly alternative electricity source than is presently
available for off-grid electricity users dependent upon diesel and gasoline
generators. For urban users, WindStor is planned to provide a means for
providing a system to store relatively low cost electricity and access that
electricity to offset "near peak," "peak" and "demand" charges by grid provided
power companies.
The cost to complete design of WindStor is part of the DWT financing described
above. If we do not obtain all of the requisite funds, we will not be able to
produce or sell any WindStors.
In November and December 2003, we entered into four agreements to install
anemometers to collect wind data for WindStor system evaluation and, with
adequate wind availability, finalize an equipment configuration and prepare a
long term pricing structure for each prospective WindStor installation. We
expect that the evaluation period will end in March 2005. After the evaluation
period, we have agreed to install the four WindStor Systems at our expense for
further evaluation. Irrespective of the results and price structure, none of
the prospective WindStor users is under any obligation to purchase or lease any
products from us.
Production
If we are able to reach the production stage, we intend to have all DWTs and
WindStors manufactured for us by others. We believe that the necessary parts and
components are readily available from numerous suppliers. We further believe
that there are numerous manufacturing companies that will be able to manufacture
the products for us at reasonable prices.
Marketing
We intend to market the DWTs and WindStors primarily through non-exclusive
independent marketing agents. 14 companies in the United States have entered
into agreements with us that provide for a payment to them in the event that one
or more WindStors are sold or leased through their efforts. The payment will
consist of 5% of WindStor's installed cost payable within 60 days of
installation of a system, exclusive of taxes and transportation. Two of the
agents will also receive a 2% "carried equity interest" in each WindStor system
they sell.
Each of the agency companies has represented to us that it has expertise in the
sale and promotion of energy products.
<page>29
Competition
We are not aware of any organization marketing wind turbines or electricity
management systems such as the WindStor for the urban, commercial-retail rate
user market. Existing alternatives to grid supplied electricity include solar,
micro-turbine and diesel generators. These devices are typically used only as
minor contributors to location demand or as a standby electricity source in the
event of a grid power outage.
Atlantic Orient Corporation, Northern Power Systems and Vergnet offer smaller
sized (less than 100 kW) wind turbines in hybrid diesel/wind systems. Atlantic
Orient has been designing and installing 10 kW and 50 kW wind-diesel systems for
more than 10 years. Atlantic Orient recently installed a system in Wales, Alaska
and has previously installed systems in Russia and Africa. Five of its turbines
are being used in conjunction with two diesel generators to pump oil in a very
remote and cold region in Siberia. Atlantic is designing a turbine called,
WindLite, to run with any phase power backup and which can either charge DC
batteries or be installed with an inverter to change DC to AC power.
Northern Power Systems has been in the wind turbine business for nearly 25 years
and has expertise with in electrical energy systems employing a wide range of
technologies including wind, photovoltaic (solar energy), and diesel-hybrid
power. Northern has developed, in conjunction with NASA, a 100 kW turbine
synchronous variable speed generator capable of operating under extreme climatic
conditions and installed a prototype in Graniteville, Vermont in 2000. Northern
Power offers a wide range of products, including the NorthWind series, which was
developed for the U.S. Department of Energy.
French firm Vergnet, over a period of 20 years, has been developing new hybrid
wind/diesel/lead-acid battery systems to provide self-sufficient electricity
production for remote sites. Vergnet is currently operating a wind/diesel power
plant consisting of twenty-five, 60 kW wind turbines in Guadeloupe. Vergnet has
installed wind turbines of 15 kW in polar environments and 50 kW in many other
places.
The off-grid market attracts a variety of alternative electricity generating
technologies. Manufacturers of wind turbines, micro-generators, biomass and fuel
cells have installed prototypes in off-grid locations. We believe diesel
generators will continue to be the preferred primary off-grid electricity
generating source for the foreseeable future, with alternative energy devices
and systems only being used to improve power and cost performance, not replacing
diesel generators.
Substantially all manufacturers and developers of products that will compete
with our products have substantially greater resources than do we. Intense
competitive pressures could have a material adverse effect on our proposed
business.
Companies with substantially greater expertise and resources than those
available to us may develop or market new, similar or virtually identical
products that directly compete with us. Competitors may also develop
technologies or products that render our products less marketable or obsolete.
If we are unable to continually enhance and improve our products, we may be
unable to compete with others. We may not be able to successfully enhance or
improve any product or develop or acquire new products, because of our limited
resources.
<page>30
Intellectual Property
In January 2003, we filed a patent application in Canada, Japan and with the
European Union, which includes, among other countries, France, Germany, Spain
and the United Kingdom. In September 2003, we filed a patent application in the
United States and we expect to file patent applications in additional countries.
The claims in the patent applications are for:
- A wind system of the type having a rotating shaft perpendicular to the
ground;
- A blade attachment structure for a windmill;
- A blade for a windmill;
- A generator assembly for a windmill to produce electricity;
- A self erecting structure for a windmill; and
- A method for erecting a self-contained windmill.
We believe that that the claims in the applications represent potential
improvements to the Darrieus style vertical axis wind turbines. The potential
improvements are in the following areas:
- Blade Assembly
The improvements relate to a rotating shaft perpendicular to the ground,
comprising three blades positioned in a pre-strained triangular rigid
configuration. The potential benefit is allowing the blades to adopt a true
troposkein (turning rope) shape at targeted speed, believed to improve vertical
axis wind turbine performance.
- Blade Attachment Structure
The improvements relate to the attachment of the blades to the rotating shaft
using a set of securing elements having a tri-dimensional, triangular
configuration designed to maintain a constant troposkein shape. The potential
benefit is the minimizing of the dynamic stress on the turning blades which may
result in cost savings in the fabrication process and could contribute to
extended blade life.
- Integrated Direct Drive Generator
The improvements relate to reduction of mechanical losses in geared transmission
between the turbine and the generator. The potential benefit is the absence of a
speed-increasing device and its replacement by an integrated generator providing
for a reduction of the friction between mechanical parts which may increase
electrical output and reduce wear.
<page>31
- Self-Erecting Design
The improvements relate to a method for fabrication of a self-erecting wind
turbine which may make wind turbines easier to erect.
By letter of January 20, 2004 from the Canadian Intellectual Property Office, we
were advised that each of the claims in our patent application was "indefinite"
and did not comply with certain relevant provisions of the Canadian Patent Act.
In May 2004, we amended and resubmitted our patent application responding to the
comments from the Canadian Intellectual Property Office.
We have not received a response from any other patent agency.
There can be no assurance that any patent will be issued, or if issued, that it
will include any meaningful claims. Furthermore the validity of issued patents
are frequently challenged by others. One or more patent applications may have
been filed by others previous to our filing which encompass the same or similar
claims. If we do not receive a patent which provides adequate protection for us,
we may not be able to manufacture our proposed products in our intended manner.
Because of our limited resources, we may be unable to protect a patent or to
challenge others who may infringe upon a patent. Because many holders of patents
in the alternate energy industry have substantially greater resources than we do
and patent litigation is very expensive, we may not have the resources necessary
to challenge successfully the validity of patents held by others or withstand
claims of infringement or challenges to any patent we may obtain. Even if we
prevail, the cost and management distraction of litigation could have a material
adverse effect on us.
Because wind turbines and their related manufacturing processes are covered by a
large number of patents and patent applications, infringement actions may be
instituted against us if we use or are suspected of using technology, processes
or other subject matter that is claimed under patents of others. An adverse
outcome in any future patent dispute could subject us to significant liabilities
to third parties, require disputed rights to be licensed or require us to cease
using the infringed technology.
If trade secrets and other means of protection upon which we may rely may not
adequately protect us, our intellectual property may become available to others.
Although we may rely on trade secrets, copyright law, employee and third party
nondisclosure agreements and other protective measures to protect some of our
intellectual property, these measures may not provide meaningful protection to
us.
The laws of many foreign countries do not protect intellectual property rights
to the same extent as do the laws of the United States, if at all.
<page>32
Research and Development
During the fiscal year ended September 30, 2003 and the nine months ended June
30, 2004, we expended approximately $242,451 and $505,604 ($156,350 and $202,483
net of non-refundable grant), respectively, on research and development related
to DWTs and WindStor. During the three months ended September 30, 2004, we
expended approximately $465,000 (approximately $423,000 net of non-refundable
grant) on research and development related to DWTs and WindStor. The
expenditures consisted primarily of engineering for the DWT and the system
integrator. The amounts do not include amounts expended for vanadium refining
technology. During the fiscal year ended September 30, 2002, we made no
expenditures on research and development related to DWTs and WindStor.
Regulation of Power Projects
Overview - United States
We propose to own and operate wind powered electric generating facilities to be
located on the property of our prospective customers. Our principal prospective
customers would be end-users (retail consumers) of electricity, such as
commercial office buildings, schools, and government buildings, who would
purchase electricity from us. While we do not intend to sell power from our
facilities to utilities or other re-sellers or into the open market (wholesale
sales), we may do so in specific applications.
The electric industry in the United States is governed by both federal and state
law and regulation, with the federal government having jurisdiction over the
sale and transmission of electric power at wholesale in interstate commerce, and
the states having jurisdiction over the construction of electric generating and
transmission facilities and the sale of electricity at retail.
The federal government regulates the electric wholesale and transmission
business in interstate commerce through the Federal Energy Regulatory Commission
("FERC"), which draws its jurisdiction from the Federal Power Act ("FPA"), and
from other legislation such as the Public Utility Regulatory Policies Act of
1978 ("PURPA") and the Energy Policy Act of 1992. The FERC has comprehensive and
plenary jurisdiction over the rates and terms for sales of power at wholesale,
and over the organization, governance and financing of the companies engaged in
such sales. The wholesale power and electric transmission industry is also
subject to operating standards established by regional reliability councils,
and, increasingly, to governance of the operation of interconnected utility and
non-utility operations and wholesale markets through Independent System
Operators and Regional Transmission Organizations, all of which are in turn
subject to the plenary jurisdiction of the FERC.
The States regulate the sale of electric power at retail in their state in
accordance with individual state laws which can vary widely in material
respects.
<page>33
Holding companies owning electric utility companies are, unless exempted by law
or regulation, subject to comprehensive and burdensome regulation under the
Public Utility Holding Company Act of 1935 ("PUHCA"). Unless they qualify for an
exemption or fall under a statutory exception, these companies and their direct
and indirect subsidiaries are not permitted to engage in a variety of
transactions, including financing transactions, without the authorization of the
SEC. For purposes of PUHCA, an "electric utility company" means "any company
which owns or operates facilities used for the generation, transmission, or
distribution of electric energy for sale, other than sale to tenants or
employees of the company operating such facilities for their own use and not for
resale."
Federal Regulation - United States
PURPA and Qualifying Small Power Production Facility Status
Under PURPA and the regulations of FERC implementing PURPA, a wind-powered
generating facility with a generating capacity of 80 MW or less (including all
such facilities owned or operated by the same person or its affiliates within
one mile of the facility) ) is deemed to be a Qualifying Small Power Production
Facility ("QF"), so long as no more than 50% of the equity interest in such
facility is owned by electric utilities, electric utility holding companies, or
subsidiaries of either. QFs are required by FERC to make certain non-burdensome
filings to confirm the facts supporting their status with respect to each such
facility.
QF status is not available for facilities located outside the United States and
certain of its Protectorates. At this time we do not own or operate any
facilities in any other countries that are generating any electric power for
sale. If we were to do so in the future, we believe that we will be able to
take advantage of one or more exemptions or exceptions from PUHCA that will
allow us with respect to any such foreign operations: (1) to avoid SEC
regulation under PUHCA, and (2) to comply with the ownership restrictions under
PURPA and the regulations of the FERC there under with respect to any QFs we
may own and operate in the United States. There can be no certainty, however,
that such exceptions or exemptions will be applicable to the circumstances of
any particular project or business opportunity we may wish to pursue in such
other countries.
A QF with a generating capacity not greater than 30 MW is automatically exempt
from regulation by FERC with respect to any sales of electricity it may make at
wholesale. In addition, its owners and operators are automatically exempt from
all provisions of PUHCA with respect to their ownership of the QF. Moreover, a
QF is exempt from the laws of the states which otherwise regulate the ownership,
rates and terms of sales, corporate governance, and financing of electric
utilities. Finally, a QF has certain rights under FERC regulations, including
the right to require an electric utility to interconnect it with the utility's
electric system, the right to purchase firm power service, back-up power, and
supplementary power from an interconnected electric utility at reasonable and
non-discriminatory rates, and the right to require an electric utility to
purchase electric power generated by the QF at the cost the utility would have
incurred in generating or purchasing the same amount of power from others.
<page>34
State regulatory agencies are required by PURPA to implement FERC's regulations
under PURPA, and most have done so. Utilities and other interests have in the
past attempted to challenge or dilute the rights of QFs under PURPA, and in some
circumstances have succeeded in securing certain rulings of state regulatory
agencies that have had the result of making inside-the-fence generating business
models such as ours less attractive to customers or economically infeasible.
There have for many years been attempts in Congress to repeal PURPA, but in each
case, the only repeal that has received serious consideration has been the
possible repeal of the PURPA requirement that utilities must offer to purchase
QF power. This particular right under PURPA has become increasingly irrelevant
in any event since the passage of the Energy Policy Act of 1992, which mandated
open access to the nation's utility grid for QFs and other non-utility power
producers. We do not intend to sell power to utilities except in rare
circumstances, so that such a limited repeal, even if our contracts were not
"grandfathered" in repeal legislation, would not be of material consequence to
us as a whole. If repeal of PURPA were more broad, however, exemption from PUHCA
as a QF might no longer be available to us.
WindStor is not intended to consist solely of a wind turbine generator, but also
to include a battery for the storage of power, and in some cases may include a
generating set fueled with diesel fuel or natural gas. In addition, the system
could in some applications be interconnected with a utility grid. A fossil-fuel-
fired generator is not eligible for QF status, and the exemptions from
regulation attendant thereto, unless the generator is a Qualifying Cogeneration
Facility as defined by FERC regulations under PURPA. A Qualifying Cogeneration
Facility is one that produces both electricity and useful thermal energy from
the same fuel source, and meets certain specified standards for fuel efficiency
and balance of electric and thermal output, as well as the ownership
requirements for QFs generally.
Moreover, if the battery element of the WindStor system is ever charged with
power from (1) a non-QF generator or (2) the electric utility grid, rather than
solely from the generation of a wind turbine QF, any sales of power from the
battery, and the owners and operators of the battery, would to that extent not
qualify for QF exemptions under PURPA. Finally, the electrical distribution
system within the customer's application and site, if owned or operated by us,
might not qualify as part of a QF to the extent that it is used to transmit non-
QF power.
We intend to structure our WindStor ownership and operating template in order to
secure QF status for all of the elements that we may own and operate where power
is being sold either at wholesale or at retail. We may consider a combination of
ownership and power sales, leases, equipment sales, customer ownership and
operating contracts which divide QF and non-QF elements of any particular
WindStor application. Although there is FERC precedent for the use of such
structures in QF-eligible applications, we cannot be certain that any particular
structure would qualify. Moreover, in the event that any such facility owned by
us were to lose QF status, we could be deemed to be a utility holding company
under PUHCA and the QF status of our other projects could be jeopardized.
<page>35
State Regulation
With few exceptions, state regulatory agencies generally have the jurisdiction,
among other things, to approve the construction of new electric generating
facilities, and to permit or disapprove the sale of electric power to end-users
(retail sales). Just as importantly, these agencies have plenary jurisdiction
over a utility's rates and terms for service to retail customers, including the
rates and terms for interconnection of retail customers including the facilities
needed for interconnection, rates and terms for firm power service, for
supplementary power service (power needed on a firm basis in addition to the
power a customer generates for itself), and for back-up power service (extra
power a customer may need from time to time in the event of an outage of its own
generation). In some states, the agency determines whether a customer may
terminate its utility service in order to meet its needs with self-generated
power, or power from a non-utility third party such as us, and whether the
customer must pay a special charge for the right to "go off the grid" partially
or completely. Any or all of the regulations may have important, and possibly
materially adverse, implications for our business model and operations in
specific circumstances.
In most of our anticipated commercial retail applications, the WindStor system
would supply part of a customer's power requirements, but not produce excess
power that would go on to the utility distribution or transmission system. We
expect to provide and sell a portion of the customer's power requirements to the
customer, rather than selling or leasing the WindStor system to the customer.
The remainder of the customer's power requirements would be supplied by a local
electric utility or other retail supplier, or by other customer-owned
generation.
The first issue in any state will be whether a Certificate of Public Convenience
and Necessity or similar authorization ("CPCN") is required to be obtained from
the state regulatory agency before construction of the WindStor system may
begin. In some states, a CPCN is not required for the construction and operation
of small-scale generating facilities with generating capacity less than 1 MW,
which would be larger than most WindStor systems we anticipate installing. Where
a CPCN is required, it may involve a lengthy and expensive application process,
possibly including an environmental impact evaluation and opposition by
interested parties or utilities. We intend to require the prospective customer
to obtain such an authorization where required by law, and there can be no
certainty that potential customers will agree to undertake this process, or if
they do, that they will be successful.
The next critical issue is whether and under what circumstances a sale of power
to an end user at retail will be permitted by the state at all. QF status, as
described above, gives a QF no right to sell power at retail. If the state
permits such sales, however, a QF is legally exempt by FERC regulations under
PURPA from most burdensome utility-type regulation by the state regulatory
authority. Accordingly, if the state permits a QF to make retail sales, the
state will be pre-empted by PURPA from regulating the QF's rates for sales of
retail power, or its corporate governance or financial organization. The extent
to which a state honors such federal preemption, however, may be subject to
varying practice. Where a CPCN is required, for instance, the conditions of a
CPCN may impose certain obligations that have the same effect as some level of
utility-type regulation, such as restrictions on the amount of financing that
can be obtained, on any future transfer of ownership of the facility, on the
ability of the facility's owners to engage in other businesses in the state, as
well as certain periodic reporting requirements.
<page>36
At this time, the State of New York permits the construction of small scale wind
turbines without a CPCN, and permits the sale of power from such turbines to end
users with no regulatory interference or limitation. There can be no certainty
that these favorable conditions will continue in New York, or that other States
will have or will maintain laws and regulations that are as favorable to us
in this respect when we wish to do business there.
Finally, the state regulatory authority may determine or approve a utility's
determination as to the physical interconnection requirements a utility may
impose on a customer who wishes to install a WindStor system in parallel with
the utility's distribution and transmission, what charges a utility may impose
on a retail customer for interconnection with the utility's system when the
customer maintains a WindStor system, and what charges, penalties or other
restrictions the utility may impose on the customer for, among other things,
permanently reducing its purchased power requirement from the utility. Charges
imposed by a utility and authorized by a state regulatory authority may make
purchasing power from our WindStor system or our wind turbines uneconomical for
some customers or for all customers in some utility service territories or
states. New York State has published standardized interconnection requirements
for small-scale generators, which attempt to reduce the burden and cost of the
interconnection process, and we and our customers may benefit from such rules
where they apply. QFs and their "host" customers also have the benefit of
PURPA's prohibition against unreasonable or discriminatory rates and charges for
these services and for supplementary and back-up power service, but exercising
those rights in particular cases may be costly and time-consuming.
Extraction and Refining of Vanadium
Acquisition of Lac Dore Mining Inc.
On February 1, 1999, we acquired all of the outstanding equity securities of Lac
Dore Mining Inc., a Canadian corporation formed on August 23, 1996. Lac Dore
Mining Inc. holds 443 contiguous mining claims for the Lac Dore
vanadium/titanium deposit. The deposit, which has never been in production, is
located in the Rinfret and Lemoine townships, approximately 43 miles from
Chibougamau, Quebec, Canada. At the time we acquired Lac Dore Mining Inc., we
intended, subject to obtaining sufficient funds, to build a mine and refinery at
Lac Dore for the extraction and production of high-purity vanadium compounds.
We have deferred engaging in any material exploratory or other activities in
connection with the deposit. Even if we determine to commence operational
activities, we will not be able to do so unless we are able to obtain funding to
the extent described below.
When we first acquired an interest in the Lac Dore deposit, SOQUEM INC. owned 21
claims covering a portion of the deposit. SOQUEM is a division of SGF Mineral
Inc., which is a subsidiary of Societe Generale de Financement du Quebec, a
corporation owned by the Quebec government. In accordance with an option and
joint venture agreement between SOQUEM and Lac Dore Mining Inc., SOQUEM
transferred an undivided interest in the 21 claims to Lac Dore Mining Inc. in
exchange for 1,000,000 shares of our common stock and warrants to purchase a
like number of shares. SOQUEM did not exercise these warrants and the warrants
have expired.
<page>37
In order to maintain our claims, we are obligated to expend varying amounts of
capital (a complicated formula combining the type of exploration work executed
and the claims on or near to which the work is conducted) or pay approximately
CDN $50,000 per year in claim renewal fees. In the event we fail to fulfill our
obligations, we will lose our claims.
We granted SOQUEM an option to purchase a 20% undivided interest in the Lac Dore
project if SOQUEM funded 20% of the capital expenditures for the Lac Dore
project. The option was to expire 60 days after we delivered to SOQUEM a
"bankable" feasibility study for the Lac Dore project, which we did not do.
SOQUEM had the right to receive back a 50% interest in its original 21 claims.
On April 17, 2003, SOQUEM relinquished any rights it had relating to the
deposits in exchange for 250,000 shares of our common stock.
We have undertaken certain preliminary exploratory activities since we acquired
the mining claims for which we expended approximately $6,000,000.
Properties and Uses of Vanadium
Vanadium is a metallic element found in several minerals. Its natural structural
strength makes it useful in industrial and consumer applications, primarily as
an alloying agent for iron, steel and aluminum. Vanadium can act as a carbide
stabilizer, improving the strength and toughness, as well as the rust-
resistance, of steel. Vanadium's high melting point and high creep resistance
(resistance to shear crystals and deformation, resisted with vanadium as an
alloy in steel products) make it useful in a number of applications, including
components for nuclear reactors, aerospace material and aluminum and titanium
alloys.
Processed vanadium comes in varying types or "grades." Grades having less than
99.6% vanadium content are known as metallurgical-grade vanadium. Processed
vanadium with grades above that level are known as chemical or high-purity
vanadium.
According to Roskill, a metals industry periodical and recognized information
resource, more than 90% of world-wide vanadium production is in the form of
vanadium pentoxide and approximately 85% of annual vanadium pentoxide production
is in the form of metallurgical-grade vanadium pentoxide used for the production
of ferro-vanadium, a steel-vanadium pentoxide alloy. Vanadium pentoxide is a
strengthening agent and various amounts are added to steel depending on the
hardness and strength required. Vanadium pentoxide also is used in various
commercial applications, including ceramics, as a catalyst to produce certain
vitamins, for screening ultraviolet rays in glass and other materials, in dyeing
and printing of fabrics and in the production of sulphuric acid.
