** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

**FORM 10-K**

 

**(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, 2007**                                                   |
| ** ** | ** ** | ** **                                                                                              |
| ** ** | ** ** | **Or**                                                                                                  |
| ** ** | ** ** | ** **                                                                                              |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For thetransition period from                             to**

 

**CommissionFile No.: 0-52294**

 

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**AMERICANDG ENERGY INC.**

(Exact name of registrantas specified 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)                       |

 

Registrant’s telephonenumber, including area code:**(781) 622-1120**

 

Securities registeredpursuant to Section 12(b) of the Act: **None**

 

Securities registeredpursuant to Section 12(g) of the Exchange Act:**CommonStock, $.001 par value**

 

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o No x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Securities Act. Yes o No x

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months, and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or an amendment to this Form 10-K.  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 
| Large  Accelerated Filer o | Accelerated  Filer o | Non-Accelerated  Filer o                       | Smaller  reporting company x |
|----------------------------|----------------------|------------------------------------------------|------------------------------|
|                       |                 | (Do not check if  a smaller reporting company) |                         |
|                       |                 |                                           |                         |

 

 

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).          Yes o No x

 

The aggregate marketvalue of the voting shares of the registrant held by non-affiliates is notapplicable because our common stock was not yet trading on the Over-the-CounterBulletin Board as of June 29, 2007.

 

Numberof the registrant’s common shares outstanding as of February 6, 2008:32,805,924.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Certain informationrequired by in Items 10, 11, 12, 13 and 14 of Part III of this AnnualReport on Form 10-K is incorporated by reference from our definitive ProxyStatement for our 2008 Annual Meeting of Shareholders scheduled to be held on May 30,2008.

 

**DISCLAIMERCONCERNING FORWARD LOOKING STATEMENTS**

 

THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARDLOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACTOF 1995 AND OTHER FEDERAL SECURITIES LAWS. THESE FORWARD LOOKING STATEMENTS ARE BASED ON OUR PRESENT INTENT,BELIEFS OR EXPECTATIONS, AND MAY NOT OCCUR.ACTUAL RESULTS MAY DIFFERMATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY OUR FORWARD LOOKING STATEMENTSAS A RESULT OF VARIOUS FACTORS. SEE ALSO “ITEM 1A. RISK FACTORS.”EXCEPT ASREQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO UPDATE OR RELEASE ANY FORWARDLOOKING STATEMENTS AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.

 

 

 

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TABLE OF CONTENTS

 
| **Part I**   |                                                                                                               |   |
|-------------------|--------------------------------------------------------------------------------------------------------------------|--------|
|              |                                                                                                               |   |
| Item 1.           | Business                                                                                                           |   |
|              |                                                                                                               |   |
| Item 1A.          | Risk Factors                                                                                                       |   |
|              |                                                                                                               |   |
| Item 1B.          | Unresolved Staff Comments                                                                                          |   |
|              |                                                                                                               |   |
| Item 2.           | Properties                                                                                                         |   |
|              |                                                                                                               |   |
| Item 3.           | Legal Proceedings                                                                                                  |   |
|              |                                                                                                               |   |
| Item 4.           | Submission of Matters to a Vote of Security Holders                                                                |   |
|              |                                                                                                               |   |
| **Part II**  |                                                                                                               |   |
|              |                                                                                                               |   |
| Item 5.           | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |   |
|              |                                                                                                               |   |
| Item 6.           | Selected Financial Data                                                                                            |   |
|              |                                                                                                               |   |
| Item 7.           | Management’s Discussion and Analysis of Financial  Conditions and Results of Operation                        |   |
|              |                                                                                                               |   |
| Item 7A.          | Quantitative and Qualitative Disclosures About  Market Risk                                                        |   |
|              |                                                                                                               |   |
| Item 8.           | Financial Statements and Supplementary Data                                                                        |   |
|              |                                                                                                               |   |
| Item 9.           | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |   |
|              |                                                                                                               |   |
| Item 9A(T).       | Controls and Procedures                                                                                            |   |
|              |                                                                                                               |   |
| Item 9B.          | Other Information                                                                                                  |   |
|              |                                                                                                               |   |
| **Part III** |                                                                                                               |   |
|              |                                                                                                               |   |
| Item 10.          | Directors, Executive Officers and Corporate  Governance                                                            |   |
|              |                                                                                                               |   |
| Item 11.          | Executive Compensation                                                                                             |   |
|              |                                                                                                               |   |
| Item 12.          | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |   |
|              |                                                                                                               |   |
| Item 13.          | Certain Relationships and Related Transactions                                                                     |   |
|              |                                                                                                               |   |
| Item 14.          | Principal Accountant Fees and Services                                                                             |   |
|              |                                                                                                               |   |
| **Part IV**  |                                                                                                               |   |
|              |                                                                                                               |   |
| Item 15.          | Exhibits and Financial Statement Schedules                                                                         |   |
|              |                                                                                                               |   |
|              | Signatures                                                                                                         |   |
|              |                                                                                                               |   |

** **

 

1

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**PART I**

 

**Item 1.  Business**

 

**General**

 

AmericanDG Energy Inc. (“American DG Energy”, the “company”, “ADGE”, “we”, “our” or “us”)distributes and operates clean, on-site energy systems that produceelectricity, hot water, heat and cooling. Our business model is to own theequipment that we install at customers’ facilities and to sell the energyproduced by these systems to the customers on a long-term contractual basis. Wecall this business the American DG Energy “On-Site Utility”.

 

Weoffer cogeneration systems that are highly reliable and energy efficient. Ourcogeneration systems produce electricity from an internal combustion enginedriving a generator, while the heat from the engine and exhaust is recoveredand typically used to produce heat and hot water for use at the site. We alsodistribute and operate water chiller systems for building cooling applicationsthat operate 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.  By simultaneously providingelectricity, hot water and heat, cogeneration systems also have a significant,positive impact on the environment by reducing the carbon or CO2 produced byoffsetting the traditional energy supplied by the electric grid andconventional hot water boilers.

 

Distributedgeneration of electricity (“DG” or often referred as cogeneration systems orcombined heat and power systems or “CHP”) is an attractive option for reducingenergy costs and increasing the reliability of available energy. DG has  successfully implemented by others in largeindustrial installations over 10 Megawatts (“MW”) where the market has beengrowing for several years, and is increasingly being accepted in smaller sizeunits because of technology improvements, increased energy costs and better DGeconomics. We believe that our target market (users of up to 1 MW) has beenbarely penetrated and that the reduced reliability of the utility grid,increasing cost pressures experienced by energy users, advances in new, lowcost technologies and DG-favorable legislation and regulation at the statelevel will drive our near term growth and penetration into our target market.The company maintains a web site at www.americandg.com, but our website is nota part of this annual report.

 

Thecompany was incorporated as a Delaware corporation on July 24, 2001 toinstall. As of December 31, 2007, we had installed energy systems,representing approximately 3,645 kW (kilowatts), 29.2 MMBtu’s (million Britishthermal units) of heat and hot water and 600 tons of cooling. Kilowatt (kW) isa measure of electricity generated, MMBtu is a measure of heat generated and aton is a measure of cooling generated. On December 14, 2007, the company was presented with a report by the EPA which statesthat the high efficiency of the company’s CHP projects produced an estimated7,400 metric tons of carbon equivalents less than typical separate heat andpower, resulting in emissions reductions equivalent to planting 2,006 acres offorest or removing the emissions of 1,337 automobiles.

