**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

**FORM10-KSB**

**(Mark One)**

| **x**      |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------|--------|-----------------------------------------------------------------------------------------------|
| ** ** |   | ** **                                                                                    |
| ** ** |   | **for the fiscal year ended December 31, 2006**                                          |
| ** ** |   | ** **                                                                                    |
| ** ** |   | **or**                                                                                        |
| ** ** |   | ** **                                                                                    |
| **o**      |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                             to**                             

**Commission File No.: 0-52294**

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**AMERICANDG ENERGY INC.**

(Name of small business issuer in its charter)

| **Delaware**                                                    |   | **04-3569304**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **American  DG Energy Inc.**                                    |
| **45  First Avenue**                                            |
| **Waltham,  MA 02451**                                          |
| (Address of  principal executive offices)                       |

 

Issuer’s telephone number, including areacode:**(781) 622-1120**

Securities registered pursuant toSection 12(b) of the Exchange Act: **None**

Securities registered pursuant toSection 12(g) of the Exchange Act: **Common Stock, $.001 parvalue**

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Checkwhether the issuer (1) has filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the preceding12 months (or for such shorter period that the issuer was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    Yes x    No o

Checkif there is no disclosure of delinquent filers in response to Item 405 ofRegulation S-B contained in this Form 10-KSB, and no disclosure will becontained, to the best of the issuer’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB.  o

Check whether the issueris a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

Stateissuer’s revenues for its most recent fiscal year: $3,174,326

Numberof shares of the issuer’s Common Stock outstanding at December 31, 2006:26,017,250

State the aggregatemarket value of the voting and non-voting common equity held bynon-affiliates:  Not applicable — theissuer’s Common Stock is not traded on any market.

Transitional Small Business Issuer Disclosure Format(check one): Yes o No x

 

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TABLE OF CONTENTS
| **Part I**   |       |                                                                                                              |       |       |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|------------|
|         |       |                                                                                                              |       |       |
| Item 1.      |       | Description of  Business                                                                                          |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 2.      |       | Description of  Property                                                                                          |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item  3.     |       | Legal  Proceedings                                                                                                |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 4.      |       | Submission of  Matters to a Vote of Security Holders                                                              |       |       |
|         |       |                                                                                                              |       |       |
| **Part II**  |       |                                                                                                              |       |       |
|         |       |                                                                                                              |       |       |
| Item 5.      |       | Market for  Common Equity and Related Stockholder Matters                                                         |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 6.      |       | Management’s  Discussion and Analysis or Plan of Operation                                                   |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 7.      |       | Financial Statements                                                                                              |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 8.      |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                             |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 8A.     |       | Controls and  Procedures                                                                                          |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 8B.     |       | Other Information                                                                                                 |       |       |
|         |       |                                                                                                              |       |       |
| **Part III** |       |                                                                                                              |       |       |
|         |       |                                                                                                              |       |       |
| Item 9.      |       | Directors,  Executive Officers, Promoters and Control Persons; Compliance with Section  16(a) of the Exchange Act |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 10.     |       | Executive  Compensation                                                                                           |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 11.     |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                  |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 12.     |       | Certain  Relationships and Related Transactions                                                                   |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item  13.    |       | Exhibits                                                                                                          |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 14.     |       | Principal  Accountant Fees and Services                                                                           |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
|         |       | Signatures                                                                                                        |       |       |
| ** **   | ** ** | ** **                                                                                                        | ** ** | ** ** |
|         |       | Index to Financial  Statements                                                                                    |       |       |

 

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**Item 1.  Description of Business**

**General**

American DG Energy Inc. (“American DG Energy”, the “company”, “ADGE” or“we”) distributes and operates on-site cogeneration systems that produce bothelectricity and heat. Our business is to own the equipment that we install atcustomers’ facilities and to sell the energy produced by these systems to thecustomers on a long-term contractual basis. We call this business the AmericanDG Energy “On-Site Utility”.

We offer a range of cogeneration systems that are highly reliable andenergy efficient. Our cogeneration systems produce electricity from an internalcombustion engine driving a generator, while the heat from the engine andexhaust is recovered and typically used to produce heat and hot water foron-site processes. We also distribute and operate water chiller systems thatoperate in a similar manner, except that the engine’s power drives a largeair-conditioning compressor while recovering heat for hot water. Cogenerationsystems reduce the amount of electricity that the customer must purchase fromthe local utility and produce valuable heat and hot water for the site to useas required.

Distributed generation of electricity (“DG”) is an attractive optionfor reducing energy costs and increasing the reliability of available energy.DG has been successfully implemented in large industrial installations (>10MW) where the market has been growing for several years, and is increasinglybeing accepted in smaller size units because of technology improvements, increasedenergy costs and better DG economics. We believe that our target market (usersof up to 1 MW) has been barely penetrated and that the reduced reliability ofthe utility grid, increasing cost pressures experienced by energy users,advances in new, low cost technologies and DG-favorable legislation andregulation at the state level will drive our near term growth and penetrationinto our target market. The company maintains a web site at www.americandg.com,but our website is not a part of this annual report.

The company was incorporated as a Delaware corporation on July 24, 2001to install, own, operate and maintain complete DG systems and othercomplementary systems at customer sites and sell electricity, hot water, heatand cooling energy under long-term contracts at prices guaranteed to thecustomer to be below conventional utility rates. American DG Energy operated asa subsidiary of American Distributed Generation Inc. since 2003, along withTecogen Inc. In December 2005, the Board of Directors of American DistributedGeneration Inc. decided to distribute to its shareholders all of theoutstanding shares of Tecogen in the form of a stock dividend. American DGEnergy merged with American Distributed Generation Inc. and the company then changedits name to American DG Energy Inc. As of December 31, 2006, we had installedenergy systems, representing approximately 2,535 kW (kilowatts), 28.24 MMBtu’s(million British thermal units) of heat and hot water and 400 tons of cooling.Kilowatt (kW) is a measure of electricity generated, MMBtu is a measure of heatgenerated and a ton is a measure of cooling generated.

We believe that our primary near-term opportunity for DG energy andequipment sales is where commercial electricity rates exceed $0.12 per kWh,which is predominantly in the Northeast and California. These areas representapproximately 15 percent of the U.S. commercial power market, with electricityrevenues in excess of $20 billion per year (see Figure 1. on page 6).Attractive DG economics are currently attainable in applications that includehospitals, nursing homes, multi-tenant residential housing, hotels, schools andcolleges, recreational facilities, food processing plants, dairies and otherlight industrial facilities. Two Combined Heat and Power (“CHP”) marketanalysis reports sponsored by the Energy Information Administration in 2000detailed the prospective CHP market in the commercial and institutional sectors(*The Market and Technical Potential forCombined Heat and Power in the Commercial/Institutional Sector**;*Prepared for the Energy Information Administration;Prepared by ONSITE SYCOM Energy Corporation; January 2000) and in theindustrial sectors (*The Market and TechnicalPotential for Combined Heat and Power in the Industrial Sector**;*Prepared for the Energy Information Administration;Prepared by ONSITE SYCOM Energy Corporation; January 2000). These data setswere used to estimate the CHP market potential in the 100kW to 1 MW size range.These target market segments comprise over 163,000 sites totaling 12.2 millionkW of prospective DG 

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capacity.This is the equivalent of an $11.7 billion annual electricity market plus a$7.3 billion heat and hot water energy market, for a combined market potentialof $19.0 billion.

We believe that the largest number of potential DG users in the UnitedStated requires less than 1 MW of electric power and less than 1,200 tons ofcooling capacity. We are able to design our systems to suit a particularcustomer’s needs because of our ability to place multiple units at a site. Thisapproach is part of what allows our products and services to meet changingpower and cooling demands throughout the day (also from season-to-season) andgreatly improves efficiency through a customer’s high and low power requirements.

AmericanDG purchases energy equipment from various suppliers. The primary type ofequipment implemented is a natural gas-powered, reciprocating engine. As powersources that use alternative energy technologies mature to the point that theyare both reliable and economical, we will consider employing them to supplyenergy for customers. We regularly assess the technical, economic, andreliability issues associated with systems that use solar, micro-turbine orfuel cell technologies to generate power.

**Backgroundand Market**

The delivery of energy services to commercial and residential customersin the United States has evolved over many decades into an inefficient andincreasingly unreliable structure. Power for lighting, air conditioning, refrigeration,communications and computing demands comes almost exclusively from centralizedpower plants serving users through a complex grid of transmission anddistribution lines and substations. Even with continuous improvements incentral station generation and transmission technologies, today’s powerindustry is only about 33 percent efficient (*EnergyInformation Administration, Voluntary Reporting of Greenhouse Gases*,2004, Section 2, Reducing Emissions from Electric Power, Efficiency Projects:Definitions and Terminology, page 20) meaning that it discharges to theenvironment roughly twice as much heat as the amount of electrical energydelivered to end-users. Since coal accounts for more than half of all electricpower generation, these inefficiencies are a major contributor to risingatmospheric CO2 emissions. As countermeasures are sought tolimit global warming, pressures against coal will favor the deployment ofalternative energy technologies.

On-site boilers and furnaces burning eithernatural gas or petroleum distillate fuels produce most thermal energy for spaceheating and hot water services. This separation of thermal and electricalenergy supply services has persisted despite a general recognition that thecogeneration of electricity and thermal energy services (a practice also knownas combined heat and power, or CHP) can be significantly more energy efficientthan central generation of electricity by itself. Except in large-scaleindustrial applications (e.g., paper and chemical manufacturing), cogenerationhas not attained general acceptance. This was due, in part, to thelong-established monopoly-like structure of the regulated utility industry.Also, the technologies previously available for small on-site cogenerationsystems were incapable of delivering the reliability, cost and environmentalperformance necessary to displace or even substantially modify the establishedpower industry structure.

The competitive balance began to change with the passage of the PublicUtility Regulatory Policy Act of 1978 (“PURPA”), a federal statute that hasopened the door to gradual deregulation of the energy market by the individualstates. In 1979, the accident at Three Mile Island effectively halted themassive program of nuclear power plant construction that had been a centerpieceof the electric generating strategy among US utilities for two decades. Severalfactors caused utilities’ capital spending to fall drastically, including wellpublicized cost overruns at nuclear plants, an end to guaranteed financialreturns on costly new facilities, and growing uncertainty over which powerplant technologies to pursue. Recently, investors have become increasinglyreluctant to support the risks of the long-term construction projects requiredfor new conventional generating and distribution facilities.

Because of these factors, electricity reserve margins declined, and thereliability of service began to deteriorate, particularly in regions of higheconomic growth. Widespread acceptance of computing and communicationstechnologies by consumers and commercial users has further increased the demandfor electricity, while also creating new requirements for very high powerquality and reliability. At the same time, 

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technologicaladvances in emission control, microprocessors and internet technologies havesharply altered the competitive balance between centralized and distributedgeneration. These fundamental shifts in economics and requirements are key tothe emerging opportunity for distributed generation equipment and services.

**TheRole of Distributed Generation**

Distributed generation, or co-generation, is the production of twosources or two types of energy (electricity or cooling and heat) from a singleenergy source (natural gas). We use technology that utilizes a low-cost,mass-produced, internal combustion engine, used primarily in light trucks andsport utility vehicles (i.e., a General Motors engine) that is modified to runon natural gas. The engine spins either a standard generator to produceelectricity, or a conventional compressor to produce cooling. For heating,since the working engine generates heat, we capture the byproduct heat with aheat exchanger and utilize the heat for facility applications in the form ofspace heating and hot water for buildings or industrial facilities. Thisprocess is very similar to an automobile, where the engine provides the motionto the automobile and the byproduct heat is used to keep the passengers warmduring the winter months. For refrigeration or cooling, standard availableequipment uses an electric motor to spin a conventional compressor to makecooling. We replace the electric motor with the same modified engine that runson natural gas to spin the compressor to run a refrigeration cycle and makecooling.

Distributed generation, or DG, refers to the application of small-scaleenergy production systems, including electricity generators, at locations inclose proximity to the end-use loads that they serve. Integrated energysystems, operating at user sites but interconnected to existing electricdistribution networks, can reduce demand on the nation’s utility grid, increaseenergy efficiency, reduce air pollution and greenhouse gas emissions, andprotect against power outages, while,**inmost cases, significantly lowering utility costs for power users and buildingoperators.

The growing importance of DG as a key component of our future energysupply is underscored by the establishment of a Distributed Energy Programwithin the U.S. Department of Energy. The DOE has stated its position onthis issue as follows:

*“...thereare two problems at the root of the current power crunch. There is not alwaysenough power generation available to meet peak demand, and existingtransmission lines cannot carry all of the electricity needed by consumers....Distributed Energy resources are the power of choice for providing customerswith reliable energy supplies.... These Distributed Energy products andservices use natural gas and renewable energy and will be easily interconnectedinto the nation’s infrastructure for the generation of electricity.Furthermore, our Program works to encourage the expanded use of DistributedEnergy technologies in applications with the right combination and occurrenceof electrical and thermal demand...”*

Until recently, many DG technologies have not been a feasiblealternative to traditional energy sources because of economic, technologicaland regulatory considerations. Even now, many “alternative energy” technologies(such as solar, wind, fuel cells and micro-turbines) have not been sufficientlydeveloped and proven to economically meet the demands of commercial users orthe ability to be connected to the existing utility grid.

We supply cogeneration systems that are capable of meeting the demandsof commercial users and that can be connected to the existing utility grid.Specific advantages of the company’s on-site distributed generation of multipleenergy services, compared with traditional centralized generation anddistribution of electricity alone, include the following:

·                  Greatlyincreased overall energy efficiency (typically over 80 percent) versusless than 33 percent for the existing power grid.

·                  Rapidadaptation to changing demand requirements; e.g., weeks, not years to addnew generating capacity where and when it is needed.

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·                  Abilityto by-pass transmission line and substation bottlenecks in congestedservice areas.

·                  Avoidanceof site and right-of-way issues affecting large-scale power generation anddistribution projects.

·                  Cleanoperation, in the case of natural gas fired reciprocating engines usingmicroprocessor combustion controls and low-cost exhaust catalyst technologydeveloped for automobiles, producing exhaust emissions well below the world’sstrictest regional environmental standards (e.g., Southern California).

·                  Rapideconomic paybacks for equipment investments, often three to five years whencompared to existing utility costs and technologies.

·                  Relativeinsensitivity to fuel prices due to high overall efficiencies achieved withcogeneration of electricity and thermal energy services, including the use ofwaste heat to operate absorption type air conditioning systems (displacingelectric-powered cooling capacity at times of peak summer demand).

·                  Reducedvulnerability of multiple de-centralized small-scale generating units comparedto the risk of major outages from natural disasters or terrorist attacksagainst large central-station power plants and long distance transmissionlines.

·                  Abilityto remotely monitor, control and dispatch energy services on a real-time basisusing advanced switchgear, software, microprocessor and Internet modalities.Through our onsite energy products and services, energy users are able tooptimize, in real time, the mix of centralized and distributed electricity-generatingresources.

The disadvantages of the company’son-site distributed generation are:

·                  Cogenerationis a mechanical process and our equipment is susceptible to downtime orfailure.

·                  Thebase-rate of an electric utility is determined by a certain number ofsubscribers. Distributed generation at a significant scale will reduce thenumber of subscribers and therefore it may increase the base-rate for theelectric utility for its customer base.

·                  Bycommitting to our long-term agreements, a customer may be forfeiting theopportunity to use more efficient technology that may become available in thefuture.

**The Distributed Generation Market Opportunity**

We believe that our primarynear-term opportunity for DG energy and equipment sales is where commercial electricityrates exceed $0.12 per kWh, which is predominantly in the Northeast andCalifornia. These areas represent approximately 15 percent of theU.S. commercial power market, with electricity revenues in excess of$20 billion per year (see Figure 1. on page 7). AttractiveDG economics are currently attainable in applications that include hospitals,nursing homes, multi-tenant residential housing, hotels, schools and colleges,recreational facilities, food processing plants, dairies and other light industrialfacilities. Two Combined Heat and Power (“CHP”) market analysis reportssponsored by the Energy Information Administration in 2000 detailed theprospective CHP market in the commercial and institutional sectors (1) and inthe industrial sectors (2). These data sets were used to estimate the CHPmarket potential in the 100 kW to 1 MW size range. These target market segmentscomprise over 163,000 sites totaling 12.2 million kW of prospectiveDG capacity. This is the equivalent of an $11.7 billion annual electricitymarket plus a $7.3 billion heat and hot water energy market, for acombined market potential of $19.0 billion.

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As shown in the graph below, there are substantial variations in theelectric rates paid by commercial and institutional customers throughout theU.S. In high-cost regions, monthly payments for energy services suppliedby on-site DG projects yield rapid paybacks (e.g. often 3-5 years) onan investment in our systems. An additional 15% of commercial sectorelectricity, representing annual revenues of $14 billion, is sold at ratesbetween $0.085 and $0.12 per kWh as shown on the graph below. Although paybackson DG projects would be less rapid in such regions, future rate increases areexpected to improve DG economics.

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(1) *The Market and Technical Potential for CombinedHeat and Power in the Commercial/Institutional Sector*; Prepared forthe Energy Information Administration; Prepared by ONSITE SYCOM EnergyCorporation; January 2000

2) *The Market and Technical Potential for CombinedHeat and Power in the Industrial Sector;* Prepared for the EnergyInformation Administration; Prepared by ONSITE SYCOM Energy Corporation;January 2000

 

Figure 1.

**The DG Market Opportunity***U.S.Commercial/Institutional Electric Rate Profile*

   

*Source: U.S. Energy InformationAdministration Data [2002]*

 

**Business Model**

We are a distributed generation onsite energy company that sells energyin the form of electricity, heat, hot water and air conditioning underlong-term contracts with commercial, institutional and light industrialcustomers. We install our systems at no cost to our customers and retainownership of the system. Because our systems operate at over 80 percentefficiency (versus less than 33 percent for the existing power grid),we are able to sell the energy produced by these systems to our customers atprices below their existing cost of electricity (or air conditioning), heat andhot water. Our cogeneration systems consist of natural gas-powered internalcombustion engines that drive an electrical generator to produce electricityand that capture the engine heat to produce space heating and hot water. Ourenergy systems also can be configured to drive a compressor that produces airconditioning and that also capture the engine heat. As of December 31, 2006, wehad 39 energy systems operational.

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To date, each of our installations runs in conjunction with theelectric utility grid and requires standard interconnection approval from thelocal utility. Our customers use both our energy system and the electricutility grid for their electricity requirements. We typically supply the first20% to 60% of the building’s electricity requirements while the remainingelectricity is supplied by the electric utility grid. Our customers arecontractually bound to use the energy we supply.

To date, the price that we have charged our customers is set in ourcustomer contracts at a discount to the price of the building’s local electricutility. For the 20% to 60% portion of the customer’s electricity that wesupply, the customer realizes immediate savings on its electric bill. Inaddition to electricity, we sell our customers the heat and hot water at thesame price they were previously paying or at a discount equivalent to theirdiscount from us on electricity. Our air conditioning systems are also pricedat a discount so that the customer realizes overall cost savings from theinstallation.

**Energy and Products Portfolio**

We provide a full range of DG product and energy options.  Our primary energy and products are listedbelow:

·                  EnergySales

·                  Electricity

·                  Thermal (Hot Water, Heat and Cooling)

·                  Energy Producing Products

·                  CogenerationPackages

·                  Chillers

·                  ComplementaryEnergy Equipment (i.e., boilers, etc.)

·                  Alternative Energy Equipment (i.e., solar,fuel cells, etc.)

***Energy Sales***

For customers seeking an alternative to the outright purchase of DGequipment, we will install, maintain, finance, own and operate complete on-siteDG systems that supply, on a long-term, contractual basis, electricity andother energy services. We sell the energy to customers at a guaranteed discountrate to the rates charged by conventional utility suppliers. Customers arebilled monthly. Our customers benefit from a reduction in their current energybills without the capital costs and risks associated with owning and operatinga cogeneration or chiller system. Also, by outsourcing the management andfinancing of on-site energy facilities to us, they can reap the economicadvantages of distributed generation without the need for retaining specializedin-house staff with skills unrelated to their core business. Customers benefitfrom our On-Site Utility in a number of ways:

·                              Guaranteed lower price for energy

·                              Only pay for the energy they use

·                              No capital costs for equipment, engineering and installation

·                              No equipment operating costs for fuel and maintenance

·                              Immediate cash flow improvement

·                              No staffing, operations and equipmentresponsibility

Our customers pay us for energy produced on site at a rate that is acertain percentage below the rate at which the utility companies provide themelectrical and natural gas services. We measure the actual amount of electricaland thermal energy produced, and charge our customers accordingly. We agree toinstall, operate, maintain and repair our energy systems at our sole cost andexpense. We also agree to obtain any necessary permits or regulatory approvalsat our sole expense. Our agreements are generally for a term of 15 years,renewable for two additional 5 years terms upon the mutual agreement of theparties.