A developing application for high-purity vanadium compounds is energy storage
devices such as batteries. Batteries using vanadium may have the potential to
provide electricity from several configurations and for applications ranging
from powering cellular telephones to providing back-up power to electrical
grids. Although production of vanadium batteries has begun, the markets for
these batteries are in the early stages of development and there can be no
assurance that the markets will develop to the extent that the demand for high-
purity vanadium will significantly increase.
<page>38
Vanadium Supply
Vanadium is produced through the mining and processing of ores, concentrates,
slag and petroleum residues. Five countries currently produce vanadium compounds
in commercial quantities: South Africa, the United States, Russia, China and
Australia. Vanadium production has historically positively correlated to the
worldwide economy, especially in those industries that are significant consumers
of steel, such as construction and automobile and appliance manufacturing.
South Africa is the single largest producer of vanadium and has traditionally
been the leading exporter of vanadium slag and vanadium pentoxide. United States
production of vanadium has focused on implementing recovery processes on
industrial waste, such as vanadium-bearing ferro-phosphorus slag, iron slag, fly
ash, petroleum residues and spent catalysts. Based on information available to
us, there are eight United States firms that either are currently recovering and
producing or have at one time recovered and produced vanadium and vanadium
compounds as well as vanadium-bearing chemicals.
Lac Dore Deposit Preliminary Feasibility Study
A feasibility study is a comprehensive study of the economic potential of a
mining project. The study includes deposit geology, mining reserves, processing
methodology, waste material handling, equipment requirements, infrastructure
needs, environmental studies, market analysis, capital needs and projected
investment returns. Our preliminary feasibility study which began in March 2001
was conducted by SNC Lavalin Inc., an engineering firm headquartered in
Montreal, Quebec. We funded $1.17 million of the cost of the study and the
balance of the cost of $1.1 million was funded by federal and provincial
agencies in Canada in the form of loans and grants. Reference is made to the
Notes to Consolidated Financial Statements included elsewhere in this prospectus
for a description of the terms of the Canadian funding.
The preliminary feasibility study was based upon producing a high-purity
vanadium material to be used in an electrolyte solution that would serve as the
energy storage material for a battery being developed by Sumitomo Electric
Industries Ltd. called the vanadium redox battery. We provided a sample of
vanadium material extracted from our deposit to Sumitomo for analysis. Sumitomo
confirmed that the vanadium material sample was acceptable for use in its
vanadium redox battery, although Sumitomo has not purchased or agreed to
purchase any vanadium material from us. We believe that the economic viability
of the deposit is dependant upon, among other things, substantial production and
sales by others of vanadium redox batteries. We do not believe that any vanadium
redox batteries are presently being produced or sold.
SNC Lavalin Inc. completed the preliminary feasibility study in April 2002.
Although the analysis of the data considered during such a study is subject to a
number of interpretations and the study involves a number of subjective
decisions, we have been encouraged by the results of the study. The preliminary
feasibility study, however, is not a "bankable" study for purposes of the
agreement with SOQUEM because we have not secured contracts for the sale of the
high-purity vanadium compounds that may be produced at Lac Dore.
<page>39
The preliminary feasibility study concluded that analysis of the Lac Dore
project would be economically feasible if we could sell vanadium electrolyte for
a beginning price of approximately $2.35 per liter, declining over time to
approximately $1.50 per liter. We are not aware of any market for vanadium
electrolyte and there can be no assurance that a market will ever exist or that
the price per liter will be within the parameters set out in the feasibility
study.
The preliminary feasibility study estimated that the initial capital cost of the
Lac Dore project would be approximately $260 million. Since the study was
completed, however, we have added other high-purity vanadium products to the
expected production mix necessitating a change in the equipment that would be
required at Lac Dore. The change in equipment would increase the initial capital
cost by approximately $20 million. The study also concluded that the Lac Dore
project would incur annual operating costs of $50 million and would incur
substantial operating losses during the first two years of production.
Competition
According to Roskill, the largest producer of vanadium-bearing ore is Anglo
American plc, through its Highveld vanadium deposit located in South Africa.
Highveld is the largest known vanadium deposit in the world. Anglo American has
produced vanadium electrolyte for a vanadium redox battery installation. Because
of Anglo American's significantly greater technical and financial resources,
Anglo American may have the ability to improve and price its electrolyte at
prices with which we could not compete. We believe that the only other
significant ore-producing vanadium deposit is Windimurra, owned by Xstrata AG,
located in Australia. Another company currently producing high-purity vanadium
products in commercial quantities is Strategic Minerals Corporation. Based in
the United States, Strategic Minerals Corporation has operations in Hot Springs,
Arkansas and South Africa.
We believe than the vanadium market is characterized by significant excess mine
capacity and above ground stocks of vanadium. We further believe that the
Windimurra and possibly other mines are fully developed and could return to
production if prices rise above existing levels for a sustained period. Any
owners or exploiters of sources of vanadium which are not part of the Lac Dore
deposit will be in competition with us if we are ever able to exploit the Lac
Dore deposit.
The most common method of recovering vanadium from industrial waste involves
steel slag, which is a by-product of steel production. Steel slag contains
vanadium pentoxide, which is removed and converted to different forms of
vanadium product. Currently, there are two South African producers and one
Australian producer, each owned by Xstrata AG, which recover vanadium
exclusively in this manner. Vanadium also is recovered from direct conversion of
ore and can be recovered from power plant ashes, residues and spent catalysts. A
number of companies recover vanadium using these methods.
<page>40
If we begin exploration of our Lac Dore deposit, we will compete with other
larger, more established mining companies with significantly greater technical
and financial resources. In addition, vanadium is an accessible commodity
product and other competitors could enter the market and effectively compete
with us.
Exploration and commercialization
If we begin exploration of our Lac Dore deposit, our success will depend, in
substantial part, on our ability to respond quickly to changing technology,
market demands and the needs of prospective customers. We have committed
significant resources to preliminary exploratory activities. Our expenditures
have primarily related to completion of the preliminary feasibility study and
the development of proprietary processes in connection with our laboratory
tests. Our process development and exploration expenses related to Lac Dore were
approximately $915,000, $2.1 million and $1 million for the fiscal years ended
September 30, 2003, 2002 and 2001, respectively. We did not make any such
expenditures during the nine months ended June 30, 2004.
We intend to continue the development of vanadium refining technologies. The
next phase of development has been planned at a cost of approximately $1.0
million and is scheduled to begin during calendar 2004. A portion of the cost
includes the operating costs associated with a sample product unit constructed
by SGS Lakefield Research at its facility in Lakefield, Ontario Canada to
produce customer samples of various vanadium chemicals and continue research and
development on additional possible products. As is the case with our other
proposed business activities, unless we can obtain sufficient capital we will
not be able to proceed.
Governmental and Environmental Regulations
Impact Assessment Process
The Lac Dore project is subject to the environmental and social impact
assessment and review procedures under the Quebec Environment Quality Act, the
James Bay and Northern Quebec Agreement and the Canadian Environmental
Assessment Act. These acts are administered by separate provincial and federal
governmental agencies that have the separate authority to approve or require
changes to a company's impact assessment. Notwithstanding this separate
authority, these federal and provincial governmental agencies generally attempt
to coordinate their review and approval procedures.
In May 1999, Groupe-conseil Entraco filed a project notice with the Quebec
Environment Ministry on our behalf. In June 2000, the Ministry issued its
guidelines (which state the nature, size and scope of the impact assessment) in
accordance with the Quebec Environment Quality Act. The Ministry's guidelines
are valid for a period of three years.
<page>41
An additional project notice was issued during Summer 2002 under the Quebec
Environment Quality Act for equipment located within the territory of the
Domaine du Roy Regional municipality. This additional project notice is covered
by the Ministry's guidelines issued in June 2000.
The review processes undertaken by each provincial and federal governmental
agency are extensive and approval of our impact assessment by each agency could
take up to 18 months. If approved, we will receive a certificate of
authorization. Although we believe that we will ultimately receive a certificate
of authorization, we cannot accurately predict how long the governmental-
approval process will take. In addition, it is common for a certificate of
authorization to be conditioned on the application meeting certain additional
requirements.
The Lac Dore project also must comply with the Canadian Fisheries Act; the Guide
for the Administration of Fish Habitats from Fisheries and Oceans Canada; and
the Liquid Effluent from Metal Mining Regulation.
We filed the Lac Dore Environmental Impact Study with the provincial Quebec
Environment Ministry and Canadian federal Fisheries and Oceans Canada bodies on
June 25, 2003.
Quebec Mining Act
Any future mining at the Lac Dore deposit must comply with the provisions of the
Quebec Mining Act and Guideline No. 19 applicable to the mining industry. Under
the Quebec Mining Act, the operator of Lac Dore must file a mining site
rehabilitation plan with the Natural Resources Ministry. This rehabilitation
plan discusses how the operator intends to rehabilitate the property following
its intended use of the property and includes an estimate of the costs involved
in the rehabilitation. If the rehabilitation plan for Lac Dore is approved by
the Natural Resources Ministry, we will be required to put in trust an amount
equal to 70% of the estimated costs to rehabilitate the site.
In addition, we must obtain three types of mining rights from the Natural
Resources Ministry:
- Mining rights for all mining facilities, with mandatory land
surveys;
- Rights of the surface estate; and
- Rights for facilities other than those required for mining
purposes (for example, lease for storage of explosives,
buildings not related to mining).
Finally, the operator of Lac Dore must obtain permits and distribution rights-
of-way from the Natural Resources Ministry for the construction of the access
roads and power lines.
<page>42
Other Requirements
We will be required to comply with other provisions of the Quebec Environment
Quality Act, including standards related to protection of the soil and water and
air quality. Vanadium is considered an "unconventional" contaminant for purposes
of the Act. Accordingly, the acceptable standards for vanadium criteria are not
set forth in the Quebec Environment Quality Act, but instead are determined in
the discretion of the Quebec Environment Minister.
The preliminary feasibility study estimated that if Lac Dore becomes
operational, the annual cost of complying with provincial and federal
governmental and environmental regulations will be in the approximate range of
$80,000 to $240,000. The amounts are based on Bank of Canada inflation
calculator and current exchange rate, rounded up to next even thousand. These
amounts represent preliminary cost estimates and the actual costs may be
substantially greater.
Employees
On September 29, 2004, we had 8 full time employees. Subject to obtaining
sufficient capital, we intend to hire a controller, an administrative assistant,
a project manager, two engineers and a bookkeeper. We believe that such
personnel will be readily available at reasonable rates of compensation.
Properties
Location of and Access to the Lac Dore Deposit
The Lac Dore deposit is located approximately 70 kilometers southeast of the
city of Chibougamau, in the Rinfret and Lemoine townships of northern Quebec.
The deposit is approximately five kilometers south of Chibougamau Lake, which is
in a low, flat ground area, 380 meters above sea level. The deposit is
accessible by road from national highway 167, which is paved and links
Chibougamau to the Lac St-Jean area. At kilometer 200 on national highway 167,
approximately 32 kilometers south of Chibougamau, forest road 210, a dirt road,
leads approximately 35 kilometers east to the deposit and the main exploration
workings. The area has been clear-cut of wood, and, accordingly, provides good
access by four wheel drive vehicles to the various outcrops of the deposits.
The Chibougamau/Chapais area has a well-developed infrastructure to support
mining projects, including transportation, a well-trained labor force, service
and maintenance industries and an airport. Lac Dore is approximately 35
kilometers from Hydro-Quebec's Chibougamau electricity substation.
History of Exploration and Geology at Lac Dore
Lac Dore is expected to be an open-pit mine. The deposit has never been in
commercial production. All activity on the deposit to date has been exploration.
A chronology of work on Lac Dore follows:
<page>43
Historical Deposit Work at Lac Dore
In 1954, the Lac Dore deposit was discovered by an airborne geophysical magnetic
survey. The property was first staked and owned by Dominion GULF Company.
Between 1966 and 1975, the Ministere des Richesses Naturelles du Quebec (the
"Quebec Ministry") staked the property and conducted a series of tests for
vanadium content. In 1977, SOQUEM took over the exploration activities at Lac
Dore from the Quebec Ministry. SOQUEM subsequently carried out detailed
geological mapping, geophysical surveys and a drilling program. In 1983, SOQUEM
reduced the claimed area to 21 claims by allowing its other claims to expire.
Lac Dore Mining Inc. Activities
Beginning in 1996, Lac Dore Mining Inc. began to acquire claims covering
portions of the Lac Dore deposit. In 1997, Lac Dore Mining Inc. purchased 21
claims over a five kilometer strike length of the Lac Dore deposit from SOQUEM.
Lac Dore Mining Inc. currently owns 443 claims. The total cost for acquiring the
443 claims was approximately $113,000, 1,350,000 shares of our common stock and
warrants to purchase 1,000,000 shares of our common stock at CDN $2.00 per
share.
In 1998, Cambior inc., an international mining company, acquired an option from
Lac Dore Mining Inc. to receive a 60% interest in Lac Dore in exchange for
funding 60% of the costs related to developing the deposit. In 1999, Cambior did
extensive verification and audit work at Lac Dore. In 2000, Cambior terminated
its work on the Lac Dore deposit and its option expired.
In April 2001, Lac Dore Mining Inc. engaged SNC-Lavalin Inc. to carry out a
preliminary feasibility study of the Lac Dore deposit. SNC-Lavalin reviewed the
existing data, validated the database and drilled additional test holes, all
with respect to the 21 claims acquired from SOQUEM. SNC-Lavalin also organized
its own database and resource block model. In April 2002, SNC-Lavalin completed
the preliminary feasibility study and issued its report. SNC-Lavalin estimated
that the portion of the deposit covered by the 21 claims consists of 102 million
tons of in-place mineralized material at 35% magnetite, 17.4% ilmenite and 0.5%
vanadium pentoxide.
Topography and Geology
The topography was carved by glaciers more than 10,000 years ago. The deposit,
which is hosted in plutonic rocks, outcrops in a series of west-southwest
rolling hills, some 100 to 150 meters higher in elevation.
There is little dirt or cover on the bedrock in the deposit area, making
geological mapping easier. Vegetation is bushy, typical of harvested forest, and
the rocky surface is rugged.
<page>44
The Lac Dore property hosts a large deposit containing titanium, a type of
deposit also found in South Africa and other parts of the world, with
Precambrian shield rocks. The deposit is made up of a stratified series of
magnetite beds with ilmenite and amalgamated vanadium, known to outcrop over 17
kilometers on the south shore of Lake Chibougamau and also the north shore, some
25 kilometers away, on either side of the Chibougamau anticline.
Claims
Lac Dore Mining Inc. acquired its 443 claims in Lac Dore by purchasing claims
from third parties and staking claims for itself. We believe that Lac Dore
Mining Inc. has satisfactory title to its claims in accordance with industry
standards and applicable laws and regulations.
A claim is an area of land and/or water "claimed" by a prospector or mining
organization for the purpose of exploring the claim for a certain length of time
and subject to certain conditions as set out by a particular province in Canada.
The claim is staked out physically or by computerized map designation and
recorded in an appropriate provincial claims office. The size of a claim is 40
acres (16.2 hectares).
The claim is the only valid exploration right in Quebec for all kinds of mineral
substances in the public domain. Each claim gives the holder an exclusive right
to search for mineral substances, except sand, gravel, clay and other loose
deposits, on the land subjected to the claim. The claim also guarantees the
holder's right to obtain an extraction right upon the discovery of a mineral
deposit.
The term of a claim is two years from the day the claim is registered, and a
claim can be renewed indefinitely providing the holder meets all the conditions
set out in the Quebec Mining Act, including the obligation to invest a minimum
amount in exploration work determined by regulation. The act includes provisions
to allow any amount disbursed to perform work in excess of the prescribed
requirements to be applied to subsequent terms of the claim. The claim holder
may renew title for rolling two-year periods. To renew a claim, a holder must
submit a renewal application no later than 15 days after a claim expires and pay
the required fees. Renewal costs depend on the date that an application is
received, the title location and surface area and the value of the work
performed on the property during the claim period.
In order to maintain our claims, we are obligated to expend varying amounts of
capital (a complicated formula combining the type of exploration work executed
and the claims on or near to which the work is conducted) or pay approximately
CDN $50,000 per year in claim renewal fees. Eligibility of work-related expenses
are defined by regulations and excess value of work can be used to renew claims
within a 3.2 kilometers square area where work was not performed and/or for
future renewal.
<page>45
Lac Dore is located south of the 52nd parallel, which has different claim
renewal costs than properties located north of that point. Area size also
determines claim cost. Cost of claim renewal ranges from CDN $22 up to $330, per
claim, if more than 100 hectares and depending upon renewal date payment. Work
values must be at least CDN $500 to $3,600, per claim, depending upon hectares
claimed and the location of the claims. The cost of claim renewal also can vary
widely depending on the amount and location of work done on and near a subject
claim.
Offices
Our principal executive office which consists of approximately 400 square feet
is located at 975 Spaulding Avenue SE, Grand Rapids, Michigan 49546. The office
is leased at a monthly rental of $225. The lease is month-to-month. DERMOND has
an office at 31 rue du Terminus ouest, Rouyn-Noranda Quebec J9X 2P3 Canada.
This office, which consists of approximately 400 square feet, is leased on a
month-to-month basis for approximately $480 per month. We do not maintain any
other offices outside of home offices, for which no rental is currently paid by
us. We believe our employees and proposed future operations are and will be
located in areas in which additional office space can be obtained, if needed, at
reasonable rates. We do not expect to lease or otherwise acquire any additional
facilities during the foreseeable future.
MANAGEMENT
Executive Officers, Directors and Significant Employees
Set forth below are the name, age, position, and a brief account of the business
experience of each of our executive officers, directors and significant
employees. Each of our directors holds office until the next annual meeting of
shareholders and until the director's successor is elected and qualified or
until the director's resignation or removal.
NAME AGE POSITIONS
- ------------------ ----- -----------------------------------------------
Gary L. Westerholm 59 President, Chief Executive Officer and director
Gregory N. Bakeman 49 Treasurer, Chief Financial Officer and director
John W. Sawarin 70 Secretary, Vice President-Product Marketing
and director
John DiMora 57 Director
Doris F. Galvin 50 Director
Donald C. Harms 63 Director and Secretary
Rocco J. Martino 49 Director
Stephen D. McCormick 59 Director
John Popp 67 Director
Jacquelin Dery 63 President and director of DERMOND, INC.
Michel Garon 52 General Manager of Lac Dore Mining Inc.
Laurent B. Mondou 64 Vice President and director of DERMOND, INC.
Jan Mracek 48 Director of Technology of Lac Dore Mining Inc.
Jonathan C. Hintz 45 Senior Project Manager of WindStor Power Co.
<page> 46
Gary L. Westerholm has been a director and our President and Chief Executive
Officer since 1999. Mr. Westerholm is also President and Chief Executive Officer
of McKenzie Bay International Ltd and a director of three of our other
subsidiaries. Mr. Westerholm's term as an executive officer expires in March
2006.
Gregory N. Bakeman has been a director since 2001 and has served as Chief
Financial Officer since February 2001 and Treasurer since December 2001. Mr.
Bakeman is also Chief Financial Officer of and a director of each of our
subsidiaries. From 1999 to 2000, Mr. Bakeman served as Chief Financial Officer
of Micro-C Technologies, Inc., a manufacturer of computer chip production
equipment. From 1997 to 1999, Mr. Bakeman was a Vice President in the Investment
Banking Department of First of Michigan Corporation (now part of Oppenheimer &
Co.). Mr. Bakeman's term as an executive officer expires in March 2006.
John W. Sawarin has been a director since 1999 and has served as Secretary since
1999 and Vice President-Product Marketing since January 2003. Mr. Sawarin
previously served as Treasurer from 1999 to March 2002. Mr. Sawarin's term as an
executive officer expires in March 2006.
John J. DiMora has been a director since May 2004. For the past 15-years, Mr.
DiMora has been the owner and operating principal of a Keller Williams Realty
franchise with 22 offices and over 1650 agents operating in Michigan and
Northern Ohio.
Doris F. Galvin has been a director since February 2004. Since July 2004, Ms.
Galvin has been Senior Vice President- Corporate Development of Semco Energy,
Inc., a diversified energy and infrastructure services company. For
approximately 2 1/2 years prior to that time, Ms. Galvin was self employed as a
consultant. From 1979 to 2002, Ms. Galvin was employed by CMS Energy, holding
numerous positions in with that company, including Vice President & Treasurer,
and leaving the company as Senior Vice President-Global Development. CMS Energy
is a utility holding company.
Donald C. Harms has been a director since November 12, 2002 and Secretary since
June 2004. Since 1973, Mr. Harms has been a principal of Larson, Harms &
Bibeau, P.C., a law firm located in Farmington Hills, Michigan. Mr. Harms has
served as our outside general counsel since April 1999.
Rocco J. Martino has been a director since 1999. Since 1989, Mr. Martino, a
certified public accountant, has been a partner with LaSalle Capital Group, L.P.
or its predecessor, a private equity group.
Stephen D. McCormick has been a director since July 26, 2002. Since 1997, Mr.
McCormick has served as President of McCormick Incorporated, a holding company
that owns businesses involved in the construction industry. Since 1987, Mr.
McCormick has served as Executive Vice President of Northern Improvement
Company, a company focused on road building and movement of earth materials, and
Vice President of McCormick Construction Equipment Company, both subsidiaries of
McCormick Incorporated.
<page>47
John A. Popp has been a director since May 2004. In 1977, Mr. Popp established
MAP Mechanical Contractors, Inc. and was its president and chairman of the board
until 1999. He remains its board chairman.
Jacquelin Dery has been an executive officer and director of Dermond since 1996.
He is a Professional Engineer, educated at Ecole Polytechnique, University of
Montreal, with a degree in Electrical Engineering. In 1996 he co-formed Dermond
to improve existing Vertical Axis Wind Turbine technology to fulfill the
specific needs of isolated diesel driven electrical grids. From 1974-1996 he
worked for Hydro-Quebec, where he was responsible for overall management of a
$140,000,000 project to build a new 70 MW diesel driven power plant; provided
technical direction over conceptual engineering, detail engineering,
installation and testing of a $28 million project for a new type of 4 MW,
vertical axis wind power generator; and provided direction of a technical study
aimed at replacing a 10 MW emergency diesel power plant in the Gentilly nuclear
facility. Prior to joining Hydro-Quebec, from 1971-1974 he worked for Sonatrach,
Skikda, Algeria where he implemented a maintenance management system in a newly
built Natural Gas Liquefaction plant. From 1968-1971, he worked for the Atomic
Energy of Canada Ltd, Whiteshell Nuclear Research Establishment, Pinawa,
Manitoba, Canada, where he performed conceptual studies and direction of detail
engineering for installing experimental research loops at the Nuclear Research
Establishment, including in-core nuclear reactor experimental loops. Mr. Dery is
a Member of "Ordre des Ingenieurs du Quebec." On November 15, 2004, Dermond was
approximately $12,000 U.S. in arrears in the payment of Mr. Dery's salary.
Michel Garon has been a General Manager of Lac Dore since November 2002. Mr.