 

Webelieve that our primary near-term opportunity for DG energy and equipmentsales is where commercial electricity rates exceed $0.12 per kWh, which ispredominantly 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 CHP market analysis reports sponsored by theEnergy Information Administration in 2000 detailed the prospective CHP marketin the commercial and institutional sectors(1) and in the industrial sectors(2).These data sets were used to estimate the CHP market potential in the 100kW to1 MW size range.  These target marketsegments comprise over 163,000 sites totaling 12.2 million kW of prospective DGcapacity. This is the equivalent of an $11.7 billion annual electricity marketplus a $7.3 billion heat and hot water energy market, for a combined marketpotential of $19.0 billion.

 

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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

 

Webelieve that the largest number of potential DG users in the United Statedrequire less than 1 MW of electric power and less than 1,200 tons of coolingcapacity. We are able to design our systems to suit a particular customer’sneeds because of our ability to place multiple units at a site. This approachis part of what allows our products and services to meet 

 

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changingpower and cooling demands throughout the day (also from season-to-season) andgreatly improves efficiency through a customer’s varying high and low powerrequirements.

 

American DG Energypurchases energy equipment from various suppliers. The primary type of equipmentused is a natural gas-powered, reciprocating engine. As power sources that usealternative energy technologies mature to the point that they are both reliableand economical, we will consider employing them to supply energy for ourcustomers. We regularly assess the technical, economic, and reliability issuesassociated with systems that use solar, micro-turbine or fuel cell technologiesto generate power.

 

**Backgroundand Market**

 

Thedelivery of energy services to commercial and residential customers in theUnited States has evolved over many decades into an inefficient andincreasingly unreliable structure. Power for lighting, air conditioning,refrigeration, communications and computing demands comes almost exclusivelyfrom centralized power plants serving users through a complex grid oftransmission and distribution lines and substations. Even with continuousimprovements in central station generation and transmission technologies, today’spower industry is only about 33 percent efficient(3) meaning that it dischargesto the environment roughly twice as much heat as the amount of electricalenergy delivered to end-users. Since coal accounts for more than half of allelectric power generation, these inefficiencies are a major contributor torising atmospheric CO2 emissions. As countermeasures are sought tolimit global warming, pressures against coal will favor the deployment ofalternative energy technologies.

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(3) *Energy InformationAdministration, Voluntary Reporting of Greenhouse Gases,* 2004, Section 2,Reducing Emissions from Electric Power, Efficiency Projects: Definitions andTerminology, page 20

 

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 CHP) can be significantly more energy efficient than central generation ofelectricity by itself. Except in large-scale industrial applications (e.g.,paper and chemical manufacturing), cogeneration has not attained generalacceptance. This was due, in part, to the long-established monopoly-likestructure of the regulated utility industry. Also, the technologies previouslyavailable for small on-site cogeneration systems were incapable of deliveringthe reliability, cost and environmental performance necessary to displace oreven substantially modify the established power industry structure.

 

Thecompetitive balance began to change with the passage of the Public UtilityRegulatory Policy Act of 1978 (“PURPA”), a federal statute that has opened thedoor to gradual deregulation of the energy market by the individual states. In1979, the accident at Three Mile Island effectively halted the massive programof nuclear power plant construction that had been a centerpiece of the electricgenerating strategy among US utilities for two decades. Several factors caused utilities’capital spending to fall drastically, including well publicized cost overrunsat nuclear plants, an end to guaranteed financial returns on costly newfacilities, and growing uncertainty over which power plant technologies topursue. Recently, investors have become increasingly reluctant to support therisks of the long-term construction projects required for new conventionalgenerating and distribution facilities.

 

Becauseof these factors, electricity reserve margins declined, and the reliability ofservice began to deteriorate, particularly in regions of high economic growth.Widespread acceptance of computing and communications technologies by consumersand commercial users has further increased the demand for electricity, whilealso creating new requirements for very high power quality and reliability. Atthe same time, technological advances in emission control, microprocessors andinternet technologies have sharply altered the competitive balance betweencentralized and distributed generation. These fundamental shifts in economicsand requirements are key to the emerging opportunity for distributed generationequipment and services.

 

**TheRole of Distributed Generation**

 

Distributedgeneration, or cogeneration, is the production of two sources or two types ofenergy (electricity or cooling and heat) from a single energy source (naturalgas). We use technology that utilizes a low-cost, mass-produced, internalcombustion engine from General Motors, used primarily in light trucks and sportutility vehicles that is modified to run on natural gas. The engine spinseither a standard generator to produce electricity, or a conventionalcompressor to produce cooling. For heating, since the working engine generatesheat, we capture the byproduct heat with a heat exchanger and utilize the heatfor facility applications in the form of space heating and hot water forbuildings or industrial facilities. This process is very similar to anautomobile, where the engine provides the motion to the automobile and the byproductheat 

 

3

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isused to keep the passengers warm during the winter months. For refrigeration orcooling, standard available equipment uses an electric motor to spin aconventional compressor to make cooling. We replace the electric motor with thesame modified engine that runs on natural gas to spin the compressor to run arefrigeration cycle and produce cooling.

 

Distributedgeneration, or DG, refers to the application of small-scale energy productionsystems, including electricity generators, at locations in close proximity tothe end-use loads that they serve. Integrated energy systems, operating at usersites but interconnected to existing electric distribution networks, can reducedemand on the nation’s utility grid, increase energy efficiency, reduce airpollution and greenhouse gas emissions, and protect against power outages,while,**in most cases,significantly lowering utility costs for power users and building operators.

 

Thegrowing importance of DG as a key component of our future energy supply isunderscored by the establishment of a Distributed Energy Program within theU.S. Department of Energy. The DOE has stated its position on this issueas follows:

 

*“...there are two problems at the root of the current powercrunch. There is not always enough power generation available to meet peakdemand, and existing transmission lines cannot carry all of the electricityneeded by consumers.... Distributed Energy resources are the power of choicefor providing customers with reliable energy supplies.... These DistributedEnergy products and services use natural gas and renewable energy and will beeasily interconnected into the nation’s infrastructure for the generation ofelectricity. Furthermore, our Program works to encourage the expanded use ofDistributed Energy technologies in applications with the right combination andoccurrence of electrical and thermal demand...”*

 

Untilrecently, many DG technologies have not been a feasible alternative to traditionalenergy sources because of economic, technological and regulatoryconsiderations. Even now, many “alternative energy” technologies (such assolar, 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.

 

Wesupply cogeneration systems that are capable of meeting the demands ofcommercial 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:

 

·                  Greatly increased overall energy efficiency(typically over 80 percent) versus less than 33 percent for theexisting power grid.

 

·                  Rapid adaptation to changing demandrequirements; e.g., weeks, not years to add new generating capacity whereand when it is needed.

 

·                  Ability to by-pass transmission line andsubstation bottlenecks in congested service areas.

 

·                  Avoidance of site and right-of-way issuesaffecting large-scale power generation and distribution projects.

 

·                  Clean operation, in the case of natural gasfired reciprocating engines using microprocessor combustion controls andlow-cost exhaust catalyst technology developed for automobiles, producingexhaust emissions well below the world’s strictest regional environmentalstandards (e.g., Southern California).