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In regions where high electricity rates prevail, such as the Northeastand California, monthly payments for DG energy services can yield attractivepaybacks (e.g. often 3-5 years) on our investments in on-site utility projects.The price of natural gas has a minor effect on the financial returns obtainedfrom our energy service contracts because the value of hot water and otherthermal services produced from the recovered heat generated by the internalcombustion engine in our on-site DG system will increase in proportion tohigher fuel costs. This recovered energy, which comprises up to 60 percent ofthe total heating value of fuel supplied to our DG equipment, displaces fuelthat would otherwise be burned in conventional boilers.

Each of our customer sites becomes a profit center. The example belowpresents the energy supplied and the economics of a project in the New YorkCity area:
| Energy Type     | ** ** | **% of Site Requirements** | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| Heat and Hot  Water: |       | 100%                                      |       |
| Cooling:             |       | 100%                                      |       |
| Electricity:         |       | 45%                                       |       |

 

In 2004, we installed a 75 kW cogeneration system, a 200-ton chillerand 3 hot-water boilers rated at 13 MBtu. In 2005, our customer and American DGEnergy received the following:
|                               | ** ** | **Annual** | ** ** | **Term (16 years)** | ** ** |
|-------------------------------|------------|------------|------------|-------------------------------|------------|
| American DG  Energy Revenue   |       | $          | 358,300    |                          | $          | 5,732,800 |   |
| American DG  Energy Cash Flow |       | $          | 134,100    |                          | $          | 2,145,600 |   |
| Customer Savings              |       | $          | 36,500     |                          | $          | 584,000 |   |

 

Our investment for the site was $359,800. During the second quarter of2006, we achieved payback in 2.4 years. These values do not reflect theexpected annual increases in energy costs that should occur over the 16-yearperiod and should increase the profitability of the site by 2%-5% per year.

Since inception in 2001 and through December 31,2006, the company has entered into 32 agreements, for the supply ofon-site energy services, primarily with healthcare, housing facilities,apartments and athletic facilities in New York and New Jersey.

***Energy Producing Products***

We typically offer cogeneration units sized to produce 75 kW ofelectricity and water chillers to produce 200 tons of cooling. Forcogeneration, we prefer a modular design approach to allow us to group multipleunits together to serve customers with considerably larger power requirements.Often, cogeneration units are conveniently dispersed within a large operation,such as a hospital or campus, serving multiple process heating systems thatwould otherwise be impractical to serve from a single large machine. Theequipment we select often yield overall energy efficiencies in excess of 80percent (from our equipment supplier’s specifications) and achieve emissionlevels well below the strictest regional standards, including SouthernCalifornia.

Many other DG technologies are challenged by technical, economic andreliability issues associated with systems that generate power using solar,micro-turbine or fuel cell technologies, which have not yet proven to beeconomical for typical customer needs. When alternative energy technologiesmature to the point that they are both reliable and economical, we will employthem for the best-fit applications.

***Service and Installation***

Where appropriate, weutilize the best local service infrastructure for the equipment we deploy. Werequire long-term maintenance contracts and ongoing parts sales. Ourcentralized remote monitoring capability allows us to keep track of ourequipment in the field. Our installations are performed by local contractorswith experience in energy cogeneration systems.

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In August 2005, we beganoffering our customers a “turn-key” option whereby we provide equipment,systems engineering, environmental permitting, interconnect approvals, on-sitelabor and startup support needed to bring the complete DG system on-line. Thisallows us to offer our customers either energy or fully installed equipment.This will also aid in our ability to lower the cost of installation.

**Sales and Marketing**

Our on-site utility servicesare sold directly to end-users by our in-house marketing team and byestablished sales agents and representatives. We offer standardized packages ofenergy, equipment and services suited to the needs of national accounts such ashospital associations, hotel chains and other customer groups having a commonset of energy requirements at multiple locations.

Our energy offering istranslated into direct financial gain for our clients, and is best appreciatedby senior management. These clients recognize the gain in cash flow, theincrease in net income and the preservation of capital we offer. As such, ourenergy sales are focused on reaching these decision makers. Additionally, wehave benefited with increased sales and maintenance support through our jointventure, called American DG NY LLC, with AES-NJ Cogen Co., an establisheddeveloper of small cogeneration systems that excels in installing cogenerationequipment.

The company is continuallyexpanding its sales efforts by developing joint marketing initiatives with keysuppliers to our target industries. Particularly important are ourcollaborative programs with natural gas utility companies. For example, weengaged in a targeted mailing, telemarketing and sales campaign dedicatedexclusively to potential customers and sponsored by a major New York Statenatural gas utility. The campaign included a special incentive for newcustomers. We gain significant marketing leverage from joint marketing andselling efforts on DG projects within specific utility service areas, and fromrate incentives offered to gas users who install our efficient cogeneration andcooling equipment. Since the economic viability of any DG project is criticallydependent upon effective utilization of recovered heat, the insight of the gassupplier to the customer energy profile is particularly effective inprospecting the most cost-effective DG sites in any region.

DG is enjoying growingsupport among state utility regulators seeking to increase the reliability ofelectricity supply with cost effective environmentally responsible demand-sideresources. New York, New Jersey, Illinois, Connecticut, Massachusetts andCalifornia are among the states that encourage DG through inter-connectstandards, incentives and/or supply planning. Unlike large central stationpower plants, DG investments can be made in small increments and with lead-timesas short as just a few months.

**Competition**

We believe that the maincompetition for our DG products is the established electric utilityinfrastructure. However, DG is beginning to gain acceptance in regions whereenergy customers are dissatisfied with the cost and reliability of traditionalelectricity service. These end-users, together with growing support from statelegislatures and regulators are creating a favorable climate for the growth ofDG that is overcoming the objections of established utility providers. In ourtarget markets, we compete with large utility companies such as ConsolidatedEdison in New York City and Westchester County, LIPA in parts of New York,Public Service Gas and Electric in New Jersey, NSTAR in Massachusetts, andPacific Gas and Electric in California.

Engine manufacturers sell DGunits that range in size from a few kilowatts to many megawatts in size. Thosemanufacturers are predominantly greater than 1 MW and include Caterpillar,Cummins, and Waukesha. In many cases, we view these companies as potentialsuppliers of equipment and not as competitors.

The alternative energymarket is emerging rapidly. Many companies are developing alternative andrenewable energy sources including solar power, wind power, fuel cells and micro-turbines.Some of the companies in this sector include General Electric, BP, Shell andEvergreen Solar (in the solar energy space); Plug Power and Fuel Cell Energy(in the fuel cell space); and Capstone, Ingersoll Rand and ElliottTurbomachinery company (in the micro-turbine space). The effect of thesedeveloping technologies on our 

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business is difficult to predict;however, when their technologies become more viable for our target markets, wemay be able to adopt their technologies into our business model.

There are a number of EnergyService Companies (“ESCO’s”) that offer related services to us. These companiesinclude Siemens, Honeywell and Johnson Controls. In general, these companiesare only seeking large, diverse projects for electric demand reduction forcampuses that include building lighting and controls, and electricity (in rareoccasions) or cooling. Because of their overhead structures, these companiesoften solicit large projects and stay away from individual properties. Since wefocus on smaller projects for energy supply, we are well suited to work intandem with these companies when the opportunity arises.

There are also a few localemerging cogeneration developers and contractors that are attempting to offerservices similar to ours. To be successful, they will need to have the properexperience in equipment and technology, installation contracting, equipmentmaintenance and operation, site economic evaluation, project financing, andenergy sales plus the capability to cover a broad region.

**MaterialContracts**

In January 2007, we extended our 2006 Facilities, Support Services andBusiness Agreement with Tecogen to provide us with certain office and businesssupport services for a period of one year, renewable annually by mutualagreement. Under the business agreement, Tecogen provides us with office spaceand utilities at a flat rate of $2,294 per month. We also share personnelsupport services with Tecogen. We are allocated our share of the cost of thepersonnel support services based upon the amount of time spent by such supportpersonnel while working on our behalf. To the extent Tecogen is able to do sounder its current plans and policies, Tecogen includes us and our employees invarious of its insurance and benefit programs. The costs of these programs arecharged to us on an actual cost basis.

Under this agreement, we receive pricing based on a volume discount ifwe purchase cogeneration and chiller products from Tecogen. For certain sites,we hire Tecogen to service our Tecogen chiller and cogeneration products.

We have sales representation rights to Tecogen’s products and services.In New England, we have exclusive sales representation rights to theircogeneration products. We have granted Tecogen sales representation rights toour on-site utility energy service in California.

**GovernmentRegulation**

We are not subject toextensive government regulation. We are required to file for local construction permits (electrical,mechanical and the like) and utility interconnects, and we must make variouslocal and state filings related to environmental emissions. Our expendituresfor regulatory compliance are not material.

Effective March 7,2007, there are new air quality and permitting requirements in New Jersey thatmay require adding emission control equipment on our already existing 18cogeneration systems operating in New Jersey and any new energy systems weinstall in that State. In order to interpret and comply with the new emissionrequirements we have retained an independent environmental engineeringconsultant to review the applicability of the new requirements to our energysystems. This report will be available to the company shortly. Based on theoutcome we may have to retrofit some or all sites we operate in New Jersey. Thismay adversely affect our revenue and profitability.

**Employees**

As of December 31, 2006, weemployed nine active full-time employees and one part-time employee. We believethat our relationship with our employees is satisfactory.

**Risk Factors**

The following risk factors should be consideredcarefully in addition to the other information contained in this report. Thisreport contains forward-looking statements. Forward-looking statements relateto future events or our future financial performance. We generally identifyforward-looking statements by terminology such as “may,” “will,” “should,” “expects,”“plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,”“believes,” “estimates,” “predicts,” “potential” or “continue” or the negativeof these terms or other similar words. These statements are only predictions.The outcome of the events described in these 

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forward-lookingstatements is subject to known and unknown risks, uncertainties and otherfactors that may cause our, our customers’ or our industry’s actual results,levels of activity, performance or achievements expressed or implied by theseforward-looking statements, to differ. “Risk Factors,” “Management’s Discussionand Analysis of Financial Condition and Results of Operations” and “Business,”as well as other sections in this report, discuss some of the factors thatcould contribute to these differences.

The forward-looking statements made in this reportrelate only to events as of the date on which the statements are made. Weundertake no obligation to update any forward-looking statement to reflectevents or circumstances after the date on which the statement is made or toreflect the occurrence of unanticipated events.

This report also contains market data related to ourbusiness and industry. These market data include projections that are based ona number of assumptions. If these assumptions turn out to be incorrect, actualresults may differ from the projections based on these assumptions. As aresult, our markets may not grow at the rates projected by these data, or atall. The failure of these markets to grow at these projected rates may have amaterial adverse effect on our business, results of operations, financialcondition and the market price of our Common Stock.

**We have incurred losses, andthese losses may continue.**

We have incurredlosses in each of our fiscal years since inception. Losses were incurred andcontinue to be incurred in 2007. There is no assurance that profitability willbe achieved in the near term, if at all.

**Becauseunfavorable utility regulations make the installation of our systems moredifficult or economic, any slowdown in the utility deregulation process wouldbe an impediment to the growth of our business.**

Inthe past, many electric utility companies have raised opposition to distributedgeneration, a critical element of our on-site utility business. Such resistancehas generally taken the form of unrealistic standards for interconnection, andthe use of targeted rate structures as disincentives to combined generation ofon-site power and heating-cooling services. A DG company’s ability to obtainreliable and affordable back-up power through interconnection with the grid isessential to our business model. Utility policies and regulations in moststates are often not prepared to accommodate widespread onsite generation.These barriers erected by electric utility companies and unfavorableregulations, where applicable, make more difficult or uneconomic our ability toconnect to the electric grid at customer sites and are an impediment to thegrowth of our business. Development of our business could be adversely affectedby any slowdown or reversal in the utility deregulation process or bydifficulties in negotiating backup power supply agreements with electricproviders in the areas where we intend to do business.

Effective March 7, 2007, there are new air quality and permittingrequirements in New Jersey that may require adding emission control equipmenton our already existing 18 cogeneration systems operating in New Jersey and anynew energy systems we install in that State. In order to interpret and complywith the new emission requirements we have retained an independentenvironmental engineering consultant to review the applicability of the newrequirements to our energy systems. This report will be available to thecompany shortly. Based on the outcome we may have to retrofit some or all siteswe operate in New Jersey. This may adversely affect our revenue andprofitability.

**Our onsiteutility concept is largely unproven and may not be accepted by a sufficientnumber of customers.**

Thesale of cogeneration and cooling equipment has been successfully carried outfor more than a decade. However, our on-site utility concept (i.e., the sale ofon-site energy services, rather than equipment) is still in an early stage ofimplementation. Unresolved issues include the pricing of energy services andthe structuring of contracts to provide cost savings to customers and optimumfinancial returns to us. There is no assurance that we will be successful indeveloping a profitable on-site utility business model, and failure to do sowould have a material adverse effect on our business and financial performance.

**Theeconomic viability of our projects depends on the price spread between fuel andelectricity, and the variability of the prices of these components creates arisk that our projects will be uneconomic.**

Theeconomic viability of DG projects is dependent upon the price spread betweenfuel and electricity prices. Volatility in one component of the spread, thecost of natural gas and other fuels (e.g., propane or distillate oil) can bemanaged to a greater or lesser extent by means of futures contracts. However,the regional 

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rates charged for both base loadand peak electricity services may decline periodically due to excess capacityarising from over-building of utility power plants or recessions in economicactivity. Any sustained weakness in electricity prices could significantlylimit the market for our cogeneration, cooling equipment and on-site utilityenergy services.

**We may failto make sales to certain prospective customers because of resistance fromfacilities management personnel to the outsourcing of their service function.**

Anyoutsourcing of non-core activities by institutional or commercial entities willgenerally lead to reductions in permanent on-site staff employment. As aresult, our proposals to implement on-site utility contracts are likely toencounter strong initial resistance from the facilities managers whose jobswill be threatened by energy outsourcing. The growth of our business willdepend upon our ability to overcome such barriers among prospective customers.

**Futuregovernment regulations, such as increased emissions standards, safety standardsand taxes, may adversely impact the economics of our business.**

Theoperation of distributed generation equipment at our customers’ sites may besubject to future changes in federal, state and local laws and regulations(e.g., emissions, safety, taxes, etc.). Any such new or substantially alteredrules and standards may adversely affect our revenues, profits and generalfinancial condition.

**If we cannot expand our network ofskilled technical support personnel, we will be unable to grow our business.**

Eachadditional customer site for our services requires the initial installation andsubsequent maintenance and service of equipment to be provided by a team oftechnicians skilled in a broad range of technologies, including combustion,instrumentation, heat transfer, information processing, microprocessorcontrols, fluid systems and other elements of distributed generation. If we areunable to recruit, train, motivate, sub-contract, and retain such personnel ineach of the regional markets where our business operates we will be unable togrow our business in those markets.

**Thecompany operates in highly competitive markets and may be unable tosuccessfully compete against competitors having significantly greater resourcesand experience.**

Our businessmay be limited by competition from energy services companies arising from thebreakup of conventional regulated electric utilities. Such competitors, both inthe equipment and energy services sectors, are likely to have far greaterfinancial and other resources than us, and could possess specialized marketknowledge with existing channels of access to prospective customer locations.We may be unable to successfully compete against those competitors.

**Futuretechnology changes may render obsolete various elements of equipment comprisingour on-site utility installations.**

We mustselect equipment for our DG projects so as to achieve attractive operatingefficiencies, while avoiding excessive downtimes from the failure of unproventechnologies. If we are unable to achieve a proper balance between the cost,efficiency, and reliability of equipment selected for our projects, our growthand profitability will be adversely impacted.

**We havelimited historical operating results upon which to base projections of futurefinancial performance, making it difficult for prospective investors to assessthe value of our stock.**

Ourexperience is primarily on-site energy services, and we have only four years ofactual operating experience. These limitations make developing financialprojections more difficult. We will expand our business 

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infrastructure based on theseprojections. If these projections prove to be inaccurate, we will sustainadditional losses and will jeopardize the success of our business.

**We will need to raise additionalcapital for our business, which will dilute existing shareholders.**

Additional financings will be required toimplement our overall business plan. We will need additional capital. Equityfinancings will dilute the percentage ownership of our existing shareholders.Our ability to raise an adequate amount of capital and the terms of any capitalthat we are able to raise will be dependent upon our progress in implementingdemonstration projects and related marketing service development activities. Ifwe do not make adequate progress, we may be unable to raise adequate funds,which will limit our ability to expand our business. If the terms of any equityfinancings are unfavorable, the dilutive impact on our shareholders might besevere.

**We may make acquisitions thatcould harm our financial performance.**

In order to expedite development of ourcorporate infrastructure, particularly with regard to equipment installationand service functions, we anticipate the future acquisition of complementarybusinesses. Risks associated with such acquisitions include the disruption ofour existing operations, loss of key personnel in the acquired companies,financial charges for amortization of good will, dilution through the issuanceof additional securities, assumptions of existing liabilities and commitment tofurther operating expenses. If any or all of these problems actually occur,acquisitions could negatively impact our financial performance and future stockvalue.

**We are controlled by a smallgroup of majority shareholders, and our minority shareholders will be unable toeffect changes in our governance structure or implement actions that requireshareholder approval, such as a sale of the company.**

George Hatsopoulos and John Hatsopoulos,who are brothers, beneficially own a majority of our outstanding shares ofcommon stock. These stockholders have the ability to control various corporatedecisions, including our direction and policies, the election of directors, thecontent of our charter and bylaws, and the outcome of any other matterrequiring shareholder approval, including a merger, consolidation, sale ofsubstantially all of our assets or other change of control transaction. Theconcurrence of our minority shareholders will not be required for any of thesedecisions.

**We may be exposed to substantialliability claims if we fail to fulfill our obligations to our customers.**

We intend to enter into contractswith large commercial and not-for-profit customers under which we will assumeresponsibility for meeting a portion of the customers’ building energy demandand equipment installation. We may be exposed to substantial liability claimsif we fail to fulfill our obligations to customers. There can be no assurancethat we will not be vulnerable to claims by customers and by third parties thatare beyond any contractual protections that we are able to negotiate. We may beunable to obtain liability and other insurance on terms and at prices that arecommercially acceptable to us. As a result, liability claims could cause ussignificant financial harm.

### **Investment in our CommonStock is subject to price fluctuations which have been significant fordevelopment stage companies like us.**

Historically,valuations of many companies in the development stage have been highlyvolatile. The securities of many of these companies have experiencedsignificant price and trading volume fluctuations, unrelated to the operatingperformance or the prospects of such companies. If the conditions in the equitymarkets deteriorate, we may be unable to finance our additional funding needsin the private or the public markets. There can be no assurance that any futureoffering will be consummated or, if consummated, will be at a share price equalor superior to the price paid by our investors even if we meet ourtechnological and marketing goals.

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**There is no public market for ouroutstanding common stock, and there will be restrictions on transferability.**

There is presently no publicmarket for our outstanding common stock, and we cannot assure you that a publicmarket will ever develop. Moreover, even if a public market develops, any saleof our outstanding common stock may be made only pursuant to an effectiveregistration statement under federal and applicable state securities laws or exemptionstherefrom. Realization of any gains on an investment in us will be principallydependent upon our ability to effectuate one or more liquidity-providingtransactions.

**We anticipate that our capitalstock may be quoted on the OTC Bulletin Board. Trading in stock quoted on theOTC Bulletin Board is often thin and characterized by wide fluctuations intrading prices, due to many factors that may have little to do with ouroperations or business prospects. Moreover, the OTC Bulletin Board is not a stockexchange, and trading of securities on the OTC Bulletin Board is often moresporadic than the trading of securities listed on a quotation system or a stockexchange.**

**Trading of our common stock may be restricted by the SEC’S “pennystock” regulations which may limit a stockholder’s ability to buy and sell ourstock.**

**We anticipate that our common stockmay be traded on the OTC Bulletin Board shortly. The Securities and ExchangeCommission has adopted regulations which generally define “penny stock” to be anyequity security that has a market price less than $5.00 per share or anexercise price of less than $5.00 per share, subject to certain exceptions. Oursecurities will likely be covered by the penny stock rules, which imposeadditional sales practice requirements on broker-dealers who sell to personsother than established customers and accredited investors. The penny stockrules require a broker-dealer, prior to a transaction in a penny stock nototherwise exempt from the rules, to deliver a standardized risk disclosuredocument in a form prepared by the Securities and Exchange Commission thatprovides information about penny stocks and the nature and level of risks inthe penny stock market. The broker-dealer also must provide the customer withcurrent bid and other quotations for the penny stock, the compensation of thebroker-dealer and its salesperson in the transaction and monthly accountstatement showing the market value of each penny stock held in the customer’saccount. The bid and offer quotations, and the broker-dealer and salespersoncompensation information, must be given to the customer orally or in writingprior to effecting the transaction and must be given to the customer in writingbefore or with the customer’s confirmation. In addition, the penny stock rulesrequire that prior to a transaction in a penny stock not otherwise exempt fromthese rules, the broker-dealer must make a special written determination thatthe penny stock is a suitable investment for the purchaser and receive the purchaser’swritten agreement to the transaction. These disclosure and suitabilityrequirements may have the effect of reducing the level of trading activity inthe secondary market for a stock that is subject to these penny stock rules.Consequently, these penny stock rules may affect the ability of broker-dealersto trade our securities. We believe that the penny stock rules discourageinvestor interest in and limit the marketability of our capital stock. Tradingof our capital stock may be restricted by the SEC’S “penny stock” regulationswhich may limit a stockholder’s ability to buy and sell our stock.**

**Because we do not intend to pay cash dividends, ourstockholder will receive no current income from holding our stock.**

Wehave never paid or declared any cash dividends. We currently expect to retainearnings for use in the operation and expansion of our business, and thereforedo not anticipate paying any cash dividends for the foreseeable future.