Garon's career has been in mining, performing a variety of management functions
for more than 20-years. From 1995 until joining Lac Dore Inc. in November 2002,
Mr. Garon was General Manager for Noranda's Matagami Mine, in charge of two
underground mining operations (annual operating budget - $35,000,000), including
a concentrator and all the ancillary services. He was also responsible for the
construction and development of a new underground operation (investment -
$85,000,000). He was Vice President of smelting operations for the Brunswick
Mining and Smelting Corporation Ltd in New Brunswick, Manager of the Opemiska
Division of Minnova Inc. including three underground mines, a concentrator and
all the ancillary services, and was superintendent of several operations from
1981 - 1987. Mr. Garon has a Master in Applied Sciences, Ecole Polytechnique of
Montreal, 1976 and Bachelor in Applied Sciences, Mining Engineering, Ecole
Polytechnique of Montreal, 1975. On November 15, 2004, Lac Dore Mining Inc. was
approximately $46,000 U.S. in arrears in the payment of Mr. Garon's salary.
Laurent B. Mondou has been an executive officer and director of Dermond since
1996. He is a Professional Engineer, educated at Ecole Polytechnique, University
of Montreal with a degree in Civil Engineering, and Ecole des Hautes Etudes
Commerciales, University of Montreal, Montreal, Quebec, Canada where he has a
degree in Business Administration. In 1996 he co-formed Dermond. From 1995-1996
and 1990-1991, he worked for Kamyr Enterprises Inc. where he prepared market
studies, a 3-year strategic plan, project proposals and was the contact for
senior executives in pulp and paper industries and government authorities. From
1993 to 1994, he worked for gestion Lehoux et Tremblay inc. where he provided
engineering for revamping power and pulp and paper plants, prepared studies on
cogeneration plants and construction expertise. From 1991 to 1992 he worked for
Arno Electric Ltd. where he developed a mechanical and piping division for
industrial sectors, including aluminum, pulp and paper, hydraulic power,
electrical substations and cogeneration. From 1989 to 1990, he worked for
Dominion Bridge where he developed a mechanical and piping division for
industrial sectors including aluminum, pulp and paper, hydraulic power,
electrical substations, cogeneration, refinery and metallurgy. From 1974 to
1989, he worked for BG Checo International Ltd. where he lead business
development for industrial projects such as petro-chemistry, pulp and paper,
metallurgy and oil rigs. From 1963-1973 he provided construction management on
industrial projects for SNC Inc. Mr. Mondou is a Member of "Ordre des Ingenieurs
du Quebec." On November 15, 2004, Dermond was approximately $12,000 U.S. in
arrears in the payment of Mr. Mondou's salary.
<page>48
Jan Mracek has been Director of technology of Lac Dore since January 2003. Mr.
Mracek is a Metallurgist with 22 years of experience in hydrometallurgy, in both
research and plant operations. Mr. Mracek was responsible for technical
research, design and commissioning of new technologies, including the
development of an innovative vanadium recovery and refining process for McKenzie
Bay. In operations, he focused on new technologies and improved plant
performance. His responsibilities have included process selection, development
and design; preparation of P&IDs and flow sheets; vendors evaluation; and
selection of process equipment. Mr. Mracek has worked as a Metallurgist for SNC-
Lavalin Engineers & Contractors Inc., Toronto, Ontario and Rustenburg Base
Metals Refiners (Pty) Ltd., Rustenburg, South Africa; Plant Superintendent,
Rhombus Vanadium (Pty) Ltd., Rustenburg, South Africa; Technical Development
Manager, Hydrometallurgical Plant Bruntal, Bruntal, Czech Republic, and
Researcher to Head of Metals Productions Department, Research Institute of
Metals, Panenske Brezany, Czech Republic. Mr. Mracek has a PhD, Physical
Metallurgy, Institute of Chemical Technology, Prague, Czech Republic, 1987 and
MSc, Chemical Technology and Metallurgy, Institute of Chemical Technology,
Prague, Czech Republic, 1980. On November 15, 2004, Lac Dore Mining Inc. was
approximately $40,000 U.S. in arrears in the payment of Mr. Mracek's salary.
Jonathan C. Hintz has been a Senior Project Manager of WindStor Power Co. since
August 2004. Mr. Hintz brings more than 15-years of general and project
management, engineering and quality control expertise from highly technical
environments to WindStor Power Co. From 2003, until joining WindStor Power Co.,
Mr. Hintz was Senior Systems Engineer with The Benman Companies. From 1999
until 2003, Mr. Hintz was a Vice Presidents of Technical Operations with
Capricorn Diversified Systems and from 1993 until 1999 he was and Engineering
Manager and Area Office Manager with Clover Technologies (a wholly owned company
of Americteh).
Mr. Martino is an audit committee financial expert serving on the audit
committee of our Board of Directors. Mr. Martino is "independent" as that term
is used in Schedule 14A under the Securities Exchange Act of 1934.
There are no family relationships among our directors, executive officers, or
persons nominated or chosen by us to become directors or executive officers.
None of the following events occurred during the past five years that is
material to an evaluation of the ability or integrity of any director, person
nominated to become a director, executive officer, promoter or control person:
- Any bankruptcy petition filed by or against any business of which such
person was a general partner or executive officer either at the time of
the bankruptcy or within two years prior to that time;
- Any conviction in a criminal proceeding or being subject to a pending
criminal proceeding (excluding traffic violations and other minor
offenses);
<page>49
- Being subject to any order, judgment, or decree, not subsequently
reversed, suspended or vacated, of any court of competent jurisdiction,
permanently or temporarily enjoining, barring, suspending or otherwise
limiting his involvement in any type of business, securities or banking
activities; or
- Being found by a court of competent jurisdiction (in a civil action),
the SEC or the Commodity Futures Trading Commission to have violated a
federal or state securities or commodities law, and the judgment has not
been reversed, suspended, or vacated.
Executive Compensation
Summary Compensation Table
The following table discloses all plan and non-plan compensation awarded to,
earned by, or paid to the following for all services rendered in all capacities
to us and our subsidiaries: (a) all individuals serving as our chief executive
officer (CEO) or acting in a similar capacity during the fiscal year ended
September 30, 2004, regardless of compensation level and (b) our four most
highly compensated executive officers other than the CEO who were serving as
executive officers at September 30, 2003 and whose total annual salary and
bonus, as so determined, was in excess of $100,000; (c) up to two additional
individuals for whom disclosure would have been provided pursuant to (b) of this
paragraph but for the fact that the individual was not serving as an executive
officer of us at September 30, 2003 and whose total annual salary and bonus, as
so determined, was in excess of $100,000 (the "Named Executive Officers"):
Long Term
Compensation
------------
Annual Awards
Compensation
Name and Principal Position Fiscal Year Salary Securities
Underlying Options/SARs
(shares of (common stock)
- -------------------------------------------------------------------------------
Gary L. Westerholm, 2004 $121,000 100,000 shares
President and CEO 2003 $115,500 200,000 shares
2002 $102,262 200,000 shares
- -------------------------------------------------------------------------------
Gregory N. Bakeman, 2004 $115,500 100,000 shares
Treasurer and CFO 2003 $110,250 200,000 shares
2002 $89,282 50,000 shares
The aggregate amount of any perquisites and other personal benefits, securities
or property paid or given by us to any of the Named Executive Officers in any of
the fiscal years was less than 10% of the total of annual salary of the
respective Named Executive Officer.
<page>50
During the fiscal year ended September 30, 2003, we did not adjust or amend the
exercise price of stock options previously awarded to any of the Named Executive
Officers, whether through amendment, cancellation or replacement grants, or any
other means.
Option Grants Table
The following table provides certain information concerning individual grants of
stock options made during the fiscal year ended September 30, 2004 to each of
the Named Executive Officers:
Option Grants in Fiscal Year Ended September 30, 2004
- ----------------------------------------------------------------------------
Individual Grants
- ----------------------------------------------------------------------------
Name Number of % of Total
Securities Options
Underlying Granted to
Options Employees in Exercise or
Granted (shares of Fiscal Base Price Expiration
common stock) Year ($/Sh) Date
- ------------------ -------------- --------------- ---------- ------------
Gary L. Westerholm 100,000 30.77% $1.88 9/30/2014
- --------------------------------------------------------------------------------
Gregory N. Bakeman 100,000 30.77% $1.88 9/30/2014
We have never granted any stock appreciation rights to the Named Executive
Officers.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
The following table provides certain information concerning each exercise of
stock options and during the fiscal year ended September 30, 2004 by each of the
Named Executive Officers and the fiscal year-end value of unexercised options:
<table>
<s> <c> <c> <c>
Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values
- --------------------------------------------------------------------------------------
Name Shares Value Number of Shares of
Acquired Realized Common Stock
on ($) Underlying Unexercised Value of Unexercised
Exercise Options at FY-End In-the Money
(shares of common stock) Options
at FY-End
Exercisable/Unexercisable Exercisable/Unexercisable
- --------------------------------------------------------------------------------------
Gary L. Westerholm -0- -0- 1,030,000/0 $204,000/0
- --------------------------------------------------------------------------------------
Gregory N. Bakeman -0- -0- 555,000/0 $106,500/0
</table>
<page>51
An option is considered "in the money" for purposes of the table if its exercise
price was lower than $1.30, the market value of a share of our common stock on
September 30, 2004.
Long-Term Incentive Plans - Awards in Last Fiscal Year
We made no awards to a Named Executive Officer in the fiscal year ended
September 30, 2004 under any Long-Term Incentive Plans other than as set forth
in the Option Grants Table above.
Compensation of Directors
At the beginning of each of our fiscal years, each of our directors receives a
10-year option for the purchase of 50,000 shares of our common stock,
exercisable at the fair market value of the shares on the first trading day of
October in each year. A director who has or will serve on the Board of Directors
for less than an entire fiscal year will be granted an option to purchase a pro-
rata number of shares. The options are fully vested upon grant.
We have no other arrangements pursuant to which any of our directors were
compensated during the fiscal year ended September 30, 2004 or are expected to
be compensated in the future for any service provided as a director.
In February 2004, we extended the termination date from March 14, 2004 to
September 15, 2008 of options to purchase an aggregate of 300,000 shares of our
common stock previously granted to Gary L. Westerholm, Gregory N. Bakeman, John
W. Sawarin and Rocco J. Martino. The options are exercisable at $1.00 per share.
In November 2004, we granted options to our directors for the purchase of shares
of our common stock as follows:
NAME NUMBER OF SHARES
UNDERLYING OPTIONS
- -------------------- ------------------
Gregory N. Bakeman 100,000
John DiMora 25,000
Doris F. Galvin 39,167
Donald C. Harms 50,000
Rocco J. Martino 60,000
Stephen D. McCormick 50,000
John Popp 25,000
John W. Sawarin 75,000
Gary L. Westerholm 100,000
The options are exercisable at $1.35 a share and expire on September 30, 2014.
<page>52
Employment Contracts and Termination of Employment and Change in Control
Arrangements.
On March 21, 2003, we entered into an employment agreement with each of Messrs.
Westerholm, Bakeman and Sawarin pursuant to which they will serve as executive
officers and receive annual base compensation of $121,000, $115,500 and $93,500,
respectively. We have agreed to review the compensation annually during the last
month of each fiscal year and to grant increases in compensation which will be
effective on the first day of the immediately following calendar year, based
upon the respective employee's performance, scope of responsibility assumed,
compensation paid to similar employees in similar companies and such other
factors as may guide us in setting reasonable compensation. In September 2003,
we did not review the compensation because of our financial condition. Unless
sooner terminated as provided for in the agreements, the terms of employment
continue until April 1, 2006, provided, however, that such terms shall
automatically be extended for additional periods of twelve months each unless we
give notice, not less than three months prior to the expiration of the term,
including any extensions, of the termination of the employment effective as of
the next succeeding anniversary date of the expiration of the term or any
extension. Each employee has the right to participate in all senior executive
benefit, bonus and/or stock option plans we maintain and are available to our
senior executive officers generally. In the event of the termination of an
employee's employment as a result of disability, we will pay him an amount equal
to his base annual salary less any credit for sick pay or other benefits
received by him deriving from any private medical insurance or other similar
arrangements entered into by us. Each of the employees may voluntarily terminate
his employment with us at any time on at least 30 days prior written notice to
us and shall then be entitled to receive his base salary until the date his
employment terminates and certain other benefits. If there should be (a) a sale
of substantially all our assets; (b) a merger, amalgamation or consolidation of
us to form a new entity; or (c) a change in control of us and as a result an
employee's employment is terminated but the acquirer or the new entity, as the
case may be, offers the employee employment on terms and conditions that are
essentially the same or better than those provided under his respective
employment agreement, if the employee refuses that offer, the employee will not
be entitled to any compensation under his employment agreement. If, however,
upon any of such three events the employee is not offered employment by the
acquirer or new entity, then the employee shall be entitled to receive his
annual salary for a period of three years from the termination and any accrued
but unpaid vacation pay. All other benefits the employee may have under the
senior executive benefit bonus and/or stock option plans and programs of the
employer shall be determined in accordance with the terms and conditions of such
plans and programs. If we breach any provision of an employee's employment
agreement and such breach is not cured by us within 15 days after receipt of
written notice of the breach, the employee shall be entitled to receive his base
salary for a period of three years and all other rights and benefits the
employee may have under our senior executive benefit, bonus and/or stock option
plans and programs shall be determined in accordance with the terms and
conditions of such plans and programs. We are in breach of each of the
employment agreements because we have not paid the required salaries. On
November 15, 2004, we were in arrears in salary payments under the employment
agreements in the amounts of approximately $50,000, $31,000 and $49,000,
respectively. We have not received written notice of the breaches from any of
our executive officers.
<page>53
Equity Securities Authorized for Issuance With Respect to Compensation Plans
The following table provides certain information as of September 30, 2004 with
respect to compensation plans (including individual compensation arrangements)
under which our equity securities are authorized for issuance:
<table>
<s> <c> <c> <c>
Plan Category Number of shares Weighted average Number of shares
of common stock exercise price of common stock
to be issued upon of outstanding remaining available
exercise of options, warrants for future issuance
outstanding options, and rights other than securities
warrants and rights to be issued upon
exercise of the
outstanding options,
warrants and rights
disclosed elsewhere
in this table. (1)
- --------------------- -------------------- --------------- --------------------
Equity compensation
plans approved by 3,420,417 $1.13 4,079,583
security holders
Equity compensation
plans not approved 700,000 $1.00 -0-
by security
holders (2)(3)
</table>
(1) We have three stockholder-approved equity compensation plans, each of which
provides for a maximum of 2,500,000 shares of common stock which may be issued
upon exercise of options that have and may be granted under adjustment as
described in the plans.
(2) Prior the adoption of the shareholder approved equity compensation plans, we
granted options to various individuals who provided services to us (including
services as employees and/or directors) as partial payment for those services.
(3) The figures in this row include options for the purchase of an aggregate of
150,000 shares of common stock granted to our directors. These options were not
considered granted under the stockholder-approved 2001 Directors Non- Qualified
Stock Option Plan because the vesting schedules for these options varied from
the terms of the plan.
<page>54
Other than as set forth above, we do not have any compensation plan under which
equity securities are authorized for issuance that was adopted without the
approval of our security holders.
THE STANDBY EQUITY DISTRIBUTION AGREEMENT
Summary
In April 2004 we entered into a Standby Equity Distribution Agreement with
Cornell Capital Partners under which, subject to the conditions described below,
we may, at our discretion, periodically sell to Cornell Capital Partners shares
of our common stock for a total purchase price of up to $15 million. For each
share stock purchased under the Standby Equity Distribution Agreement, Cornell
Capital Partners will pay us 99% of, or a 1% discount from, the lowest volume
weighted average price of our common stock as quoted by Bloomberg, LP during the
five consecutive trading day period immediately following the respective dates
we give notice to Cornell Capital Partners of our intention to sell shares under
the Standby Equity Distribution Agreement. Because we have also agreed to allow
Cornell Capital Partners to retain 5% of the proceeds from our sale of shares to
Cornell Capital Partners, the net cash price to be paid by Cornell Capital
Partners to us will be 94% of the computed lowest volume weighted average price
with respect to each purchase. We have also agreed to issue to Cornell Capital
Partners shares of our common stock having a market value, similarly determined,
of $540,000 which we will satisfy by the issuance of 239,968 shares, 119,984 of
which were issued to Cornell Capital Partners on April 6, 2004. The issuance
of the shares effectively reduces the per share price we receive from Cornell
Capital Partners.
We were introduced to Cornell Capital Partners by Spencer Clarke LLC. We entered
into a Placement Agent Agreement with Spencer Clarke under which Spencer Clarke
agreed to review the terms of the Standby Equity Distribution Agreement and
advise us with respect to the terms. Spencer Clarke's fee for these services was
$10,000 which we satisfied by the issuance to Spencer Clarke of 4,444 shares of
our common stock. We have also agreed to pay Spencer Clarke for introducing us
to Cornell Capital Partners an amount equal to 10% of the gross proceeds of each
purchase of our shares by Cornell Capital Partners under the Standby Equity
Distribution Agreement of which $25,000 has been paid and the balance will be
paid at the time or times that Cornell Capital Partners purchases shares from
us. We will also issue to Spencer Clarke warrants to purchase shares of our
common stock in an amount equal to 10% of the number of shares sold to Cornell
Capital Partners. The warrants are exercisable for a period of seven years.
Although the exercise price of the warrants has not yet been determined, it will
not be less than the weighted average price computed as described above. After
giving effect to the 10% fee payable to Spencer Clarke, the net cash price we
will retain on purchases by Cornell Capital Partners, without regard to the
additional issuances of shares to Cornell Capital Partners and Spencer Clarke,
will be 84% of the computed lowest volume weighted average price with respect to
each purchase. As set forth below, based upon the number of shares actually
purchased by Cornell Capital Partners, under the described assumptions the
effective discount from such computed price could be as high as 18.48%. If
fewer shares are purchased, the effective discount could be substantially
higher. For example, although highly unlikely, if we sell only 1 million shares
to Cornell Capital Partners, the effective discount would be approximately 32%.
<page>55
Cornell Capital Partners is not obligated to purchase any of our shares unless
our shares shall have been authorized for quotation on the Nasdaq National
Market, the Nasdaq SmallCap Market, the American Stock Exchange, the OTC
Bulletin Board or the New York Stock Exchange, whichever is at the time the
principal trading exchange or market for the shares.
We have agreed with both Cornell Capital Partners and Spencer Clarke to register
with the SEC all of the shares that they may acquire under the Standby Equity
Distribution Agreement and warrants, respectively and to maintain the
registration statement's effectiveness until Cornell has sold all of its shares
included in the registration statement. We have also agreed to register the
shares in various states to the extent that exemptions from registration are
available. We further agreed to bear the entire cost of and incident to such
registration which we have estimated to be approximately $125,500. The expenses
we will pay do not include commissions, fees and discounts of underwriters,
brokers, dealers and agents. We have further agreed to indemnify Cornell Capital
Partners and Spencer Clarke and their controlling persons against certain
liabilities, including liabilities under the Securities Act of 1933.
Unless we give Cornell Capital Partners 15 day's notice, we may not issue any
common or preferred stock for less than the bid price on the date of issuance or
issue or sell any security or instrument granting the holder the right to
acquire our common stock at a price per share less than the bid price on the
date of issuance.
Each of our executive officers and directors has agreed with Cornell Capital
Partners that until the termination of the Standby Equity Distribution
Agreement, he or she will not, without the prior written consent of Cornell
Capital Partners, issue, offer, agree or offer to sell, sell, grant an option
for the purchase or sale of, transfer, pledge, assign, hypothecate, distribute
or otherwise encumber or dispose of any of our securities except pursuant to
Rule 144.
Cornell Capital Partners was formed in February 2000 as a Delaware limited
partnership. Cornell Capital Partners is a domestic hedge fund in the business
of investing in and financing public companies. Cornell Capital Partners has
advised us that it does not intend to make a market in our shares or to
otherwise engage in stabilizing or other transactions intended to help support
our share price. Prospective investors should take these factors into
consideration before purchasing our common stock. Cornell Capital Partner's
business operations are conducted through its general partner, Yorkville
Advisors, LLC.
Certain Terms of the Standby Equity Distribution Agreement Explained
Pursuant to the Standby Equity Distribution Agreement, we may periodically sell
shares of our common stock to Cornell Capital Partners. The periodic sale of
shares is referred to as an advance. We may request an advance every seven
trading days. A closing will be held six trading days after such written notice
at which time we will deliver shares of common stock and Cornell Capital
Partners is required to pay the advance amount. In addition to written notice
and associated correspondence, each advance is subject to the certain conditions
which must be satisfied after the date of this prospectus. Although we expect
that each of the conditions will be satisfied, we cannot assure you of that. The
conditions are set forth in the Standby Equity Distribution Agreement which is
an exhibit to our registration statement filed with the SEC of which this
prospectus is a part.
<page>56
We are limited in our ability to request advances under the Standby Equity
Distribution Agreement by both the number of shares we have registered in our
registration statement and the number of shares we have authorized. For example,
at an assumed offering price of $2.00 per share, the gross proceeds would amount
to $15,000,000 under the Standby Equity Distribution through the sale of
7,500,000 shares of the 20,500,000 shares we have registered for sale. However,
if the actual weighted average price at which we sell shares under the Standby
Equity Distribution Agreement is less than $0.73, we would have to register
additional shares to receive all the funds which would be available to us under
the Standby Equity Distribution Agreement. On the date of this prospectus, we
had 75 million shares authorized for issuance under our Certificate of
Incorporation, of which 43,986,202 were either outstanding or reserved for
issuance upon exercise or conversion of outstanding derivative securities or
compensation plans.
We may not request any advance from Cornell Capital Partners after the earliest
to occur of the following:
- Cornell Capital Partners has paid us gross proceeds of $15 million;
- The expiration of 24 months from the effective date of our registration
statement;
- A stop order is issued or there is a suspension in the effectiveness of
our registration statement for an aggregate of fifty trading days, other
than due to the acts of Cornell Capital Partners; or
- We fail materially to comply with certain provisions of the Standby
Equity Distribution Agreement and our failure is not cured within thirty
days after receipt of written notice from Cornell Capital Partners,
provided, however, that this termination provision does not apply to any
period commencing upon our filing of a post-effective amendment to our
registration statement and ending upon the date on which the post
effective amendment is declared effective by the SEC.
In addition, Cornell Capital Partners is not obligated to purchase our shares
unless the following additional conditions are satisfied:
- We must have deposited the shares of common stock being sold with
Cornell's counsel under an Escrow Agreement;
- We must file a registration statement with the SEC in order to register
the shares under the Securities Act of 1933 and the registration
statement must have been declared effective by the SEC;
- We must obtain any permits required for the offer and sale of the shares
from any state where securities will be sold or have available an
exemption therefrom and the sale and issuance of the shares shall be
legally permitted by all laws and regulations to which we are subject;
- We must have filed in a timely manner all reports, notices and other
documents we are required to file under the Securities Exchange Act of
1934; and
- Our transfer agent must meet certain eligibility requirements.
Although there is no time limit in which we must satisfy the conditions, there
can be no assurance that we will be able to satisfy each of them.