 

·                  Rapid economic paybacks for equipmentinvestments, often three to five years when compared to existing utility costsand technologies.

 

·                  Relative insensitivity to fuel prices due tohigh overall efficiencies achieved with cogeneration of electricity and thermalenergy services, including the use of waste heat to operate absorption type airconditioning systems (displacing electric-powered cooling capacity at times ofpeak summer demand).

 

·                  Reduced vulnerability of multiplede-centralized small-scale generating units compared to the risk of major outagesfrom natural disasters or terrorist attacks against large central-station powerplants and long distance transmission lines.

 

·                  Ability to remotely monitor, control anddispatch energy services on a real-time basis using advanced switchgear,software, microprocessor and Internet modalities. Through our onsite energyproducts and services, energy users are able to optimize, in real time, the mixof centralized and distributed electricity-generating resources.

 

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The disadvantages of the company’s on-site distributedgeneration are:

 

·                  Cogeneration is a mechanical process and ourequipment is susceptible to downtime or failure.

 

·                  The base-rate of an electric utility isdetermined by a certain number of subscribers. Distributed generation at asignificant scale will reduce the number of subscribers and therefore it mayincrease the base-rate for the electric utility for its customer base.

 

·                  By committing to our long-term agreements, acustomer may be forfeiting the opportunity to use more efficient technologythat may become available in the future.

 

                Also, DG systems possesssignificant positive environmental impact. The U.S. Environmental ProtectionAgency (“EPA”) has created a Combined Heat and Power Partnership to promote thebenefits of DG systems. The company is a member of this Partnership. Thefollowing statement is found on the EPA web site.

 

*“Combinedheat and power systems offer considerable environmental benefits when comparedwith purchased electricity and onsite-generated heat. By capturing andutilizing heat that would otherwise be wasted from the production ofelectricity, CHP systems require lessfuel than equivalent separate heat and power systems to produce the sameamount of energy.  Because less fuel iscombusted, greenhouse gas emissions, such as carbon dioxide (CO2),as well as criteria air pollutants like nitrogen oxides (NOx) andsulfur dioxide (SO2), are reduced.”*

 

**The Distributed Generation Market Opportunity**

 

                We believe that our primarynear-term opportunity for DG energy and equipment sales is where commercialelectricity rates exceed $0.12 per kWh, which is predominantly in the Northeastand California. 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 6). Attractive DGeconomics 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 market analysis reports sponsored bythe Energy Information Administration in 2000 detailed the prospective CHPmarket in the commercial and institutional sectors(4) and in the industrialsectors(5).  These data sets were used toestimate the CHP market potential in the 100 kW to 1 MW size range. Thesetarget market segments comprise over 163,000 sites totaling12.2 million kW of prospective DG capacity. This is the equivalent of an$11.7 billion annual electricity market plus a $7.3 billion heat andhot water energy market, for a combined market potential of $19.0 billion.

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(4)*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

(5)*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

 

Asshown in the graph below, there are substantial variations in the electricrates 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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Figure 1.

 

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

 

   

 

*Source: U.S. Energy Information Administration Data [2002]*

 

**Business Model**

 

Weare a distributed generation onsite energy company that sells energy in theform of electricity, heat, hot water and air conditioning under long-termcontracts with commercial, institutional and light industrial customers. Weinstall our systems at no cost to our customers and retain ownership of thesystem. Because our systems operate at over 80 percent efficiency (versusless than 33 percent for the existing power grid), we are able tosell the energy produced by these systems to our customers at prices belowtheir existing cost of electricity (or air conditioning), heat and hot water.Our cogeneration systems consist of natural gas-powered internal combustionengines that drive an electrical generator to produce electricity and thatcapture the engine heat to produce space heating and hot water. Our energysystems also can be configured to drive a compressor that produces airconditioning and that also capture the engine heat. As of December 31,2007, we had 47 energy systems operational.

 

Todate, each of our installations runs in conjunction with the electric utilitygrid and requires standard interconnection approval from the local utility. Ourcustomers use both our energy system and the electric utility grid for theirelectricity requirements. We typically supply the first 20% to 60% of thebuilding’s electricity requirements while the remaining electricity is suppliedby the electric utility grid. Our customers are contractually bound to use theenergy we supply.

 

Todate, the price that we have charged our customers is set in our customercontracts at a discount to the price of the building’s local electric utility.For the 20% to 60% portion of the customer’s electricity that we supply, thecustomer realizes immediate savings on its electric bill. In addition toelectricity, we sell our customers the heat and hot water at the same pricethey were previously paying or at a discount equivalent to their discount fromus on electricity. Our air conditioning systems are also priced at a discountso that the customer realizes overall cost savings from the installation.

 

Sincewe own and operate the energy systems and since our customers have noinvestment in the units, our customers benefit from no captal requirements andno operating responsibilities. We operate the energy systems so our customersrequire no staff and have no energy system responsibilities, they are bound,however, to pay for the energy supplied by the energy systems over the term ofthe agreement.

 

**Energyand Products Portfolio**

 

We provide a full rangeof DG product and energy options.  Ourprimary energy and products are listed below:

 

·                  Energy Sales

o                 Electricity

o                 Thermal (Hot Water, Heat and Cooling)

 

·                  EnergyProducing Products

o                 CogenerationPackages

o                 Chillers

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

 

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

 

·                  Turnkey Installation EnergyProducing Products with Incentives

·                  Other Revenue Opportunities

 

***Energy Sales***

 

For customers seeking analternative to the outright purchase of DG equipment, we will install,maintain, finance, own and operate complete on-site DG systems that supply, ona long-term, contractual basis, electricity and other energy services. We sellthe energy to customers at a guaranteed discount rate to the rates charged byconventional utility suppliers. Customers are billed monthly. Our customersbenefit from a reduction in their current energy bills without the capitalcosts and risks associated with owning and operating a cogeneration or chillersystem. Also, by outsourcing the management and financing of on-site energyfacilities to us, they can reap the economic advantages of distributedgeneration without the need for retaining specialized in-house staff withskills unrelated to their core business. Customers benefit from our On-SiteUtility in a number of ways:

 

·                              Guaranteed lower price for energy

·                              Only pay for the energy they use

·                              No capitalcosts for equipment, engineering and installation

·                              No equipmentoperating costs for fuel and maintenance

·                              Immediate cashflow improvement

·                              Significant green impact by the reduction of carbonproduced

·                              No staffing,operations and equipment responsibility

 

Our customers pay us forenergy produced on site at a rate that is a certain percentage below the rateat which the utility companies provide them electrical and natural gasservices. We measure the actual amount of electrical and thermal energyproduced, and charge our customers accordingly. We agree to install, operate,maintain and repair our energy systems at our sole cost and expense. We alsoagree to obtain any necessary permits or regulatory approvals at our soleexpense. Our agreements are generally for a term of 15 years, renewable for twoadditional five years terms upon the mutual agreement of the parties.