**There has been asignificant deficiency in our financial controls and procedures, which couldharm our operating results or cause us to fail to meet our reportingobligations.**

As of the end of the period covered by this report, our ChiefExecutive Officer and Chief Financial Officer have performed an evaluation of controlsand procedures and concluded that our controls are effective to 

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givereasonable assurance that the information required to be disclosed by ourcompany in reports that we file under the Exchange Act is recorded, processed,summarized and reported as when required. However, there is a lack ofsegregation of duties at the Company due to the small number of employeesdealing with general administrative and financial matters. This constitutes asignificant deficiency in financial reporting. Any failure to implementeffective internal controls could harm our operating results or cause us tofail to meet our reporting obligations. Inadequate internal controls could alsocause investors to lose confidence in our reported financial information, whichcould have a negative effect on the trading price of our common stock, and mayrequire us to incur additional costs to improve our internal control system.

**Item 2.  Description of Property**

Our headquarters are located in Waltham, Massachusetts and consist of1,199 square feet of office and storage space that are leased from Tecogen. Thelease expires on March 31, 2009. We believe that our facilities are appropriateand adequate for our current needs.

**Item 3.  Legal Proceedings**

We are not currently a party to any other material litigation, and weare not aware of any pending or threatened litigation against us that couldhave a material adverse affect on our business, operating results or financialcondition.

**Item 4.  Submission of Matters toa Vote of Security Holders**

None.

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**PART II**

**Item 5.  Market for Common Equity and RelatedStockholder Matters**

**Market**

There is no established public trading market forour common stock.

**Holders**

As of the date of this filing, the number of holdersof record of the common stock was 100. We have not paid any dividends withrespect to our common stock, and anticipated capital requirements make ithighly unlikely that we will pay any dividends in the foreseeable future.

**Recent Sales of Unregistered Securities**

Set forth below is informationregarding common stock issued, warrants issued and stock options granted by thecompany within the past three years. Also included is the consideration, ifany, we received and information relating to the section of the Securities Act,or rule of the SEC, under which exemption from registration was claimed.

*Common Stock and Warrants*

In December 2003, the companyraised funds through a private placement of shares of common stock to a limitednumber of accredited investors. The private placement was kept open to investorsuntil the final closing date on December 31, 2005. In connection with theprivate placement, we issued warrants to purchase an aggregate of 3,195,000shares of common stock at a price of $0.70. Each warrant represents the rightto purchase one share of common stock for a period of three years from the datethe warrant was issued. All of such investors were accredited investors, andsuch transactions were exempt from registration under the Securities Act underSection 4(2) and/or Regulation D thereunder.

In March 2005, the company issued warrants to purchase 500,000 sharesof common stock at an exercise price of $0.70 per share to certain boardmembers and members of management in consideration for their giving personalguarantees of certain company obligations. Eachwarrant represents the right to purchase one share of common stock for a periodof five years from the date the warrant was issued. Such transactions were on terms that were atleast as fair to the company as it could have obtained from outside investors.

In November 2006, the company raised funds through a private placement of 1,647,400 shares ofcommon stock to a limited number of accredited investors at a price of $0.70per share. The private placement was kept open to investors until the finalclosing date on December 29, 2006.

In February 2007, the company raised funds through a private placement of 4,292,150 shares ofcommon stock and warrants to a limited number of accredited investors at aprice of $0.70 per share. The private placement was kept open to investorsuntil the final closing date on March 8, 2007.

All of such investors were accredited investors, and such transactionswere exempt from registration under the Securities Act under Section 4(2)and/or Regulation D thereunder.

*Conversion of Demand Notes*

On April 1, 2006, certain investors converted demand notes payableto them by the company aggregating $1,350,000 in principal and accrued interestinto shares of common stock or convertible debentures of the company asfollows: George Hatsopoulos and spouse converted $350,000 principal amountdemand notes into 500,000 shares of common stock at a price of $0.70 per share;

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John Hatsopoulos and spouse converted$350,000 principal amount demand notes into 500,000 shares of common stock at aprice of $0.70 per share; John Hatsopoulos and spouse converted $550,000principal amount demand notes into the company’s 8% convertible debentures;George Hatsopoulos and spouse converted $30,000 of accrued interest related tothe demand notes into the company’s 8% convertible debentures; and JohnHatsopoulos and spouse converted $$70,000 of accrued interest related to thedemand notes into the company’s 8% convertible debentures. Exemption is claimed underSection 3(a)(9) and/or Section 4(2) of the Securities Act, and/ orRegulation D thereunder.

*Restricted Stock Grants*

On June 7, 2006, the company made restricted stock grants to10 employees by permitting them to purchase an aggregate of257,500 shares of common stock at a price of $0.001 per share. On July 1, 2006, the company maderestricted stock grants to 12 persons who were employees of, or otherwiseassociated with Tecogen, by permitting them to purchase an aggregate of876,800 shares of common stock at a price of $0.001 per share. On October 4, 2006, the company made arestricted stock grant to one employee for 30,000 shares of common stockat a price of $0.001 per share. Suchtransactions were exempt from registration under the Securities Act underSection 4(2), Regulation D and/or Rule 701 thereunder.

On February 20, 2007, the company made restricted stock grants toemployees, directors and consultants by permitting them to purchase anaggregate of 737,000 shares of common stock at a price of $0.001 pershare. Such transactions were exempt from registration under the Securities Actunder Section 4(2), Regulation D and/orRule 701 thereunder.

*8% Convertible Debentures*

From April 15, 2006 to June 30, 2006, the company sold anaggregate of $6,075,000 principal amount of its 8% convertible debentures to anaggregate of 15 persons. The foregoing includes the demand notes convertedby Messrs. Hatsopoulos referred to above. The initial conversion priceinto common stock is $0.84. Total proceeds were approximately $5,425,000. Inconnection with such transaction, a consultant received 4,300 shares ofcommon stock as a commission. All of such investors were accredited investors,and such transactions were exempt from registration under the Securities Actunder Section 4(2) and/or Regulation D thereunder.

**Rule 144**

In general, under Rule 144 under the Securities Act, a person who hasbeneficially owned shares of our Common Stock for at least one year would beentitled to sell within any three-month period a number of shares that does notexceed the greater of:

·                  1%of the number of shares of our Common Stock then outstanding, which will equalapproximately 260,172 shares of our Common Stock; or

·                  theaverage weekly trading volume of our Common Stock, if and when our Common Stockis traded on the OTC Bulletin Board, during the four calendar weeks precedingthe filing of a notice on Form 144 with respect to the sale.

Sales under Rule 144 are also subject to manner of sale provisions andnotice requirements and to the availability of current public information aboutus for at least 90 days. As of December 31, 2006, a total of 22,006,250 sharesof our Common Stock are eligible for resale under Rule 144.

Under Rule 144(k) under the Securities Act, a person who is not deemedto have been one of our affiliates at any time during the 90 days preceding asale, and who has beneficially owned the shares proposed to be sold for atleast two years, is entitled to sell the shares without complying with themanner of sale, public 

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information,volume limitation or notice provisions of Rule 144. As of December 31, 2006,1,817,500 shares of our Common Stock qualified for resale under Rule 144(k).

**Stock Options**

Since December 2003, we havegranted stock options under our stock option plan to an aggregate of 9employees, directors and consultants at a weighted average exercise price of$0.70. The grant of such options was exempt from registration under Rule 701under the Securities Act.

**Dividends**

We have never declared or paid any cash dividends on shares of ourcapital stock. We currently intend to retain earnings, if any, to fund thedevelopment and growth of our business and do not anticipate paying cashdividends in the foreseeable future. Our payment of any future dividends willbe at the discretion of our board of directors after taking into accountvarious factors, including our financial condition, operating results, cashneeds and growth plans.

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**Item 6. Management’s Discussion and Analysis or Plan of Operation**

**Overview**

We derive sales from sellingenergy in the form of electricity, heat, hot water and cooling to our customersunder long-term energy sales agreements (with a typical term of 10 to 15years). The energy systems are owned by us and are installed in our customers’buildings. Each month we obtain readings from our energy meters to determinethe amount of energy produced for each customer. We multiply these readings bythe appropriate published price of energy (electricity, natural gas or oil)from our customer’s local energy utility, to derive the value of our monthlyenergy sale, less the applicable negotiated discount. Our revenues per customeron a monthly basis vary based on the amount of energy produced by our energysystems and the published price of energy (electricity, natural gas or oil)from our customer’s local energy utility that month. Our revenues commence asnew energy systems become operational.

Our operations are comprisedof one business segment. Our business is selling energy in the form ofelectricity, heat, hot water and cooling to our customers under long-term salesagreements. We expect togrow our revenues and our customer base in 2007.

As of December 31, 2006, we have experienced total net losses sinceinception of approximately $6.0 million. For the foreseeable future, we expectto experience continuing operating losses and negative cash flows fromoperations as our management executes our current business plan. The cash, cashequivalents, and marketable securities available at December 31, 2006 willprovide sufficient working capital to meet our anticipated expendituresincluding installations of new equipment for the next twelve months however, aswe continue to grow our business by adding more energy systems, the cashrequirements will increase. We believe that our cash and cash equivalentsavailable at December 31, 2006 and our ability to control certain costs,including those related to general and administrative expenses will enable usto meet our anticipated cash expenditures through December 2007. Beyond December2007 we will need to raise additional capital through a debt financing orequity offering. There can be no assurance, however, that we will be successfulin our fundraising efforts or that additional funds will be available onacceptable terms, if at all.

In 2006 we raised approximately$6.5 million through a private placement of our common stock, the exercise ofvarious warrants and the issuance of a convertible debenture. If we are unableto raise additional capital in 2008 we may need to terminate certain of ouremployees and adjust our current business plan. Financial considerations maycause us to modify planned deployment of new energy systems and we may decideto suspend installations until we are able to secure additional workingcapital. In the event, however, that we suspend installations for an extendedtime period, our working capital needs will significantly be reduced duringthat time period so the company may return to a cash flow positive position. Wewill evaluate possible acquisitions of, or investments in, businesses,technologies and products that are complementary to our business, however, wecurrently have no such discussions.

The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with statements and notesthereto appearing elsewhere herein.

**Recent Accounting Pronouncements**

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109.” This interpretation clarifiesthe accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, “Accountingfor Income Taxes.” This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. It alsoprovides guidance on de-recognition, classification, interest and penalties,accounting in interim periods, disclosure and transition. This Interpretationis effective for the company beginning in fiscal year 2007. The company doesnot expect the adoption of this pronouncement to have a significant impact onits consolidated financial statements.

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In February 2006, the FASB issued SFAS No. 155 (FAS155), “Accounting for Certain Hybrid Financial Instruments: an amendment ofFASB Statements No. 133 and 140.” FAS 155 permits fair valuere-measurement for any hybrid financial instrument that contains an embeddedderivative that otherwise would require bifurcation, clarifies whichinterest-only strips and principal-only strips are not subject to therequirements of Statement 133, establishes a requirement to evaluate interestsin securitized financial assets to identify interests that are freestandingderivatives or that are hybrid financial instruments that contain an embeddedderivative requiring bifurcation, clarifies that concentrations of credit riskin the form of subordination are not embedded derivatives, and amends Statement140 to eliminate the prohibition on a qualifying special purpose entity fromholding a derivative financial instrument that pertains to a beneficialinterest other than another derivative financial instrument. FAS 155 iseffective for all financial instruments acquired or issued after the beginningof an entity’s first fiscal year that begins after September 15, 2006. TheCorporation does not expect the adoption of FAS 155 will have a material impacton its results of operations, financial position or liquidity.

In March 2006, the FASB issued SFAS No. 156, “Accountingfor Servicing of Financial Assets” (“SFAS NO. 156”), which provides an approachto simplify efforts to obtain hedge-like (offset) accounting. This Statementamends FASB Statement No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities”, with respect to theaccounting for separately recognized servicing assets and servicingliabilities. The Statement (1) requires an entity to recognize a servicingasset or servicing liability each time it undertakes an obligation to service afinancial asset by entering into a servicing contract in certain situations;(2) requires that a separately recognized servicing asset or servicingliability be initially measured at fair value, if practicable; (3) permits anentity to choose either the amortization method or the fair value method forsubsequent measurement for each class of separately recognized servicing assetsor servicing liabilities; (4) permits at initial adoption a one-timereclassification of available-for-sale securities to trading securities by anentity with recognized servicing rights, provided the securities reclassifiedoffset the entity’s exposure to changes in the fair value of the servicingassets or liabilities; and (5) requires separate presentation of servicingassets and servicing liabilities subsequently measured at fair value in thebalance sheet and additional disclosures for all separately recognizedservicing assets and servicing liabilities. SFAS No. 156 is effective for allseparately recognized servicing assets and liabilities as of the beginning ofan entity’s fiscal year that begins after September 15, 2006, with earlieradoption permitted in certain circumstances. The Statement also describes themanner in which it should be initially applied. The company does not believethat SFAS No. 156 will have a material impact on its financial position,results of operations or cash flows.

In September 2006,the FASB issued SFAS No. 157 “Fair Value Measures” (“SFAS 157”). SFAS 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements. This statement applies underother accounting pronouncements that require or permit fair value measurements,however it does not apply to SFAS 123R. This Statement shall be effective forfinancial statements issued for fiscal years beginning after November 15, 2007,and interim periods within those fiscal years. The Company is currentlyevaluating the effect, if any, of SFAS 157 on its financial statements.

In February 2007, the FASB issued SFASNo. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS159”). SFAS 159 provides companies with an option to report selected financialassets and liabilities at fair value. SFAS 159 also establishes presentationand disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement attributes for similar types ofassets and liabilities and to provide additional information that will helpinvestors and other financial statement users to more easily understand theeffect of the company’s choice to use fair value on its earnings. Finally, SFAS159 requires entities to display the fair value of those assets and liabilitiesfor which the company has chosen to use fair value on the face of the balancesheet. SFAS 159 is effective as of the beginning of an entity’s first fiscalyear beginning after November 15, 2007. Early adoption is permitted. TheCompany is currently assessing the impact of SFAS 159 which it will be requiredto adopt.

In September 2006, theSecurities and Exchange Commission (SEC) issued Staff Accounting Bulletin 108, “Consideringthe Effects on Prior Year Misstatements when Quantifying Misstatements inCurrent Year 

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Financial Statements,” (“SAB108”). SAB 108 requires registrants to quantify errors using both the incomestatement method (i.e. iron curtain method) and the rollover method andrequires adjustment if either method indicates a material error. If acorrection in the current year relating to prior year errors is material to thecurrent year, then the prior year financial information needs to be corrected.A correction to the prior year results that are not material to those yearswould not require a “restatement process” where prior financials would beamended. SAB 108 is effective for our year ended December 31, 2006. The companydoes not believe that the adoption of the SAB 108 will have a material effecton its financial position, results of operations or cash flows.

**Critical Accounting Policies**

The preparation of financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities at the date of the financial statements, thereported amounts of revenues and expenses during the reporting period, and thedisclosure of contingent assets and liabilities at the date of the financialstatements. Actual results could differ from those estimates. Managementbelieves the following critical accounting policies involve more significantjudgments and estimates used in the preparation of our consolidated financialstatements.

*Partnerships, Joint Ventures and EntitiesUnder Common Control*

Certain contracts are executed jointly through partnershipsand joint ventures with unrelated third parties. The company consolidates all jointventures and partnerships in which it owns, directly or indirectly, 50% or moreof the membership interests. All significant intercompany accounts andtransactions are eliminated. Minority interest in net assets and earnings orlosses of consolidated entities are reflected in the caption “Minority interest”in the accompanying consolidated financial statements. Minority interestadjusts the consolidated results of operations to reflect only the company’sshare of the earnings or losses of the consolidated entities. Upon dilution ofownership below 50%, the accounting method is adjusted to the equity or costmethod of accounting, as appropriate.

Financial Accounting Standards Board (“FASB”) InterpretationNo. 46 (Revised), “Consolidation of Variable Interest Entities” (“FIN 46-R”)provides the principles to consider in determining when variable interestentities must be consolidated in the financial statements of the primarybeneficiary. In general, a variable interest entity is an entity used forbusiness purposes that either (a) does not have equity investors withvoting rights or (b) has equity investors that are not required to providesufficient financial resources for the entity to support its activities withoutadditional subordinated financial support. FIN 46-R requires a variableinterest entity to be consolidated by a company if that company is subject to amajority of the risk of loss from the variable interest entity’s activities oris entitled to receive a majority of the entity’s residual returns or both. Acompany that consolidates a variable interest entity is called the primarybeneficiary of that entity. The company evaluates the applicability of FIN 46-Rto partnerships and joint ventures at the inception of its participation toensure its accounting is in accordance with the appropriate standards.

The company has a variable interest in Tecogen through itscontractual interests in that entity; however, the company is not the primarybeneficiary and does not have any exposure to loss as a result of itsinvolvement with Tecogen. See related party footnotes to the company’sconsolidated financial statement for discussion of the company’s involvementwith Tecogen.

*Related Party Transactions*

 We have purchasedthe majority of our cogeneration units from Tecogen Inc., an affiliate sharingsimilar ownership. In addition, Tecogen pays certain operating expenses,including benefits and insurance, on our behalf, and we lease office space fromTecogen. These costs are reimbursed to Tecogen by us. Tecogen has a subleaseagreement for the office building, which expires on March 31, 2009.

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*Property andEquipment and Depreciation and Amortization*

Propertyand equipment are stated at cost. Depreciation and amortization are computedusing the straight-line and accelerated methods at rates sufficient to writeoff the cost of the applicable assets over their estimated useful lives.Repairs and maintenance are expensed as incurred.

The companyevaluates the recoverability of its long-lived assets in accordance withStatement of Financial Accounting Standards No. 144 (SFAS No. 144), *Accounting for the Impairment or Disposal ofLong-Lived Assets.*SFAS No. 144 requires the recognition ofimpairment of long-lived assets in the event the net book value of such assetsexceeds the estimated future undiscounted cash flows attributable to suchassets. If impairment is indicated, the asset is written down to its estimatedfair value based on a discounted cash flow analysis. The company reviewslong-lived assets for impairment annually or whenever events or changes inbusiness circumstances indicate that the carrying value of the assets may notbe fully recoverable or that the useful lives of the assets are no longerappropriate. At December 31, 2006, the company determined that its long-livedassets are recoverable.

*Stock-Based Compensation*

Effective January 1, 2006, we adopted SFAS No. 123 (revised2004), *Share Based Payment*, orSFAS 123(R), which is a revision of Statement No. 123 (“SFAS 123”) *Accounting for Stock Based Compensation*.SFAS 123(R) supersedes Accounting Principles Board (“APB”) No. 25, *Accounting for Stock Issued to Employees* (“APB25”), and amends Financial Accounting Standards Board (“FASB”) StatementNo. 95 *Statement of Cash Flows.*SFAS 123(R) requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the income statement based on theirfair values. Pro forma disclosure is no longer an alternative.

Prior to January 1, 2006, we accounted for employeestock-based compensation in accordance with the provisions of APB 25 and FASBInterpretation No. 44, *Accounting forCertain Transactions Involving Stock Compensation — an Interpretation of APBNo. 25*, and we complied with the disclosure provisions ofSFAS 123, and related SFAS No. 148, *Accountingfor Stock-Based Compensation — Transaction and Disclosure*. Under APB25, compensation expense is based on the difference, if any, on the date of thegrant, between the fair value of our stock and the exercise price of the option.We amortized such stock-based compensation, if any, using the straight-linemethod over the vesting period.