The amount of any advance may not exceed $625,000 and we may not request an
advance within seven trading days of a prior advance. In addition, we may not
request advances if the shares to be issued in connection with such advances
would result in Cornell Capital Partners owning more than 9.9% of our then
outstanding common stock. Other than described above, the amount available under
the Standby Equity Distribution Agreement is not dependent upon the price or
volume of our common stock.
We do not have any agreements with Cornell Capital Partners regarding the
distribution of the shares it purchases from us. Cornell Capital Partners has
advised us that it intends to promptly sell any shares it purchases from us
under the Standby Equity Distribution Agreement.
<page>57
We cannot predict the actual number of shares that we will require Cornell
Capital Partners to purchase under the Standby Equity Distribution Agreement
primarily because the purchase price of the shares will fluctuate based on
prevailing market conditions. Nonetheless, we can estimate the number of shares
using certain assumptions. Assuming we issued the number of shares registered in
our registration statement at a recent price of $2.00 per share, we would issue
7,500,000 shares of common stock to Cornell Capital Partners for gross proceeds
of $15,000,000. If these shares had been issued on the date of this prospectus,
they would represent approximately 22.3 % of our outstanding common stock. In
addition, we cannot predict the number of shares, if any, that Spencer Clarke
may purchase from us upon exercise of warrants.
There is no cap on the number of shares that can be issued under the Standby
Equity Distribution Agreement. Based upon our current capital needs and the
market price of our common stock, we presently have no intention of drawing
down the entire $15 million amount. Accordingly, our estimate of the number of
shares that we will issue pursuant to the equity line is 10 million shares If
our circumstances change and we have no other source of financing, we may
ultimately have to draw down the entire $15 million assuming that we will then
be in a position to satisfy all of the relevant conditions.
Cornell Capital Partners is not obligated to purchase any of our shares unless
our shares shall have been authorized for quotation on the Nasdaq National
Market, the Nasdaq SmallCap Market, the American Stock Exchange, the OTC
Bulletin Board or the New York Stock Exchange, whichever is at the time the
principal trading exchange or market for the shares.
There is a large number of shares of common stock underlying the Standby Equity
Distribution Agreement that will be available for future sale and the sale of
these shares will cause dilution to our existing shareholders. The resale of
such shares can be expected to depress the market price of our shares.
There is an inverse relationship between our stock price and the number of
shares to be issued under the Standby Equity Distribution Agreement. If the
market price of our stock declines, we would be required to issue a greater
number of shares under the Standby Equity Distribution Agreement and warrants
for a given advance. This inverse relationship is demonstrated by the following
table, which shows the number of shares to be issued under the Standby Equity
Distribution Agreement at various assumed prices per share.
Assumed Purchase Price:$ 2.00 $ 1.50 $ 1.00 $ 0.50
Number of Shares (2) 7,500,000 10,000,000 15,000,000 30,000,000(1)
Total Outstanding (3) 33,908,255 36,408,255 41,408,255 56,408,255
Percent Outstanding (4) 22.1% 27.5% 36.2% 53.2%
Net cash proceeds $12,600,000 $12,600,000 $12,600,000 $12,600,000
(1) In order for us to sell more than an aggregate of 22,239,968 shares pursuant
to the Standby Equity Distribution Agreement and exercise of the warrants
which may be issued to Spencer Clarke, we will be required to register the
additional shares with the SEC.
(2) Represents the number of shares of common stock to be issued to Cornell
Capital Partners under the Standby Equity Distribution Agreement at the
assumed prices set forth in the table, assuming sufficient authorized shares
are then available.
(3) Represents the total number of shares outstanding after the issuance of the
shares to Cornell Capital Partners under the Standby Equity Distribution
Agreement if the shares had been issued on the date of this prospectus. Does
not include any shares which may be acquired by Spencer Clarke or others
upon exercise of the warrants or conversion of promissory notes.
(4) Represents the shares of common stock to be issued to Cornell Capital
Partners as a percentage of the total number of shares outstanding based
upon the assumptions described in Note (2) above. Cornell Capital Partners
is not obligated to purchase any shares from us to the extent that its
holdings would exceed 9.9% of our then outstanding common stock.
<page>58
The following table sets forth the effective price per share we will receive
from purchases made by Cornell Capital Partners under the Standby Equity
Distribution Agreement at various assumed prices per share.
Market Price (1) $2.00 $1.50 $1.00 $0.50
Number of Shares (2) 7,575,758 10,101,010 15,151,515 30,303,030
Net cash to be
received from
Cornell Capital $14,250,000 $14,250,000 $14,250,000 $14,250,000
Partners (3)
Placement Agent fee(4) $1,500,000 $1,500,000 $1,500,000 $1,500,000
Net cash to be
received from
Cornell Capital
Partners after $12,750,000 $12,750,000 $12,750,000 $12,750,000
deduction of
Placement Agent
Fee
Net cash to be
received from
Cornell Capital
Partners after 84% 84% 84% 84%
deduction of
Placement Agent
Fee as a percentage
of Market Price
Net cash to be
received from Cornell $12,750,000 $12,750,000 $12,750,000 $12,750,000
Capital Partners
after deduction of
Placement Agent
Fee and giving
effect to issuance of
additional shares (5)
Net cash to be
received from Cornell
Capital Partners after
deduction of Placement 81.52% 82.16% 82.81% 83.48%
Agent Fee and giving
effect to issuance
of additional shares
as a percentage of
Market Price (5)
Effective discount
from Market Price
after deduction of
Placement Agent Fee $.37 $.27 $.17 $.08
and giving effect
to issuance of
additional shares (5)
Effective discount
from Market Price
after deduction of
Placement Agent Fee 18.48% 17.84% 17.19% 16.52%
and giving effect
to issuance of
additional shares
as a percentage of
Market Price (5)
<page>59
(1) The term "Market Price" as used in the table refers to the lowest volume
weighted average price of our common stock as quoted by Bloomberg, LP
during the five consecutive trading day period immediately following the
date we give notice of our intention to sell shares.
(2) Represents the number of shares of common stock to be issued to Cornell
Capital Partners under the Standby Equity Distribution Agreement at the
assumed prices set forth in the table, assuming sufficient authorized
shares are then available. Cornell Capital Partners is not obligated to
purchase any shares from us to the extent that its holdings would exceed
9.9% of our then outstanding common stock.
(3) Represents 94% of the Market Price.
(4) Represents 10% of gross proceeds.
(5) The additional shares refer to the issuance of 239,968 shares and 4,444
shares described above.
The table does not give effect to the warrants that may be issued to Spencer
Clarke.
Reference is made to the "Use of Proceeds" section of this prospectus. We expect
to require Cornell Capital Partners to make advances to the full extent provided
in the Standby Equity Distribution Agreement.
Pursuant to the Standby Equity Distribution Agreement, each of our officers and
directors and SOQUEM has agreed with Cornell Capital Partners that until the
termination of that Agreement, he, she or it will not without Cornell Capital
Partner's consent, sell, encumber or otherwise dispose of any securities issued
by us except pursuant to Rule 144 under the Securities Act of 1933.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of November 15, 2004 with
respect to any person who is known to us to be the beneficial owner of more than
5% of our common stock, which is the only class of our outstanding voting
securities, and as to our common stock beneficially owned by our directors and
officers and directors as a group:
Name and Shares of Common Stock Approximate
Address of Beneficial Owner Beneficially Owned (1)(2) Percent of Class
- --------------------------- ------------------------- ----------------
Gary L. Westerholm
3362 Moraine Drive
Brighton, Michigan 48114 5,379,700 (3) 19.5%
John W. Sawarin
143 Windsor Ave.
London, ONT Canada N6C 2A1 2,469,600 (4) 9.0 %
Stephen D. and
Karen A. McCormick
PO Box 1254
Bismarck, ND 58502 9,770,048 (5) 29.9 %
SOQUEM, INC.
1000, route de l'Eglise,
bureau 500
Sainte-Foy Quebec Canada
G1V 3V9 1,520,123 5.8 %
Gregory N. Bakeman
975 Spaulding Avenue SE
Grand Rapids, Michigan 49546 668,700 (6) 2.5 %
<page>60
Rocco J. Martino
1468 Gary Wood Drive
Bass Ridge, Illinois 60527 894,698 (7) 3.3 %
Donald C. Harms
37899 Twelve Mile Road
Farmington Hills, Michigan 48331 198,918 (8) (9)
Doris F. Galvin
19495 Sibley Road
Chelsea, MI 48118 71,167 (10) (9)
John A. Popp
PO Box 2917
Midland, MI 48640 1,285,930 (11) 4.9 %
John DiMora (11)
17640 White Pine Court
Northville, MI 48167 549,468 (12) 2.1 %
Officers and directors
as a group (9 persons) 21,288,229 (13) 57.7 %
<page>60
(1) Unless otherwise noted below, we believe that all persons named in the
table have sole voting and investment power with respect to all shares of
common stock beneficially owned by them.
(2) For purposes hereof, a person is deemed to be the beneficial owner of
securities that can be acquired by such person within 60 days from the date
hereof upon the exercise of warrants or options or the conversion of
convertible securities. Each beneficial owner's percentage ownership is
determined by assuming that any such warrants, options or convertible
securities that are held by such person (but not those held by any other
person) and which are exercisable within 60 days from the date hereof, have
been exercised or converted.
(3) Includes (a) 200,000 shares owned by Mr. Westerholm's spouse, (b) 87,500
shares owned by Mr. Westerholm's son who resides in his household, (c)
3,957,700 shares held by the Westerholm Family Living Trust as to which Mr.
Westerholm and his spouse are co-trustees and (d) 1,130,000 shares that can
be acquired by Mr. Westerholm upon exercise of options and warrants.
(4) Includes (a) 754,600 shares owned by Mr. Sawarin's spouse, (b) 855,000
shares that can be acquired by Mr. Sawarin upon exercise of options, and
(c) 60,000 shares that can be acquired by Mr. Sawarin's spouse upon
exercise of options.
(5) Includes (a) 2,535,018 shares owned jointly by Mr. McCormick and his
spouse, (b) 938,063 shares owned by a company of which Mr. McCormick is an
affiliate and (c) 6,216,667 shares that can be acquired by Mr. McCormick
upon exercise of options.
(6) Includes (a) 13,700 shares owned by Mr. Bakeman's spouse, (b) 700 shares
owned by Mr. Bakeman's minor children, and (c) 655,000 shares that can be
acquired by Mr. Bakeman upon exercise of options.
(7) Represents (a) 560,055 shares owned by Martino Investment Partners, L.P.,
general partners of which are Mr. Martino and his spouse, (b) 230,000
shares that can be acquired upon exercise of options and (c) 104,643 shares
that can be acquired upon exercise of warrants.
(8) Represents (a) 55,168 shares owned by Harms Family Living Trust, the sole
beneficiaries and co-trustees of which are Mr. Harms and his spouse and (b)
93,970 shares that can be acquired upon exercise of options.
(9) Less than 1%.
(10) Includes 39,167 shares that can be acquired upon exercise of options.
(11) Represents (a) an aggregate of 405,440 shares held by Mr. Popp and his
Individual Retirement Accounts, (b) 19,990 shares owned by Mr. Popp's
spouse, (c) 328,900 shares owned by MAP Mechanical Contractors, Inc. of
which Mr. Popp is an affiliate, (d) 206,700 shares owned by MAP Mechanical
Contractors, Inc. Profit Sharing Plan, (e) 299,900 shares owned by MAP
Mechanical Contractors, Inc. Pension Plan and (f) 25,000 shares that can be
acquired upon exercise of options.
<page>61
(12) Represents (a) 7,000 shares held by Mr. DiMora, (b) 75,000 shares held
jointly by Mr. DiMora and his spouse, (c) 292,735 shares held by DiMora and
Associates Inc. of which company Mr. DiMora is an affiliate, (d) 33,333
shares of common stock which may be acquired upon conversion of a
promissory note, (e) 37,500 shares which may be acquired upon exercise of
warrants and (f) 103,900 shares that can be acquired upon exercise of
options.
(13) See notes above.
MARKET FOR COMMON EQUITY AND CERTAIN RELATED STOCKHOLDER MATTERS
Our common stock is principally traded in the over-the-counter market. The
trading market is limited and sporadic and should not be considered to
constitute an established trading market. The following table sets forth the
range of high and low bid prices for the common stock for the fiscal quarters
indicated. The common stock is listed in the "Pink Sheets." The following
quotations were obtained from BarChart.com.
All quotes reflect inter-dealer prices without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
2003 2002
Quarter Ended Low High Low High
- -------------- ---- ---- ---- ----
March 31 0.93 1.70 1.05 2.45
June 30 0.71 1.10 2.00 3.30
September 30 0.75 2.25 1.20 2.43
December 31 $ 0.57 1.65 $ 1.10 $ 1.85
Quarter Ended Low High
-------------- ---- ----
March 31, 2004 $2.00 $3.40
June 30, 2004 $1.15 $2.45
On November 15, 2004 our common stock was held of record by approximately 325
holders.
We have never paid dividends on our common stock and do not anticipate paying
cash dividends in the foreseeable future. We intend to retain any earnings for
the operation and expansion of our business. Other than financial ability, we
have no legal, contractual or corporate constraints against the payment of
dividends. Commitments we may make in the future may, however, contractually
limit or prohibit the payment of dividends.
<page>62
DESCRIPTION OF COMMON STOCK
Our authorized capital consists of 75,000,000 shares of common stock, par value
$.001 per share. All of the authorized common shares are of the same class and,
once issued, rank equally as to dividends, voting powers, and participation in
assets. Holders of the shares are entitled to one vote for each share held of
record on all matters to be acted upon by the stockholders. Holders of the
shares are entitled to receive such dividends as may be declared from time to
time by the Board of Directors, in its discretion, out of funds legally
available for that purpose. No shares have been issued subject to call or
assessment. There are no preemptive or conversion rights and no provisions for
redemption or, other than as set forth above, purchase for cancellation,
surrender, or sinking or purchase funds, nor any cumulative voting rights. Our
Board of Directors may from time to time declare and authorize payment of
dividends, as it deems advisable. The outstanding shares are fully-paid and non-
assessable.
Our authorized but unissued shares of common stock are available for future
issuance without stockholder approval and may be utilized for a variety of
corporate purposes, including future offerings to raise capital, corporate
acquisitions and employee benefit plans. The existence of authorized but
unissued and unreserved common stock could render more difficult or discourage
an attempt to obtain control of us by means of a proxy contest, tender offer,
merger or otherwise.
We may become subject to provisions of the Delaware General Corporation Law
which, in general, prohibits certain Delaware corporations from engaging in a
business combination with an interested stockholder for a period of three years
after the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
A business combination includes mergers, asset sales or other transactions
resulting in a financial benefit to the stockholder. The provisions could have
the effect of delaying, deferring or preventing a change in control of us.
CERTAIN TRANSACTIONS
Other than as set forth under this caption and under the caption "Management,"
during the last two years there have been no transactions, or are there any
proposed transactions, to which we were or are to be a party, in which any of
the following persons had or is to have a direct or indirect material interest
and the amount involved in the transaction or a series of similar transactions
does not exceed $60,000
- Any of our directors or executive officers;
- Any nominee for election as a director;
- Any security holder named in this prospectus as beneficially owning more
than 5% of our outstanding common stock; and
- Any member of the immediate family (including spouse, parents, children,
siblings, and in-laws) of any of the above persons.
<page>63
We previously granted SOQUEM an option to purchase a 20% undivided interest in
the Lac Dore project if SOQUEM. On April 17, 2003, SOQUEM relinquished any
rights it had relating to the deposits in exchange for 250,000 shares of our
common stock.
We have retained the law firm of Larson, Harms & Bibeau, P.C. to perform certain
legal services for us and expect to continue to do so in the future. Since May
1, 2002, we have incurred legal fees and expenses with such firm of
approximately $250,000. Donald C. Harms, one of our directors, is a principal
of Larson, Harms & Bibeau, P.C. On May 15, 2003, we issued 20,000 shares of our
common stock in consideration of the forgiveness of $17,100 we owed to Larson,
Harms & Bibeau, P.C. At the direction of Larson, Harms & Bibeau, P.C., 10,000 of
the shares were issued to a trust the sole beneficiaries and co-trustees of
which are Mr. Harms and his spouse. At the time of the issuance, the market
value of our common stock was $.95 per share.
On April 29, 2004, companies which are affiliates of John Popp exercised
previously issued options for the purchase of 158,100 shares of our common stock
at $2.00 per share.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been a limited public market for our common
stock, and we cannot assure you that a significant public market for our common
stock will develop or be sustained after this offering. Future sales of
significant amounts of our common stock, including shares of our outstanding
common stock and shares of our common stock issued upon exercise of outstanding
options and warrants, in the public market after this offering could adversely
affect the prevailing market price of our common stock and could impair our
future ability to raise capital through the sale of our equity securities.
All of the shares sold in this offering by the selling stockholders will be
freely tradable without restriction under the Securities Act of 1933, unless
acquired by an affiliate of us, as that term is defined in Rule 144 under that
Act.
On November 15, 2004, we had outstanding 26,408,255 shares of common stock,
which includes 119,984 shares issued to Cornell Capital Partners. Of the
14,792,653 shares held by persons who are not our affiliates on that date,
approximately 11,931,240 shares were freely tradable without restriction or
further registration under the Securities Act of 1933. In addition,
approximately 2,184,498 additional shares were then eligible to be sold in
accordance with Rule 144 under that Act and approximately at least 640,000 more
shares will be eligible to be sold within the ensuing twelve month period.
<page>64
In general, Rule 144 allows a stockholder (or stockholders where shares are
aggregated) who has owned shares which have been acquired from us or an
affiliate of us at least one year prior to resale and who files a requisite
notice with the SEC to sell within any three month period a number of those
shares that does not exceed the greater of:
- 1% of the number of shares of common stock then outstanding; or
- the average weekly trading volume of the common stock on a national
securities exchange and/or reported through the automated quotation
system of a registered securities association during the four calendar
weeks preceding the filing of the notice with respect to such sale.
Sales under Rule 144, however, generally are subject to specific manner of sale
provisions, notice requirements, and the availability of current public
information about our company. If, however, a stockholder (or stockholders where
shares are aggregated) has owned shares which have been acquired from us or an
affiliate of us at least two years prior to resale and who is not then and has
not been an affiliate of us at any time during the immediately preceding three
months, the stockholder(s) may sell the shares without complying with the manner
of sale provisions, notice requirements, public information requirements, or
volume limitations of Rule 144.
We intend to file a registration statement with the SEC for shares of our common
stock issued or reserved for issuance under our present or future compensatory
plans. Any shares registered under that registration statement will be available
for sale in the open market.
THE SELLING STOCKHOLDERS
The following table sets forth information as of November 15, 2004 with respect
to our common stock held by each selling stockholder:
Name of Selling Stockholder Number Number of Number Percentage of
of Shares Shares of Shares Outstanding
Owned Being Offered of to be Shares to be
Before Owned Owned After
The After the the Offering
Offering Offering (assuming the
sale of all
shares being
offered by
the selling
stockholders)
- -------------------------- ---------- ---------- ------------ --------------
Cornell Capital Partners, LP 239,968 20,239,968 (1) -0- -0-
Spencer Clarke LLC 4,444 2,004,444 (2) -0- -0-
Joseph Trauth Jr. -0- 70,833 (3) -0- -0-
Ropaco Realty
General Partnership 30,000 141,667 (3) 30,000 < 1%
John & Karen DiMora 478,635(4) 70,833 (3) 478,635 < 2.1%
Jim DiMora 33,000 70,833 (3) 33,000 < 1%
Henry & Nancy
Arnebold Family Trust -0- 70,833 (3) -0- -0-
Milton H Dresner
Revocable Living Trust -0- 283,333 (3) -0- -0-
Thomas L. Griffin -0- 141,667 (3) -0- -0-
Jan Fredriksson 20,000 70,833 (3) 20,000 <1%
J.W. Mason & Millicent Mason -0- 70,833 (3) -0- -0-
Phil Palmedo -0- 141,667 (3) -0- -0-
Joseph Fung -0- 141,667 (3) -0- -0-
Edward Wex -0- 70,833 (3) -0- -0-
Roland Heitmann & Julie Nucci -0- 70,833 (3) -0- -0-
Societe d'aide au
developpement des
collectivites -0- 200,500 (3) -0- -0-
Larry Swift -0- 70,833 (3) -0- -0-
Robert Neff 11,000 141,667 (3) 11,000 < 1%
James Barrons -0- 141,667 (3) -0- -0-
Andre Dawson -0- 141,667 (3) -0- -0-
Timothy Kaehr -0- 141,667 (3) -0- -0-
Feather & Gay Family Trust -0- 425,000 (3) -0- -0-
John & Kyoko Robinson 4,000 70,833 (3) 4,000 < 1%
Barton Katz -0- 141,667 (3) -0- -0-
William Klingenstein -0- 141,667 (3) -0- -0-
The Stephen Lindsay Group -0- 65,000 -0- -0-
<page>65
(1) Represents the maximum number of shares which we have registered under the
Securities Act of 1933 which may be acquired by Cornell Capital Partners
under the Standby Equity Distribution Agreement.
(2) Includes the maximum number of shares which may be acquired by Spencer
Clarke upon exercise of the warrants which may be issued in connection with
the Standby Equity Distribution Agreement.
(3) Represents the maximum number of shares which may be acquired upon
conversion of promissory notes and upon exercise of warrants.
(4) Represents (a) 85,900 shares held by John DiMora, (b) 112,500 shares held
jointly by Mr. DiMora and Karen DiMora, his spouse, (c) 292,735 shares held
by DiMora and Associates Inc. of which company Mr. DiMora is an affiliate,
(d) 33,333 shares of common stock which may be acquired upon conversion of
a promissory note, (e) 37,500 shares which may be acquired upon exercise of
warrants and (f) 25,000 shares that can be acquired upon exercise of
options
We have been advised that the respective persons identified below have voting
and investment control of the following entities:
ENTITY NAME OF PERSON
- ----------------------------- ---------------------
Cornell Capital Partners, LP Mark Angelo
Spencer Clarke LLC Reid H. Drescher
Ropaco Realty General Partnership Nathan Robfogel
Henry & Nancy Arnebold Family Trust Henry Arnebold
Milton H Dresner Revocable Living Trust Milton Dresner
Societe d'aide au developpement
des collectivites Marcel Perreault, president and
Denis Jodouin, general manager
Feather & Gay Family Trust Art Feather
The Stephen Lindsay Group Stephen B. Lindsay
On August 13, 2004 we borrowed $500,000 from 13 of the selling stockholders and
issued our 12% promissory notes in that aggregate amount. The promissory notes
are convertible into shares of our common stock at $.75 per share and are
payable on November 14, 2004 if not sooner converted. We also issued warrants
to those selling stockholders for the purchase of an aggregate of 750,000 shares
of our common stock on or before August 13, 2006 at $1.07 per share. The
selling stockholders' rights of conversion of the promissory notes commences on
the effective date of the registration statement of which this prospectus is a
part and expires ninety days thereafter. On September 7, 2004, we borrowed
$593,750 from 13 of the selling stockholders. The terms of the loans and the
issuance of warrants in connection with the latter loans are substantially the
same as those of the loans of August 13, 2004 except that (a) the conversion
price of the promissory notes is approximately $.795 per share and (b) the
selling stockholders received warrants for the purchase of aggregate of 873,300
shares of our common stock on or before September 7, 2006 at $1.42 per share.