 

In regions where highelectricity rates prevail, such as the Northeast, monthly payments for DGenergy services can yield attractive paybacks (e.g. often 3-5 years) on ourinvestments in on-site utility projects. The price of natural gas has a minoreffect on the financial returns obtained from our energy service contractsbecause the value of hot water and other thermal services produced from therecovered heat generated by the internal combustion engine in our on-site DGsystem will increase in proportion to higher fuel costs. This recovered energy,which comprises up to 60 percent of the total heating value of fuel supplied toour DG equipment, displaces fuel that would otherwise be burned in conventionalboilers. Each of our customer sites becomes a profit center. The example belowpresents the energy supplied by two 75 kW cogeneration units and the economicsof a typical energy service contract where we supply 80% of the site’s heat andhot water and 45% of the site’s electricity:

 

| ** **                      | ** ** | **Annual** | ** ** | **Term (15 years)** | ** ** |
|---------------------------------|------------|------------|------------|-------------------------------|------------|
| American DG Energy Revenue      |       | $          | 284,000    |                          | $          | 4,908,000 |   |
| American DG Energy Gross Margin |       | $          | 84,000     |                          | $          | 1,456,000 |   |
| Customer Savings                |       | $          | 32,000     |                          | $          | 545,000 |   |

 

The example reflects anAmerican DG Energy investment of $345,000 with a payback in 4 years or a 25%internal rate of return (IRR). The example also reflects a 2% of expectedannual increase in energy costs that should occur over the 15-year period.

 

Since inception in 2001 andthrough December 31, 2007, the company has entered into 42 agreements, forthe supply of on-site energy services, primarily with healthcare, housingfacilities, apartments and athletic facilities in the Northeast.

 

***EnergyProducing Products***

 

We typically offercogeneration units sized to produce 75 kW of electricity and water chillerssized to produce 200 to 400 tons of cooling. For cogeneration, we prefer amodular design approach to allow us to group multiple units together to servecustomers with considerably larger power requirements. Often, cogenerationunits are conveniently dispersed within a large operation, such as a hospital orcampus, serving multiple process heating systems that would otherwise beimpractical 

 

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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).

 

Many other DG technologiesare challenged by technical, economic and reliability issues associated withsystems that generate power using solar, micro-turbine or fuel celltechnologies, which have not yet proven to be economical for typical customerneeds. When alternative energy technologies mature to the point that they areboth reliable and economical, we will employ them for the best-fitapplications.

 

***Serviceand Installation***

** **

Where appropriate, we utilize the best local serviceinfrastructure for the equipment we deploy. We require long-term maintenancecontracts and ongoing parts sales. Our centralized remote monitoring capabilityallows us to keep track of our equipment in the field. Our installations areperformed by local contractors with experience in energy cogeneration systems.

 

In August 2005, we began offering our customersa “turn-key” option whereby we provide equipment, systems engineering,installation, interconnect approvals, on-site labor and startup services neededto bring the complete DG system on-line. For some customers, we are also paid afee to operate the systems and may receive a portion of the savings generatedfrom the equipment.

 

***Other Funding and Revenue Opportunities***

 

American DG Energy isable to participate in the Demand Response market and receive payments due tothe availability of our energy systems. Demand Response programs providepayments for either the reduction of electricity usage or the increase in electricityproduction during periods of peak usage through out a utility territory. Wehave also received grants and incentives from state organizations and naturalgas companies for our installed energy systems.

 

**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 property owners inhealthcare, hospitality, large residential, athletic facilities and certainindustrial sites. This includes national accounts and other customer groupshaving a common set 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.

 

The company iscontinually expanding its sales efforts by developing joint marketinginitiatives with key suppliers to our target industries. Particularly importantare our collaborative programs with natural gas utility companies. Since theeconomic viability of any DG project is critically dependent upon effectiveutilization of recovered heat, the insight of the gas supplier to the customerenergy profile is particularly effective in prospecting the most cost-effectiveDG 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, Connecticut, and Massachusetts are among thestates that encourage DG through inter-connecting standards, incentives and/orsupply planning. Unlike large central station power plants, DG investments canbe made in small increments and with lead-times as short as just a few months.

 

**Competition**

 

We believe that the main competition for our DG products isthe established electric utility infrastructure. DG is beginning to gainacceptance in regions where energy customers are dissatisfied with the cost andreliability of traditional electricity service. These end-users, together withgrowing support from state legislatures and regulators are creating a favorableclimate for the growth of DG that is overcoming the objections of establishedutility providers. In our target markets, we compete with large utilitycompanies such as Consolidated Edison in New York City and Westchester County,LIPA in Long Island, New York, Public Service Gas and Electric in New Jersey,and NSTAR in Massachusetts.

 

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Engine manufacturers sell DG units that range in size froma few kilowatts to many megawatts in size. Those manufacturers arepredominantly greater than 1 MW and include Caterpillar, Cummins, and Waukesha.In many cases, we view these companies as potential suppliers of equipment andnot as competitors. For example, we are installing a Waukesha unit at acustomer site.

 

The alternative energy market is emerging rapidly. Manycompanies are developing alternative and renewable energy sources includingsolar power, wind power, fuel cells and micro-turbines. Some of the companiesin this sector include General Electric, BP, Shell, Sun Edison and EvergreenSolar (in the solar energy space); Plug Power and Fuel Cell Energy (in the fuelcell space); and Capstone, Ingersoll Rand and Elliott Turbomachinery (in themicro-turbine space). The effect of these developing technologies on ourbusiness is difficult to predict; however, when their technologies become moreviable for our target markets, we may be able to adopt their technologies intoour business model.

 

There are a number of Energy Service Companies (“ESCO’s”)that offer related services. These companies include Siemens, Honeywell andJohnson Controls. In general, these companies seek large, diverse projects forelectric demand reduction for campuses that include building lighting and controls,and electricity (in rare occasions) or cooling. Because of their overheadstructures, these companies often solicit large projects and stay away fromindividual properties. Since we focus on smaller projects for energy supply, weare well suited to work in tandem with these companies when the opportunityarises.

 

There arealso a few local emerging cogeneration developers and contractors that areattempting to offer services similar to ours. To be successful, they will needto have the proper experience in equipment and technology, installationcontracting, equipment maintenance and operation, site economic evaluation,project financing, and energy sales plus the capability to cover a broadregion.

 

**Material Contracts**

** **

In January 2007, weextended our 2006 Facilities, Support Services and Business Agreement withTecogen to provide us with certain office and business support services for aperiod of one year, renewable annually by mutual agreement. Under the 2007business agreement we revised the rent allocation whereby Tecogen provides thecompany with office space and utilities at a flat rate of $2,294 per month. Wealso share personnel support services with Tecogen. We are allocated our shareof the cost of the personnel support services based upon the amount of timespent by such support personnel while working on our behalf. To the extentTecogen is able to do so under its current plans and policies, Tecogen includesus and our employees in several of its insurance and benefit programs. The costsof these programs are charged to us on an actual cost basis.

 

Under this agreement, wereceive pricing based on a volume discount if we purchase cogeneration andchiller products from Tecogen. For certain sites, we hire Tecogen to serviceour Tecogen chiller and cogeneration products.

 

We have sales representationrights to Tecogen’s products and services. In New England, we have exclusivesales representation rights to their cogeneration products. We have grantedTecogen sales representation rights to our on-site utility energy service inCalifornia.

 

**Government Regulation**

** **

Weare not subject to extensive government regulation. We are required to file forlocal construction permits (electrical, mechanical and the like) and utilityinterconnects, and we must make various local and state filings related toenvironmental emissions. Our expenditures for regulatory compliance are notmaterial.