SFAS 123(R) requires nonpublic companies that used theminimum value method in SFAS 123 for either recognition or pro formadisclosures to apply SFAS 123(R) using the prospective-transition method. Assuch, since we were not a public Company as of the adoption date, we willcontinue to apply APB 25 in future periods to equity awards outstanding at thedate of SFAS 123(R)’s adoption that were measured using the minimum valuemethod. In accordance with the requirements of SFAS 123(R), the Company willnot present pro forma disclosures for periods prior to the adoption of SFAS123(R), as the estimated fair value of the Company’s stock options grantedthrough December 31, 2005 was determined using the minimum value method.

The determination of thefair value of share-based payment awards is affected by our stock price. We donot have a history of market prices of our common stock as we are not yet a publiclytraded company. The Company considered the sales price of common stock inprivate placements to unrelated third parties during the year as a measure ofthe fair value of its common stock.

SFAS 123(R) alsorequires companies to utilize an estimated forfeiture rate when calculating theexpense for the period, whereas, SFAS 123 permitted companies to recordforfeitures based on actual forfeitures, which was our historical policy underSFAS 123. As a result, we applied an estimated forfeiture rate of 0% during2006 in determining the expense recorded in the accompanying consolidatedstatement of income. Forfeitures are estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. Stock-based compensation expense recognized in our financialstatements in 2006 and thereafter is based on awards that are ultimatelyexpected to vest. We evaluate the assumptions used to value our awards on aquarterly basis and if factors change and we employ different assumptions,stock-based compensation expense may differ significantly from what we haverecorded in the past. If there are any 

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modifications or cancellations of theunderlying unvested securities, we may be required to accelerate, increase orcancel any remaining unearned stock-based compensation expense.

On November 10, 2005, theFinancial Accounting Standards Board (“FASB”) issued FASB Staff Position SFAS123R-3 “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards.”  The Companyhas elected to adopt the alternative transition method provided the FASB StaffPosition for calculating the tax effects (if any) of stock-based compensationexpense pursuant to SFAS 123R.  Thealternative transition method includes simplified methods to establish thebeginning balance of the additional paid-in capital pool related to the taxeffects of employee stock-based compensation, and to determine the subsequentimpact to the additional paid-in capital pool and the consolidated statementsof operations and cash flows of the tax effects of employee stock-basedcompensation awards that are outstanding upon adoption of SFAS 123R.

*Revenue Recognition*

Revenue from energy contracts is recognized when energy isproduced by the cogeneration systems onsite. The company bills each month basedon the energy produced by on-site energy systems, as determined by acontractually defined formula.

*Income Taxes*

As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income taxes in each ofthe jurisdictions in which we operate. This process involves us estimating ouractual current tax exposure together with assessing temporary differencesresulting from differing treatment of items, such as our deferred gain andlease rights, for tax and accounting purposes. These differences result indeferred tax assets and liabilities, which are included within our consolidatedbalance sheet. We must then assess the likelihood that our deferred tax assetswill be recovered from future taxable income and to the extent we believe thatrecovery is not likely, we must establish a valuation allowance. To the extentwe establish a valuation allowance or increase this allowance in a period, wemust include an expense within the tax provision in the consolidated statementof operations.

Significant management judgment is required in determiningour provision for income taxes, our deferred tax assets and liabilities and anyvaluation allowance recorded against our deferred tax assets. As ofDecember 31, 2006, there was no deferred income tax asset on our books. Werecorded a valuation allowance of $1,730,000 against the entire gross deferredincome tax asset; due to uncertainties related to our ability to utilize ournet operating loss carry forwards before they expire. The valuation allowanceis based on our estimates of taxable income by jurisdiction in which we operateand the period over which our deferred tax assets will be recoverable. In theevent that actual results differ from these estimates or we adjust theseestimates in future periods we may need to establish an additional valuationallowance which could materially impact our financial position and results ofoperations.

**Results of Operations for the Years Ended December 31, 2006and December 31, 2005**

*Fiscal 2006 Compared with Fiscal 2005*

*Revenues*

Revenues in 2006 were $3,174,326, an increase of $1,006,600(46%) from 2005. Revenues increased as a result of new energy sales from ourincreased customer base. During 2006, we continued to add customers in theNortheast by entering into energy supply agreements. At the end of 2006 we had39 energy systems operational. Our revenues per customer on a monthly basisvary based on the amount of energy produced by our energy systems and thepublished price of energy (electricity, natural gas or oil) from our customer’slocal energy utility that month. Our revenues commence as new energy systemsbecome operational.

Effective March 7, 2007, there are new air quality andpermitting requirements in New Jersey that may require adding emission controlequipment on our already existing 18 cogeneration systems operating in NewJersey and any new energy systems we install in that State. In order tointerpret and comply with the new emission requirements we have retained anindependent environmental engineering consultant to review the applicability ofthe new requirements to our energy systems. This report will be available tothe company shortly. Based on the outcome we may have to retrofit some or allsites we operate in New Jersey. This may adversely affect our revenue andprofitability.

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#### *Cost of Sales*

The cost of sales, including depreciation, in 2006 was$2,740,535, an increase of $981,705 (56%) from 2005. Included in the cost ofsales was depreciation expense, which in 2006 was $316,515, compared with $181,185 in2005 due to additional sites coming on line. Our cost of sales consists of fuel required to operate ourenergy systems, the cost of maintenance, and minimal communications costs. Thecost of natural gas is the largest component of our cost of sales and anychange in natural gas prices affects our margins. During 2006, the cost of fuelas a percent of sales increased by 5%, which resulted in an unfavorable impactto our margins of $158,716. Our gross margin in 2006 was 14% compared with agross margin of 19% in 2005. If this unfavorable direction to the price of fuelcontinues, it will put pressure on our margins. We are currently making everyeffort to secure favorable fuel pricing and to improve the operation of ourenergy systems. Furthermore we are making considerable effort to capture morepremium (on peak) billing time.

*Operating Expenses*

Our general and administrative expense consists ofexecutive staff, accounting and legal expenses, and costs for space, auditservices, general insurance and other administrative expenses. At the end of2006, the staff included the President, the part-time Chief Financial Officer,the Vice President of Finance and a part-time administrative assistant. In2006, our general and administrative expenses were $1,033,252 compared to$705,412 in 2005. The increase in the general and administrative expenses of $327,840 wasprimarily affected by larger than usual accounting and legal costs associatedwith the effort to go public through the Form 10SB process. All otherexpenses remained relatively constant.

During the year ended December 31, 2006, thecompany issued 876,800 shares of common stock to Tecogen employees andconsultants. The shares of common stock were fully vested and did not containany restrictive provisions. We accounted for stock based awards issued tonon-employees in accordance with EITF 96-18, *Accountingfor Equity Instruments that are Issued to Other Than Employees for Acquiring orin Conjunction with Selling, Goods or Services*. The common stock wasissued at $0.001 per share when the fair value was estimated to be $0.70 pershare. We recorded an expense of $612,883 in 2006, related to such awards.

Our selling expenses consist of sales staff, commissions,marketing and advertising expenses, travel and other selling related expenses.We sell energy using both direct sales and commissioned agents. Our marketingeffort consisted of trade shows, print literature, media relations and eventdriven direct mail. At the end of 2006, our selling expenses were$331,916 compared to $175,829 in 2005. The increase in the selling expenses in2005 was primarily due to the hiring of a second salesperson in August2005 and, to a lesser extent to additional advertising, trade shows, recruitingcosts and travel costs.

Our engineering expenses consisted of technical staff andother engineering related expenses. The role of engineering is to evaluatepotential customer sites based on technical and economic feasibility, managethe installed base of energy systems and oversee each new installation project.At the end of 2006 our engineering staff consisted of three people and ourengineering expenses were $308,921 compared to $206,040 in 2005. Our expenses wereprimarily affected by hiring an engineer in August 2005 and a second engineerin December of 2005. The addition of the two employees along with otherengineering related expenses contributed to the increase of $102,881 in 2006.

**Operating Income**

Operating income in 2006 was a loss of $1,853,180 ascompared with a loss of $678,385 in 2005. The increase in our operating loss in2006 was primarily due to the increase in our cost of sales expenses related tothe unfavorable direction to the price of fuel used to power our energysystems. The increase in our operating loss was also affected by unusually highaccounting and legal expenses related with the SEC filing of the Form 10-SB, aswell as salaries of new employees. Furthermore, during the third quarter weissued a stock based award to employees of Tecogen and consultants whichresulted in a non- cash expense of $612,883.

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*Other Income (Expense), Net*

The company reported other expense, net, of $200,327 in2006 and other expense, net, of $34,032 in 2005. Other income (expense), net,includes interest income, interest expense, and other items. Interest incomewas $126,996 in 2006 compared to $14,505 in 2005. The increase was primarilydue to additional funds raised which were invested in Treasury Bills. Interestexpense increased to $311,280 in 2006 from $46,029 in 2005 due to additionalinterest paid related to the convertible debenture of 2006.

#### *Provision for Income Taxes*

The company did not have a tax provision or benefit in 2006and 2005, respectively, since both periods had losses.

*Minority Interest*

In 2002, the company and AES-NJ Cogen Inc. of New Jersey created alimited liability company named American DG New York LLC (“ADGNY”) to developprojects in the New York and New Jersey area. The company owns 51% ofADGNY.  Both partners in ADGNY share inthe profits of the business. The percentage share of the profit is based on thepartner’s investment in each individual project. The company’s investments inADGNY projects have ranged from 51% to 80%. The minority interest expenserepresents our partner’s share of profits in the entity. On our balance sheet,minority interest represents our partner’s investment in the entity, plus itsshare of after tax profits less any cash distributions. The company reported minorityinterest of $19,283 in 2006 and $99,689 in 2005. The decrease was due to betterperformance of energy systems that the company had significantly largerpercentage of than its partner.

****Liquidity and Capital Resources****

Consolidated working capitalin 2006 was $3,375,980, compared with $(1,192,290) in 2005. Included in workingcapital were cash and cash equivalents of $3,420,446 in 2006, compared with$84,492 in 2005. The increase in working capital was a result of additionalfunds raised through aprivate placement of our common stock, the exercise of various warrants and theissuance of a convertible debenture. The cash and cash equivalents available atDecember 31, 2006 will provide sufficient working capital to meet ouranticipated expenditures including installations of new equipment for the nexttwelve months however, as we continue to grow our business by adding moreenergy systems, the cash requirements will increase. We believe that our cashand cash equivalents available at December 31, 2006 and our ability to controlcertain costs, including those related to general and administrative expenseswill enable us to meet our anticipated cash expenditures through January 1,2008. Beyond January 1, 2008 we may need to raise additional capital through adebt financing or equity offering to meet our operating and capital needs. In2006 we raised approximately $6.5 million.

Cash used in operatingactivities was $912,786 in 2006. The company’s net receivables balanceincreased from $162,012 in 2005 to $284,398 in 2006, resulting in $122,386reduction of cash to the company. The increase in the net receivable balance isa resultor the overall sales increase of 46%. The company’s due from related partiesincreased from $26,750 in 2005 to $121,896 in 2006, using $95,146 of cash. Theincrease is due to a note from the company’s partner AES-NJ. Offsetting thoseitems was in increase in accrued expenses and other current liabilities of$190,778 due to an increase in accrued payables, accrued interest, accruedvacation and other business activity.

During 2006, the primary investing activities of thecompany’s operations were expenditures of $2,354,181 for purchases of property,plant and equipment.

The company’s financing activities provided $6,602,921 ofcash in 2006 primarily from the convertible debenture offered and the sale ofcommon stock and warrants.

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**Seasonality**

The majority of our heating systems sales are in the winterand the majority of our chilling systems sales are in the summer.

**Quantitative and Qualitative Disclosures about Market Risk**

The company’s exposure to market risk from changes ininterest rates, and equity prices, has not changed materially from its exposureat December 31, 2005.

**Off Balance Sheet Arrangements**

The company has no material off balance sheet arrangements.

**Controls andprocedures**

*As of the end of the period covered by this report,our Chief Executive Officer and Chief Financial Officer have performed anevaluation of controls and procedures and concluded that our controls areeffective to give reasonable assurance that the information required to bedisclosed by our company in reports that we file under the Exchange Act isrecorded, processed, summarized and reported as when required. However, thereis a lack of segregation of duties at the Company due to the small number ofemployees dealing with general administrative and financial matters. Thisconstitutes a significant deficiency in financial reporting. At this timemanagement has decided that, considering the employees involved and the controlprocedures in place, the risks associated with such lack of segregation areinsignificant, and the potential benefits of adding additional employees toclearly segregate duties do not justify the expenses associated with suchincreases. Management will continue to evaluate this segregation of duties.*

*The company had 10 employees as ofDecember 31, 2006. Only one of those individuals is in the finance function,other than the Chief Financial Officer. This individual is responsible forreceiving and distributing cash, billing, processing transactions, recordingjournal entries, reconciling accounts, and preparing the financial statementsand related disclosures. He also has check signing authority, for transactionsunder $2,000. As a result, there is the potential for this individual toknowingly or unknowingly misappropriate assets or misstate our financialstatements. To mitigate these risks, the Company has put in place procedureswhere the Chief Executive Officer, the President and the Chief FinancialOfficer have check signing authority. In addition they review and approve allmaterial contracts, transactions and related journal entries. They are alsoresponsible for reviewing and approving monthly financials and related reconciliations,budget to actual comparisons and the information required to be disclosed bythe company in all reports we have and will file under the Exchange Act.*

**Item 7.  FinancialStatements**

Reference is made to the Index to Financial Statements on page F-1.

**Item 8.  Changes in andDisagreements with Accountants on Accounting and Financial Disclosure**

On May 31, 2006,we engaged Vitale, Caturano & Company, Ltd. (“Vitale, Caturano”) as ourprincipal independent registered public accountants. We have also engagedVitale, Caturano & Company, Ltd. for 2006 tax compliance services and hadpreviously consulted with Vitale, Caturano concerning the tax treatment ofcertain transactions, specifically the spin out transaction of Tecogen. We havenot consulted with Vitale, Caturano with regard to the application ofaccounting principles to any transaction, the type of audit opinion that mightbe rendered on our financial statements or any disagreement (as defined in Item304(a)(1)(iv) of Regulation S-B) during the fiscal years ended December 31,2005 and December 25, 2004 or the subsequent interim period.

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Our previousprincipal independent registered public accountants were Carlin, Charron &Rosen, LLP, (“CCR”). CCR had previously audited our financial statements and issuedan opinion on our 2005 financial statements on February 15, 2006. CCR were theauditors of our financial statements for the years ended December 27, 2003,December 25, 2004 and December 31, 2005.

As approved by ourBoard of Directors, we dismissed CCR on May 31, 2006. CCR’s reports on ourfinancial statements for the fiscal year ended December 31, 2005 did notcontain either an adverse opinion or a disclaimer of opinion, nor were suchreports qualified or modified as to uncertainty, audit scope or accountingprinciples. In connection with this the Form 10-SB, we updated the 2005financial statements to be in accordance with PCAOB and Security and ExchangeCommission rules and regulations. CCR audited the changes to 2005 financialstatements and brought down the date of their opinion to October 30, 2006.

At no time duringthe fiscal year ended December 31, 2005 or the subsequent interim periodthrough October 30, 2006 were there any disagreements (as defined in Item304(a)(1)(iv) of Regulation S-B) between us, and CCR on any matter ofaccounting principles or practices, financial statement disclosure or auditingscope or procedure.

**Item 8A.  Controls and Procedures**

*Evaluationof disclosure controls and procedures:*

The chief executive officer and the chief financial officer, afterevaluating the effectiveness of our “disclosure controls and procedures” (asdefined in the Securities Exchange Act of 1934 Rules 13a-15(e) and15d-15(e); collectively, “Disclosure Controls”) as of the end of theperiod covered by this annual report (the “Evaluation Date”) has concluded thatas of the Evaluation Date, our Disclosure Controls were effective to providereasonable assurance that information required to be disclosed in our reportsfiled or submitted under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified by theSEC, and that material information relating to our company and any consolidatedsubsidiaries is made known to management, including the chief executive officerand chief financial officer, particularly during the period when our periodicreports are being prepared to allow timely decisions regarding requireddisclosure.

*Changesin internal controls:*

In connection with the evaluation referred to in the foregoingparagraph, we have identified no change in our internal control over financialreporting that occurred during the year ended December 31, 2006 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting. Limitations on the effectiveness of controls:

*InherentLimitations on Effectiveness of Controls:*

Our management, including the chief executive officer and chieffinancial officer, do not expect that our Disclosure Controls or our internalcontrol over financial reporting will prevent or detect all error and allfraud. A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the control system’s objectiveswill be met. The design of a control system must reflect the fact that thereare resource constraints, and the benefits of controls must be consideredrelative to their costs. Further, because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any, within the company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Projections of any evaluation of controls 

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effectivenessto future periods are subject to risks. Over time, controls may becomeinadequate because of changes in conditions or deterioration in the degree ofcompliance with policies or procedures.

**Item 8B.  OtherInformation**

None.

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**PART III**

**Item9.  Directors, Executive Officers,Promoters and Control Persons; Compliance with Section 16(a) of the ExchangeAct**

The followingtable lists the current members of our board of directors and our executiveofficers. The address for our directors is c/o American DG Energy Inc., 45First Avenue, Waltham, Massachusetts 02451**.** There are nofamily relationships among members of our board or our executive officers,other than Dr. George N. Hatsopoulos and Mr. John N. Hatsopoulos who arebrothers.

| Name                   | ** ** | **Age** | ** ** | **Position**                                      |
|------------------------|------------|---------|------------|---------------------------------------------------|
| ** **             |       |    |       |                                              |
| George N.  Hatsopoulos |       | 80      |       | Chairman of the  Board                            |
|                   |       |    |       |                                              |
| John N.  Hatsopoulos   |       | 72      |       | Chief Executive  Officer and Director             |
|                   |       |    |       |                                              |
| Barry J. Sanders       | ** ** | 46      |       | President and  Chief Operating Officer            |
|                   |       |    |       |                                              |
| Anthony S. Loumidis    | ** ** | 42      |       | Chief Financial  Officer, Secretary and Treasurer |
|                   |       |    |       |                                              |
| Charles T.  Maxwell    |       | 75      |       | Director                                          |
|                   |       |    |       |                                              |
| Alan D.  Weinstein     |       | 64      |       | Director                                          |
|                   |       |    |       |                                              |
| Earl R. Lewis          |       | 63      |       | Director                                          |
|                   |       |    |       |                                              |

 

*George N. Hatsopoulos* has been our Chairman of the Boardsince the organization of the company in July 2001. He is the founder and CEOof Pharos, LLC, an organization devoted to the creation of leading edgebusiness ventures. He is the founder and chairman emeritus of Thermo ElectronCorporation (NYSE:TMO), and served as Chairman and CEO since its founding in1956 until his retirement from those positions in 1999. Dr. Hatsopoulos hasserved on the board of the Federal Reserve Bank of Boston, including a term aschairman. He was a member of the SEC Advisory Committee on Capital Formationand Regulatory Process, the Advisory Committee of the US Export-Import Bank,and the boards of various corporations and institutions. Dr. Hatsopoulos is afellow of the American Academy of Arts and Sciences, the American Society ofMechanical Engineers and other scientific and technical organizations. He isthe recipient of numerous honors and awards in engineering, science, industryand academics, has authored over 60 articles in professional journals, and isthe principal author of textbooks in Thermodynamics and Thermionic EnergyConversion. Dr. Hatsopoulos has been a faculty member and senior lecturer atMassachusetts Institute of Technology and continues his association with theInstitute as a Life Member of the Corporation and chair of the Department ofCivil and Environmental Engineering Committee. Dr. Hatsopoulos holds abachelors degree from the National Technical University of Athens, and masterand doctorate degrees from Massachusetts Institute of Technology – all inmechanical engineering.

*John N.Hatsopoulos* is our Chairman of the Board. Mr. Hatsopoulos is one of the fourfounding members of GlenRose Partnership L.P., and a General Partner ofGlenRose Capital LLC, formed in 2000 as a leverage buyout firm focused onmaking acquisitions in the environmental services and instrumentation businessareas. Mr. Hatsopoulos is Partner and Managing Director of Alexandros PartnersLLC, a financial advisory firm providing consulting services to early stageentrepreneurial ventures. Since 1999, he is also Chief Executive Officer ofAmerican DG Energy Inc. and Tecogen Inc. Mr. Hatsopoulos is a co-founder ofThermo Electron Corporation and the retired President and Vice Chairman of theBoard of that company. He is a member of the board of directors of TEIBiosciences Inc., American CareSource Holdings, Inc., and a “Member of theCorporation” for Northeastern University. Mr. Hatsopoulos graduated from AthensCollege in Greece, and 

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graduated from Northeastern University in1959 with a Bachelor Degree in History and Mathematics. He also has HonoraryDoctorates in Business Administration from Boston College and NortheasternUniversity.