Other than Cornell Capital Partners, Spencer Clarke and The Stephen Lindsay
Group, all of the selling stockholders participated in the loans to us. Spencer
Clarke acted as our placement agent in connection with loans for we paid a
commission to Spencer Clarke of $109,375.
<page>66
We intend to issue 65,000 shares of our common stock to The Stephen Lindsay
Group in satisfaction of an indebtedness in the amount of approximately
$83,200.
John DiMora is a member of our Board of Directors.
Except for the relationships and transactions described under the captions "The
Selling Stockholders" and "Standby Equity Distribution Agreement," none of the
selling stockholders has had any position, office or other material relationship
with us or any of our affiliates or any of our predecessors within the past
three years.
PLAN OF DISTRIBUTION
The selling stockholders have advised us that the sale or distribution of our
common stock which may be effected by them or by pledgees, transferees or other
successors in interest, as principals or through one or more underwriters,
brokers, dealers or agents from time to time in one or more transactions (a) on
the over-the-counter market or in any other market on which the price of our
shares is quoted or (b) in transactions otherwise than on the over-the-counter
market or in any other market on which the price of our shares is quoted. Until
such time, if any, that our shares are listed on the over-the-counter bulletin
board, the offering price will be $1.50 per share. Subsequent to that time, if
at all, such transactions may be effected at or about prevailing market prices
at the time of sale, at prices related to such prevailing market prices, at
varying prices determined at the time of sale or at negotiated or fixed prices,
in each case as determined by the selling stockholders or by agreement between
the selling stockholders and underwriters, brokers, dealers or agents, or
purchasers. If the selling stockholders effect such transactions by selling
their shares of common stock to or through underwriters, brokers, dealers or
agents, such underwriters, brokers, dealers or agents may receive compensation
in the form of discounts, concessions or commissions from the selling
stockholders or commissions from purchasers of common stock for whom they may
act as agent (which discounts, concessions or commissions as to particular
underwriters, brokers, dealers or agents may be in excess of those customary in
the types of transactions involved). The selling stockholders and any brokers,
dealers or agents that participate in the distribution of the common stock may
be deemed to be underwriters, and any profit on the sale of common stock by them
and any discounts, concessions or commissions received by any such underwriters,
brokers, dealers or agents may be deemed to be underwriting discounts and
commissions under the Securities Act of 1933.
Under the securities laws of certain states, the shares may be sold in such
states only through registered or licensed brokers or dealers. We have advised
the selling stockholders to ensure that any underwriters, brokers, dealers or
agents effecting transactions on behalf of the selling stockholders are
registered to sell securities in all fifty states. In addition, in certain
states the shares may not be sold unless the shares have been registered or
qualified for sale in such state or an exemption from registration or
qualification is available and is complied with.
<page>67
We have advised the selling stockholders that the anti-manipulation provisions
of Regulation M under the Securities Exchange Act of 1933 will apply to
purchases and sales of shares of our common stock by them and that there are
restrictions on market-making activities by persons engaged in the distribution
of the shares. Under Registration M, the selling stockholders or their agents
may not bid for, purchase, or attempt to induce any person to bid for or
purchase, shares of our common stock while the selling stockholders are
distributing shares which are the subject of this prospectus. Accordingly, the
selling stockholders are not permitted to cover short sales by purchasing shares
while the distribution is taking place. We have also advised the selling
stockholders that if a particular offer of common stock is to be made on terms
constituting a material change from the information set forth above with respect
to the Plan of Distribution, then, to the extent required, a post-effective
amendment to the registration statement of which this prospectus is a part must
be filed by us with the SEC.
We have agreed to indemnify Spencer Clarke and each of its officers, directors,
shareholders, employees or representatives and each person controlling,
controlled by or under common control with it from and against certain
liabilities to which Spencer Clarke or such other indemnified persons may become
subject under any federal or state securities law or regulation or otherwise
arising out the offer and sale of our common stock. We have similarly agreed to
indemnify Cornell Capital Partners.
INDEMNIFICATION
We have agreed to indemnify our executive officers and directors to the fullest
extent permitted by the Delaware General Corporation Law. That law generally
permits us to indemnify any person who is, or is threatened to be made, a party
to any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative or investigative by reason of the fact that the
person is or was an officer or director or is or was serving at our request as
an officer or director. The indemnity may include expenses (which we may pay in
advance of a final disposition), including attorney's fees, judgments, fines and
amounts paid in settlement actually and reasonably incurred by the person in
connection with the action, suit or proceeding, provided that the person acted
in good faith and in a manner the person reasonably believed to be in or not
opposed to our best interests and, with respect to any criminal action or
proceeding, had no reasonable cause to believe the person's conduct was
unlawful. The termination of any action, suit or proceeding by judgment, order,
settlement, conviction, or upon a plea of nolo contendere or its equivalent,
will not, of itself, create a presumption that the person did not act in good
faith and in a manner which the person reasonably believed to be in or not
opposed to our best interests and, with respect to any criminal action or
proceeding, had reasonable cause to believe that the person's conduct was
unlawful approval if the officer or director is adjudged to be liable to us. The
indemnification provisions of the Delaware General Corporation Law are not
exclusive of any other rights to which an officer or director may be entitled
under our bylaws, by agreement, vote, or otherwise.
<page>68
Insofar as indemnification arising under the Securities Act may be permitted to
our directors, officers and controlling persons pursuant to the foregoing
provisions or otherwise, we have been advised that in the opinion of the SEC
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable.
LEGALITY OF SHARES
The legality of the shares of common stock offered by this prospectus has been
passed upon for us by Larson, Harms & Bibeau, P.C. to the extent set forth in
that firm's opinion filed as an exhibit to the registration statement of which
this prospectus is a part.
CHANGES IN ACCOUNTANTS
On February 17, 2003 the Board of Directors approved the resignation of KPMG LLP
as the Company's independent registered chartered accountants. The report of
KPMG LLP on the Company's financial statements as of and for the fiscal year
ended September 30, 2002 contained a going concern opinion but did not contain
an adverse opinion or a disclaimer of opinion, and was not modified as to
uncertainty, audit scope or accounting principles. There were no disagreements
between us and KPMG LLP concerning any matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of KPMG LLP, would have
caused it to make reference to the subject matter of the disagreements in
connection with its report on our consolidated financial statements for the
fiscal year ended September 30, 2002.
We dismissed Deloitte & Touche LLP, Rouyn-Noranda, Canada office, as our
auditors effective August 16, 2004. Deloitte & Touche LLP were our independent
registered chartered accountants through the date of their dismissal.
During our association with Deloitte & Touche LLP, as our independent registered
chartered accountants until Deloitte & Touche LLP dismissal, there were no
disagreements with Deloitte & Touche LLP within the meaning of Item 304 of
Regulation S-B on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements if not
resolved to Deloitte & Touche LLP's satisfaction, would have caused Deloitte &
Touche LLP to make reference to the subject matter of the disagreements in
connection with its report.
Deloitte & Touche LLP audited our financial statements for the fiscal year ended
September 30, 2003. Deloitte & Touche LLP's report for this period did not
contain an adverse opinion or a disclaimer of opinion, nor was it modified as to
uncertainty, audit scope or accounting principles, except that the report
indicated that we had suffered recurring losses and had a deficiency in assets
that raise substantial doubt about our ability to continue as a going concern.
During our association with Deloitte & Touche LLP as independent registered
chartered accountants until Deloitte & Touche LLP's dismissal, there were no
reportable events within the meaning of Item 304(a)(1)(iv)(B) of Regulation S-B.
<page>69
On August 16, 2004 we engaged BDO Seidman, LLP as our principal independent
accountants for the fiscal year ended September 30, 2004. The decision to
engage BDO Seidman LLP was approved by the Audit Committee of our Board of
Directors.
LEGAL PROCEEDINGS
We are not a party to any pending legal proceeding that primarily involves a
claim for damages and the amount involved in such proceeding, exclusive of
interest and costs, exceeds 10% of our current assets nor is any of our property
the subject of such a pending legal proceeding. We are not aware of any such
proceeding that a governmental authority is contemplating.
EXPERTS
The consolidated financial statements for the year ended September 30, 2003 and
for the period from August 23, 1996 (date of inception) to September 30, 2003
included in this prospectus have been audited by Deloitte & Touche LLP, an
independent registered chartered accounting firm as stated in their report
appearing herein (which report expresses an unqualified opinion and includes an
explanatory paragraph referring our ability to continue as a going concern) and
is included in reliance upon the report of such firm given upon their authority
as experts in accounting and auditing. The consolidated financial statements
for the year ended September 30, 2002 and for the period from August 23, 1996
(date of inception) to September 30, 2002 included in this prospectus have been
audited by KPMG LLP, an independent registered chartered accounting firm as
stated in their report appearing herein (which report expresses an unqualified
opinion and includes an explanatory paragraph referring our ability to continue
as a going concern) and is included in reliance upon the report of such firm
given upon their authority as experts in accounting and auditing.
ADDITIONAL INFORMATION
We have electronically filed a registration statement on Form SB 2 and an
amendment thereto with the SEC with respect to the shares of common stock to be
sold in this offering. This prospectus, which forms a part of that registration
statement, does not contain all of the information included in the registration
statement. Certain information is omitted and you should refer to the
registration statement and its exhibits for complete information. With respect
to references made in this prospectus to any contract or other document, the
references are not necessarily complete and you should refer to the exhibits
attached to the registration statement for copies of the actual contract or
document. You may read and copy the registration statement and other materials
we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street,
N.W., Washington, D.C. 20549. The public may obtain information on the operation
of the Public Reference Room by calling the SEC at 1 800 SEC 0330. The SEC
maintains an Internet site that contains reports, proxy statements and
information statements, and other information regarding issuers that file
electronically with the SEC. The address of that site is http://www.sec.gov.
<page>70
We are subject to the information and reporting requirements of the Securities
Exchange Act of 1934 and file periodic reports, proxy soliciting material and
other information with the SEC.
We intend to furnish our stockholders with annual reports containing audited
financial statements.
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(as at September 30, 2003)
PAGE
Reports of Independent Registered Chartered Accountants....................F-1
Consolidated Balance Sheets................................................F-2
Consolidated Statement Of Changes In Stockholders' Equity (Deficit)........F-3
Consolidated Statement Of Loss.............................................F-4
Consolidated Statement Of Cash Flows.......................................F-5
Notes to Consolidated Financial Statements.................................F-6
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A Development Stage Company) (as at June 30, 2004) (unaudited)
Condensed Consolidated Balance Sheets......................................F-24
Consolidated Statements Of Loss............................................F-25
Consolidated Statements Of Cash Flows......................................F-26
Notes To Condensed Consolidated Financial Statements.......................F-27
===============================================================================
REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS
To the Board of Directors and Stockholders of McKenzie Bay International Ltd.
and Subsidiaries
We have audited the accompanying consolidated balance sheet of McKenzie Bay
International Ltd. and subsidiaries (the "Company"), a development-stage
company, as at September 30, 2003 and the consolidated statements of changes in
stockholders' equity (deficit), loss and cash flows for the year then ended, and
for the period from August 23, 1996 (date of inception) to September 30, 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 audit. The financial statements of the Company for the period from
inception on August 23, 1996 to September 30, 2002 were audited by other
auditors, whose reports expressed unqualified opinions on those statements and
included an explanatory paragraph regarding matters that raised substantial
doubt about the Company's ability to continue as a going concern. The financial
statements of the Company as of September 30, 2002 and for the year then ended,
were audited by other auditors who expressed an unqualified opinion on those
statements and included explanatory paragraphs in their report dated November
30, 2002, regarding matters that raised doubt about the Company's ability to
continue as a going concern and regarding their audit of adjustments to restate
the 2001 financial statements. The other auditors' reports have been furnished
to us, and our opinion, insofar as it relates to the amounts included for such
prior periods, is based solely on the reports of such other auditors.
<page>71
We conducted our audit in accordance with 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. We believe that our audit and the reports of
other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the reports of other auditors, these
consolidated financial statements present fairly, in all material respects, the
financial position of the Company as at September 30, 2003, and the results of
its operations and cash flows for the year then ended, and for the period from
August 23, 1996 (date of inception) to September 30, 2003, in conformity with
accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company is a development stage
enterprise engaged in a vanadium/titanium deposit with the development of wind
turbine technology and a diamond mine. As discussed in Note 2 to the financial
statements, the Company has suffered recurring losses and has a deficiency in
assets that raise substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Deloitte & Touche LLP
- --------------------------
Deloitte & Touche LLP
Rouyn-Noranda, Canada
December 23, 2003
(April 6, 2004 as to note 17)
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors of McKenzie Bay International Ltd.
We have audited the consolidated balance sheet of McKenzie Bay International
Ltd. and its subsidiaries, a development-stage company, as at September 30, 2002
and the consolidated statements of changes in stockholders' equity (deficit),
loss 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 consolidated financial statements based on our audit. The
consolidated financial statements of the Company as of September 30, 2001 and
for the period from inception on August 23, 1996 to September 30, 2001, were
audited by other auditors whose report dated January 31, 2002, expressed an
unqualified opinion on those statements.
<page>72
We also audited the adjustments that were applied to restate the 2001 financial
statements. In our opinion, such adjustments are appropriate and have been
properly applied. We conducted our audit in accordance with the standards of
the Public Company Accounting Oversight Board (United States of America). 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. We believe
that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and its
subsidiaries as at September 30, 2002 and the results of their operations and
their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company and its subsidiaries will continue as a going concern. As discussed in
Note 2 to the consolidated financial statements, the Company and its
subsidiaries have suffered recurring losses from operations and have a
deficiency in assets that raise substantial doubt about their ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ KPMG LLP
- --------------------------
KPMG LLP
Chartered Accountants
Montreal, Canada
November 30, 2002
<page>73
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A development-stage company)
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2003 and 2002
(Amounts stated in US dollars)
ASSETS
2003 2002
----------- -----------
Current:
Cash and cash equivalents $ 49,208 $ 45,325
Marketable securities - 83,501
Accounts receivable 262,979 186,961
Inventories - 19,562
Prepaid expenses and deposits 145,441 172,057
----------- -----------
Total current assets 457,628 507,406
Reclamation cash bond (note 3) 338,685 338,685
Property and equipment (note 4) 76,263 84,577
Goodwill (note 2) - 146,972
----------- -----------
Total assets 872,576 1,077,640
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current:
Bank indebtedness (note 10) $ 83,463 $ 47,441
Accounts payable and accrued liabilities 2,162,934 583,378
Current portion of long-term debt (note 5) 32,945 36,156
----------- -----------
Total current liabilities 2,279,342 666,975
Long-term and other liabilities:
Long-term debt (note 5) 1,074,651 888,304
Redeemable capital stock (note 6) 252,175 -
Reclamation and closure liabilities (note 3) 250,000 250,000
----------- -----------
Total long-term and other liabilities 1,576,826 1,138,304
Redeemable capital stock (note 6) - 1,481,854
Stockholders' equity (deficit):
Capital stock (note 6)
75,000,000 common stock authorized, at
$0.001 par value 25,229,958 common stock
issued and outstanding (2002,23,177,640) 23,649 21,607
Additional paid in capital (note 6) 16,781,788 13,618,367
Accumulated deficit (19,564,758) (15,872,366)
Accumulated other comprehensive income(loss) (224,271) 22,899
----------- -----------
Total stockholders' deficit (2,983,592) (2,209,493)
Contingency (note 10)
Commitments (note 11)
Total liabilities and stockholders' deficit $ 872,576 $ 1,077,640
=========== ==========
(See accompanying notes)
<page>F-2
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A development-stage company)
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Deficit)
FROM INCEPTION TO SEPTEMBER 30, 2003
(Amounts stated in US dollars)
<table>
<s> <c> <c> <c>
Accumulated
other Total
Additional comprehensive stockholders'
Common paid in Accumulated income equity
stock capital deficit (loss) (deficit)
---------- --------- ----------- -------------- -------------
Common shares issued for cash $ 200 $ 7,097 $ - - $ 7,297
Common shares issued in exchange of
exploration claims and services 50 1,774 - - 1,824
Net loss for the year - - (7,116) - (7,116)
Change in foreign currency
translation adjustment - - - 12 12
---------- --------- ----------- --------------- ------------
Balance, September 30, 1996 250 8,871 (7,116) 12 2,017
Common shares issued for cash 5,150 748,534 - - 753,684
Common shares issued in exchange of
exploration claims and services 2,804 114,159 - - 116,963
Net loss for the year - - (816,944) - (816,944)
Change in foreign currency
translation adjustment - - - (473) (473)
---------- --------- ----------- --------------- -------------
Balance, September 30, 1997 8,204 871,564 (824,060) (461) 55,247
Common shares issued for cash 517 440,277 - - 440,794
Common shares issued in exchange of
exploration claims and services 1,105 43,719 - - 44,824
Net loss for the year - - (519,123) - (519,123)
Change in foreign currency
translation adjustment - - - (3,557) (3,557)
---------- --------- ----------- --------------- -------------
Balance, September 30, 1998 9,826 1,355,560 (1,343,183) (4,018) 18,185
Common shares issued for cash 1,756 381,685 - - 383,441
Common shares issued in exchange of
exploration claims and services 1,245 1,337,925 - - 1,339,170
Net loss for the year - - (1,608,740) - (1,608,740)
Change in foreign currency
translation adjustment - - - 257 257
---------- --------- ------------ -------------- -------------
Balance, September 30, 1999 12,827 3,075,170 (2,951,923) (3,761) 132,313
Common shares issued for cash 1,734 1,054,409 - - 1,056,143
Common shares issued for services 42 20,958 - - 21,000
Net loss for the year - - (1,470,687) - (1,470,687)
Change in foreign currency
translation adjustment - - - (938) (938)
----------- --------- ------------ -------------- -------------
Balance, September 30, 2000 14,603 4,150,537 (4,422,610) (4,699) (262,169)
<page>F-3
Issuance of redeemable capital stock - - (545,938) - (545,938)
Issuance of other capital stock 4,390 4,940,158 - - 4,944,548
Purchase of common stock for treasury (79) (145,174) - - (145,253)
Net loss for the year - - (4,933,244) - (4,933,244)
Change in foreign currency
translation adjustment - - - (12,833) (12,833)
Unrealized holding loss on marketable
securities - - - (371,735) (371,735)
Expiry of redemption rights - 12,000 - - 12,000
Stock options - 902,585 - - 902,585
----------- --------- ------------- ------------- -------------
Balance as at September 30, 2001 18,914 9,860,106 (9,901,792) (389,267) (412,039)
Issuance of capital stock 2,696 2,856,002 - - 2,858,698
Purchase of common stock for treasury (3) (4,366) - - (4,369)
Net loss for the year - - (5,970,574) - (5,970,574)
Change in foreign currency
translation adjustment - - - 40,431 40,431
Reclassification to the consolidated
statement of loss of the holding
loss on marketable securities - - - 371,735 371,735
Expiry of redemption rights - 439,659 - - 439,659
Stock options - 466,966 - - 466,966
----------- --------- ------------- ------------- -------------
Balance as at September 30, 2002 21,607 13,618,367 (15,872,366) 22,899 (2,209,493)
Issuance of capital stock 2,052 1,668,592 - - 1,670,644
Purchase of common stock for treasury (10) (11,290) - - (11,300)
Net loss for the year - - (3,692,392) - (3,692,392)
Change in foreign currency
translation adjustment - - - (247,170) (247,170)
Expiry of redemption rights - 514,471 - - 514,471
Stock options - 991,648 - - 991,648
----------- --------- ------------- ------------- -------------
Balance as at September 30, 2003 $ 23,649 $16,781,788 $(19,564,758) $(224,271) $(2,983,592)
========== ========== ============== ============= ============
(See accompanying notes)
</table>
<page>F-4
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A development-stage company)
CONSOLIDATED STATEMENT OF LOSS
YEARS ENDED SEPTEMBER 30, 2003 and 2002
(Amounts stated in US dollars)
<table>
<s> <c> <c> <c>
Cumulative
from inception
on August 23,
2003 2002 1996
---------- ---------- ---------------
Revenue $ - $ 12,825 $ 12,825
Expenses:
Research, development and exploration (note 7) 1,139,471 2,586,476 7,703,272
General administration 295,642 572,672 1,152,935
Reorganization costs - - 102,914
Wages and benefits 205,134 456,821 1,145,994
Management wages and benefits 797,493 525,648 2,352,800
Professional fees 832,886 314,027 1,574,961
Advertising, promotion and travel 155,512 262,179 823,601
Amortization 18,360 21,070 388,842
Interest and bank charges 50,906 108,896 159,802
Interest on long-term debt 21,182 22,358 90,174
---------- ---------- --------------
3,516,586 4,870,147 15,495,295
---------- ---------- --------------
Loss before the following: (3,516,586) (4,857,322) (15,482,470)
Write-down of assets - - (1,626,821)
Write-off of incorporation and
reorganization costs - (49,137) (49,137)
Write-down of marketable securities (32,731) (1,071,483) (1,104,214)
Gain (loss) on sale of marketable securities 140 (138,168) (138,028)
Interest income 3,757 4,536 27,897
---------- ---------- --------------
Net loss before mining taxes and cumulative
effect of change in accounting principle
for SFAS 142 (3,545,420) (6,111,574) (18,372,773)
Current mining tax recovery (note 9) - 141,000 141,000
---------- ---------- --------------
Net loss before cumulative effect of change
in accounting principle for SFAS 142 $ (3,545,420) $(5,970,574) $ (18,231,773)
---------- ---------- --------------
Cumulative effect of change in accounting
principle for SFAS 142 (note 2) $ (146,972) - (146,972)
---------- ---------- --------------
Net loss $ (3,692,392) $(5,970,574) $ (18,378,745)
---------- ---------- --------------
Comprehensive loss (note 13) $ (3,939,562) $(5,558,408) $ (18,603,016)
========== ========== ==============
Basic and diluted loss per share:
Net loss before cumulative effect of change
in accounting principle for SFAS 142 $ (0.14) $ (0.29)
Cumulative effect of change in accounting principle (0.01) -
----------- -----------
Net loss $ (0.15) $ (0.29)
=========== ===========
Weighted average shares outstanding 24,186,803 20,940,128
========== ==========
(See accompanying notes)
</table>
<page>F-5
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A development-stage company)
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2003 and 2002
(Amounts stated in US dollars)
<table>
<s> <c> <c> <c>
Cumulative
from inception
on August 23,
2003 2002 1996
---------- ---------- ---------------
Cash flows from (used in) operating activities:
Net loss $ (3,692,392) $(5,970,574) $ (18,378,745)
Items not affecting cash:
Cumulative effect of change in accounting principle 146,972 - 146,972
Amortization 18,360 21,070 388,842
Expenses settled through issuance of common stock 362,992 1,442,670 1,805,662
Capitalized interest on convertible notes payable - 2,571 2,571
Reclamation and closure costs (note 3) - - 250,000
Write-down of assets - - 1,626,821
Write-down of marketable securities 32,731 1,071,483 1,104,214
Write-off of incorporation and reorganization costs - 49,137 49,137
Loss (gain) on sale of marketable securities (140) 138,168 138,028
Stock-based compensation 353,278 416,278 1,672,141
Net change in non-cash working capital related to
operations:
Accounts receivable (51,452) (69,811) (205,616)
Inventories 19,562 (19,562) -
Prepaid expenses and deposits 26,616 (76,926) (94,957)
Accounts payable and accrued liabilities 1,446,532 (189,066) 2,136,202
----------- ----------- --------------
(1,336,941) (3,184,562) (9,358,728)
----------- ----------- ---------------
Financing activities:
Issuance of notes payable 350,000 - 350,000
Increase of bank indebtedness 29,755 47,441 77,196
Increase in convertible notes payable - - 23,055
Issuance of long-term debt - - 137,435
Repayment of long-term debt (36,156) (32,794) (104,490)
Receipt of repayable government assistance (note 5) 71,272 855,359 926,631
Proceeds from sale of common stock 847,653 1,265,402 11,877,657
Proceeds on sale of options 33,160 - 33,160
Redemption of redeemable capital stock - (37,500) (37,500)
Purchase of common stock for treasury - (4,369) (149,622)
------------ ----------- --------------
1,295,684 2,093,539 13,133,522
------------ ----------- --------------
Investing activities:
Purchase of marketable securities - - (1,767,835)
Proceeds-sale of marketable securities 50,910 474,683 525,593
Purchase of reclamation cash bond (note 3) - - (338,685)
Purchase of property and equipment (9,273) (1,666) (2,058,006)
Incorporation and reorganization costs - - (81,769)
Acquisition of business net of cash acquired (note 8) - (31,286) (31,286)
------------ ----------- -------------
41,637 441,731 (3,751,988)
Effect of foreign currency
exchange rate changes on cash and equivalents 3,503 40,431 26,402
------------ ----------- -------------
Net increase (decrease) in cash and cash
equivalents 3,883 (608,861) 49,208
Cash and cash equivalents, beginning of period 45,325 654,186 -
------------ ----------- -------------
Cash and cash equivalents, end of period $ 49,208 $ 45,325 $ 49,208
============ =========== =============
Supplemental non-cash financing activities:
Issuance of common stock in lieu of requiring
the Company to repurchase redeemable capital stock $ 110,000 $ - $ 110,000
Issuance of options in lieu of requiring Company
to repurchase redeemable capital stock 605,210 - 605,210
Issuance of common stock in lieu of payment of notes
payable and accrued interest 356,424 - 356,424
Conversion of notes payable into capital stock - 25,626 25,626
------------ ----------- -------------
$ 1,071,634 $ 25,626 $ 1,097,260
============ =========== =============
(See accompanying notes)
<page>F-6
</table>
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
(Amounts stated in US dollars unless indicated otherwise)
1. Nature of operations
The Company is a development stage company with no operations. The Company
has interests in a vanadium/titanium deposit, with wind turbine technology
and a diamond mine. The Company was incorporated in Delaware on August 17,
1998 under the name Decker Organic Systems, Inc.