 

Effective March 7, 2007, there were new airquality and permitting requirements in New Jersey that required adding emissioncontrol equipment on our already existing 18 cogeneration systems operating inNew Jersey and any new energy systems we install in that state. In order tointerpret and comply with the new emission requirements, we retained anindependent environmental engineering consultant to review our existinginstallations, as well as all new construction. Of the existing 18 systemspreviously identified, a total of 9 systems in two locations were affected bythe new regulations. The first location at a hospital has been outfitted withcommercially available dry catalyst technology, all permits have been obtainedand the project has returned to full capacity and is generating revenue. Thesecond location at a large housing complex was in the final permitting phase atyear-end 2007 and we expect a successful return of those units during thesecond quarter of 2008. The estimated lost revenue from those two locations wasapproximately $499,000 during 2007.

** **

**Employees**

** **

As of December 31, 2007, we employed eightactive full-time employees and three part-time employees. We believe that ourrelationship with our employees is satisfactory. None of our employees arerepresented by a collective bargaining agreement.

 

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**Item 1A.Risk Factors**

 

Thefollowing risk factors should be considered carefully in addition to the otherinformation contained in this report. This report contains forward-lookingstatements. Forward-looking statements relate to future events or our futurefinancial performance. We generally identify forward-looking statements byterminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,”“could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,”“predicts,” “potential” or “continue” or the negative of these terms or othersimilar words. These statements are only predictions. The outcome of the eventsdescribed in these forward-looking statements is subject to known and unknownrisks, uncertainties and other factors that may cause our, our customers’ orour industry’s actual results, levels of activity, performance or achievementsexpressed or implied by these forward-looking statements, to differ. “RiskFactors,” “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and “Business,” as well as other sections in thisreport, discuss some of the factors that could contribute to these differences.

 

Theforward-looking statements made in this report relate only to events as of thedate on which the statements are made. Except as required by law, we undertakeno obligation to update any forward-looking statement to reflect events orcircumstances after the date on which the statement is made or to reflect theoccurrence of unanticipated events.

 

Thisreport also contains market data related to our business and industry. Thesemarket data include projections that are based on a number of assumptions. Ifthese assumptions turn out to be incorrect, actual results may differ from theprojections based on these assumptions. As a result, our markets may not growat the rates projected by these data, or at all. The failure of these marketsto grow at these projected rates may have a material adverse effect on ourbusiness, results of operations, financial condition and the market price ofour Common Stock.

 

**We have incurred losses, and theselosses may continue.**

** **

We have incurred losses in each of ourfiscal years since inception. Losses continued to incure in 2007. There is noassurance that profitability will be achieved in the near term, if at all.

 

**Because unfavorable utility regulations make theinstallation of our systems more difficult or economic, any slowdown in theutility deregulation process would be an impediment to the growth of ourbusiness.**

 

In the past, many electric utilitycompanies have raised opposition to distributed generation, a critical elementof our on-site utility business. Such resistance has generally taken the formof unrealistic standards for interconnection, and the use of targeted ratestructures as disincentives to combined generation of on-site power andheating-cooling services. A DG company’s ability to obtain reliable andaffordable back-up power through interconnection with the grid is essential toour business model. Utility policies and regulations in most states are oftennot prepared to accommodate widespread onsite generation. These barrierserected by electric utility companies and unfavorable regulations, whereapplicable, make more difficult or uneconomic our ability to connect to theelectric grid at customer sites and are an impediment to the growth of ourbusiness. Development of our business could be adversely affected by anyslowdown or reversal in the utility deregulation process or by difficulties innegotiating backup power supply agreements with electric providers in the areaswhere we intend to do business.

 

Effective March 7, 2007, there were new airquality and permitting requirements in New Jersey that required adding emissioncontrol equipment on our already existing 18 cogeneration systems operating inNew Jersey and any new energy systems we install in that state. In order tointerpret and comply with the new emission requirements, we retained anindependent environmental engineering consultant to review our existinginstallations, as well as all new construction. Of the existing 18 systemspreviously identified, a total of 9 systems in two locations were affected bythe new regulations. The first location at a hospital has been outfitted withcommercially available dry catalyst technology, all permits have been obtainedand the project has returned to full capacity and is generating revenue. Thesecond location at a large housing complex was in the final permitting phase atyear-end 2007.

 

**Our onsite utility concept is largely unproven and maynot be accepted by a sufficient number of customers.**

 

The sale of cogeneration andcooling equipment has been successfully carried out for more than a decade.However, our on-site utility concept (i.e., the sale of on-site energyservices, rather than equipment) is still in an early stage of implementation.Unresolved issues include the pricing of energy services and the structuring ofcontracts to provide cost savings to customers and optimum financial returns tous. There is no assurance that we will be successful in developing a profitableon-site utility business model, and failure to do so would have a materialadverse effect on our business and financial performance.

 

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**The economic viability of ourprojects depends on the price spread between fuel and electricity, and thevariability of the prices of these components creates a risk that our projectswill be uneconomic.**

 

The economic viability of DGprojects is dependent upon the price spread between fuel and electricityprices. Volatility in one component of the spread, the cost of natural gas andother fuels (e.g., propane or distillate oil) can be managed to a greater orlesser extent by means of futures contracts. However, the regional ratescharged for both base load and peak electricity services may declineperiodically due to excess capacity arising from over-building of utility powerplants or recessions in economic activity. Any sustained weakness in electricityprices could significantly limit the market for our cogeneration, coolingequipment and on-site utility energy services.

 

**We may fail to make sales to certain prospectivecustomers because of resistance from facilities management personnel to the outsourcingof their service function.**

 

Any outsourcing of non-coreactivities by institutional or commercial entities will generally lead toreductions in permanent on-site staff employment. As a result, our proposals toimplement on-site utility contracts are likely to encounter strong initialresistance from the facilities managers whose jobs will be threatened by energyoutsourcing. The growth of our business will depend upon our ability toovercome such barriers among prospective customers.

 

**Future government regulations, such as increasedemissions standards, safety standards and taxes, may adversely impact theeconomics of our business.**

 

The operation of distributedgeneration equipment at our customers’ sites may be subject to future changesin federal, state and local laws and regulations (e.g., emissions, safety,taxes, etc.). Any such new or substantially altered rules and standardsmay adversely affect our revenues, profits and general financial condition.

 

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

 

Each additional customer site forour services requires the initial installation and subsequent maintenance andservice of equipment to be provided by a team of technicians skilled in a broadrange of technologies, including combustion, instrumentation, heat transfer,information processing, microprocessor controls, fluid systems and otherelements of distributed generation. If we are unable to recruit, train,motivate, sub-contract, and retain such personnel in each of the regionalmarkets where our business operates we will be unable to grow our business inthose markets.

 

**The company operates in highlycompetitive markets and may be unable to successfully compete againstcompetitors having significantly greater resources and experience.**

 

Our business may be limited bycompetition from energy services companies arising from the breakup ofconventional regulated electric utilities. Such competitors, both in theequipment and energy services sectors, are likely to have far greater financialand other resources than us, and could possess specialized market knowledgewith existing channels of access to prospective customer locations. We may beunable to successfully compete against those competitors.