*Barry J. Sanders* has been our President and ChiefOperating Officer since 2001. From 1992 to 2001, he served as Executive VicePresident of Micrologic, Inc., an equipment asset management company where hedirected the company’s business-to-business group. From 1990 to 1992, he wasthe Marketing Manager at Andover Controls Corp., a building automation systemscompany, and from 1988 to 1990 he was at Tecogen where he directed thesuccessful introduction of that company’s DG chiller products. Mr. Sanders hasalso managed research and development projects for the New York State EnergyResearch and Development Authority (“NYSERDA”) in Albany, NY, where he createdthe University-Industry Energy Research Program to accelerate commercializationof new technologies. Mr. Sanders has a BS degree in chemical engineering fromthe University of Rochester and an MBA in marketing from Rensselaer PolytechnicInstitute.

*Anthony S. Loumidis* has been our Chief FinancialOfficer and Treasurer since 2001.  Mr.Loumidis devotes a substantial majority of his business time to the affairs ofthe company.  Mr. Loumidis is alsoPartner and President of Alexandros Partners LLC, a financial advisory firmproviding consulting services to early stage entrepreneurial ventures. He isalso the Chief Financial Officer of GlenRose Instruments Inc. Mr. Loumidis waspreviously with Thermo Electron Corporation where he held various positionsincluding National Sales Manager for Thermo Capital Financial Services, Managerof Investor Relations and Manager of Business Development of Tecomet, asubsidiary of Thermo Electron. Mr. Loumidis is an NASD registeredrepresentative, holds a Bachelor degree in Business Administration from theAmerican College of Greece in Athens and an MBA from Northeastern University.

*Charles T. Maxwell* has been a member of our Board ofDirectors since 2001. He is a widely recognized expert in the energy sector,with over 40 years of experience with major oil companies and investmentbanking firms. He is currently Senior Energy Analyst with Weeden & Co. ofGreenwich, CT where he develops strategic data and forecasts on oil, gas andpower markets. Since the early 1980’s, he has been an active member of anOxford-based organization comprised of OPEC and other industry executives from30 countries who meet twice annually to analyze trends within the global energyindustries and markets. Mr. Maxwell graduated cum laude in political sciencesfrom Princeton University as a Jadwin Scholar and holds a BA from OxfordUniversity as a Marshall Scholar in literature and history.

*Alan D. Weinstein* has been a member of our Board ofDirectors since 2001. He is currently a consultant working with healthcarestartups. He is the retired President of Premier Inc., a strategic alliance ofover 1,700 hospitals throughout the U.S. Mr. Weinstein left Premier in 2000after merging his previous company, Premier Health Alliance, with AmHS andSunHealth in 1995. During his tenure at Premier the alliance’s members weregroup purchasing $12 billion annually in goods and services negotiated byPremier on their behalf. The alliance also provided its members withbroad-based services including process design, benchmarking, performanceimprovement, technology assessment, insurance programs and biomedicalengineering maintenance programs. From 1983 to 1995, Mr. Weinstein was the CEOand President of Premier Health Alliance, a strategic alliance owned by 54teaching hospitals across the U.S. During his three-decade career inhealthcare, Mr. Weinstein has supported medical care organizations indeveloping shared programs and achieving greater economies of scale. Mr.Weinstein currently serves on the board of the American International HealthAlliance, and is a speaker and writer on collaborative endeavors in hospitaland health system management. Mr. Weinstein has a BA from Allegheny College inMeadville, PA and an MBA from Cornell University.

*Earl R. Lewis* became a member of our Board ofDirectors in September 2005.  He isChairman of the Board, Chief Executive Officer and President of FLIR SystemsInc. (NASDAQ:FLIR). Previously, Mr. Lewis was CEO and President of ThermoInstrument Systems Inc., a publicly held subsidiary of Thermo ElectronCorporation from 1998 to 2000, and held various senior management positionswith that company since 1984. Mr. Lewis is a board member of Harvard BioscienceInc. (NASDAQ:HBIO), as well as several private companies. He is on the Board ofTrustees at Dean College and the Board of Associates at the WhiteheadInstitute. Mr. Lewis has a Bachelor of Science degree from Clarkson College ofTechnology. He has also 

30

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completed the Manufacturing Management Program at HarvardUniversity and Management Development Program at Northeastern University.

**Board Committees**

Our board of directors established an audit committee and a compensationcommittee in 2006. Messrs. Lewis and Maxwell compose the audit committee, andMessrs. G. Hatsopoulos and Weinstein comprise the compensation committee. Allof the members of each of these standing committees are independent as definedunder Nasdaq rules and, in the case of the audit committee, the independencerequirements contemplated by Rule 10A-3 under the Securities Exchange Act.

*AuditCommittee*

The audit committee’s responsibilities will include:

·                  appointing, approving thecompensation of, and assessing the independence of our independent auditor;

·                  overseeing the work of ourindependent auditor, including through the receipt and consideration of reportsfrom the independent auditor;

·                  reviewing and discussing withmanagement and our independent auditor our annual and quarterly financialstatements and related disclosures;

·                  monitoring our internal controlover financial reporting, disclosure controls and procedures, and code ofbusiness conduct and ethics;

·                  discussing our risk managementpolicies;

·                  establishing policies regardinghiring employees from our independent auditor and procedures for the receiptand retention of accounting related complaints and concerns;

·                  meeting independently with ourindependent auditor and management; and

·                  preparing the audit committeereport required by SEC rules to be included in our proxy statements.

All audit services and all non-audit services, except de minimisnon-audit services, must be approved in advance by the audit committee.

*Compensation Committee*

The compensation committee’sresponsibilities will include:

·                  annuallyreviewing and approving corporate goals and objectives relevant to compensationof our chief executive officer;

·                  determiningthe compensation of our chief executive officer;

·                  reviewingand approving, or making recommendations to our board of directors with respectto, the compensation of our other executive officers;

·                  overseeingan evaluation of our senior executives;

·                  overseeingand administering our cash and equity incentive plans; and

·                  reviewingand making recommendations to our board with respect to director compensation.

**Corporate Governance**

We believe that good corporate governance is important to ensurethat, as a public company, we will be managed for the long-term benefit of ourstockholders. In that regard, we have established and adopted a charter for ouraudit committee and for our compensation committee, as well as a code ofbusiness conduct and ethics applicable to all of our directors, officers andemployees.

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**Compensation Committee Interlocks and Insider Participation**

Two of our directors, George Hatsopoulos and John Hatsopoulos, aredirectors of Tecogen; George Hatsopoulos also serves as a member of ourcompensation committee. Other than that, none of our executive officers servesas a member of the board of directors or compensation committee, or othercommittee serving an equivalent function, of any other entity that has one ormore of its executive officers serving as a member of our board of directors orits compensation committee. None of the current members of the compensationcommittee of our board has ever been one of our employees.

**Director Compensation**

Eachdirector who is not also one of our employees will receive a fee of $500 perday for service on the board, plus an additional fee of $500 per day forserving on each of the audit and compensation committees. Non-employeedirectors also will be eligible to receive stock options under our equityincentive plan.

We reimburse all of our non-employee directors for reasonabletravel and other expenses incurred in attending board of directors andcommittee meetings. Any director who is also one of our employees receives noadditional compensation for serving as a director.

**Liability Limitations and Indemnification**

The Delaware General Corporation Law, our charter and by-lawsprovide for indemnification of our directors and officers for liabilities andexpenses that they may incur in such capacities. In general, directors andofficers are indemnified with respect to actions taken in good faith in amanner reasonably believed to be in, or not opposed to, the best interests ofthe company, and with respect to any criminal action or proceeding, actionsthat the indemnitee had no reasonable cause to believe were unlawful. Referenceis made to our corporate charter and by-laws filed as Exhibits 3.2 and 3.4hereto, respectively.

Our current insurance policy expires on November 15, 2007. We havealso purchased a separate Directors and Officers insurance policy that expireson January 1, 2008.

The following description is intended as a summary only and isqualified in its entirety by reference to our amended and restated charter andamended and restated by-laws filed as exhibits to this Form 10-KSB and toDelaware law. The description of liability limitations and indemnificationreflects provisions of our amended and restated charter and by-laws. We referin this section to our amended and restated charter as our charter, and werefer to our amended and restated by-laws as our by-laws.

Our charter and by-laws limit the liability of directors to themaximum extent permitted by Delaware law. Delaware law provides that directorsof a corporation will not be personally liable for monetary damages for breachof their fiduciary duties as directors, except liability for:

·                  any breach of their duty of loyaltyto the corporation or its stockholders;

·                  acts of omissions that are not ingood faith or that involve intentional misconduct or a knowing violation oflaw;

·                  unlawful payments of dividends orunlawful stock repurchases or redemptions; or

·                  any transaction from which thedirector derived an improper personal benefit.

The limitations do not apply to liabilities arising under thefederal securities laws and do not affect the availability of equitableremedies, including injunctive relief or rescission.

Our charter and by-laws provide that we will indemnify ourdirectors and officers, and may indemnify other employees and agents, to themaximum extent permitted by law. We believe that indemnification under ourby-laws covers at least negligence and gross negligence on the part of indemnifiedparties. Our by-laws also permit us to secure insurance on behalf of anyofficer, director, employee or agent for any liability arising out of actionstaken in his or her capacity as an officer, director, employee or agent,regardless of whether the by-laws would permit indemnification.

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At present, there is no pending litigation or proceeding involvingany of our directors, officers or employees in which indemnification is sought,nor are we aware of any threatened litigation that may result in claims forindemnification.

Insofar as indemnification for liabilities arising under theSecurities Act may be permitted to our directors, officers and controllingpersons under our charter or by-laws or the indemnification agreements we haveentered into with our directors and officers, we have been advised that in theopinion of the SEC this indemnification is against public policy as expressedin the Securities Act and is, therefore, unenforceable.

Our charter provides that we must indemnify our directors andofficers and that we must advance expenses, including attorneys’ fees, to ourdirectors and officers in connection with legal proceedings, subject to verylimited exceptions. In addition, our charter provides that our directors willnot be personally liable for monetary damages to us for breaches of theirfiduciary duty as directors, except to the extent that the Delaware law statuteprohibits the elimination or limitation of liability of directors for breachesof fiduciary duty.

These provisions may discourage stockholders from bringing alawsuit against our directors for breach of their fiduciary duties. Theseprovisions may also have the effect of reducing the likelihood of derivativelitigation against directors and officers, even though such an action, ifsuccessful, might otherwise benefit us and our stockholders. Furthermore, youmay lose some or all of your investment in our common stock if we pay the costsof settlement or damage awards against our directors and officers under theseprovisions. We believe these provisions, the director and officer insurance wemaintain, and the indemnification agreements we have entered into with ourdirectors and officers are necessary to attract and retain talented andexperienced directors and officers.

**Compliance with Section 16(a) of the Securities Exchange Actof 1934**

Section 16(a) of the Securities Exchange Act of 1934 requires theofficers and directors of the Company, and persons who own 10% or more of anyclass of equity interests in the Company, to report their beneficial ownershipof equity interests in the Company to the SEC. Their initial reports arerequired to be filed using the SEC’s Form 3, and they are required to reportsubsequent purchases, sales, and other changes using the SEC’s Form 4, whichmust be filed within two business days of most transactions. Officers,directors, and shareholders owning more than 10% of any class of equityinterests in the Company are required by SEC regulations to furnish us withcopies of all of reports they file pursuant to Section 16(a).  The officers and directors of the Company,and Konstantinos Samaras, a person who indirectly owns 10% or more of any classof equity interests in the Company, each filed a late Form 3 in calendar year2007 and Messrs. Lewis, Loumidis, Maxwell, Weinstein and Sanders each filed alate Form 4 during the same calendar year.

**Item 10. ExecutiveCompensation**

The following summarizesthe compensation earned during fiscal 2006 by our chief executive officer andby our only other executive officer who earned over $100,000 in totalcompensation during the fiscal year. We use the term “named executiveofficers” to refer to these people later in this report.

**SummaryCompensation Table**
| Name and Principal Position | ** ** | **Year** | ** ** | **Salary($)** | ** ** | **Option Awards($)** | ** ** | **All Other Compensation($)** | ** ** | **Total ($)** | ** ** |
|--------------------------------------------|------------|----------|------------|---------------|------------|---------------------------|------------|-----------------------------------------|------------|--------------------|------------|
| ** **                                 |       |     |       |          |       |                      |       |                                    |       |               |       |   |   |   |   |   |   |
| John N. Hatsopoulos (1)                    |       | 2006     |       |          | 0          |                      |       | 0                                       |       |               |       |   |   |   |   |   |   |
| *Chief Executive Officer*                  |       | 2005     |       |          | 0          |                      |       | 0                                       |       |               |       |   |   |   | 0 |   |   |
|                                            |       | 2004     |       |          | 0          |                      |       | 0                                       |       |               |       |   |   |   | 0 |   |   |
|                                       |       |     |       |          |       |                      |       |                                    |       |               |       |   |   |   |   |   |   |
| Barry J. Sanders (2)                       |       | 2006     |       |          | 163,770    |                      |       | 0                                       |       |               | 34,950     |   |   |   | 198,720 |   |   |
| *President and Chief*                      |       | 2005     |       |          | 163,770    |                      |       | 0                                       |       |               | 0          |   |   |   | 163,770 |   |   |
| *Operating Officer*                        |       | 2004     |       |          | 159,000    |                      |       | 0                                       |       |               | 10,962     |   |   |   | 169,962 |   |   |

 

33

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(1)          JohnN. Hatsopoulos did not receive a salary, bonus or any other compensation in2006, 2005 or 2004, and will not receive a salary, bonus or any othercompensation in 2007, excluding reimbursable expenses.

(2)          Barry J. Sanders was granted an additional20,000 shares of restricted stock in 2006, none of which are vested.

**Outstanding Equity Awards at Fiscal Year End**

The following table sets forth information with respect to equity awardsas of December 31, 2006:
| Name                 | ** ** | **No. of Securities  Underlying  Unexercised  Options that are  Exercisable** | ** ** | **No. of Securities  Underlying  Unexercised  Options that are  Unexercisable** | ** ** | **Option  Exercise  Price** | ** ** | **Option   Expiration   Date** | ** ** |
|----------------------|------------|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------------------|------------|
|                 |       |                                                                                              |       |                                                                                                |       |                        |       |                                     |       |   |   |   |   |   |   |   |   |
| John N.  Hatsopoulos |       |                                                                                              | 0          |                                                                                                |       |                        | 0          |                                     |       |   | N/A |   |   |   | N/A |   |   |
| Barry J. Sanders     |       |                                                                                              | 320,000    |                                                                                                |       |                        | 0          |                                     |       |   | $ | 0.07 |   |   |   | 12/10/2011 |   |   |
| Barry J. Sanders     |       |                                                                                              | 50,000     |                                                                                                |       |                        | 37,500     |                                     |       |   | $ | 0.70 |   |   |   | 3/14/2015 |   |   |

 

**Director Compensation**

The following table sets forth information with respect to directorcompensation with respect to the fiscal year ended December 31, 2006:
| Name                   | ** ** | **Fees Earned or Paid in Cash ($)** | ** ** | **Total ($)** | ** ** |
|------------------------|------------|-------------------------------------------------------------------|------------|--------------------|------------|
|                   |       |                                                              |       |               |       |   |   |   |   |
| George N.  Hatsopoulos |       |                                                              | $          | 1,000              |       |   |   | $ | 1,000 |   |   |
| John N.  Hatsopoulos   |       |                                                              | $          | 0                  |       |   |   | $ | 0 |   |   |
| Charles D  Maxwell     |       |                                                              | $          | 1,000              |       |   |   | $ | 1,000 |   |   |
| Alan D.  Weinstein     |       |                                                              | $          | 1,000              |       |   |   | $ | 1,000 |   |   |
| Earl R. Lewis          |       |                                                              | $          | 1,000              |       |   |   | $ | 1,000 |   |   |

 

**Employment contracts and termination of employment andchange-in-control arrangements**

None of our named executive officers has an employmentcontract or change-in-control arrangement.

**EmployeeBenefit Plans**

**Stock Incentive Plan**

The following table sets forth information withrespect to our securities authorized for issuance under our 2001 StockIncentive Plan, which as amended in May 2003:
| **Plan Category**                                          | ** ** | **Number of securities  to be issued upon   exercise of   outstanding options,   rights and warrants** | ** ** | **Weighted average  exercise price of   outstanding   options, rights and   warrants** | ** ** | **Number of securities remaining  available for future issuance   under equity compensation plans  excluding securities reflected in  second column** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                            |       |                                                                                                                                                               |       |                                                                                                                           |       |                                                                                                                                                                                                                        |       |   |   |   |   |   |   |
| Equity Compensation  plans approved by security holders         |       |                                                                                                                                                               |       |                                                                                                                           |       |                                                                                                                                                                                                                        |       |   |   |   |   |   |   |
| Equity Compensation  plans without approval by security holders |       |                                                                                                                                                               | 2,087,500  |                                                                                                                           |       |                                                                                                                                                                                                                        | $          | 0.21 |   |   |   | 1,912,500 |   |   |
| Total                                                           |       |                                                                                                                                                               |       |                                                                                                                           |       |                                                                                                                                                                                                                        |       |   |   |   |   |   |   |
|                                                                 |            |                                                                                                                                                                    |            |                                                                                                                                |            |                                                                                                                                                                                                                             |            |  |  |  |  |  |  |  |

 

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In December 2001, thecompany adopted the 2001 Stock Incentive Plan, which was amended in May2003.  The Stock Incentive Planauthorizes the issuance of incentive stock options, non-qualified stockoptions, restricted stock and stock awards to the company’s employees,officers, directors, consultants and service providers for the purchase of upto 4,000,000 shares of Common Stock. The Stock Incentive Plan will terminate nolater than December 2011. As of December 31, 2006, there were outstanding underthe Stock Incentive Plan:

(a)          Incentiveand non-qualified options to acquire 1,620,000 shares of Common Stock granted,of which 1,120,000 shares have an exercise price of $0.07 per share, and 500,000shares have an exercise price of $0.70 per share;

(b)         180,000shares of restricted Common Stock at a purchase price of $0.0007 per share; and

(c)          287,500shares of restricted Common Stock at a purchase price of $0.001.

All of the options andrestricted shares are subject to vesting requirements and the company has theright to cancel or repurchase at cost all unvested stock options or restrictedshares at the time the recipient’s employment or consulting relationship withthe company is terminated.

**401(k) Plan**

Our retirement plan, which we refer to as the 401(k) plan, isqualified under Section 401 of the Internal Revenue Code. Our employeesmay elect to reduce their current compensation by an amount no greater than thestatutorily prescribed annual limit and may have that amount contributed to the401(k) plan. We may make matching or additional contributions to the 401(k)plan based on participant contributions up to a maximum of 4.5% of eachparticipant’s salary. We have contributed $16,273 to the Plan for the yearended December 31, 2006.

**Item11.  Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters**

The following table sets forthinformation with respect to the beneficial ownership of our Common Stock as ofDecember 31, 2006 for:

·                  each of our executive officers and directors;

·                  all of our executive officers and directors asa group; and

·                  anyother beneficial owner of more than 5% of our outstanding Common Stock.

Beneficial ownership is determined in accordance with the rules of theSEC. These rules generally attribute beneficial ownership of securities topersons who possess sole or shared voting power or investment power withrespect to those securities and include ordinary shares issuable upon theexercise of stock options that are immediately exercisable or exercisablewithin 60 days. Except as otherwise indicated, all persons listed belowhave sole voting and investment power with respect to the shares beneficiallyowned by them, subject to applicable community property laws. The informationis not necessarily indicative of beneficial ownership for any other purpose.

Percentage ownership calculations are based on26,017,250 shares outstanding as of December 31, 2006. Except as otherwiseindicated in the table below, addresses of named beneficial owners are care ofAmerican DG Energy Inc., 45 First Avenue, Waltham, Massachusetts 02451.