2. Accounting policies
The accompanying consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles ("US
GAAP") and reflect the following significant accounting policies:
[a] Basis of presentation
The financial statements of the Company have been prepared on the basis
of the Company continuing as a going concern, which contemplates the
realization of assets and the payment of liabilities in the ordinary
course of business. Should the Company be unable to continue as a going
concern, it may be unable to realize the carrying value of its assets and
to meet its liabilities as they become due.
The Company suffered recurring losses and has a deficiency in assets that
raise substantial doubt about its ability to continue as a going
concern. The Company's continued existence is dependent upon its ability
to raise additional capital and generate profits. Although management
believes that it will be successful at raising additional capital in the
short-term and will have profitable operations in the long-term, it is
unable to disclose firm commitments as of the date of these financial
statements.
As discussed in note 6, the Company may be required to repurchase shares,
at the option of the holders, for an amount of $252,175.
The accompanying financial statements do not include any adjustments
relating to the recoverability and classification of recorded assets and
classification of liabilities that might be necessary should the Company
be unable to continue as a going concern.
[b] Consolidation
These consolidated financial statements include the activities of the
Company and its wholly-owned subsidiaries, McKenzie Bay Resources Ltd.,
Great Western Diamond Company, Experts Conseils Dermond Inc. and a 62.5%
interest in Ptarmigan Energie Inc. All intercompany balances and
transactions have been eliminated in consolidation.
<page>F-7
[c] Foreign currency translation
The translation to US dollars for consolidation purposes is performed
using the current rate method whereby balance sheet accounts are
converted at exchange rates in effect at the balance sheet date and
revenue and expense accounts are translated at the weighted-average
exchange rate during the period. The gains and losses resulting from
such translation are included as a foreign currency translation
adjustment in stockholders' equity (deficit). For statutory and other
reporting purposes, the Company's wholly and partially owned
subsidiaries, McKenzie Bay Resources Ltd., Experts Conseils Dermond Inc.
and Ptarmigan Energie Inc. prepare financial statements in Canadian
dollars.
[d] Cash and cash equivalents
Cash and cash equivalents includes those short-term investments which, at
the date of acquisition, have an original term to maturity of three
months or less.
[e] Marketable securities
The Company invests in marketable securities with maturities greater than
three months. The securities are classified as available-for- sale
securities and reported at fair market value with unrealized gains and
losses excluded from earnings and recorded to accumulated other
comprehensive loss.
[f] Inventories
Inventories are valued at the lower of average cost and net realizable
value.
[g] Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses
during the fiscal period. Financial statements items that require
significant estimates from management are the useful life of long-lived
assets for amortization purposes, carrying value of goodwill and
sufficiency of reclamation and closure liabilities. Actual results could
differ from such estimates.
[h] Exploration and development expenditures
Costs related to the exploration and development of resource properties
are expensed as incurred. Amounts are reduced by grants and other
related revenues.
<page>F-8
[i] Research and development
Research and development expenditures are charged to earnings as incurred
and amounted to $629,078 and $0 in the years ended September 31, 2003 and
2002, respectively.
[j] Property and equipment
Property and equipment are recorded at cost and are being amortized over
their estimated useful lives using the declining balance method at the
following annual rates:
Equipment under capital lease 20%
Furniture and fixtures 20%
Computer 30%
Office equipment 20%
[k] Impairment for long-lived assets
The Company evaluates the carrying value of long-lived assets and other
intangible assets, excluding goodwill, based upon current and anticipated
undiscounted cash flows, and recognizes an impairment when such estimated
cash flows will be less than the carrying value of the asset. Measurement
of the amount of impairment, if any, is based upon the difference between
carrying value and fair value.
[l] Income and mining taxes
The Company accounts for income and mining taxes under the asset and
liability method. Under this method, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date. A valuation allowance is
set up when it is more likely than not that a deferred tax asset will not
be recovered.
[m] Loss per common share
Basic earnings (loss) per share is computed by dividing net loss (the
numerator) by the weighted-average number of outstanding common shares
(the denominator) for the period. The computation of diluted earnings
(loss) per share includes the same numerator, but the denominator is
increased to include the number of additional common shares that would
have been outstanding if potentially dilutive common shares had been
issued (such as the common share equivalents for stock options). Fully
diluted loss per share has not been presented as it is anti-dilutive.
<page>F-9
[n] Comprehensive loss
In addition to net loss, comprehensive loss includes foreign currency
translation adjustment and unrealized holding loss on marketable
securities.
[o] Stock-based compensation plan
(i) The Company has stock-based compensation plans which are described in
note 6. The Company uses the fair value method of accounting for all
stock options granted to non-employees in accordance with the provisions
of SFAS 123 and the intrinsic value method for those granted to employees
in conformity with Accounting Principles Board Opinion No. 25 and its
related interpretation as allowed by SFAS 123. Under the fair value
based method, compensation cost attributable to awards is measured at the
date of the grant and recognized over the vesting period in operating
expense as it is the case under the intrinsic value method when exercise
price is lower than the current market price at the date of the grant.
No compensation cost is recorded for all other stock-based employee
compensation awards and consideration paid by employees on the exercise
of stock options is recorded as capital stock.
(ii) Fair value disclosure
SFAS 123 encourages but does not require companies to include in compensation
cost the fair value of stock options granted to employees. A company that does
not adopt the fair-value method must disclose the cost of stock compensation
awards, at their fair value, on the date the award is granted. This fair value
was estimated using the Black-Scholes model with assumptions of a 2 to 10 years
expected term, 113% to 130% volatility, interest rates ranging from 1.49% to
4.03% and an expected dividend yield of 0%. Had the compensation cost for stock
options issued to employees, officers and directors been determined based on the
fair value at the grant date consistent with SFAS No. 123, the Company's net
loss and loss per share would have been as follows:
2003 2002
--------- ----------
Net loss (3,692,392) (5,970,574)
--------- ----------
Pro forma (4,603,974) (6,728,768)
--------- ----------
2003 2002
--------- ----------
Net loss per share:
As reported (0.15) (0.29)
--------- ----------
Pro forma (0.19) (0.32)
--------- ----------
<page>F-10
The Company used the Black-Scholes option pricing model to determine the fair
value of grants made in the period ended September 30, 2003 and 2002,
respectively.
2003 2002
--------- ----------
Stock based compensation
expense as reported 290,091 125,269
--------- ----------
Stock based compensation
expense if fair value was used. 1,201,673 883,463
--------- ----------
[p] Goodwill and other intangible assets
Effective October 1, 2002 the Company adopted SFAS 141, "Business
Combinations, "and SFAS 142, "Goodwill and Other Intangible Assets".
SFAS 141 was issued by the FASB in June 2001. SFAS 141 requires that the
purchase method of accounting be used for all business combinations
completed after June 30, 2001. SFAS 141 also specifies the types of
acquired intangible assets that are required to be recognized and
reported separately from goodwill and those acquired intangible assets
that are required to be included in goodwill. The Company's adoption of
this standard did not have any effect on our accounting for prior
business combinations.
SFAS 142 requires that goodwill no longer be amortized, but instead be
tested for impairment at least annually. SFAS 142 requires recognized
intangible assets to be amortized over their respective estimated useful
lives and reviewed for impairment in accordance with SFAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". Any
recognized intangible assets determined to have an indefinite useful life
are not amortized, but instead tested for impairment in accordance with
the standard until its life is determined to no longer be indefinite.
The Company has completed its SFAS 142 transitional impairment review and
determined that the goodwill ("excess cost of investment over net assets
acquired") of $146,972 associated with the fiscal 2002 acquisitions of
DERMOND INC. should be reduced to $0. The fair value of the reporting
unit (DERMOND INC.) was determined using the present value of expected
future cash flows and other valuation measures.
The $146,972 non-cash charge is reflected as a cumulative effect of an
accounting change in the accompanying Consolidated Statements of Loss for
the year ended September 30, 2003. In accordance with SFAS 142 and SFAS
3, "Reporting Accounting Changes in Interim Financial Statements" ("SFAS
3"), when a transitional impairment loss for goodwill (cumulative effect
type accounting change) is measured in other than the first interim
reporting period, it shall be recognized in the first interim period
irrespective of the period in which it is measured. The impact on the
three-month period ended December 31, 2002 is as follows:
<page>F-11
Three months ended December 31, 2002
Net income (loss) Basic loss per share
------------------ ---------------------
Reported net income $(1,097,801) $(0.05)
Less: Impairment charge (146,972) (0.01)
------------------ ---------------------
Adjusted net loss $(1,244,773) $(0.06)
=================== =====================
[q] New accounting pronouncements
In November 2002, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (FIN 45). FIN 45 requires that upon issuance of a
guarantee, a guarantor must recognize a liability for the fair value of
an obligation assumed under a guarantee. FIN 45 also requires additional
disclosures by a guarantor in its interim and annual financial statements
about the obligations associated with guarantees issued. The recognition
provisions of FIN 45 are effective for any guarantees issued or modified
after December 31, 2002. The disclosure requirements are effective for
interim and annual financial statements for periods ending after December
15, 2002. The adoption of FIN 45 had no impact on the Company's
financial position, results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock
Based Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported
results. The Company has adopted the requirements of the Statement.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it
has a significant variable interest. The consolidation requirements of
FIN 46 apply immediately to variable interest entities created after
January 31, 2003. In addition, FIN 46, as amended in December 2003 (FIN
46R), will be effective for public entities for periods ending after
March 15, 2004. The adoption of this interpretation and its revision will
not have a material impact on the Company's financial position or results
of operations.
<page>F-12
[q] New accounting pronouncements (continued)
In October 2001, the Financial Accounting Standards Board issued
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS
144), which is effective for fiscal years beginning after December 15,
2001. SFAS 144 addresses accounting and reporting for the impairment or
disposal of long-lived assets. This statement superseded SFAS 121,
"Accounting for the Impairment of Long-Lived Assets to be Disposed Of".
The Company's adoption of SFAS 144 on October 1, 2002 did not have a
material effect on its consolidated financial statements.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity", which is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003, to address the
balance sheet classification of certain financial instruments that have
characteristics of both liabilities and equity. As a result of the
adoption of SFAS 150, the Company has reclassified the balance of its
Redeemable Capital Stock at September 30, 2003. SFAS 150 does not permit
the restatement of prior years balances of reclassified financial
instruments. Accordingly, the balances of the Company's Redeemable
Capital Stock have not been reclassified.
In July 2001, the Financial Accounting Standards Board finalized SFAS
143, Accounting for Asset Retirement Obligations ("ARO"), which requires
the recognition of a liability for an asset retirement obligation in the
period in which it is incurred. Retirement obligations associated with
long-lived assets included within the scope of SFAS 143 are those for
which there is a legal obligation to settle under existing or enacted
law, statute, written or oral contract, or by legal construction under
the doctrine of promissory estoppel. Retirement obligations are included
in the scope of the standard only if the legal obligation exists in
connection with or as a result of the permanent retirement, abandonment
or sale of a long-lived asset. When the liability is initially recorded,
the carrying amount of the related long-lived asset is correspondingly
increased. Over time, the liability is accreted to its future value.
The corresponding amount capitalized at inception is depreciated over the
useful life of the asset. The liability must be revalued each period
based on current market prices. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. The Company has adopted the requirements
of the statement.
3. Reclamation cash bond
The Company was required to post a cash bond with the State of Colorado,
Department of Natural Resources to cover future site reclamation and
closure liabilities associated with the Kelsey Lake mine. A liability
for the estimated restoration costs of $250,000 ($250,000 in 2002) has
been accrued in these financial statements.
<page>F-13
4. Property and equipment
The details of property and equipment are as follows:
2003 2002
Accumulated Net Book Net Book
Cost Amortization Value Value
---------- ------------- ---------- -------------
Equipment under
capital lease $ 137,435 $ 73,435 $ 64,000 $ 80,000
Furniture and
fixtures 7,865 4,366 3,499 3,348
Computer 11,333 2,811 8,522 970
Office equipment 639 397 242 259
---------- ------------- ---------- -------------
$ 157,272 $ 81,009 $ 76,263 $ 84,577
========= ============ ========== ============
5. Long-term debt
The Company received financial assistance from the government of Canada and
the province of Quebec in connection with the completion of a feasibility
study of the Vanadium deposits at Lac Dore, Quebec and a test pilot project
for the refining of Vanadium. These financial assistance packages have been
recorded as liabilities in the financial statements.
2003 2002
--------- ------------
Province of Quebec unsecured financial
assistance, non-interest bearing,
repayable in scheduled payments over 4
years after the second year of production
of the mine. This assistance is
forgivable if, after 24 months following the
release of the feasibility study, a
decision is made not to begin production $ 665,190 $ 570,240
Government of Canada unsecured financial
assistance, non-interest bearing,
repayable in quarterly payments of
CDN$62,500 commencing October 1, 2004 369,550 285,119
Government of Canada unsecured financial
assistance, non-interest bearing, repayable
in two equal annual payments,
commencing January 1, 2005 39,911 -
Obligation under capital lease, payable
in monthly blended installments of $3,444,
interest at 10%, due July, 2004 32,945 69,101
----------- ------------
1,107,596 924,460
Less current portion 32,945 36,156
----------- ------------
$ 1,074,651 $ 888,304
=========== ============
<page>F-14
The Company has provided equipment subject to the lease agreement above as
collateral for amounts owing.
Future minimum lease payments required under the lease are as follows:
2004 $34,443
2005 -
-------
34,443
Less amount representing interest 1,498
-------
$32,945
=======
6. Capital stock
Authorized - 75,000,000 common stock, par value $0.001 per share
<table>
<s> <c> <c>
Issued -
Common Paid in Stock
Shares stock capital options Total
--------- -------- -------- -------- ----------
Balance, September 30, 2002 23,177,640 $21,689 $13,767,907 - $13,789,596
Common stock issued for:
Expenses and accounts
payable settled through
issuance of common stock 937,943 938 822,053 - 822,991
Cash 453,337 453 295,414 - 295,867
Exercise of warrants 661,038 661 551,125 - 551,786
Stock options, compensation - - 353,278 - 353,278
Stock options, in lieu of
redemption rights - - 605,210 - 605,210
Stock options, cash - - 33,160 - 33,160
Expiry of redemption rights - - 514,471 - 514,471
---------- -------- ---------- ---- ----------
Balance, September 30, 2003 25,229,958 23,741 16,942,618 - 16,966,359
Less treasury stock at cost (92,000) (92) (160,830) - (160,922)
---------- -------- ---------- ---- ----------
Balance, September 30, 2003 25,137,958 $23,649 $16,781,788 $ - $16,805,437
========== ======== ========== ==== ===========
<page>F-15
</table>
Share-based incentive plans
At September 30, 2003, the Company had three stock-based incentive plans each
being limited so that options to acquire no more than 2,500,000 shares per plan
in the aggregate may be outstanding at any one time.
(i) Under the 2001 Employee Incentive Stock Option Plan, options may be
granted at an exercise price equal to the market price on the date of the grant.
All options expire no later than ten years from the grant date. In the event an
option is granted to an employee who owns 10% or more of the voting power of
stock of the Company, the purchase price of each share shall be 110% of the fair
market value on the date of grant and the expiration date of option shall be no
more than five years after the date of grant of such option.
(ii) Under the 2001 Employee non-qualified Stock Option Plan, options may be
granted to employees or certain non-employees at an exercise price as determined
by the administrator of the plan on the date of the grant, all options expire
ten years after the date of grant.
(iii) Under the 2001 Directors non-qualified Stock Option Plan, options to
purchase common shares of the Company may be granted to directors of the Company
or certain non-employees for terms up to ten years at an exercise price as
determined by the administrator on the date of the grant.
The following table contains information with respect to all options
granted by the Company:
Weighted average
exercise price
Shares US$/share
------------ ----------------
Options outstanding,
September 30, 2001 2,410,000 1.02
Granted 950,000 1.25
Expired (25,000) 0.64
Options outstanding,
September 30, 2002 3,335,000 1.09
Granted 9,896,617 1.03
Expired (100,000) 1.50
------------ ----------------
Options outstanding,
September 30, 2003 13,131,617 1.04
=========== ================
<page>F-16
The following table contains information with respect to all options granted by
the Company at September 30, 2003:
Outstanding options Exercisable options
--------------------- ------------------------
Weighted Weighted
Average average average
life price price
Shares (years) US$/share Shares US$/share
-------- ------- ---------- --------- ----------
$0.74 300,000 3.96 0.74 - -
$1.00 11,121,917 5.26 1.00 10,431,917 1.00
$1.25 476,200 1.88 1.25 476,200 1.25
$1.30-$1.50 1,175,000 6.94 1.38 775,000 1.42
$2.00-$3.00 58,500 0.49 2.85 58,500 2.85
---------- -------- ---------- ---------- ----------
13,131,617 11,741,617
========== ==========
As at September 30, 2003, the following are outstanding:
[a] Stock warrants
Number
of warrants
------------
Outstanding, September 30, 2001 3,544,030
Issued during the year 145,000
Exercised during the year (969,935)
Outstanding, September 30, 2002 2,719,095
Issued during the year 446,762
Exercised during the year (661,038)
Expired during the quarter (1,552,200)
------------
Outstanding, September 30, 2003 952,619
============
The warrants outstanding at September 30, 2003 can be exercised at prices
ranging from US $1.48 to US $3.00. The expiry dates on the warrants
range from November 29, 2003 to August 19, 2005.
During 2003, the Company agreed to a cashless exercise of certain
outstanding warrants for shares of the Company's common stock which would
have expired in February 2003. The Company agreed to a cashless exercise
of the warrants, in effect accepting shares issuable upon exercise as
payment for the exercise. As a result, 15,000 shares of common stock
were issued in exchange for warrants for 75,000 shares based on an
exercise price of $1.28 per share and an exchange price of $1.60 per
share. The exchange price of $1.60 per share was set on a date when the
quoted market price of a share of common stock was the same.
<page>F-17
[b] Treasury stock
During the year, the Company repurchased 10,000 (2,500 in 2002) common
shares for treasury at a cost of $11,300 in settlement of an account
receivable ($4,369 in cash in 2002).
[c] Redeemable capital stock
i) 81,700 common shares of the Company have certain rights attached
permitting the holder to require the Company to repurchase these shares.
Pertaining to subscription agreements, if stockholders decide to exercise
their rights, the Company would be obligated to pay, as at September 30,
2003 or gradually over the next two years a maximum amount of $252,175.
This right requires a repurchase at prices increasing in time from $2.50
to $3.25.
7. Mineral properties and exploration expenditures
The Company's expenditures, net of grant revenues received on vanadium and
diamond exploration are as follows:
2003 2002
--------- ---------
$510,393 $2,586,476
The Lac Dore Vanadium/Titanium Project is located in the Province of
Quebec, Canada.
The Kelsey Lake Diamond Mine is located on the Colorado, USA and
Wyoming, USA border.
At September 30, 2003, the accumulated expenditures incurred by the
Company on mineral properties and exploration expenditures totaled
$7,074,194 (2002 - $6,563,801).
8. Experts Conseils Dermond Inc.
On February 12, 2002, the Company entered into an agreement to purchase all
the issued and outstanding common stock of Experts Conseils Dermond Inc.
(Dermond), a Canadian corporation, which owns technology known as the Dermond
Wind Generator. As consideration for the common stock of Dermond, the
Company paid cash of CDN$50,000 (US$31,369), issued 100,000 of its common
stock and agreed to provide employment contracts and royalty agreements to
the existing shareholders of Dermond.
<page>F-18
The acquisition of Dermond was accounted for using the purchase method
whereby the results of its operations were consolidated since the date of
acquisition.