 

**Future technology changes mayrender obsolete various elements of equipment comprising our on-site utilityinstallations.**

 

We must select equipment for our DGprojects so as to achieve attractive operating efficiencies, while avoidingexcessive downtimes from the failure of unproven technologies. If we are unableto achieve a proper balance between the cost, efficiency, and reliability ofequipment selected for our projects, our growth and profitability will beadversely impacted.

 

**We have limited historical operating results uponwhich to base projections of future financial performance, making it difficultfor prospective investors to assess the value of our stock.**

 

Our experience is primarily on-siteenergy services, and we have only four years of actual operating experience.These limitations make developing financial projections more difficult. We willexpand our business infrastructure based on these projections. If theseprojections prove to be inaccurate, we will sustain additional losses and willjeopardize the success of our business.

 

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** **

**Wewill need to raise additional capital for our business, which will diluteexisting shareholders.**

 

Additionalfinancings will be required to implement our overall business plan. We willneed additional capital. Equity financings will dilute the percentage ownershipof our existing shareholders. Our ability to raise an adequate amount ofcapital and the terms of any capital that we are able to raise will be dependentupon our progress in implementing demonstration projects and related marketingservice development activities. If we do not make adequate progress, we may beunable to raise adequate funds, which will limit our ability to expand ourbusiness. If the terms of any equity financings are unfavorable, the dilutiveimpact on our shareholders might be severe.

 

**Wemay make acquisitions that could harm our financial performance.**

 

Inorder to expedite development of our corporate infrastructure, particularlywith regard to equipment installation and service functions, we anticipate thefuture acquisition of complementary businesses. Risks associated with suchacquisitions include the disruption of our existing operations, loss of keypersonnel in the acquired companies, dilution through the issuance ofadditional 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.

 

**Weare controlled by a small group of majority shareholders, and our minorityshareholders will be unable to effect changes in our governance structure orimplement actions that require shareholder approval, such as a sale of thecompany.**

 

GeorgeHatsopoulos and John Hatsopoulos, who are brothers, beneficially own a majorityof our outstanding shares of common stock. These stockholders have the abilityto control various corporate decisions, including our direction and policies,the election of directors, the content of our charter and bylaws, and theoutcome of any other matter requiring shareholder approval, including a merger,consolidation, and sale of substantially all of our assets or other change ofcontrol transaction. The concurrence of our minority shareholders will not berequired for any of these decisions.

 

**We may be exposed to substantial liability claimsif we fail to fulfill our obligations to our customers.**

 

Weintend to enter into contracts with large commercial and not-for-profitcustomers under which we will assume responsibility for meeting a portion ofthe customers’ building energy demand and equipment installation. We may beexposed to substantial liability claims if we fail to fulfill our obligationsto customers. There can be no assurance that we will not be vulnerable toclaims by customers and by third parties that are beyond any contractualprotections that we are able to negotiate. We may be unable to obtain liabilityand other insurance on terms and at prices that are commercially acceptable tous. As a result, liability claims could cause us significant financial harm.

 

### **Investment in our common stock is subject toprice fluctuations which have been significant for development stage companieslike us.**

###  

Historically, valuations of many companies in thedevelopment stage have been highly volatile. The securities of many of thesecompanies have experienced significant price and trading volume fluctuations,unrelated to the operating performance or the prospects of such companies. Ifthe conditions in the equity markets deteriorate, we may be unable to financeour additional funding needs in the private or the public markets. There can beno assurance that any future offering will be consummated or, if consummated,will be at a share price equal or superior to the price paid by our investorseven if we meet our technological and marketing goals.

 

**                Ourcommon stock is quoted on the OTC Bulletin Board which may have an unfavorableimpact on our stock price and liquidity*.***

 

Our common stock is quoted on the OTC Bulletin Board.The OTC Bulletin Board is a significantly more limited market than the New YorkStock Exchange or NASDAQ system. The quotation of our shares on the OTCBulletin Board may result in a less liquid market available for existing andpotential stockholders to trade shares of our common stock, could depress thetrading price of our common stock and could have a long-term adverse impact onour ability to raise capital in the future. Trading in stock quoted onthe OTC 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 astock exchange, and trading of securities on the OTC Bulletin Board is oftenmore sporadic than the trading of securities listed on a quotation system or astock exchange.

 

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** **

**Futuresales of common stock by our existing stockholders may cause our stock price tofall.**

 

The market price of our common stock could decline asa result of sales by our existing stockholders of shares of common stock in themarket or the perception that these sales could occur. These sales might alsomake it more difficult for us to sell equity securities at a time and pricethat we deem appropriate and thus inhibit our ability to raise additionalcapital when it is needed.

 

**We havenever paid dividends on our capital stock, and we do not anticipate paying anycash dividends in the foreseeable future.**

 

We have paid no cash dividends on our capital stock todate and we currently intend to retain our future earnings, if any, to fund thedevelopment and growth of our business. In addition, the terms of any futuredebt or credit facility may preclude us from paying these dividends. As aresult, capital appreciation, if any, of our common stock will be your solesource of gain for the foreseeable future.

 

**Because we do not intend to paycash dividends, our stockholders will receive no current income from holdingour stock.**

 

We have never paid or declared any cashdividends.  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.

 

**Trading of our common stock isrestricted by the SEC’S “penny stock” regulations which may limit a stockholder’sability to buy and sell our stock.**

** **

**The Securities and Exchange Commission (the “SEC”) has adoptedregulations which generally define “penny stock” to be any equity security thathas a market price less than $5.00 per share or an exercise price of less than$5.00 per share, subject to certain exceptions. Our securities are covered bythe penny stock rules, which impose additional sales practice requirements onbroker-dealers who sell to persons other than established customers andaccredited investors.  The penny stock rules requirea broker-dealer, prior to a transaction in a penny stock not otherwise exemptfrom the rules, to deliver a standardized risk disclosure document in a formprepared by the Securities and Exchange Commission that provides informationabout penny stocks and the nature and level of risks in the penny stock market.The broker-dealer also must provide the customer with current bid and otherquotations for the penny stock, the compensation of the broker-dealer and itssalesperson in the transaction and monthly account statement showing the marketvalue of each penny stock held in the customer’s account. The bid and offerquotations, and the broker-dealer and salesperson compensation information,must be given to the customer orally or in writing prior to effecting thetransaction and must be given to the customer in writing before or with thecustomer’s confirmation. In addition, the penny stock rules require thatprior to a transaction in a penny stock not otherwise exempt from these rules,the broker-dealer must make a special written determination that the pennystock 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 ofbroker-dealers to 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 is restricted by the SEC’S “penny stock” regulations whichmay limit a stockholder’s ability to buy and sell our stock.**

** **

**There has been a material weakness in ourfinancial controls and procedures, which could harm our operating results orcause us to fail to meet our reporting obligations.**

 

As of the end of the periodcovered by this report, our Chief Executive Officer and Chief Financial Officerhave performed an evaluation of controls and procedures and concluded that ourcontrols are effective to give reasonable assurance that the informationrequired to be disclosed by our company in reports that we file under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded,processed, summarized and reported as when required. However, there is a lackof segregation of duties at the company due to the small number of employeesdealing with general administrative and financial matters. Furthermore, the company did not havepersonnel with an appropriate level of accounting knowledge, experience andtraining in the selection, application and implementation of GAAP as it relatesto complex transactions and financial reporting requirements. Thisconstitutes a material weakness 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.