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| ** **                                                                                                          | ** ** | **Beneficial Ownership** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| **Name and Address**                                                                                      | ** ** | **Outstanding  Shares**       | ** ** | **Right to Acquire  Within 60 Days** | ** ** | **Shares  Beneficially Owned** | ** ** |
| **of Beneficial Owner**                                                                                   | ** ** | **Beneficially Owned**   | ** ** | **After Dec. 31, 2006** | ** ** | **Number** | ** ** | **Percentage** | ** ** |
| ** **                                                                                                          | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Holders of 5% or  more of our voting securities:**                                                                |       |                          |       |   |   |   |   |   |   |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| John and Patricia  Hatsopoulos  3 Woodcock Lane   Lincoln, MA 01773                                                 | ** ** | 8,300,000                     |       | 963,095 |   | 9,263,095 |   | 34.3 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| George N. Hatsopoulos   233 Tower Road   Lincoln, MA 01773                                                          |       | 6,217,609                     |       | 498,809 |   | 6,716,418 |   | 25.3 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| IDS Technologies Ltd. (1)   4 Andrea Zakou Street   Nicosia, Cyprus                                                 |       | 0                             |       | 4,761,905 |   | 4,761,905 |   | 15.5 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| Joseph J. Ritchie   2100 Enterprise Avenue   Geneva, IL 60134                                                       |       | 1,998,750                     |       | 0 |   | 1,998,750 |   | 7.7 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| Joseph Giamanco   4 White Rock Terrace   Holmdel, NJ 07733                                                          |       | 1,150,000                     |       | 900,000 |   | 2,050,000 |   | 7.6 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| Daphne Hatsopoulos, as Trustee   994 Trust f/b/o Marina  Hatsopoulos Bornhorst   233 Tower Road   Lincoln, MA 01773 |       | 1,336,195                     |       | 0 |   | 1,336,195 |   | 5.1 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| **Directors and Officers:**                                                                                         |       |                          |       |   |   |   |   |   |   |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| John N. Hatsopoulos                                                                                                 | ** ** | 8,300,000                     |       | 963,095 |   | 9,263,095 |   | 34.3 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| George N. Hatsopoulos                                                                                               |       | 6,217,609                     |       | 498,809 |   | 6,716,418 |   | 25.3 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |
| Charles T. Maxwell                                                                                                  |       | 100,000                       |       | 319,048 |   | 419,048 | ** ** | 1.6 | % |
| ** **                                                                                                          |       |                          |       |   |   |   |   |   |   |
| Alan D. Weinstein                                                                                                   |       | 0                             |       | 100,000 |   | 100,000 | ** ** | 0.4 | % |
|                                                                                                                |       |                          |       |   |   |   | ** ** |   |   |
| Barry J. Sanders                                                                                                    |       | 80,000                        |       | 332,500 |   | 412,500 | ** ** | 1.6 | % |
| ** **                                                                                                          |       |                          |       |   |   |   |   |   |   |
| Anthony S. Loumidis                                                                                                 |       | 60,000                        |       | 35,000 |   | 95,000 | ** ** | 0.4 | % |
| ** **                                                                                                          |       |                          |       |   |   |   |   |   |   |
| Earl R. Lewis                                                                                                       |       | 0                             |       | 25,000 |   | 25,000 |   | 0.1 | % |
| ** **                                                                                                          |       |                          |       |   |   |   |   |   |   |
| All executive officers and   directors as a group   (7 persons)                                                     |       | 14,757,609                    |       | 2,273,452 |   | 17,031,061 |   | 60.2 | % |
|                                                                                                                |       |                          |       |   |   |   |   |   |   |

 

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(1)The beneficial owner of IDS Technologies Ltd. is Konstantinos Samaras, whoseaddress is c/o IDS Technologies Ltd.

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**Item12.  Certain Relationships and RelatedTransactions**

In January 2006 the company entered into aFacilities, Support Services and Business Agreement with Tecogen.

The company has purchased the majority of its cogeneration unitsfrom Tecogen. For the year ending December 31, 2006, the company purchasedenergy generation assets in the amount of $1,309,933 from Tecogen. In addition,Tecogen paid certain operating expenses, including maintenance, benefits andinsurance, on behalf of the company in the amount of $452,316 and the companyhas leased office space from Tecogen. These costs were reimbursed to Tecogen bythe company. Tecogen has a sublease agreement for the office building, whichexpires on March 31, 2009. The company’s rent expense was determined on asquare foot usage basis. Under this sub-sub lease arrangement, rent expense in2006 amounted to $8,592. At December 31, 2006, Tecogen owed the company $18,613which is classified in the “Due from related party” account in the accompanyingbalance sheet.

On April 1, 2006, the following persons converted demand notesfrom the company into shares of common stock or convertible debentures of thecompany — George Hatsopoulos and spouse: $350,000 into 500,000 shares of commonstock at a price of $0.70 per share; and John Hatsopoulos and spouse: $350,000into 500,000 shares of common stock at a price of $0.70 per share, and $550,000into the company’s 8% convertible debentures for an aggregate principal amountequal to the principal and accrued interest converted. The terms of theforegoing transactions are as fair as would have been obtained with unrelatedparties.

InMay of 2006, the company loaned the minority interest partner in the NY LLC$125,000. The principal earns interest at 12% per annum and is due May 31,2007. The note receivable is classified in the Due from related party accountin the accompanying balance sheet. As of December 31, 2006 the balance on thisnote was $120,000.

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**Item 13.  Exhibits**
| Exhibit No. | ** ** | ** ** | ** ** | **Description**                                                                     |
|-------------|------------|------------|------------|-------------------------------------------------------------------------------------|
|        |       |       |       |                                                                                |
| 3.1*        |       | —     |       | Certificate of  Incorporation                                                       |
|        |       |       |       |                                                                                |
| 3.2*        |       | —     |       | By-laws                                                                             |
|        |       |       |       |                                                                                |
| 4.1*        |       | —     |       | Form of Warrant                                                                     |
|        |       |       |       |                                                                                |
| 10.1*       |       | —     |       | Audit Committee  Charter                                                            |
|        |       |       |       |                                                                                |
| 10.2*       |       |       |       | Compensation  Committee Charter                                                     |
|        |       |       |       |                                                                                |
| 10.3*       |       |       |       | 2001 Stock  Incentive Plan                                                          |
|        |       |       |       |                                                                                |
| 10.4*+      |       | —     |       | Facilities,  Support Services and Business Agreement with Tecogen Inc.              |
|        |       |       |       |                                                                                |
| 10.5*       |       | —     |       | Operating  Agreement of American DG New York LLC                          |
|        |       |       |       |                                                                                |
| 10.6*       |       | —     |       | Form of Energy  Purchase Agreement                                                  |
|        |       |       |       |                                                                                |
| 10.7*       |       | —     |       | Form of 8%  Senior Convertible Debenture Due 2011                                   |
|        |       |       |       |                                                                                |
| 14.1*       |       | —     |       | Code of Business  Conduct and Ethics                                                |
|        |       |       |       |                                                                                |
| 16.1*       |       | —     |       | Letter on change  in certifying accountant                                          |
|        |       |       |       |                                                                                |
| 21.1*       |       | —     |       | List of  subsidiaries                                                               |
|        |       |       |       |                                                                                |
| 31.1#       |       | —     |       | Rule 13a-14(a)  Certification of Chief Executive Officer                            |
|        |       |       |       |                                                                                |
| 31.2#       |       | —     |       | Rule 13a-14(a)  Certification of Chief Financial Officer                            |
|        |       |       |       |                                                                                |
| 32.1#       |       | —     |       | Section 1350  Certifications of Chief Executive Officer and Chief Financial Officer |

 

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* Incorporated by reference from the registrant’s Form 10-SB, as amended,originally filed with the Securities and Exchange Commission on October 3,2006.

+ Confidential treatment has been granted for portions of this document.The confidential portions have been omitted and have been filed separately, ona confidential basis, with the Securities and Exchange Commission.

# Filed herewith.

No reports on Form 8-K were filed during the last quarter of the fiscalyear ended December 31, 2006.

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**Item14.  Principal Accounting Fees andServices**

The following table summarizes fees billed to the company by Vitale,Caturano & Co., Ltd for professional services rendered for the period endedDecember 31, 2006:
|                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
| Audit Fees          |       | $        | —     |     | $          | — |   |
| Audit-related  fees |       | $        | 135,486    |     | $          | — |   |
| Tax fees            |       | $        | —     |     | $          | — |   |
| Other fees          |       | $        | 10,200     |     | $          | — |   |
| Total               |       | $        | 145,686    |     | $          | — |   |

 

Audit Fees. The audit fees consist of aggregate fees billed forprofessional services rendered by the audit of our consolidated financialstatements and review of the interim consolidated financial statements includedin quarterly reports.

Audit-Related Fees. The audit related fees consist of aggregate feesbilled for assurance and related services reasonably related to the performanceof the audit or review of our consolidated financial statements and are notreported under “Audit Fees”. These services were primarily for the benefitcompensation plan audits.

Tax Fees. Tax fees consist of aggregate fees billed for professionalservices for tax compliance, tax advice and tax planning. These servicesincluded assistance regarding federal and state tax compliance, and tax auditdefense.

All Other Fees. Fees are billed for professional services rendered inconnection with the Form 10SB are included in All Other Fees.

*Audit Pre-Approval of Policies and Procedures*

The Audit Committee’s current policy is to pre-approve all audit andpermissible non-audit services provided by our independent auditors. Theseservices may include audit services, audit related services, tax services andother services. The Audit Committee may also pre-approve particular services ona case-by-case basis.

*Audit Committee Approval of Fees*

Our Audit Committee approved all audit related fees, tax fees and allother fees listed above provided by Vitale, Caturano & Co., Ltd to usduring the year ended December 31, 2006

39

----

**SIGNATURES**

In accordance with Section 13 or 15(d) of the Exchange Act, theregistrant has caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, on March 30, 2007.
|   |                          |
|--------|-------------------------------|
|   | AMERICAN DG ENERGY INC.       |
|   | (Registrant)                  |
|   |                          |
|   | By: /s/ JOHN N. HATSOPOULOS   |   |
|   | Chief Executive Officer       |
|   | (Principal Executive Officer) |
|   |                          |
|   |                          |
|   | By: /s/ ANTHONY S. LOUMIDIS   |   |
|   | Chief Financial Officer       |
|   | (Principal Financial Officer) |
|   |                          |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the issuer and in the capacities and on thedates indicated.
| Signature                 | ** ** | **Title**               | ** **                                   | **Date** |
|---------------------------|------------|-------------------------|----------------------------------------------|----------|
|                      |       |                    |                                         |     |
| /s/ GEORGE N. HATSOPOULOS |       |                    | Chairman of the Board                        |     | March 30, 2007 |
| George N. Hatsopoulos     |       |                    |                                         |     |
|                      |       |                    |                                         |     |
| /s/ JOHN N. HATSOPOULOS   |       |                    | Chief Executive Officer                      |     | March 30, 2007 |
| John N. Hatsopoulos       |       |                    |                                         |     |
|                      |       |                    |                                         |     |
| /s/ ANTHONY S. LOUMIDIS   |       |                    | Chief Financial Officer (Principal Financial |     | March 30, 2007 |
| Anthony S. Loumidis       |       | and Accounting Officer) |                                         |     |
|                      |       |                    |                                         |     |
| /s/ BARRY J. SANDERS      |       |                    | President and Chief Operating Officer        |     | March 30, 2007 |
| Barry J. Sanders          |       |                    |                                         |     |
|                      |       |                    |                                         |     |
| /s/ EARL R. LEWIS         |       |                    | Director                                     |     | March 30, 2007 |
| Earl R. Lewis             |       |                    |                                         |     |
|                      |       |                    |                                         |     |
| /s/ CHARLES T. MAXWELL    |       |                    | Director                                     |     | March 30, 2007 |
| Charles T. Maxwell        |       |                    |                                         |     |
|                      |       |                    |                                         |     |
| /s/ ALAN D. WEINSTEIN     |       |                    | Director                                     |     | March 30, 2007 |
| Alan D. Weinstein         |       |                    |                                         |     |
|                           |            |                         |                                              |          |  |  |  |  |  |  |  |

 

40

----

**AMERICANDG ENERGY INC.**

**INDEX TO FINANCIAL STATEMENTS**
|                                                                                                                    | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------|
| Report of  Independent Registered Public Accounting Firm Vitale Caturano & Company  Ltd as of March 30, 2007   |       |       |
|                                                                                                               |       |       |
| Report of  Independent Registered Public Accounting Firm, Carlin Charron & Rosen,  LLP as of October 30, 2006  |       |       |
|                                                                                                               |       |       |
| Consolidated  Balance Sheets as of December 31, 2006 and December 31, 2005                                         |       |       |
|                                                                                                               |       |       |
| Consolidated  Statements of Operations for the years ended December 31, 2006 and December 31, 2005                 |       |       |
|                                                                                                               |       |       |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31, 2006 and  December 31, 2005 |       |       |
|                                                                                                               |       |       |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2006 and December  31, 2005                |       |       |
|                                                                                                               |       |       |
| Notes to  Consolidated Financial Statements                                                                        |       |       |

 

F-1

----

**Report of Independent Registered Public Accounting Firm**

To the Board of Directors and Stockholders of American DG Energy Inc. and subsidiaries:

We have audited theaccompanying consolidated balance sheet of American DG Energy Inc. andsubsidiaries (collectively, the “Company”) as of December 31, 2006 and therelated consolidated statements of operations, stockholders’ equity, and cashflows for the year ended December 31, 2006. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on the consolidated financial statements based on our audit.

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  The company isnot required to have, nor were we engaged to perform, and audit of its internalcontrol over financial reporting.  Anaudit includes consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above, present fairly, in allmaterial respects, the financial position of American DG Energy Inc. andsubsidiaries at December 31, 2006, and the results of their operations andtheir cash flows for the year ended December 31, 2006, in conformity withaccounting principles generally accepted in the United States of America.

As discussed in Note 2 tothe consolidated financial statements, the company adopted the provisions ofStatement of Financial Accounting Standard No. 123(R), “Share-Based Payment”,effective January 1, 2006.
|                                 |
|--------------------------------------|
| /s/ VITALE, CATURANO & CO., LTD. |   |
|                                 |   |
| Boston, Massachusetts                |
| March 28, 2007                       |

 

F-2

----

**Report of Independent Registered Public Accounting Firm**

To the Board of Directorsand Stockholders of

American DG Energy

Waltham,Massachusetts

We have auditedthe accompanying consolidated balance sheet of American DG Energy andSubsidiaries (f/k/a American Distributed Generation, Inc., hereinafter theCompany) as of December 31, 2005, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for the year ended December31, 2005. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audit.

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The company is not required tohave, nor were engaged to perform, an audit of its internal control overfinancial reporting. An audit includes consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audit provides areasonable basis for our opinion.

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of American DG Energy andSubsidiaries as of December 31, 2005, and the consolidated results of itsoperations and cash flows for the year ended December 31, 2005 in conformitywith accounting principles generally accepted in the United States of America.
|                                 |
|--------------------------------------|
| /s/ CARLIN, CHARRON & ROSEN, LLP |   |
|                                 |
| Boston, Massachusetts                |
| October 30, 2006                     |

 

F-3

----

**AMERICAN DG ENERGY AND SUBSISIARIES**

***CONSOLIDATED BALANCE SHEETS***
| ** **                                                                                                                                                   | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                   |       |                  |       |   |   |
| Current assets                                                                                                                                               |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                   |       | $                     | 3,420,446  |   | $ | 84,492 |   |
| Accounts receivable,  net                                                                                                                                    |       | 284,398               |       | 162,012 |   |
| Due from related party                                                                                                                                       |       | 121,896               |       | 26,750 |   |
| Prepaid and other  current assets                                                                                                                            |       | 84,667                |       | 95,235 |   |
| Total current assets                                                                                                                                         |       | 3,911,407             |       | 368,489 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Property, plant, and  equipment, net                                                                                                                         |       | 4,430,624             |       | 2,392,958 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| **TOTAL ASSETS**                                                                                                                                             |       | $                     | 8,342,031  |   | $ | 2,761,447 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                               |       |                  |       |   |   |
| Current liabilities                                                                                                                                          |       |                  |       |   |   |
| Accounts payable                                                                                                                                             |       | 115,125               |       | 67,973 |   |
| Short- term notes  payable- stockholders                                                                                                                     |       | —                |       | 1,250,000 |   |
| Accounts payable-  affiliate                                                                                                                                 |       | —                |       | 34,782 |   |
| Accrued expenses and  other current liabilities                                                                                                              |       | 420,302               |       | 208,024 |   |
| Total current  liabilities                                                                                                                                   |       | 535,427               |       | 1,560,779 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Convertible debentures                                                                                                                                       |       | 6,075,000             |       | — |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Redeemable common  stock, $0.001 par value; 450,000 shares issued and outstanding at December  31, 2006 and 2005                                             |       | 315,000               |       | 315,000 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Total liabilities                                                                                                                                            |       | 6,925,427             |       | 1,875,779 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Minority interest                                                                                                                                            |       | 682,388               |       | 515,525 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Commitments and  contingencies (Note10)                                                                                                                      |       |                  |       |   |   |
|                                                                                                                                                         |       |                  |       |   |   |
| Stockholders’ equity                                                                                                                                    |       |                  |       |   |   |
| Common stock, $0.001  par value; 50,000,000 shares authorized; 25,567,250 and 21,751,250 issued and  outstanding at December 31, 2006 and 2005, respectively |       | 25,567                |       | 21,751 |   |
| Additional paid- in-  capital                                                                                                                                |       | 6,659,448             |       | 4,233,176 |   |
| Common stock  subscription                                                                                                                                   |       | 6,775                 |       | — |   |
| Accumulated deficit                                                                                                                                          |       | (5,957,574            | )          | (3,884,784 | ) |
| Total Stockholders’  Equity                                                                                                                             |       | 734,216               |       | 370,143 |   |
|                                                                                                                                                         |       |                  |       |   |   |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                          |       | $                     | 8,342,031  |   | $ | 2,761,447 |   |

 

See accompanyingnotes to consolidated financial statements

F-4

----

**AMERICAN DG ENERGY AND SUBSISIARIES**

***CONSOLIDATED STATEMENTS OF OPERATIONS***
| ** **                                              | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                                    |       |                  | ** ** |   |   |
| Net Sales                                               |       | $                     | 3,174,326  | ** ** | $ | 2,167,726 |   |
|                                                    |       |                  | ** ** |   |   |
| Cost of sales                                           |       | ** **            |       |   |   |
| Fuel and maintenance                                    |       | 2,424,020             | ** ** | 1,577,645 |   |
| Depreciation expense                                    |       | 316,515               | ** ** | 181,185 |   |
|                                                    |       | 2,740,535             | ** ** | 1,758,830 |   |
| Gross profit                                            |       | 433,791               | ** ** | 408,896 |   |
|                                                    |       |                  | ** ** |   |   |
| Operating expenses                                      |       | ** **            |       |   |   |
| General and  administrative                             |       | 1,646,134             | ** ** | 705,412 |   |
| Selling                                                 |       | 331,916               | ** ** | 175,829 |   |
| Engineering                                             |       | 308,921               | ** ** | 206,040 |   |
|                                                    |       | 2,286,971             | ** ** | 1,087,281 |   |
| Loss from operations                                    |       | (1,853,180            | )          | (678,385 | ) |
|                                                    |       |                  | ** ** |   |   |
| Other income (expense)                                  |       | ** **            |       |   |   |
| Interest income                                         |       | 126,996               | ** ** | 14,505 |   |
| Interest expense                                        |       | (311,280              | )          | (46,029 | ) |
| Other                                                   |       | (16,043               | )          | (2,508 | ) |
|                                                    |       | (200,327              | )          | (34,032 | ) |
|                                                    |       | ** **            | ** ** | ** ** | ** ** |
| Net loss before  minority interest                      |       | (2,053,507            | )          | (712,417 | ) |
|                                                    |       |                  | ** ** | ** ** | ** ** |
| Minority interest                                       |       | 19,283                | ** ** | 99,689 |   |
| Net loss                                                |       | $                     | (2,072,790 | ) | $ | (812,106 | ) |
|                                                    |       |                  |       | ** ** |   |
| Net loss per share -  basic and diluted                 |       | $                     | (0.09      | ) | $ | (0.04 | ) |
|                                                    |       |                  |       |   |   |
| Weighted average shares outstanding - basic and diluted |       | 23,608,362            |       | 22,503,360 |   |

 