The net assets acquired were:
Cash $ 83
Accounts receivable 32,712
Computer 606
Goodwill (see note 2) 146,972
Accounts payable and
accrued liabilities (24,004)
-----------
$ 156,369
===========
Consideration for the purchase consisted of:
Cash $ 31,369
Issuance of common stock 125,000
-----------
$ 156,369
===========
9. Income and mining taxes
As the Company operates in a specialized industry and in several tax
jurisdictions, its income is subject to various rates of taxation. Major
items causing the Company's income tax rate to differ from the federal income
tax rate of 34% to which are subject the majority of its operations, were as
follows:
2003 2002
---------- -----------
Loss before taxes and cumulative
effect of change in accounting
principle for SFAS 142 $(3,545,420) $(6,111,574)
---------- -----------
Computed "expected" tax recovery (1,205,443) (2,086,882)
Increase (reduction) in income taxes
resulting from:
Resource allowance deduction 39,246 56,966
Earnings in foreign jurisdiction
taxed at different rates (50,381) (249,614)
Tax benefits of losses not recognized 1,214,804 1,583,361
Tax loss realized on intercompany transaction - 566,637
Non-deductible expenses (stock options) 1,774 129,532
--------- ----------
- -
Income taxes - -
Mining duties - (141,000)
--------- ----------
Total income and mining tax recovery $ - $ (141,000)
========= ==========
<page>F-19
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets are presented below:
As at September 30, 2003 2002
--------- --------
Deferred tax assets:
Loss carried forward and
exploration expenditures $4,193,360 $ 2,959,192
Capital loss carried forward 518,074 516,521
Others 126,399 111,414
--------- ---------
Total gross deferred tax assets 4,837,833 3,587,127
Less valuation allowance (4,837,833) (3,587,127)
--------- ---------
Net deferred tax assets $ - $ -
========= =========
The Company and certain subsidiaries have accumulated the following losses and
credits for income tax purposes, which may be carried forward to reduce taxable
income and taxes payable in future years.
Expiring
Amounts dates
------------ ------------
Non-capital loss carried forward
for Canadian subsidiaries $ 1,667,960 2004 to 2010
Non-capital loss carried forward for the Company 2,905,840 2019 to 2023
Capital loss carried forward for the Company 1,213,289 2008
Pool of deductible exploration expenditures 6,713,837 Unlimited
============ =============
10. Contingency
As a result of exploration work performed at the Lac Dore Vanadium/Titanium
Project, the Company has a potential environmental liability in the range of
$15,000 to $30,000. This liability will not be incurred if the project goes
into production. As management believes that the project will go into
production, the amount has not been accrued in the financial statements.
Bank indebtedness and other loans
The bank indebtedness of a subsidiary company, Great Western Diamond
Company, carries interest at 8% per annum and is secured by the assets of
Great Western Diamond Company.
The bank indebtedness of a subsidiary company, Experts Conseils Dermond
Inc., carries interest at 7.5% per annum and is secured by an assignment of
the subsidiary's refundable research and development tax credit.
<page>F-20
In addition to the above, the assets of Great Western Diamond Company have
been pledged to secure certain of the accounts payable of Great Western
Diamond Company.
In the normal course of business, the Company and its subsidiaries are
parties to various legal claims, actions and complaints and various other
risks. It is not possible to predict with certainty whether or not the
Company and its subsidiaries will ultimately be successful in any of these
legal matters or, if not, what the impact might be. However, the Company's
management does not expect that the results in any of these legal
proceedings will have a material adverse effect on the Company's results of
operations, financial position or cash flows.
11. Commitments
The Company has provided a 50% lien on the reclamation bond on deposit with
the state of Colorado with payment being made in the event that the Great
Western Diamond Company is sold and the deposit returned.
Royalty Agreements
The Company has entered into agreements with third parties to make royalty
payments based on production from the Kelsey Lake mine and a royalty of 2.5%
of Dermond wind turbine sales.
12. Financial instruments
Financial instruments include cash and cash equivalent, accounts receivable,
accounts payable and accrued liabilities, all of which are carried at cost
which approximates fair value because of the near-term maturity of those
instruments. As at September 30, 2003, fair value of repayable government
assistance could not be determined because no equivalent market exists for
such loans, therefore these loans have been carried at cost.
13. Comprehensive loss
Cumulative
From inception
on August 23,
2003 2002 1996
--------------- --------------- -----------------
Net loss $(3,692,392) $ (5,970,574) $ (18,378,745)
Unrealized holding
loss on marketable
securities - 371,735 -
Foreign currency
translation adjustment (247,170) 40,431 (224,271)
--------------- --------------- -----------------
Comprehensive loss $(3,939,562) $ (5,558,408) $ (18,603,016)
=============== =============== =================
<page>F-21
14. Net basic and diluted loss per common share
2003 2002
----------- -----------
Net loss $ (3,692,392) $ (5,970,574)
----------- -----------
Total weighted average
number of common
shares and equivalent 24,186,803 20,940,128
------------ -----------
Net loss per common share $ (0.15) $ (0.29)
============ ===========
15. Related party transactions
The Company has retained a law firm to perform legal services for which
Company has incurred total expenditure of $125,086 for the year ended
September 30, 2003. A director for the Company is a partner in that law
firm. The transactions were valued at the exchange amount, which is the
amount of consideration agreed to by the related parties. As of September
30, 2003, an amount of $60,294 resulting from these transactions is included
in accounts payable and accrued liabilities. On May 15, 2003, the Company's
Board of Directors approved the cancellation of $17,100 of the amount
outstanding at March 30, 2003, in exchange for the issuance of 20,000 of
common stock shares to certain principals in the law firm, including the
Company's director.
16. Comparative figures
Certain figures from the prior year have been reclassified for comparison
purposes only.
17. Subsequent event
On April 6, 2004 the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, LP. Under the agreement and
subject to its terms and conditions, which the Company may not be able to
satisfy, the Company may require Cornell Capital Partners, LP to purchase
newly issued common shares from the Company, to a maximum market value of
$15 million, over a 24-month period, less certain fees and expenses.
<page>F-22
=================================================================
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A Development-Stage Company)
Condensed Consolidated Balance Sheets
(Unaudited)
(Amounts stated In US dollars)
June 30, September 30,
2004 2003
----------- -----------
ASSETS (Unaudited)
Current:
Cash and cash equivalents $ 47,571 $ 49,208
Accounts receivable 89,576 262,979
Prepaid expenses and deposits 54,873 145,441
Deferred issue costs (note 5) 280,000 -
----------- -----------
Total current assets 472,020 457,628
Reclamation cash bond 338,685 338,685
Property and equipment 77,702 76,263
----------- -----------
Total assets $ 888,407 $ 872,576
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current:
Bank indebtedness $ 103,660 $ 83,463
Accounts payable and accrued liabilities 2,063,793 2,162,934
Current portion of long-term debt 157,763 32,945
----------- -----------
Total current liabilities 2,325,216 2,279,342
Long-term and other liabilities:
Long-term debt 932,274 1,074,651
Reclamation and closure liabilities 250,000 250,000
Redeemable capital stock 91,975 252,175
----------- -----------
Total long-term and other liabilities 1,274,249 1,576,826
Stockholders' equity (deficit):
Capital stock
75,000,000 shares of common stock
authorized, $0.001 par value;
26,210,648 and 25,229,958 shares
issued and outstanding 24,722 23,649
Additional paid in capital 19,414,998 16,781,788
Accumulated deficit (21,902,255) (19,564,758)
Accumulated other comprehensive income(loss) (248,523) (224,271)
----------- -----------
Total stockholders' deficit (2,711,058) (2,983,592)
----------- -----------
Total liabilities and stockholders' deficit $ 888,407 $ 872,576
=========== ===========
(See accompanying notes to condensed consolidated financial statements)
F-23
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A development-stage company)
CONSOLIDATED STATEMENTS OF LOSS
(Unaudited)
(Amounts dtated in US dollars)
<table>
<s> <c> <c> <c> <c> <c>
Cumulative
Three months ended Nine months ended from inception
June 30, June 30, on August 23,
2004 2003 2004 2003 1996
---------- ----------- ---------- ---------- ---------------
Revenue $ - $ - $ - $ - $ 12,825
---------- ----------- ---------- ---------- ---------------
Expenses:
Research, development and exploration 74,816 597,515 164,477 959,323 7,867,749
General administration 99,642 31,183 295,511 261,479 1,448,446
Reorganization costs - - - - 102,914
Wages and benefits 16,818 27,509 85,246 172,179 1,231,240
Management wages and benefits 166,717 173,272 1,199,698 655,176 3,552,498
Professional fees 166,984 143,845 419,712 724,799 1,994,673
Advertising, promotion and travel 46,704 22,078 112,858 115,473 936,459
Amortization 4,382 5,716 12,472 16,825 401,314
Interest and bank charges 12,551 37,863 46,003 37,863 205,805
Interest on long-term debt 3,402 7,924 4,623 10,953 94,797
--------- ---------- --------- --------- --------------
592,016 1,046,905 2,340,600 2,954,070 17,835,895
--------- ---------- --------- --------- --------------
Loss before the following: (592,016) (1,046,905) (2,340,600) (2,954,070) (17,823,070)
Write-down of assets - - - - (1,626,821)
Write-off of incorporation and
reorganization costs - - - - (49,137)
Write-down of marketable securities - - - (32,731) (1,104,214)
Gain on sale of marketable securities - 9,367 - 2,026 (138,028)
Interest income - 212 3,103 1,820 31,000
--------- ---------- -------- ---------- -------------
Net loss before mining taxes and cumulative
effect of change in accounting principle
for SFAS 142 (592,016) (1,037,326) (2,337,497) (2,982,955) (20,710,270)
Current mining tax recovery - 13,927 - 52,991 141,000
--------- ---------- --------- --------- ------------
Net loss before cumulative effect of change
in accounting principle for SFAS 142 (592,016) (1,023,399) (2,337,497) (2,929,964) (20,569,270)
Cumulative effect of change in accounting
principle for SFAS 142 - - - (146,972) (146,972)
--------- ---------- --------- ---------- -------------
Net loss $ (592,016) $(1,023,399) $(2,337,497) $(3,076,936) $ (20,716,242)
---------- ---------- ----------- ---------- --------------
Comprehensive loss (note 7) (536,974) (1,088,715) (2,361,749) (3,218,116) (20,964,765)
Basic and diluted loss per share: Net loss
before cumulative effect of change in
accounting principle $ (0.02) $ (0.04) $ (0.09) $ (0.12)
Cumulative effect of change in accounting
principle - - - (0.01)
--------- -------- ---------- ----------
Net loss $ (0.02) $ (0.04) $ (0.09) $ (0.13)
========= ======== ========== ==========
Weighted average shares outstanding 26,082,842 24,341,914 25,691,524 23,916,382
========== ========== ========== ==========
(See accompanying notes to condensed consolidated financial statements)
</table>
F-24
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A development-stage company)
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(Amounts stated in US dollars)
<table>
<s> <c> <c> <c>
Cumulative
Nine months ended from inception
June 30, on August 23,
2004 2003 1996
---------- ---------- ---------------
Operating activities:
Net loss $(2,337,497) $ (3,076,936) $ (20,716,242)
Items not affecting cash:
Cumulative effect of change in accounting principle - 146,972 146,972
Amortization 12,472 16,825 401,314
Expenses settled through issuance of common stock - 286,518 1,805,662
Capitalized interest on convertible notes payable - - 2,571
Reclamation and closure costs - - 250,000
Write-down of assets - - 1,626,821
Write-down of marketable securities - 32,731 1,104,214
Write-off of incorporation and reorganization costs - - 49,137
Loss (gain) on sale of marketable securities - (140) 138,028
Stock-based compensation 794,467 324,614 2,466,608
Net change in non-cash working capital related to
operations:
Accounts receivable 172,329 (149,648) (33,287)
Inventories - 19,562 -
Prepaid expenses and deposits 90,568 138,891 (4,389)
Accounts payable and accrued liabilities (139,319) 1,241,150 1,996,884
---------- ---------- --------------
Net cash used in operating activities (1,406,980) (1,019,461) (10,765,708)
---------- ---------- --------------
Investing activities:
Purchase of marketable securities - - (1,767,835)
Purchase of reclamation cash bond - - (338,685)
Purchase of property and equipment (13,974) (11,080) (2,071,980)
Proceeds - sale of marketable securities - 50,910 (525,593)
Incorporation and reorganization costs - - (81,769)
Business acquisition - Dermond - - (31,286)
---------- ---------- --------------
Net cash (used in) provided by investing activities (13,974) 39,830 (3,765,962)
---------- ---------- --------------
Financing activities:
Issuance of notes payable - - 350,000
Increase in bank indebtedness 19,775 1,694 96,971
Increase in convertible notes payable - 200,000 23,055
Issuance of long-term debt - - 137,435
Repayment of long-term debt (29,529) (26,785) (134,019)
Receipt of repayable government assistance 4,795 77,259 931,425
Proceeds from sale of common stock 1,424,401 748,399 13,302,058
Proceeds on sale of options - - 33,160
Redemption of redeemable capital stock - - (37,500)
Purchase of common stock for treasury - - (149,622)
---------- ---------- --------------
Net cash provided by financing activities 1,419,442 1,000,567 14,552,964
----------- ---------- --------------
Effect of foreign currency
exchange rate changes on cash and equivalents (125) 7,848 26,277
---------- ---------- --------------
Net increase (decrease) in cash and cash
equivalents (1,637) 28,784 47,571
Cash and cash equivalents, beginning of period 49,208 45,325 -
---------- ---------- --------------
Cash and cash equivalents, end of period $ 47,571 $ 74,109 $ 47,571
========== ========== ==============
Supplemental non-cash financing activities:
Issuance of common stock in lieu of payment
of issue costs $ 280,000 $ - $ 280,000
Issuance of common stock in lieu of requiring
the Company to repurchase redeemable capital stock 60,000 - 170,000
Issuance of options in lieu of requiring Company
to repurchase redeemable capital stock - - 605,210
Issuance of common stock in lieu of payment of notes
payable - - 356,424
Conversion of notes payable into capital stock - - 25,626
Repurchase of capital stock in settlement of
accounts receivable - 11,300 11,300
---------- ---------- -------------
$ 340,000 $ 11,300 $ 1,448,560
========== ========== =============
(See accompanying notes to condensed consolidated financial statements)
</table>
F-25
MCKENZIE BAY INTERNATIONAL LTD. and subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
JUNE 30, 2004
(Amounts stated in US dollars unless indicated otherwise)
1. Nature of operations
The Company is a development stage company with no operations. The Company has
interests in a vanadium/titanium deposit, wind turbine technology and a diamond
mine. The Company was incorporated in Delaware on August 17, 1998 under the
name Decker Organic Systems, Inc.
2. Accounting policies
The accompanying consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles ("US
GAAP") and reflect the following significant accounting policies:
(a) Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring entries)
considered necessary for a fair presentation have been included. The
accompanying financial statements should be read with Notes to Consolidated
Financial Statements included in the Company's Annual Report of Form 10-KSB for
the fiscal year ended September 30, 2003. The balance sheet at September 30,
2003 has been derived from the audited financial statements at that date but
does not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. Operating
results for the three-months and nine-months periods ended June 30, 2004 are not
necessarily indicative of the results of operations that may be expected for the
year ending September 30, 2004.
The financial statements of the Company have been prepared on the basis of the
Company continuing as a going concern, which contemplates the realization of
assets and the payment of liabilities in the ordinary course of business. Should
the Company be unable to continue as a going concern, it may be unable to
realize the carrying value of its assets and to meet its liabilities as they
become due.
The Company suffered recurring losses and has a deficiency in assets that raise
substantial doubt about its ability to continue as a going concern. The
Company's continued existence is dependent upon its ability to raise additional
capital and generate profits. Although management believes that it will be
successful at raising additional capital in the short-term and will have
profitable operations in the long-term, there are no firm commitments as of the
date of these financial statements.
As discussed in note 4, the Company may be required to repurchase shares, at the
option of the holders, for an amount of $91,975.
The accompanying financial statements do not include any adjustments relating to
the recoverability and classification of recorded assets and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern.
(b) Consolidation
These financial statements include the activities of the Company and its wholly-
owned subsidiaries, Lac Dore Mining Inc. (formerly McKenzie Bay Resources Ltd.),
Great Western Diamond Company, DERMOND INC. (formerly Experts Conseils Dermond
Inc.), WindStor Power Company and a 62.5% interest in Ptarmigan Energie Inc.
All intercompany balances and transactions have been eliminated in
consolidation.
(c) New accounting pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 requires a variable interest entity
to be consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. FIN 46 also
requires disclosures about variable interest entities that a company is not
required to consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003. In addition, FIN 46, as amended in
December 2003 (FIN 46R), will be effective for public entities for periods
ending after March 15, 2004. The adoption of this interpretation and its
revision did not have a material impact on the Company's financial position or
results of operations.
(d) Stock based compensation plan
i. The Company has stock-based compensation plans which are described in
note 4. The Company uses the fair value method of accounting for all
stock options granted to non-employees in accordance with the
provisions of SFAS 123 and the intrinsic value method for those granted
to employees in conformity with Accounting Principles Board Opinion No.
25 and its related interpretation as allowed by SFAS 123. Under the
fair value based method, compensation cost attributable to awards is
measured at the date of the grant and recognized over the vesting
period in operating expense. No compensation cost is recorded for all
other stock-based employee compensation awards and consideration paid
by employees on the exercise of stock options is recorded as capital
stock.
ii. Fair value disclosure
SFAS 123 encourages but does not require companies to include in
compensation cost the fair value of stock options granted to employees.
A company that does not adopt the fair-value method must disclose the
cost of stock compensation awards, at their fair value, on the date the
award is granted. This fair value was estimated using the Black-Scholes
model with assumptions of a 4.5 to 10 years expected term, 105% to 115%
volatility, interest rates ranging from 3.04% to 4.58% and an expected
dividend yield of 0%. Had the compensation cost for stock options
issued to employees, officers and directors been determined based on
the fair value at the grant date consistent with SFAS No. 123, the
Company's net loss, loss per share and stock based compensation would
have been as follows:
F-26
Three months ended Nine months ended
June 30, June 30,
----------------------- ------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net loss, as reported $(592,016) $(1,023,399) $(2,337,497) $(3,076,936)
Add: Stock-based
employee compensation
expense included in
reported net income,
net of related tax
effects 6,443 13,066 739,326 270,343
Deduct: Total
stock-based employee
compensation expense
determined under fair
value based method for
all awards, net of
related tax effects (21,539) (78,750) (1,952,634) (1,341,539)
-------- ----------- ----------- -----------
Pro forma net loss (607,112) (1,089,083) (3,550,805) (4,148,132)
========= =========== =========== ===========
Basic and diluted
earning per share:
As reported $ (0.02) $ (0.04) $ (0.09) $ (0.13)
Pro forma $ (0.02) $ (0.04) $ (0.14) $ (0.17)
3. Goodwill and other intangible assets
SFAS 142 requires that goodwill no longer be amortized, but instead be tested
for impairment at least annually. The Company has completed their SFAS 142
transitional impairment review and determined that the goodwill ("excess cost of
investment over net assets acquired") of $146,972 associated with the fiscal
2002 acquisition of DERMOND INC. should be reduced to $0. The fair value of the
reporting unit (DERMOND INC.) was determined using the present value of expected
future cash flows and other valuation measures. The $146,972 non-cash charge is
reflected as a cumulative effect of an accounting change in the accompanying
Consolidated Statements of Loss for the nine-month period ended June 30, 2003.
F-27
4. Capital stock
Authorized -
75,000,000 common stock, par value $0.001 per share
Issued -
Common Paid in
Shares stock capital Total
---------- ------- ----------- -----------
Balance, September 30, 2003 25,229,958 $23,741 $16,942,618 $16,966,359
Common stock issued for:
Cash 132,286 132 168,238 168,370
Stock options, compensation - - 54,896 54,896
---------- ------ ---------- ----------
Balance December 31, 2003 25,362,244 23,873 17,165,752 17,189,625
Common stock issued for:
Cash and other 34,503 35 81,966 82,001
Exercise of warrants 185,600 186 302,014 302,200
Exercise of options 58,800 59 60,941 61,000
Stock options, compensation - - 726,442 726,442
Expiry of redemption right - - 38,601 38,601
Cancellation of treasury stock (92,000) (92) (160,830) (160,922)
---------- ------ ----------- ----------
Balance, March 31, 2004 25,549,147 $ 24,061 $18,214,886 $18,238,947
Common stock issued for:
Expenses and accounts
payable settled
through issuance of
common stock 124,428 124 279,876 280,000
Cash and other 378,973 379 494,251 494,630
Exercise of warrants 185,100 158 316,042 316,200
Stock options, compensation - - 6,443 6,443
Expiry of redemption right - - 103,500 103,500
---------- ------ ----------- ----------
Balance, June 30, 2004 26,210,648 $ 24,722 $ 19,414,998 $19,439,719
========== ====== =========== ==========
Share-based incentive plans
As of June 30, 2004, the Company has the following three stock-based incentive
plans. Each plan permits the issuance of up to 2,500,000 options.
Under the 2001 Employee Incentive Stock Option Plan, options may be granted at
an exercise price equal to the market price on the grant date. All options
expire no later than ten years from the grant date. If an option is granted to
an employee who owns 10% or more of the Company's voting stock, the purchase
price of each share shall be 110% of the fair market value on the grant date and
the expiration date shall not exceed five years after the grant date.
Under the 2001 Employee Non-Qualified Stock Option Plan, options may be granted
to employees or certain non-employees at an exercise price as determined by the
administrator of the plan on the grant date. All options expire ten years after
the date of grant.
F-28
Under the 2001 Directors Non-Qualified Stock Option Plan, options may be granted
to directors of the Company or certain non-employees for terms up to ten years
at an exercise price as determined by the administrator on the grant date.
The following tables contain information with respect to all options granted by
the Company:
Weighted
average
exercise
price
per
Shares share
-------------- -------------
Options outstanding,
September 30, 2003 13,131,617 $ 1.04
Granted 550,000 $ 1.89
-------------- -------------
Options outstanding,
December 31, 2003 13,681,617 $ 1.08
Exercised (58,800) $(1.04)
Expired (100,000) $(1.00)
-------------- --------------
Options outstanding,
March 31, 2004 13,522,817 $ 1.08
Exercised - -
Expired - -
============== =============
Options outstanding,
June 30, 2004 13,522,817 $1.08
============== =============
Outstanding options Exercisable options
- ---------------------------------- ---------------------------------
Weighted Weighted
average average
price price
Shares per share Shares per share
-------- --------- -------- -----------
$0.74 300,000 $ 0.74 - $ -
$1.00 10,971,917 1.00 10,341,917 1.00
$1.25 467,400 1.25 467,400 1.25
$1.30 - $1.50 1,175,000 1.38 775,000 1.42
$1.88 525,000 1.88 525,000 1.88
$2.00 - $3.00 83,500 2.63 83,500 2.63
---------- ----------
13,522,817 12,192,817
========== ==========
(a) Stock warrants
As at June 30, 2004 the following warrants are outstanding:
Number
of warrants
-----------
Outstanding at September 30, 2003 952,619
Issued during the quarter 66,143
Expired during the quarter (42,857)
--------
Outstanding at December 31, 2003 975,905
Issued during the quarter 15,730
Exercised during the quarter (185,600)
--------
Outstanding, March 31, 2004 806,035
Issued during the quarter 186,550
Expired during the quarter (158,100)
--------
Outstanding, June 30, 2004 834,485
========
The warrants outstanding can be exercised at prices ranging from $1.75 to $3.00.