 

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**Item 1B. Unresolved StaffComments**

 

None.

 

**Item 2.  Properties**

 

Our headquarters are locatedin Waltham, Massachusetts and consist of 1,199 square feet of office andstorage space that are leased from Tecogen. The lease expires on March 31,2009. We believe that our facilities are appropriate and adequate for our currentneeds.

 

**Item3.  Legal Proceedings**

 

We are not currently a partyto any other material litigation, and we are not aware of any pending orthreatened litigation against us that could have a material adverse affect onour business, operating results or financial condition.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

None.

 

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**PART II**

 

**Item 5.  Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities**

 

**Market**

 

                    Our common stock is tradedon the Over-the-Counter Bulletin Board, under the symbol “ADGE”. Our stockstarted trading on November 8, 2007. During the period ended December 31,2007, the high price was $1.25 and the low price was $0.83 as reported by theOver-the-Counter Bulletin Board (“OTC”). OTC market quotations reflectinter-dealer prices, without retail mark-up, mark-down or commissions and maynot necessarily represent actual transactions.

 

**Holders**

 

Asof December 31, 2007, the number of holders of record of the common stockwas 107.

 

**Dividends**

 

We have never declared orpaid any cash dividends on shares of our capital stock. We currently intend toretain earnings, if any, to fund the development and growth of our business anddo not anticipate paying cash dividends in the foreseeable future. Our paymentof any future dividends will be at the discretion of our board of directorsafter taking into account various factors, including our financial condition,operating results, cash needs and growth plans.

 

**RecentSales of Unregistered Securities**

 

Setforth below is information regarding common stock issued, warrants issued andstock options granted by the company during fiscal year 2007. Also included isthe consideration, if any, we received and information relating to the sectionof the Securities Act of 1933, as amended (the “Securities Act”), or rule ofthe SEC, under which exemption from registration was claimed.

 

*Common Stock and Warrants*

 

On March 8, 2007, the company raised $3,004,505in a private placement of 4,292,150 shares of common stock exclusively toaccredited investors, representing 16.5% of the total shares then outstanding,at a price of $0.70 per share. Included in those shares are 750,000 shares toMaxwell C.B. Ward, 30,000 shares to Giordano Venzi, 15,000 shares to FerminAlou, 20,000 shares to Edmond Viedma, 500,000 shares to Christian Levett,357,150 shares to Berger van Berchem & Co Ltd., 10,000 shares toAthanasios Kyranis, 2,150,000 shares to Nettlestone Enterprises Limited,100,000 shares to Paris and Aliki Nikolaidis (through the exercise of warrants)and 360,000 shares to Martin C.B. Mellish. Prior to this transaction thecompany had 26,017,250 shares of common stock outstanding. All of suchinvestors were accredited investors, and such transactions were exempt fromregistration under the Securities Act under Section 4(2) and/orRegulation D thereunder.

 

On April 30, 2007, the company raised $1,120,000in a private placement of 1,600,000 shares of common stock exclusively toaccredited investors, representing 5.2% of the total shares then outstanding,at a price of $0.70 per share. Included in those shares are 1,500,000 shares toBrevan Howard Asset Management, 50,000 shares to Ernest Aloi through the exerciseof warrants, 25,000 to Nancy Schachter A/C 7379-1230 through the exercise ofwarrants and 25,000 to Adam Schachter A/C 7378-8270 through the exercise ofwarrants. Prior to this transaction the company had 31,046,400 shares of commonstock outstanding. All of such investors were accredited investors, and suchtransactions were exempt from registration under the Securities Act under Section 4(2) and/orRegulation D thereunder.

 

On June 30, 2007, the company issued to Joseph P.Kennedy 100,000 shares of common stock through an option exercise at $0.07 pershare, representing 0.3% of the total shares then outstanding. Prior to thistransaction the company had 32,646,400 shares of common stock outstanding.

 

On October 2, 2007, Michael H. Carstens, a holderof the company’s 8% Convertible Debenture elected to convert $50,000 of theoutstanding principal amount of the debenture into 59,524 shares of commonstock. Prior to this transaction the company had 32,746,400 shares of commonstock outstanding.

 

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* *

*Restricted Stock Grants*

 

On February 20, 2007, the company made restrictedstock grants to employees, directors and consultants by permitting them topurchase an aggregate of 737,000 shares of common stock, representing 2.4%of the total shares then outstanding at a price of $0.001 per share. Prior tothis transaction the company had 30,309,400 shares of common stock outstanding.

 

Such transactions were exempt from registration underthe Securities Act under Section 4(2), Regulation D and/or Rule 701 thereunder.

 

*Stock Options*

 

In 2007 the company granted nonqualified options topurchase 1,156,000 shares of the commonstock to 7 employees at $0.90 per share. Of those shares 1,130,000 havea vesting schedule of 10 years and 26,000 shares have a vesting schedule of 4years. The grant of such options was exempt from registration under Rule 701under the Securities Act.

 

No underwriters were involved in the foregoing salesof securities. All purchasers of shares of our convertible debentures andwarrants described above represented to us in connection with their purchasethat they were accredited investors and made customary investmentrepresentations. All of the foregoing securities are deemed restrictedsecurities for purposes of the Securities Act.

 

**Rule 144**

 

Under Rule 144 under the Securities Act, asrecently amended, in general, a person who is not deemed to have been one ofour affiliates at any time during the 90 days preceding a sale, and who hasbeneficially owned shares of our Common Stock for more than six months but lessthan one year would be entitled to sell an unlimited number of shares.  Sales under Rule 144 during this timeperiod are still subject to the requirement that current public information isavailable about us for at least 90 days prior to the sale.  After such person beneficially owns shares ofour Common Stock for a period of one year or more, the person is entitled tosell an unlimited number of shares without complying with the public informationrequirement or any of the other provisions of Rule 144. As of February 15,2008, all of our shares of Common Stock held by non-affiliates were eligiblefor resale under amended Rule 144.

 

**Item 6. Selected Financial Data**

 

                Notapplicable.

 

**Item 7. ****Management’s Discussion andAnalysis of Financial Conditions and Results of Operation**

 

*Youshould read the following discussion and analysis of our financial conditionand results of operations together with our financial statements and relatednotes appearing elsewhere in this report. Some of the information contained inthis discussion and analysis or set forth elsewhere in this report, includinginformation with respect to our plans and strategy for our business, includesforward-looking statements that involve risks and uncertainties. You shouldreview the “Risk Factors” section beginning on page 10 of this report fora discussion of important factors that could cause actual results to differmaterially from the results described in or implied by the forward-lookingstatements contained in the following discussion and analysis.*

 

**Overview**

 

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 the appropriatepublished price of energy (electricity, natural gas or oil) from our customer’slocal energy utility, to derive the value of our monthly energy sale, less theapplicable negotiated discount. 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. As of December 31, 2007, we had 47 energysystems operational.