See accompanyingnotes to consolidated financial statements

F-5

----

**AMERICANDG ENERGY AND SUBSISIARIES**

***CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY***
| ** **                                  | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Common  Stock  Subscription** | ** ** | **Accumulated  Deficit** | ** ** | **Unearned  Compensation** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|-------------------|------------|----------------------------------|------------|---------------------------------|------------|--------------------------|------------|----------------------------|------------|------------|------------|
| ** **                                  | ** ** | ** **        | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** **               | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Balance at December 25,  2004               |       | 22,260            |       | $                                | 2,945,148  |                            | $          | —                   |       | $                          | (2,095,178 | )          | $          | (4,500 | ) | $ | 867,730 |   |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Issuance of common  stock                   |       | 1,490             |       | 1,433,254                        |       | —                          |       | —                   |       | —                     |       | 1,434,744  |       |
| Repurchase and  retirement of common stock  |       | (1,999            | )          | (145,226                         | )          | —                          |       | —                   |       | —                     |       | (147,225   | )          |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Dividend - common stock                     |       | —            |       | —                           |       | —                          |       | (977,500                 | )          | —                     |       | (977,500   | )          |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Net loss                                    |       | —            |       | —                           |       | —                          |       | (812,106                 | )          | —                     |       | (812,106   | )          |
| Amortization of  unearned compensation      |       | —            |       | —                           |       | —                          |       | —                   |       | 4,500                      |       | 4,500      |       |
| Balance at December 31,  2005               |       | 21,751            |       | 4,233,176                        |       | —                          |       | (3,884,784               | )          | —                     |       | 370,143    |       |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Conversion of note  payable to common stock |       | 1,000             |       | 699,000                          |       | —                          |       | —                   |       | —                     |       | 700,000    |       |
| Sale of common stock,  net of costs         |       | 902               |       | 571,265                          |       | —                          |       | —                   |       | —                     |       | 572,166    |       |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Issuance of restricted  stock               |       | 288               |       | —                           |       | (225                            | )          | —                   |       | —                     |       | 63         |       |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Common stock  subscription                  |       | —            |       | —                           |       | 7,000                           |       | —                   |       | —                     |       | 7,000      |       |
| Stock based  compensation expense           |       | 877               |       | 663,257                          |       | —                          |       | —                   |       | —                     |       | 664,134    |       |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Exercise of stock  options                  |       | 50                |       | 3,450                            |       | —                          |       | —                   |       | —                     |       | 3,500      |       |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Exercise of warrants                        |       | 700               |       | 489,300                          |       | —                          |       | —                   |       | —                     |       | 490,000    |       |
|                                        |       |              |       |                             |       |                            |       |                     |       |                       |       |       |       |
| Net loss                                    |       | —            |       | —                           |       | —                          |       | (2,072,790               | )          | —                     |       | (2,072,790 | )          |
| Balance at December 31, 2006                |       | 25,567            |       | $                                | 6,659,448  |                            | $          | 6,775                    |       | $                          | (5,957,574 | )          | $          | — |   | $ | 734,216 |   |

 

See accompanying notes to consolidated financial statements

F-6

----

**AMERICAN DG ENERGY AND SUBSISIARIES**

***CONSOLIDATED STATEMENTS OF CASH FLOWS***
| ** **                                                                                                       | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                                       |       |                  |       |   |   |
| Net loss                                                                                                         |       | $                     | (2,072,790 | ) | $ | (812,106 | ) |
| *Adjustments to reconcile net  loss to net cash used in operating activities:*                                   | ** ** | ** **            | ** ** | ** ** | ** ** |
| Depreciation and  amortization                                                                                   |       | 316,515               | ** ** | 181,185 |   |
| Minority interest in  net income of consolidated subsidiaries                                                    |       | 19,283                | ** ** | 99,689 |   |
| Amortization of  deferred financing costs                                                                        |       | 6,028                 | ** ** | — |   |
| Provision for losses on  accounts receivable                                                                     |       | 57,000                | ** ** | — |   |
| Non cash interest  expense                                                                                       |       | 121,500               | ** ** | — |   |
| Stock-based  compensation                                                                                        |       | 664,134               | ** ** | 4,500 |   |
|                                                                                                             |       | ** **            | ** ** | ** ** | ** ** |
| *Changes in operating assets and  liabilities*                                                                   | ** ** | ** **            | ** ** | ** ** | ** ** |
| (Increase) decrease in:                                                                                          |       | ** **            | ** ** | ** ** | ** ** |
| Accounts receivable,  net                                                                                        |       | (179,386              | )          | 121,210 |   |
| Due from related party                                                                                           |       | (95,146               | )          | 48,250 |   |
| Prepaid assets                                                                                                   |       | 46,928                | ** ** | (95,235 | ) |
| Increase (decrease) in:                                                                                          |       | ** **            | ** ** | ** ** | ** ** |
| Accounts payable                                                                                                 |       | 47,152                | ** ** | (32,894 | ) |
| Accounts payable-  affiliate                                                                                     |       | (34,782               | )          | (224,956 | ) |
| Accrued expenses and  other current liabilities                                                                  |       | 190,778               | ** ** | 43,925 |   |
| Net cash used in  operating activities                                                                           |       | (912,786              | )          | (666,432 | ) |
|                                                                                                             |       | ** **            | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** |
| Acquisition of property  and equipment                                                                           |       | (2,354,181            | )          | (1,018,203 | ) |
| Net cash used in  investing activities                                                                           |       | (2,354,181            | )          | (1,018,203 | ) |
|                                                                                                             |       | ** **            | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** |
| Proceeds from issuance  of restricted stock                                                                      |       | 63                    | ** ** | — |   |
| Proceeds from common  stock subscription                                                                         |       | 7,000                 | ** ** | — |   |
| Proceeds from sale of  warrants                                                                                  |       | 490,000               | ** ** | — |   |
| Minority contribution  (distribution) from consolidated subsidiaries                                             |       | 147,580               | ** ** | (180,333 | ) |
| Proceeds from sale of  common stock, net of costs                                                                |       | 572,166               | ** ** | 1,564,744 |   |
| Proceeds from exercise  of stock options                                                                         |       | 3,500                 | ** ** | — |   |
| Repurchase of  outstanding common stock                                                                          |       | —                | ** ** | (347,225 | ) |
| Proceeds from sale of  convertible debenture net of issuance cost and conversion of notes payable                |       | 5,382,612             | ** ** | — | ** ** |
| Net cash provided by  financing activities                                                                       |       | 6,602,921             |       | 1,037,186 |   |
|                                                                                                             |       |                  | ** ** | ** ** | ** ** |
| Net increase (decrease)  in cash and cash equivalents                                                            |       | 3,335,954             |       | (647,449 | ) |
| Cash and cash  equivalents, beginning of year                                                                    |       | 84,492                |       | 731,941 |   |
| Cash and cash  equivalents, ending of year                                                                       |       | $                     | 3,420,446  |   | $ | 84,492 |   |
|                                                                                                             |       |                  | ** ** | ** ** | ** ** |
| **Supplemental disclosures of  cash flows information:**                                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Cash paid during the year for:**                                                                               | ** ** | ** **            | ** ** | ** ** | ** ** |
| Interest                                                                                                         |       | $                     | —     |   | $ | — |   |
| Income taxes                                                                                                     |       | $                     | 21,448     |   | $ | 6,189 |   |
|                                                                                                             |       |                  | ** ** | ** ** | ** ** |
| **Non-cash investing and financing  activities:**                                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| Conversion of note  payable and interest to convertible debenture                                                |       | $                     | 650,000    |   | $ | — |   |
| Conversion of note  payable to common stock                                                                      |       | $                     | 700,000    |   | $ | — |   |
|                                                                                                             |       |                  | ** ** | ** ** | ** ** |
| Common stock  distributed as dividend                                                                            |       | $                     | —     |   | $ | 977,500 |   |
| Property and equipment  acquired through in-kind installation contributed as equity by minority  interest holder | ** ** | $                     | —     |   | $ | 133,750 | ** ** |

 

See accompanyingnotes to consolidated financial statements

F-7

----

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**Note 1 — The Company and Basis ofPresentation:**

American DG Energy Inc. (“American DG Energy”, the “company”, “ADGE” or“we”) distributes and operates on-site cogeneration systems that produce bothelectricity and heat. Our business is to own the equipment that we install atcustomers’ facilities and to sell the energy produced by these systems to thecustomers on a long-term contractual basis. We call this business the AmericanDG Energy “On-Site Utility”.

The company was incorporated as a Delaware corporation on July 24, 2001to install, own, operate and maintain complete DG systems and othercomplementary systems at customer sites and sell electricity, hot water, heatand cooling energy under long-term contracts at prices guaranteed to thecustomer to be below conventional utility rates. American DG Energy has beenoperating as a subsidiary of American Distributed Generation Inc. since 2003,along with Tecogen. In December 2005, the Board of Directors of AmericanDistributed Generation Inc. decided to distribute to its shareholders all ofthe outstanding shares of Tecogen in the form of a stock dividend. American DGEnergy merged with American Distributed Generation Inc. and the company thenchanged its name to American DG Energy Inc. As of December 31, 2006, we hadinstalled energy systems, representing approximately 2,535 kW (kilowatt), 28.24MMBtu’s (million British thermal units) of heat and hot water and 400 tons ofcooling. Kilowatt (kW) is a measure of electricity generated, MMBtu is ameasure of heat generated and a ton is a measure of cooling generated.

We derive sales from selling energy in the form ofelectricity, heat, hot water and cooling to our customers under long-termenergy sales agreements (with a typical term of 10 to 15 years). The energysystems are owned by us and are installed in our customers’ buildings. Eachmonth we obtain readings from our energy meters to determine the amount ofenergy produced for each customer. We multiply these readings by theappropriate published price of energy (electricity, natural gas or oil) fromour customer’s local energy utility, to derive the value of our monthly energysale, less the applicable negotiated discount. Our revenues per customer on amonthly basis vary based on the amount of energy produced by our energy systemsand the published price of energy (electricity, natural gas or oil) from ourcustomer’s local energy utility that month. Our revenues commence as new energysystems become operational. Asof December 31, 2006, we had 39 energy systems operational.

We haveexperienced total net losses since inception of approximately $6.0 million. Forthe foreseeable future, we expect to experience continuing operating losses andnegative cash flows from operations as our management executes our currentbusiness plan. The cash and cash equivalents available at December 31, 2006will provide sufficient working capital to meet our anticipated expendituresincluding installations of new equipment for the next twelve months however, aswe continue to grow our business by adding more energy systems, the cashrequirements will increase. We believe that our cash and cash equivalentsavailable at December 31, 2006 and our ability to control certain costs, includingthose related to general and administrative expenses will enable us to meet ouranticipated cash expenditures through January 1, 2008. Beyond January 1, 2008we may need to raise additional capital through a debt financing or equityoffering to meet our operating and capital needs. There can be no assurance,however, that we will be successful in our fundraising efforts or thatadditional funds will be available on acceptable terms, if at all.

In 2006 we raised approximately $6.5million through a private placement of our common stock, the exercise ofvarious warrants and the issuance of a convertible debenture. If we are unableto raise additional capital in 2008 we may need to terminate certain of ouremployees and adjust our current business plan. Financial considerations maycause us to modify planned deployment of new energy 

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systems and we may decide to suspend installationsuntil we are able to secure additional working capital. We will evaluatepossible acquisitions of, or investments in, businesses, technologies andproducts that are complementary to our business, however, we currently have nosuch discussions.

The company’s operations are comprised of one business segment. Ourbusiness is selling energy in the form of electricity, heat, hot water andcooling to our customers under long-term sales agreements.

**Note 2 —Summary of significant accounting policies:**

*Principles of Consolidation*

The accompanying consolidated financial statements include the accounts ofAmerican DG Energy, its wholly owned subsidiary American DG Energy, Inc. andits 51% joint venture, American DG New York, LLC (NY, LLC), and Hermany Energy,LLC (Hermany), of which NY, LLC is a 50% member (referred to hereafter as “Investeeentities”). All material intercompany accounts and transactions have beeneliminated in consolidation.

Investee entities in which American DG Energy, Inc. owns directly orindirectly 50% or more of the membership interests have been consolidated as aresult of the company’s control over the investee entities. Minority interestsin the net assets and earnings or losses of consolidated Investee entities arereflected in the caption “Minority interest” in the accompanying consolidatedfinancial statements. Minority interest adjusts the consolidated results ofoperations to reflect only American DG Energy’s share of the earnings or lossesof the consolidated Investee entities. Upon dilution of ownership below 50%,the accounting method is adjusted to the equity or cost method of accounting,as appropriate, for subsequent periods.

In January 2006, the company entered into an agreement with Hermany Farmsto liquidate the entity. The assets and liabilities were distributed inaccordance with the terms of the limited liability company agreement. Theprocess to liquidate Hermany was completed on December 29, 2006.

The company evaluates the applicability of Financial Accounting StandardsBoard (“FASB”) Interpretation No. 46 (Revised) “Consolidation of VariableInterest Entities” (FIN 46(R)) to partnerships and joint ventures at theinception of its participation to ensure its accounting is in accordance withthe appropriate standards. The company has contractual interests in TecogenInc. and determined that Tecogen was a Variable Interest Entity (VIE), asdefined by FIN 46R; however, the company was not considered the primarybeneficiary and does not have any exposure to loss as a result of itsinvolvement with Tecogen. Therefore, Tecogen was not consolidated in ourConsolidated Financial Statements through December 31, 2006. See Note 8 forfurther discussion.

*Use of Estimates*

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

*Revenue Recognition*

Revenue from ourenergy systems is recognized when energy is used by our customers. We sellenergy to our customers at a guaranteed rate that is at or below rates chargedby conventional utility 

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suppliers. Our monthlycustomer invoice is based on a formula that is defined in each customeragreement. Each month our energy systems produce energy in the form ofelectricity, heat, hot water and cooling. At the end of each month, we read themeters on our equipment that indicate the amount of energy produced anddelivered to our customer for the period. Typically, our revenue for the periodis calculated by multiplying the meter readings times the current price ofenergy charged by conventional utility suppliers, and then subtracting theappropriate contracted discount and any other adjustments.

We do not have anymaterial contracts where we have recognized revenue based on the sale orinstallation of our energy systems. Additionally we do not have any revenueassociated with maintenance or servicing the energy systems.

*Cash and cash equivalents*

The company considers all highly liquidinvestments with a maturity of three months or less when purchased to be cashequivalents. The company has cash balances in certain financial institutions inamounts which occasionally exceed current federal deposit insurance limits. Thefinancial stability of these institutions is continually reviewed by seniormanagement.  The company believes it isnot exposed to any significant credit risk on cash and cash equivalents.

*Accounts receivable*

The company maintains receivable balancesprimarily with customers located throughout New York and New Jersey. Thecompany reviews its customer’s credit history before extending credit andgenerally does not require collateral. An allowance for doubtful accounts isestablished based upon factors surrounding the credit risk of specificcustomers, historical trends, and other information. Generally, such losseshave been within management’s expectations.

Accounts receivable are presented net of anallowance for doubtful collections of $57,000 and $0 at December 31, 2006 and2005 respectively. Included in accounts receivable as of December 31, 2006 areamounts from four major customers accounting for approximately 56% of totalaccounts receivable. There were sales to three customers accounting forapproximately 46% of total sales for the year ended December 31, 2006. Therewere sales to four customers accounting for approximately 36% of total salesfor the year ended December 31, 2005.

*Accounts payable*

Included in accounts payable as of December 31,2006 are amounts due to five major vendors accounting for approximately 66% oftotal accounts payable. Purchases from four vendors accounted for approximately51% of total cost of goods sold for the year ended December 31, 2006.  Purchases from four vendors accounted forapproximately 54% of total cost of goods sold for the year ended December 31,2005.

*Supply Concentrations*

Approximately 100% of the company’s cogenerationunit purchases for the year ended December 31, 2006 and 2005 were from onevendor (see Note 8). We believe there are sufficient alternative vendorsavailable to ensure a constant supply of cogeneration units on comparableterms. However, in the event of a change in suppliers, there could be a delayin obtaining units which could result in a temporary slowdown of installingadditional income producing sites. In addition, the majority of the company’sunits are installed and maintained by the minority interest holder ormaintained by Tecogen. The company believes there are sufficient alternativevendors available to ensure a constant supply of 

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installation services on comparable terms.However, in the event of a change of vendor, there could be a delay ininstallation or maintenance services.

*Property and Equipment and Depreciation andAmortization*

Property andequipment are stated at cost. Depreciation and amortization are computed usingthe straight-line method at rates sufficient to write off the cost of theapplicable assets over their estimated useful lives. The company uses 10 yearsfor the majority of the assets such as its energy systems and 3-5 years forcomputer equipment, software, office furniture etc. Repairs and maintenance areexpensed as incurred.

*Stock Based Compensation*

Effective January 1, 2006, we adopted SFAS No. 123 (revised2004), *Share Based Payment*, orSFAS 123(R), which is a revision of Statement No. 123 (“SFAS 123”) *Accounting for Stock Based Compensation*.SFAS 123(R) supersedes Accounting Principles Board (“APB”) No. 25, *Accounting for Stock Issued to Employees* (“APB25”), and amends Financial Accounting Standards Board (“FASB”) StatementNo. 95 *Statement of Cash Flows.*SFAS 123(R) requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the income statement based on theirfair values. Pro forma disclosure is no longer an alternative.

Prior to January 1, 2006, we accounted for employeestock-based compensation in accordance with the provisions of APB 25 and FASBInterpretation No. 44, *Accounting forCertain Transactions Involving Stock Compensation — an Interpretation of APBNo. 25*, and we complied with the disclosure provisions ofSFAS 123, and related SFAS No. 148, *Accountingfor Stock-Based Compensation — Transaction and Disclosure*. Under APB25, compensation expense is based on the difference, if any, on the date of thegrant, between the fair value of our stock and the exercise price of theoption. We amortize such stock-based compensation, if any, using the straight-linemethod over the vesting period.

SFAS 123(R) requires nonpublic companies that used theminimum value method in SFAS 123 for either recognition or pro formadisclosures to apply SFAS 123(R) using the prospective-transition method. Assuch, since we were not a public Company as of the adoption date, we willcontinue to apply APB 25 in future periods to equity awards outstanding at thedate of SFAS 123(R)’s adoption that were measured using the minimum valuemethod. In accordance with the requirements of SFAS 123(R), the Company willnot present pro forma disclosures for periods prior to the adoption of SFAS123(R), as the estimated fair value of the Company’s stock options grantedthrough December 31, 2005 was determined using the minimum value method.

During the year ended December 31, 2006 the companyrecognized employee non-cash compensation expense of $50,374 related to theissuance of restricted stock. At December 31, 2006 there were 287,500 unvestedshares of restricted stock outstanding. The total compensation cost related tounvested restricted stock awards not yet recognized is $150,589. This amountwill be recognized over the next five years. No stock options were grantedduring 2006.

The determination of thefair value of share-based payment awards is affected by our stock price. We donot have a history of market prices of our common stock as we are not yet apublicly traded company. The Company considered the sales price of common stockin private placements to unrelated third parties during the year as a measureof the fair value of its common stock.

SFAS 123(R) alsorequires companies to utilize an estimated forfeiture rate when calculating theexpense for the period, whereas, SFAS 123 permitted companies to recordforfeitures based on actual forfeitures, which was our historical policy underSFAS 123. As a result, we applied an estimated 

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forfeiture rate of 0% during 2006 indetermining the expense recorded in the accompanying consolidated statement ofincome. Forfeitures are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. Stock-based compensation expense recognized in our financialstatements in 2006 and thereafter is based on awards that are ultimately expectedto vest. We evaluate the assumptions used to value our awards on a quarterlybasis and if factors change and we employ different assumptions, stock-basedcompensation expense may differ significantly from what we have recorded in thepast. If there are any modifications or cancellations of the underlyingunvested securities, we may be required to accelerate, increase or cancel anyremaining unearned stock-based compensation expense.

Prior to January 1, 2006, wegranted our employees options to purchase common stock at exercise prices equalto the fair market value of the underlying stock at the time of each grant, asdetermined by our compensation committee and reference to sale of common stockin private placements to unrelated third parties. At the date of each optiongrant, our board of directors determined that the exercise price for eachoption was equivalent to the then-existing fair value of our common stock. Ourboard of directors believes it properly valued our common stock in all periods.

On November 10, 2005, theFinancial Accounting Standards Board (“FASB”) issued FASB Staff Position SFAS123R-3 “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards.”  The Companyhas elected to adopt the alternative transition method provided the FASB StaffPosition for calculating the tax effects (if any) of stock-based compensationexpense pursuant to SFAS 123R.  Thealternative transition method includes simplified methods to establish thebeginning balance of the additional paid-in capital pool related to the taxeffects of employee stock-based compensation, and to determine the subsequentimpact to the additional paid-in capital pool and the consolidated statementsof operations and cash flows of the tax effects of employee stock-basedcompensation awards that are outstanding upon adoption of SFAS 123R.

See Note 6 for a summary of the restricted stock and stockoption activity under our stock-based employee compensation plan for the yearended December 31, 2006 and 2005.

*Earningsper Common Share*

We compute basic earnings per share by dividing net income (loss) for theperiod by the weighted average number of shares of common stock outstandingduring the period. We compute our diluted earnings per common share using thetreasury stock method. For purposes of calculating diluted earnings per share,we consider our shares issuable in connection with stock options and warrantsto be dilutive common stock equivalents when the exercise price is less thanthe average market price of our common stock for the period. For the year endedDecember 31, 2006, we excluded 8,285,145 anti-dilutive shares resulting fromconversion of debentures and exercise of stock options and warrants, and forthe year ended December 31, 2005 we excluded 1,053,000 anti-dilutive stockoptions and warrants.

*Other Comprehensive Net Loss*

The comprehensive net loss for the years endedDecember 31, 2006 and 2005 does not differ from the reported loss.