The expiration dates of the warrants range from July 13, 2004 to May 19, 2006.
(b) Redeemable capital stock
The Company has 28,300 common shares outstanding that have certain rights
attached permitting the holder to require the Company to repurchase these
shares. If the holders exercise their rights, the Company would be obligated to
pay, as of June 30, 2004 or gradually over the next two years, a maximum amount
of $91,975. This right requires a repurchase at prices increasing in time from
$2.50 to $3.25.
5. Deferred issue costs
On April 6, 2004 the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, L.P. Under the agreement and subject
to its terms and conditions, the Company may require Cornell Capital Partners,
L.P. to purchase newly issued common shares from the Company, to a maximum
market value of $15 million, over a 24-month period, less certain fees and
expenses. For the quarter ended June 30, 2004, the Company incurred $280,000 in
issue costs related to the signing of the Standby Equity Distribution Agreement
with Cornell Capital Partners, L.P. These costs were settled through the
issuance of 124,428 of common shares at $2.25 per share, which represented the
volume weighted average trading price of the Company's shares on the signing
date of the agreement. These costs have been deferred and will be treated as a
reduction to the proceeds from the shares issued under the Standby Equity
Distribution Agreement with Cornell Capital Partners, L.P.
In addition to the above costs, under the terms of the Standby Equity
Distribution Agreement a further payment of $270,000 will be due on the
fulfillment of the terms and conditions of the agreement.
6. Kelsey Lake Diamond Mine
The Company is actively seeking a partner or purchaser to take over the Kelsey
Lake mine. If the Company is unable to find a partner or purchaser in 2004,
Great Western Diamond intends to close the Kelsey Lake mine permanently and
initiate mine reclamation.
F-29
<table>
<s> <c> <c> <c> <c> <c>
7. Comprehensive loss Cumulative
from
Three months ended Nine Months ended inception on
June 30, June 30, August 23,
2004 2003 2004 2003 1996
------------ ----------- ------------ ----------- -----------
Net loss $ (592,016) $ (1,023,399) $(2,337,497) $(3,076,936) $(20,716,242)
Foreign currency
translation
adjustment $ 55,042 $ (65,316) $ (24,252) $ (141,180) $ (248,523)
Comprehensive
loss $ (536,974) $ (1,088,715) $(2,361,749) $(3,218,116) $(20,964,765)
========= =========== =========== =========== ============
</table>
8. Net loss per common share
Basic net loss per common share has been computed based upon the weighted
average number of shares of common stock outstanding during the periods. Diluted
loss per share has not been presented, as it would be anti-dilutive. The
computation of net loss per share is reflected in the following schedule:
<table>
<s> <c> <c> <c> <c>
Computation of Net Loss Three Months ended June 30, Nine Months ended June 30,
Per Common Share 2004 2003 2004 2003
- ----------------------- ------------ -------------- ------------ -----------
Net Loss $ (592,016) $ (1,023,399) $ (2,337,497) $ (3,076,936)
Total Weighted Average
Number of Common
Shares and Equivalents 26,082,842 24,341,914 25,691,524 23,916,382
----------- ---------- ---------- ----------
Net Loss per
Common Share $ (0.02) $ (0.04) $ (0.09) $ (0.13)
=========== ========== ========== ==========
</table>
F-30
9. Related party transactions
The Company has retained a law firm to perform legal services for which Company
has incurred a total expenditure of $33,984 for services for the three months
and $92,145 for the nine months ended June 30, 2004 ($4,350 for three months and
$74,164 for nine months ended June 30, 2003). A director of the Company is a
partner in that law firm. The transactions were valued at the exchange amount,
which is the amount of consideration agreed to by the related parties. As of
June 30, 2004 an amount of $102,440 ($42,018 as of June 30, 2003) resulting from
these transactions is included in accounts payable and accrued liabilities.
10. Commitments and Contingencies
The Company has provided to a creditor 50% lien on the reclamation bond on
deposit with the state of Colorado with payment being made in the event that the
Great Western Diamond Company is sold and the deposit returned.
As a result of exploration work performed at the Lac Dore Vanadium/Titanium
Project, the Company has a potential environmental liability in the range of
$15,000 to $30,000. This liability will not be incurred if the project goes
into production. As management believes that the project will go into
production, the amount has not been accrued in the financial statements.
Royalty Agreements
The Company has entered into a royalty agreement that will pay 2.5% of Dermond
wind turbine sales to the former owners of DERMOND INC.
Bank indebtedness and other loans
The bank indebtedness of a subsidiary company, Great Western Diamond Company,
carries interest at 8% per annum and is secured by the assets of Great Western
Diamond Company.
The bank indebtedness of a subsidiary company, DERMOND INC., carries interest at
7.5% per annum and is secured by an assignment of the subsidiary's refundable
research and development tax credit.
In addition to the above, the assets of Great Western Diamond Company have been
pledged to secure certain of the accounts payable of Great Western Diamond
Company.
In the normal course of business, the Company and its subsidiaries are parties
to various legal claims, actions and complaints and various other risks. It is
not possible to predict with certainty whether or not the Company and its
subsidiaries will ultimately be successful in any of these legal matters or, if
not, what the impact might be. However, the Company's management does not expect
that the results in any of these legal proceedings will have a material adverse
effect on the Company's results of operations, financial position or cash flows.
11. Subsequent events
On August 16, 2004, the Company dismissed Deloitte & Touche LLP as its auditor
and signed an engagement letter with BDO Seidman, LLP for these services. The
Company and Deloitte & Touche LLP did not have disagreements within the meaning
of item 304 of Regulation S-B or any matter of accounting principles or
practices, financial disclosure, or auditing scope or procedure, nor were there
any events required to be reported by Item 304(a)(1)(iv)(B) of Regulation S-B
during Deloitte & Touche LLP's engagement.
On August 13, 2004 the Company borrowed $500,000 from thirteen lenders and
issued its 12% promissory notes in that aggregate amount. The promissory notes
are convertible into shares of the Company's common stock at $0.75 per share and
are payable on November 15, 2004 if not sooner converted. The Company also
issued warrants to the lenders for the purchase of an aggregate of 750,000
shares of the Company's common stock on or before August 13, 2006 at $1.07 per
share. The Company has agreed to register the shares underlying the promissory
notes and the warrants under the Securities Act of 1933 for public sale by the
holders. The lenders' rights of conversion of the promissory notes commences on
the date that the shares are so registered and expires ninety days thereafter.
Although the Company intends to shortly file a registration statement under the
Securities Act of 1933 which will include the shares underlying the promissory
notes and the warrants, the shares will not be registered under that Act until
the registration statement is declared effective by the Securities and Exchange
Commission. There can be no assurance that the registration statement will be
so declared effective on or before November 15, 2004.
On September 7, 2004, the Company borrowed $593,750 from ten lenders. The terms
of the loans and the issuance of warrants in connection with the loans are
substantially the same as those of the loans of August 13, 2004 except that (a)
the conversion price of the promissory notes is approximately $0.795 per share
and (b) the lenders received warrants for the purchase of aggregate of 873,300
shares of the Company's common stock on or before September 7, 2006 at $1.42 per
share.
<page>F-31
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses to be paid by the registrant in connection with this offering are
as follows. All amounts other than the SEC registration fee are estimates.
SEC registration fee $ 3,853
Printing and engraving $ 10,000
Legal fees and expenses $ 62,000
Accounting and auditing fees and expenses $ 30,000
Blue sky fees and expenses $ 5,000
Transfer agent fees $ 10,000
Escrow fee $ 2,500
Miscellaneous $ 2,147
Total............................................. $ 125,500
==========
ITEM 25. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The registrant has agreed to indemnify its executive officers and directors to
the fullest extent permitted by Delaware law. That law permits the Registrant to
indemnify any person who is, or is threatened to be made, a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action by the
Registrant or in its right) by reason of the fact that the person is or was an
officer or director or is or was serving at our request as an officer or
director. The indemnity may include expenses (including attorney's fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by the person in connection with the action, suit or proceeding, provided that
he acted in good faith and in a manner he reasonably believed to be in or not
opposed to our best interests, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful. The
registrant may indemnify officers and directors in an action by the registrant
or in its right under the same conditions, except that no indemnification is
permitted without judicial approval if the officer or director is adjudged to be
liable to the registrant. Where an officer or director is successful on the
merits or otherwise in the defense of any action referred to above, the
registrant must indemnify him against the expenses which he actually and
reasonably incurred. The foregoing indemnification provisions are not exclusive
of any other rights to which an officer or director may be entitled under our
bylaws, by agreement, vote, or otherwise.
<page>73
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
During the three year period ended November 15, 2004, the registrant sold the
following equity securities that were not registered under the Securities Act of
1933.
From November 15, 2001 to November 12, 2004, the registrant sold 3,261,580
shares of its common stock to 128 private investors for an aggregate of
$3,617,204. In connection with the sales, the registrant issued options and
warrants expiring from November 15, 2003 to November 15, 2006 for the purchase
of an aggregate of 689,580 shares of its common stock for no additional
consideration. The sales of shares include 2,097,046 shares which the
registrant issued upon exercise of certain warrants and options.
On August 15, 2003, the registrant sold options expiring from August 15, 2005 to
August 15, 2008 for the purchase of an aggregate of 8,252,700 shares of its
common stock for cash and other consideration aggregating $551,100 to 34 private
investors. The options were exercisable at prices ranging from $1.00 to $1.25.
From January 11, 2002 to December 11, 2003, the registrant sold options expiring
from January 10, 2005 to December 10, 2005 for the purchase of an aggregate of
376,000 shares of its common stock for services rendered or to be rendered by
four persons. The options were exercisable at prices ranging from $1.00 to
$3.00. The registrant valued the services attributable to the purchase price of
the options at $403,935.
From September 20, 2001 to December 9, 2002, the registrant sold options
expiring from December 30, 2007 to December 30, 2112 for the purchase of an
aggregate of 2,735,000 shares of its common stock for services rendered or to be
rendered by seven employees. The options were exercisable at prices ranging
from $1.00 to $1.49. The registrant valued the services attributable to the
purchase price of the options at $992,000.
From October 1, 2001 to July 3, 2003, the registrant sold 225,000 shares of its
common stock to one person for services rendered or to be rendered which the
registrant valued at $258,500.
From September 20, 2001 to March 15, 2004, the registrant sold options expiring
from September 15, 2008 to September 30, 2113 for the purchase of an aggregate
of 1,760,417 shares of its common stock for services rendered or to be rendered
by seven directors. The options were exercisable at prices ranging from $1.00
to $1.88. The registrant valued the services attributable to the purchase price
of the options at $1,003,645.
From January 10, 2002 to August 15, 2003, the registrant sold 2,024,897 shares
of its common stock to ten persons in consideration of the release of
indebtedness in the aggregate amount of $1,644,364.
<page>74
From February 18, 2003 to May 3, 2004, the registrant sold 80,467 shares of its
common stock to four persons in consideration of their release of the
registrant's obligation to repurchase an aggregate of 60,000 of their shares at
prices ranging from $2.75 to $3.00.
From March 1, 2002 to April 17, 2003, the registrant sold 350,000 shares of its
common stock to three persons and entities in consideration for acquisitions of
assets with an aggregate value of $350,000.
On April 6, 2004, the registrant sold 124,428 shares of its common stock to
Cornell Capital Partners, LP and Spencer Clarke LLC in satisfaction of $280,000
of fees the registrant had agreed to pay to them in connection with a financing
arrangement.
On August 13, 2004 the registrant borrowed $500,000 from 13 lenders and issued
its 12% promissory notes in that aggregate amount The promissory notes are
convertible into shares of the Company's common stock at $.75 per share and are
payable on November 14, 2004 if not sooner converted. The registrant also
issued warrants to the lenders for the purchase of an aggregate of 750,000
shares of the registrant's common stock on or before August 13, 2006 at $1.07
per share. The lenders' rights of conversion of the promissory notes commences
on the effective date of this registration statement and expires ninety days
thereafter.
On September 7, 2004, the Company borrowed $593,750 from ten lenders. The terms
of the loans and the issuance of warrants in connection with the loans are
substantially the same as those of the loans of August 13, 2004 except that (a)
the conversion price of the promissory notes is approximately $.795 per share
and (b) the lenders received warrants for the purchase of aggregate of 873,300
shares of the Company's common stock on or before September 7, 2006 at $1.42 per
share.
There were no principal underwriters in connection with any of the foregoing
transactions.
The registrant claimed exemption from registration provisions of the Securities
Act of 1933 pursuant to Section 4(2) thereof and/or Rules 506 and 701
thereunder. Although the registrant believed that the transactions did not
involve a public offering and that each purchaser either received adequate
information about the registrant or had access, through employment or other
relationships, to such information, the exemptions may not have been available
to us.
<page>75
ITEM 27. EXHIBITS
Exhibit
Number Description
- ------- ---------------------------------------------------------------
2.1 Share Purchase Agreement between McKenzie Bay International,
Ltd. and Jacquelin Dery, Laurent Mondou and Experts Conseils
Dermond Inc. of February 12, 2002. Previously filed as an
exhibit to Amendment No. 2 to our registration statement on Form
10-SB and hereby incorporated by reference.
3.1 Certificate of Incorporation, as amended. Previously filed as an
exhibit to our registration statement on Form 10-SB and hereby
incorporated by reference.
3.2 Bylaws. Previously filed as an exhibit to our registration
statement on Form 10-SB and hereby incorporated by reference.
4.1 See Exhibits 3.1 and 3.2.
4.3 Specimen Stock Certificate. Previously filed as an exhibit to
our Annual Report on Form 10-KSB for the fiscal year ended
September 30, 2002 and hereby incorporated by reference.
4.4 Form of Warrant. Previously filed as an exhibit to our Annual
Report on Form 10-KSB for the fiscal year ended September 30,
2002, and hereby incorporated by reference.
4.5 Form of Subscription Agreement. Previously filed as an exhibit
to our Annual Report on Form 10-KSB for the fiscal year ended
September 30, 2002 and hereby incorporated by reference.
Previously filed as an exhibit to our Quarterly Report on Form
10-QSB for the quarterly period year ended June 30, 2004 and
hereby incorporated by reference.
4.6 Promissory Note and Warrant issued on August 13, 2004, letter of
August 16, 2004 amending certain terms and "Debenture" setting
forth certain terms. Previously filed as an exhibit to our
Quarterly Report on Form 10-QSB for the quarterly period ended
June 30, 2004 and hereby incorporated by reference.
4.7 Promissory Note and Warrant issued on September 7, 2004 and
"Debenture" setting forth certain terms. Previously filed as an
exhibit to our Quarterly Report on Form 10-QSB for the quarterly
period ended June 30, 2004 and hereby incorporated by reference.
<page>76
5.1 Opinion of Larson, Harms & Bibeau, P.C. re legality. Previously
filed as an exhibit to Amendment No. 1 to this registration
Statement and hereby incorporated by reference.
10.1 Employment Agreement between Experts Conseils Dermond Inc. and
Jacquelin Dery, dated February 12, 2002. Previously filed as an
exhibit to our Annual Report on Form 10-KSB for the fiscal year
ended September 30, 2002 and hereby incorporated by reference.
10.2 Royalty Agreement between McKenzie Bay International, Ltd. and
Jacquelin Dery as of February 12, 2002. Previously filed as an
exhibit to our Annual Report on Form 10-KSB for the fiscal year
ended September 30, 2002 and hereby incorporated by reference.
10.3 Employment Agreement between Experts Conseils Dermond Inc. and
Lauren Mondou, dated February 12, 2002. Previously filed as an
exhibit to our Annual Report on Form 10-KSB for the fiscal year
ended September 30, 2002 and hereby incorporated by reference.
10.4 Royalty Agreement between McKenzie Bay International, Ltd. and
Lauren Mondou as of February 12, 2002. Previously filed as an
exhibit to our Annual Report on Form 10-KSB for the fiscal year
ended September 30, 2002, and incorporated herein by reference.
10.5 Employment Agreement between McKenzie Bay Resources, Ltd. and
Michel Garon, dated November 1, 2002. Previously filed as an
exhibit to our Annual Report on Form 10-KSB for the fiscal year
ended September 30, 2002 and hereby incorporated by reference.
10.6 2001 Employee Non-qualified Stock Option Plan. Previously filed
as an exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended September 30, 2002 and hereby incorporated by
reference.
10.7 Amended 2001 Directors Non-qualified Stock Option Plan.
Previously filed as an exhibit to Amendment No. 1 to our Annual
Report on Form 10-KSB for the fiscal year ended September 30,
2002 and hereby incorporated by reference.
10.8 2001 Employee Incentive Stock Option Plan. Previously filed as
an exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended September 30, 2002, and incorporated herein by
reference.
<page>77
10.9 Agreement dated April 17, 2003 between McKenzie Bay Resources
Ltd. and SOQUEM Inc. terminating prior agreements. Previously
filed as an exhibit to our Annual Report on Form 10-KSB for the
fiscal year ended September 30, 2003, and incorporated herein by
reference.
10.10 Employment Agreement dated March 21, 2003 between Gary L.
Westerholm and McKenzie Bay International, Ltd. Previously
filed as an exhibit to our Annual Report on Form 10-KSB for the
fiscal year ended September 30, 2003, and incorporated herein by
reference.
10.11 Employment Agreement dated March 21, 2003 between Gregory N.
Bakeman and McKenzie Bay International, Ltd. Previously filed
as an exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended September 30, 2003, and incorporated herein by
reference.
10.12 Employment Agreement dated March 21, 2003 between John W.
Sawarin and McKenzie Bay International, Ltd. Previously filed
as an exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended September 30, 2003, and incorporated herein by
reference.
10.13 Consulting Agreement as of February 15, 2003 between McKenzie
Bay Resources, Inc.(now known as Lac Dore Mining Inc.) and
Savanco, (Pty) Ltd, incorporated. Previously filed as an
exhibit to our Annual Report on Form 10- KSB for the fiscal year
ended September 30, 2003, and incorporated herein by reference.
10.14 Agreement of August 19, 2003 between McKenzie Bay International,
Ltd. Resources, Inc. and Yes International Inc. Previously
filed as an exhibit to our Annual Report on Form 10-KSB for the
fiscal year ended September 30, 2003, and incorporated herein by
reference.
10.15 Standby Equity Distribution Agreement as of April 6, 2004
between Cornell Capital Partners, LP and McKenzie Bay
International Ltd. Previously filed as an exhibit to our Annual
Report on Form 10-KSB for the fiscal year ended September 30,
2003, and incorporated herein by reference.
10.16 Registration Rights Agreement as of April 6, 2004 between
Cornell Capital Partners, LP and McKenzie Bay International Ltd.
Previously filed as an exhibit to our Annual Report on Form 10-
KSB for the fiscal year ended September 30, 2003, and
incorporated herein by reference.
<page>78
10.17 Placement Agent Agreement as of April 6, 2004 between McKenzie
Bay International Ltd. and Spencer Clarke LLC. Previously filed
as an exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended September 30, 2003, and incorporated herein by
reference.
10.18 Escrow Agreement as of April 6, 2004 between McKenzie Bay
International Ltd., and Butler Gonzalez LLP. Previously filed
as an exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended September 30, 2003, and incorporated herein by
reference.
10.19 Agreement of June 2004 between Dermond Inc. and Universite du
Quebec en Abitibi-Temiscamingue.**
14.1 Code of Ethics. Previously filed as an exhibit to our Annual
Report on Form 10-KSB for the fiscal year ended September 30,
2003, and incorporated herein by reference.
16.1 Letter of February 21, 2003 from KPMG LLP. Previously filed as
an exhibit to our Current Report on Form 8-K dated February 17,
2003 and incorporated herein by reference.
16.2 Letter of August 18, 2004 from Deloitte & Touche LLP. Previously
filed as an exhibit to our Current Report on Form 8-K dated
August 18, 2004 and incorporated herein by reference.
21.1 Subsidiaries. Previously filed as an exhibit to our Annual
Report on Form 10-KSB for the fiscal year ended September 30,
2003, and incorporated herein by reference.
23.1 Consent of Larson, Harms & Bibeau, P.C. The consent is contained
in Exhibit 5 filed herewith.
23.2 Consent of Deloitte & Touche LLP. Previously filed as an
exhibit to Amendment No. 1 to this registration statement
and hereby incorporated by reference.
23.3 Consent of KPMG LLP. Previously filed as an exhibit to
Amendment No. 1 to this registration statement and hereby
incorporated by reference.
99.1 Lac Dore Preliminary Feasibility Study - Executive Summary.
Previously filed as an exhibit to Amendment No. 2 to our
registration statement on Form 10-SB and hereby incorporated by
reference.
___________________
<page>79
ITEM 28. UNDERTAKINGS
The undersigned small business issuer hereby undertakes to:
(1) File, during any period in which it offers or sells securities, a post-
effective amendment to this registration statement to:
(i) Include any prospectus required by section 10(a)(3) of the Securities Act;
(ii) Reflect in the prospectus any facts or events which, individually or
together, represent a fundamental change in the information in the registration
statement other than any increase or decrease in volume of securities offered
(if the total dollar value of securities offered would not exceed that which was
registered) or any deviation from the low or high end of the estimated maximum
offering range if, in the aggregate, the changes in volume and price represent
no more than a 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement; and
(iii) Include any additional or changed material information on the plan of
distribution.
(2) For determining liability under the Securities Act, treat each post-
effective amendment as a new registration statement of the securities offered,
and the offering of the securities at that time to be the initial bona fide
offering.
(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the registrant
pursuant to the foregoing provisions or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
<page>80
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB 2 and has authorized this registration
statement to be signed on its behalf by the undersigned, in the City of
Brighton, State of Michigan, on the 15th day of November, 2004.
MCKENZIE BAY INTERNATIONAL, LTD.
By: /s/Gary L. Westerholm
______________________
Gary L. Westerholm,
President and Chief Executive Officer
In accordance with the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date indicated.
Signature Title Date
/s/Gary L. Westerholm
_____________________
Gary L. Westerholm President, Chief Executive
Officer and Director November 15, 2004
(Principal Executive Officer)
/s/Gregory N. Bakeman
_____________________
Gregory N. Bakeman Treasurer, Chief Financial
Officer and Director
(Principal Financial
and Accounting Officer) November 15, 2004
/s/John DiMora
______________
John DiMora Director November 15, 2004
__________________
Doris F. Galvin Director
/s/Donald C. Harms
__________________
Donald C. Harms Director November 15, 2004
/s/Rocco J. Martino
___________________
Rocco J. Martino Director November 15, 2004
_______________________
Stephen D. McCormick Director
/s/John Popp
____________
John Popp Director November 15, 2004
/s/John W. Sawarin
__________________
John W. Sawarin Director November 15, 2004
<page>81