*Impairmentof Intangible Assets:*

The company evaluates the recoverabilityof its long-lived assets in accordance with Statement of Financial AccountingStandards No. 144 (“SFAS No. 144”), *Accountingfor the Impairment or Disposal of Long-Lived Assets.*SFAS No. 144requires the recognition of impairment of long-lived assets in the event thenet book value of such assets exceeds the estimated future undiscounted cashflows attributable 

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to such assets. If impairment isindicated, the asset is written down to its estimated fair value based on adiscounted cash flow analysis. The company reviews long-lived assets forimpairment annually or whenever events or changes in business circumstancesindicate that the carrying value of the assets may not be fully recoverable orthat the useful lives of the assets are no longer appropriate. At December 31,2006 the company determined that its long-lived assets are recoverable.

*Income Taxes*

We account for income taxes in accordance SFAS No. 109, “Accounting forIncome Taxes”. Under SFAS No. 109, deferred tax assets and liabilities aredetermined based on differences between the financial reporting and taxreporting bases of assets and liabilities and are measured by applying theenacted tax rates and laws to taxable years in which the differences areexpected to reverse. We recognize a deferred tax asset for the tax benefit ofnet operating loss carry forwards when it is more likely than not that the taxbenefits will be realized and reduce the deferred tax asset with a valuationreserve when it is more likely than not that some portion of the tax benefitswill not be realized.

*Fair Value of Financial Instruments*

The company’s financial instruments are cash andcash equivalents, accounts receivable, accounts payable and convertibledebentures. The recorded values of cash and cash equivalents, accountsreceivable and accounts payable approximate their fair values based on theirshort-term nature. The carrying value of the convertible debentures on thebalance sheet at December 31, 2006 approximates fair value as the termapproximate those currently available for similar instruments.

*Recent Accounting Pronouncements*

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109.” This interpretation clarifiesthe accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, “Accountingfor Income Taxes.” This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. It alsoprovides guidance on de-recognition, classification, interest and penalties,accounting in interim periods, disclosure and transition. This Interpretationis effective for the company beginning in fiscal year 2007. The company doesnot expect the adoption of this pronouncement to have a significant impact onits consolidated financial statements.

InFebruary 2006, the FASB issued SFAS No. 155 (FAS 155), “Accounting forCertain Hybrid Financial Instruments: an amendment of FASB StatementsNo. 133 and 140.” FAS 155 permits fair value re-measurement for any hybridfinancial instrument that contains an embedded derivative that otherwise wouldrequire bifurcation, clarifies which interest-only strips and principal-onlystrips are not subject to the requirements of Statement 133, establishes arequirement to evaluate interests in securitized financial assets to identifyinterests that are freestanding derivatives or that are hybrid financialinstruments that contain an embedded derivative requiring bifurcation,clarifies that concentrations of credit risk in the form of subordination arenot embedded derivatives, and amends Statement 140 to eliminate the prohibitionon a qualifying special purpose entity from holding a derivative financialinstrument that pertains to a beneficial interest other than another derivativefinancial instrument. FAS 155 is effective for all financial instrumentsacquired or issued after the beginning of an entity’s first fiscal year thatbegins after September 15, 2006. The Corporation does not expect theadoption of FAS 155 will have a material impact on its results of operations,financial position or liquidity.

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InMarch 2006, the FASB issued SFAS No. 156, “Accounting for Servicing ofFinancial Assets” (“SFAS NO. 156”), which provides an approach to simplifyefforts to obtain hedge-like (offset) accounting. This Statement amends FASBStatement No. 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities”, with respect to the accounting forseparately recognized servicing assets and servicing liabilities. The Statement(1) requires an entity to recognize a servicing asset or servicing liabilityeach time it undertakes an obligation to service a financial asset by enteringinto a servicing contract in certain situations; (2) requires that a separatelyrecognized servicing asset or servicing liability be initially measured at fairvalue, if practicable; (3) permits an entity to choose either the amortizationmethod or the fair value method for subsequent measurement for each class ofseparately recognized servicing assets or servicing liabilities; (4) permits atinitial adoption a one-time reclassification of available-for-sale securitiesto trading securities by an entity with recognized servicing rights, providedthe securities reclassified offset the entity’s exposure to changes in the fairvalue of the servicing assets or liabilities; and (5) requires separatepresentation of servicing assets and servicing liabilities subsequentlymeasured at fair value in the balance sheet and additional disclosures for allseparately recognized servicing assets and servicing liabilities. SFAS No. 156is effective for all separately recognized servicing assets and liabilities asof the beginning of an entity’s fiscal year that begins after September 15,2006, with earlier adoption permitted in certain circumstances. The Statementalso describes the manner in which it should be initially applied. The companydoes not believe that SFAS No. 156 will have a material impact on its financialposition, results of operations or cash flows.

In September 2006, the FASB issued SFAS No.157 “Fair Value Measures” (“SFAS 157”). SFAS 157 defines fair value,establishes a framework for measuring fair value, and expands disclosures aboutfair value measurements. This statement applies under other accountingpronouncements that require or permit fair value measurements, however it doesnot apply to SFAS 123R. This Statement shall be effective for financialstatements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. TheCompany is currently evaluating the effect, if any, of SFAS 157 on itsfinancial statements.

In February 2007, the FASB issued SFASNo. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS159”). SFAS 159 provides companies with an option to report selected financialassets and liabilities at fair value. SFAS 159 also establishes presentationand disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement attributes for similar types ofassets and liabilities and to provide additional information that will helpinvestors and other financial statement users to more easily understand theeffect of the company’s choice to use fair value on its earnings. Finally, SFAS159 requires entities to display the fair value of those assets and liabilitiesfor which the company has chosen to use fair value on the face of the balancesheet. SFAS 159 is effective as of the beginning of an entity’s first fiscalyear beginning after November 15, 2007. Early adoption is permitted. TheCompany is currently assessing the impact of SFAS 159 which it will be requiredto adopt.

In September 2006, theSecurities and Exchange Commission (SEC) issued Staff Accounting Bulletin 108, “Consideringthe Effects on Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements,” (“SAB 108”). SAB 108 requires registrantsto quantify errors using both the income statement method (i.e. iron curtainmethod) and the rollover method and requires adjustment if either methodindicates a material error. If a correction in the current year relating toprior year errors is material to the current year, then the prior yearfinancial information needs to be corrected. A correction to the prior year resultsthat are not material to those years would not require a “restatement process”where prior financials would be amended. SAB 108 is effective for our yearended December 31, 2006. The company does not believe that the adoption of theSAB 108 will have a material effect on its financial position, results ofoperations or cash flows.

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**Note 3 — Property plant and equipment:**

Property and equipment consists of the followingas of December 31, 2006 and 2005:
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Computer equipment  and software     |       | $                     | 12,660     |   | $ | 10,342 |   |
| Furniture and  fixtures              |       | 906                   |       | 906 |   |
| Machinery and  equipment             |       | —                |       | 124,804 |   |
| Co-generation  units                 |       | 4,127,872             |       | 2,048,008 |   |
|                                 |       | 4,141,438             |       | 2,184,060 |   |
| Less — accumulated depreciation |       | 664,765               |       | 348,250 |   |
|                                 |       | 3,476,673             |       | 1,835,810 |   |
| Construction in  progress            |       | 953,951               |       | 557,148 |   |
|                                 |       | $                     | 4,430,624  |   | $ | 2,392,958 |   |

 

Depreciation of property and equipment totaled $316,515 and $181,185 forthe years ended December 31, 2006 and 2005.

**Note 4 —Short-term notes payable:**

OnDecember 31, 2005 the company had short-term notes payable to stockholders of$1,250,000. The notes were due upon the earlier of either written demand forpayment or consummation of any financing by the company. During the year endedDecember 31, 2006, the company converted $700,000 of the short-term notes to1,000,000 shares of common stock. In addition, the company converted theremaining $550,000 of short-term notes and $100,000 of accrued interest relatedto the notes to convertible debentures (see Note 5).

**Note 5 —Convertible debentures:**

InApril and June of 2006, the company issued convertible debentures totaling$6,075,000 to existing investors (the “debentures”). The debentures accrueinterest at a rate of 8% per annum and are due 5 years from the issuance date.The debentures are convertible, at the option of the holder, into a number ofshares of common stock as determined by dividing the original outstandingamount of the respective debenture by the conversion price in effect at thetime. The initial conversion price of the debenture is $0.84 and is subject toadjustment in accordance with the agreement. As of December 31, 2006, therewere 7,232,145 shares of common stock issuable upon conversion of ouroutstanding convertible debentures.

**Note 6 —Stockholders’ equity:**

*Common Stock*

In 2005 the company raised funds through a private placement of commonstock and warrants to a limited number of accredited investors. In connectionwith the private placement we sold an aggregate of 1,490,000 shares of commonstock at a purchase price of $0.70 per share, resulting in net cash proceeds 

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of $1,434,744. In 2006 the company raised additional funds through aprivate placement of common stock to a limited number of accredited investors.In connection with the private placement we sold an aggregate of 901,700 sharesof common stock at a purchase price of $0.70 per share, resulting in net cashproceeds or $572,166. The holders of common stock have the right to vote theirinterest on a per share basis. Asof December 31, 2006, there were 25,567,250 shares of common stock outstanding.

The company has also issued redeemable common stock. The holders of theshares of the redeemable common stock may elect to require the company toredeem their shares, if certain obligations are not met in accordance with theterms of the redemption agreement. Due to the redemption features, the commonstock is classified separately in the accompanying balance sheet of December31, 2006 and 2005. At December 31, 2006 the company had outstanding 450,000shares of common stock subject to redemption at $0.70 per share with variousexpiration dates.

On February 1,2005, the company entered into an agreement with Craig Drill Capital, L.P. (“CDC”),a New York based fund-management company, to purchase from CDC shares of thecapital stock of the company and pay down certain outstanding promissory notesof the company held by CDC. Under the terms of the agreement the company, in2005, purchased 1,998,750 shares of the company’s common stock, at the originalpurchase price, without any appreciation rights for the amount of $147,225.

*Warrants*

From December 1,2003 to December 31, 2005, the company raised funds through a private placementof shares of common stock to a limited number of accredited investors. Inconnection with the private placement, the company issued warrants to purchasean aggregate of 3,895,000 shares of common stock at a price of $0.70. Thecompany issued 1,030,000, 775,000 and 2,090,000 warrants in 2003, 2004 and 2005respectively. Each warrant represents the right to purchase one share of commonstock for a period of three or five years from the date the warrant was issued.During the year ended December 31, 2006, investors exercised 700,000 warrantswith expiration dates in 2006, for gross proceeds to the company of $490,000.As of December 31, 2006 there were 2,765,000 fully vested exercisablewarrants outstanding at $0.70 per share, which expire between 2007 and 2010.

*Stock Awards*

During the year ended December 31, 2006, thecompany issued 876,800 shares of common stock to Tecogen employees andconsultants (Note 8). The shares of common stock were fully vested and did notcontain any restrictive provisions. The company accounts for stock based awardsissued to non-employees in accordance with EITF 96-18, *Accountingfor Equity Instruments that are Issued to Other Than Employees for Acquiring orin Conjunction with Selling, Goods or Services*. The common stock wasissued at $0.001 per share when the fair value was estimated to be $0.70 pershare. The company recorded an expense of $612,883 in 2006, related to suchawards.

*Stock BasedCompensation*

In 2003, the company adopted the AmericanDistributed Generation, Inc. stock incentive plan under which the board ofdirectors may grant incentive or non-qualified stock options and stock grantsto key employees, directors, advisors, and consultants of the company.

The maximum number of shares of stockallowable for issuance under the Plan is 4,000,000 shares of common stock,including 467,500 restricted shares as of December 31, 2006. These options, areexercisable within a five-year or ten-year period from the date of grant andvest based upon the terms within the individual option grants, usually over atwo- or four-year period with an acceleration of the 

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unvested portion of such options upon a liquidity event, as definedin the company’s stock option agreement. The options are not transferableexcept by will or domestic relations order. The option price per share underthe Plan is not less than the fair market value of the shares on the date ofthe grant. The number of securities remaining available for future issuanceunder the Plan was 1,697,500 at December 31, 2006.

We accountfor stock awards issued to employees in accordance with FASB Statement No. 123(Revised 2004), Share-Based Payment (SFAS 123(R)) and have adopted theprospective application transition method. During the year ended December 31, 2006 thecompany recognized employee non-cash compensation expense of $50,374 related tothe issuance of restricted stock. At December 31, 2006 there were 287,500unvested shares of restricted stock outstanding. The total compensation costrelated to unvested restricted stock awards not yet recognized is $150,589.This amount will be recognized over the next five years. No stock options weregranted during 2006.

Stock option activity for the year endedDecember 31, 2006 and 2005 was as follows:
| ** **                                   | ** ** | ** **  | ** ** | **Exercise** | ** ** | **Weighted** | ** ** | **Weighted**  | ** ** | ** **    | ** ** |
|----------------------------------------------|------------|-------------|------------|--------------|------------|--------------|------------|---------------|------------|---------------|------------|
| ** **                                   | ** ** | **Number**  | ** ** | **Price**    | ** ** | **Average**  | ** ** | **Average**   | ** ** | **Aggregate** | ** ** |
| ** **                                   | ** ** | **Of**      | ** ** | **Per**      | ** ** | **Exercise** | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** |
| **Common Stock Options**           | ** ** | **Options** | ** ** | **Share**    | ** ** | **Price**    | ** ** | **Life**      | ** ** | **Value**     | ** ** |
|                                         |       |        |       |         |       |         | ** ** | ** **    | ** ** | ** **    | ** ** |
| Outstanding,  December 25, 2004              |       | 2,885,000   |       | $            | 0.07-$0.70 |         | $          | 0.12          |       | 4.27 years    |       | $ | 1,672,650 |   |
| Granted                                      |       | 305,000     |       | $            | 0.70       |         | $          | 0.70          |       |          |       |   |   |
| Canceled or  Expired                         |       | (35,000     | )          | $            | 0.70       |         | $          | 0.70          |       |          |       |   |   |
| Outstanding,  December 31, 2005              |       | 3,155,000   |       | $            | 0.07-$0.70 |         | $          | 0.17          |       | 3.84 years    |       | $ | 1,672,650 |   |
| Vested &  Exercisable, December 31, 2005 |       | 2,653,750   |       |         |       |         |       |          |       |          |       |
|                                         |       |        |       |         |       |         | ** ** | ** **    | ** ** | ** **    | ** ** |
| Outstanding,  December 31, 2005              |       | 3,155,000   |       | $            | 0.07-$0.70 |         | $          | 0.17          |       | 3.84 years    |       |   |   |
| Exercised                                    |       | (50,000     | )          | $            | 0.07       |         | $          | 0.07          |       |          |       |   |   |
| Canceled or  Expired                         |       | (1,485,000  | )          | $            | 0.07       |         | $          | 0.07          |       |          |       |   |   |
| Outstanding,  December 31, 2006              |       | 1,620,000   |       | $            | 0.07-$0.70 |         | $          | 0.26          |       | 6.29 years    |       | $ | 705,600 |   |
| Vested &  Exercisable, December 31, 2006 |       | 1,293,750   |       |         |       |         |       |          |       |          |       |

 

The aggregate intrinsic value of options outstanding as of December 31,2006 is calculated as the difference between the exercise price of theunderlying options and the price of the Company’s common stock for options thatwere in-the-money as of that date. Options that were not in-the-money as ofthat date, and therefore have a negative intrinsic value, have been excludedfrom this amount.

In 2006, the company made restrictedstock grants to 9 employees by permitting them to purchase an aggregate of287,500 shares of common stock at a price of $0.001 per share. Out of thoseshares, 257,500 have a vesting schedule of 25% 180 days after the company’sInitial Public Offering and then 25% on each subsequent anniversary thereafter,and 30,000 shares have a vesting schedule of 100% one year after the InitialPublic Offering.

Restrictedstock activity for the year ended December 31, 2006 and 2005 was as follows:

F-17

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|                              | ** ** | **Number of** | ** ** | **Grant**           | ** ** |
|------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                   | ** ** | **Restricted**     | ** ** | **Date**            | ** ** |
| **Restricted Stock**    | ** ** | **Stock**          | ** ** | **Fair Value** | ** ** |
|                         |       |               | ** ** | ** **          | ** ** |
| Unvested,  December 31, 2005 |       | —             |       | $                   | —     |   |
| Granted                      |       | 287,500            |       | $                   | 0.70       |   |
| Vested                       |       | —             |       | $                   | —     |   |
| Forfeited                    |       | —             |       | $                   | —     |   |
| Unvested, December 31,  2006 |       | 287,500            |       | $                   | 0.70       |   |

 

**Note 7 —Employee benefit plan:**

The company has a defined contributionretirement plan (the “Plan”) which qualifies under Section 401(k) of theInternal Revenue Code (“IRC”). Under the Plan, employees meeting certainrequirements may elect to contribute a percentage of their salary up to themaximum allowed by the IRC. The company matches a variable amount based on participantcontributions up to a maximum of 4.5% of each participant’s salary. The companycontributed $16,273 and $10,606 to the Plan for the years ended December 31,2006 and 2005, respectively.

**Note 8 —Related party:**

Thecompany purchases all of its cogeneration units from Tecogen, an affiliatecompany sharing similar ownership. In addition, Tecogen pays certain operatingexpenses, including benefits and payroll, on behalf of the company and thecompany leases office space from Tecogen. These costs were reimbursed by thecompany. Tecogen has a sublease agreement for the office building, whichexpires on March 31, 2009.

In January 2006,the company entered into a Facilities, Support Services and Business Agreementwith Tecogen, to provide the company with certain office and business supportservices for a period of one year, renewable annually by mutual agreement (Note10).

The company hassales representation rights to Tecogen’s products and services. In New England,the company has exclusive sales representation rights to Tecogen’s cogenerationproducts. The company has granted Tecogen sales representation rights to itson-site utility energy service in California.

During the year ended December 31, 2006, thecompany issued 876,800 shares of common stock to Tecogen Inc. employees. Theshares of common stock were fully vested and did not contain any restrictiveprovisions. The common stock was issued at a fair value of $0.70 per share(Note 6).

InMay of 2006, the company loaned the minority interest partner in the NY LLC$125,000. The principal earns interest at 12% per annum and is due May 31,2007. The note receivable is classified in the Due from related party accountin the accompanying balance sheet. As of December 31, 2006 the balance on thisnote was $120,000.

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**Note 9 — Incometaxes:**

A reconciliation of federal statutoryincome tax provision to the company’s actual provision for the years endedDecember 31, 2006 and 2005 respectively are as follows:
|                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Benefit at federal  statutory tax rate |       | $        | (705,000   | )        | $          | (276,000 | ) |
| Unbenefited  operating losses          |       | 705,000  |       | 276,000  |       |
| Tax Expense                            |       | $        | —     |     | $          | — |   |

 

The components of net deferred tax assetsrecognized in the accompanying balance sheets at December 31, 2006 and 2005respectively are as follows:
|                                   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
| Net Operating  Loss Carryforwards |       | $          | 1,734,000  |       | $          | 1,342,000 |   |
| Accrued Expenses  and other       |       | 41,000     |       | 39,000     |       |
| Depreciation                      |       | (45,000    | )          | (64,000    | )          |
|                              |       | 1,730,000  |       | 1,317,000  |       |
| Valuation  allowance              |       | (1,730,000 | )          | (1,317,000 | )          |
| Net deferred tax  asset           |       | $          | —     |       | $          | — |   |

 

As of December 2006, the Company hasfederal and state loss carryforwards of approximately 4,797,000 and $2,907,000,respectively, which may be used to offset future federal and state taxableincome, expiring at various dates through 2026. Of this amount, approximately $139,000 of federal and state netoperating loss carryforwards relate to stock option deductions and the relatedtax benefit will be recognized in equity when realized.

Management has determined that it is morelikely than not that the company will not recognize the benefits of the federaland state deferred tax assets and as a result has recorded a valuationallowance against the entire net deferred tax asset. If the company shouldgenerate sustained future taxable income, against which these tax attributesmay be recognized, some portion or all of the valuation allowance would bereversed.

**Note 10 —Commitments and contingencies:**

In January 2006,the company entered into a Facilities, Support Services and Business Agreementwith Tecogen, to provide the company with certain office and business supportservices for a period of one year, renewable annually by mutual agreement.Under the business agreement, Tecogen provides the company with office spaceand utilities at a flat rate of $716 per month. The company also sharespersonnel support services with Tecogen. The company is allocated its share ofthe cost of the personnel support services based upon the amount of time spentby such support personnel while working on the company’s behalf. To the extentTecogen is able to do so under its current plans and policies, Tecogen includesthe company and its employees in various of its insurance and benefit programs.The costs of these programs are charged to the company on an actual cost basis.Under this agreement, the company receives pricing based on a volume discountif it purchases cogeneration and chiller products from Tecogen. For certainsites, the company hires Tecogen to service its Tecogen chiller andcogeneration products.

F-19

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**Note 11 —Subsequent events:**

In February 2007,the company raisedfunds through a private placement of 4,292,150 shares of common stock andwarrants to a limited number of accredited investors at a price of $0.70 pershare.

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