 

As a by-product of our energy business, in some casesthe customer may choose to have us construct the system for them rather thanhave it owned by American DG Energy. In this case we account for revenue andcosts using the percentage-of-completion method of accounting. Under thepercentage-of-completion method of accounting, revenues are recognized byapplying percentages of completion to the total estimated revenues for therespective contracts. Costs are 

 

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recognized as incurred. The percentages of completion are determined byrelating the actual cost of work performed to date to the current estimatedtotal cost at completion of the respective contracts. When the estimate on acontract indicates a loss, the company’s policy is to record the entireexpected loss, regardless of the percentage of completion. In certaininstances, revenue from unresolved claims is recorded when, in the opinion ofmanagement, realization of such revenue is probable and can be reliablyestimated, only to the extent of actual costs incurred. Otherwise, revenue fromclaims is recorded in the year in which such claims are resolved. Costs andestimated earnings in excess of related billings represents the excess ofcontract costs and profit recognized to date on the percentage-of-completionaccounting method over billings to date on certain contracts. Billings inexcess of related costs and estimated earnings represents the excess of billingsto date over the amount of contract costs and profits recognized to date on thepercentage-of-completion accounting method for certain contracts. Customers maybuy out their long term obligation under energy contracts and purchase theunderlying equipment from the company. Any resulting gain on these transactionsis recognized over the payment period in the accompanying consolidatedstatements of operations. Revenues from operation and maintenance services,including shared savings are recorded when provided and verified.

 

We have experienced total net losses since inceptionof approximately $7.4 million. For the foreseeable future, we expect toexperience continuing operating losses and negative cash flows from operationsas our management executes our current business plan. The cash and cashequivalents available at December 31, 2007 will provide sufficient workingcapital to meet our anticipated expenditures including installations of newequipment for the next twelve months; however, as we continue to grow ourbusiness by adding more energy systems, the cash requirements will increase. Webelieve that our cash and cash equivalents available at December 31, 2007and our ability to control certain costs, including those related to generaland administrative expenses will enable us to meet our anticipated cashexpenditures through January 1, 2009. Beyond January 1, 2009, we mayneed to raise additional capital through a debt financing or equity offering tomeet our operating and capital needs. There can be no assurance, however, thatwe will be successful in our fundraising efforts or that additional funds willbe available on acceptable terms, if at all.

 

In 2007, we raisedapproximately $4.1 million through a private placement of our common stock andthe exercise of various warrants and stock options. If we are unable to raiseadditional capital in 2009 we may need to terminate certain of our employeesand adjust our current business plan. Financial considerations may cause us tomodify planned deployment of new energy systems and we may decide to suspendinstallations until we are able to secure additional working capital. We willevaluate possible acquisitions of, or investments in, businesses, technologiesand products that are complementary to our business, however, we currently haveno such discussions.

 

Thecompany’s operations are comprised of one business segment. Our business isselling energy in the form of electricity, heat, hot water and cooling to ourcustomers under long-term sales agreements. 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.

 

The following discussionand analysis of our financial condition and results of operations should beread in conjunction with statements and notes thereto appearing elsewhereherein.

 

**Recent Accounting Pronouncements**

 

In September 2006,the FASB issued FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS157 establishes a common definition of fair value to be used whenever GAAPrequires (or permits) assets or liabilities to be measured at fair value, anddoes not expand the use of fair value in any new circumstances. It alsorequires expanded disclosure about the extent to which companies measure assetsand liabilities at fair value, the information used to measure fair value, andthe effect of fair value measurements on earnings. In addition, in February 2007,the FASB issued FAS No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities-including an amendment of FASB Statement No. 115”(“FAS 159”). FAS 159 expands the use of fair value accounting but does notaffect existing standards that require assets or liabilities to be carried atfair value. Under FAS 159, a company may elect to use fair value to measuremost financial assets and liabilities and any changes in fair value arerecognized in earnings. The fair value election is irrevocable and generallymade on an instrument-by-instrument basis, even if a company has similarinstruments that it elects not to measure based on fair value. Both FAS 157 andFAS 159 will be effective for the company on January 1, 2008. On February 12,2008, the FASB issued proposed FASB Staff Position No. FAS No. 157-2,“Effective Date of FASB Statement No. 157” which defers the effective datefor all nonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (that is, at least annually) to fiscal years beginning after November 15,2008. The company does not expect the adoption of FAS 157 and FAS 159 will havea material impact on its consolidated financial statements in 2008.

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In December 2007,the FASB issued FAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51”(“FAS 160”). FAS 160 clarifies the classification in a company’s consolidatedbalance sheet and the accounting for and disclosure of transactions between thecompany and holders of noncontrolling interests. FAS 160 is effective for thecompany January 1, 2009. Early adoption is not permitted. The company doesnot expect the adoption of FAS 160 to have a material impact on itsconsolidated financial statements.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities at thedate of the financial statements, the reported amounts of revenues and expensesduring the reporting period, and the disclosure of contingent assets andliabilities at the date of the financial statements. Actual results coulddiffer from those estimates. Management believes the following criticalaccounting policies involve more significant judgments and estimates used inthe preparation of our consolidated financial statements.

 

*Partnerships, Joint Ventures andEntities under Common Control*

 

Certain contracts are executed jointly throughpartnerships and joint ventures with unrelated third parties. The companyconsolidates all joint ventures and partnerships in which it owns, directly orindirectly, 50% or more of the membership interests. All significantintercompany accounts and transactions are eliminated. Minority interest in netassets and earnings or losses of consolidated entities are reflected in thecaption “Minority interest” in the accompanying consolidated financialstatements. Minority interest adjusts the consolidated results of operations toreflect only the company’s share of the earnings or losses of the consolidatedentities. Upon dilution of ownership below 50%, the accounting method isadjusted to the equity or cost method of accounting, as appropriate.

 

FASB Interpretation No. 46 (Revised), “Consolidationof Variable Interest Entities” (“FIN 46-R”) provides the principles to considerin determining when variable interest entities must be consolidated in thefinancial statements of the primary beneficiary. In general, a variableinterest entity is an entity used for business purposes that either (a) doesnot have equity investors with voting rights or (b) has equity investorsthat are not required to provide sufficient financial resources for the entityto support its activities without additional subordinated financial support.FIN 46-R requires a variable interest entity to be consolidated by a company ifthat company is subject to a majority of the risk of loss from the variableinterest entity’s activities or is entitled to receive a majority of the entity’sresidual returns or both. A company that consolidates a variable interestentity is called the primary beneficiary of that entity. The company evaluatesthe applicability of 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 a variable interest in Tecogen throughits contractual interests in that entity; however, the company is not theprimary beneficiary and does not have any exposure to loss as a result of itsinvolvement with Tecogen. See related party footnotes to the company’s consolidatedfinancial statement for discussion of the company’s involvement with Tecogen.

 

*Related Party Transactions*

 

The companypurchases the majority 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, which expireson March 31, 2009.

 

*Property and Equipment andDepreciation and Amortization*

 

Property and equipment are stated at cost.Depreciation and amortization are computed using the straight-line andaccelerated methods at rates sufficient to write off the cost of the applicableassets over their estimated useful lives. Repairs and maintenance are expensedas incurred.

 

The company evaluates the recoverability of itslong-lived assets in accordance with SFAS No. 144 (SFAS 144), *Accounting for the Impairment or Disposal ofLong-Lived Assets.* SFAS 144 requires the recognition of impairmentof long-lived assets in the event the net book value of such assets exceeds theestimated future undiscounted cash flows attributable to such assets. Ifimpairment is indicated, the asset is written down to its estimated fair valuebased on a discounted cash flow analysis. The company reviews long-lived assetsfor impairment annually or whenever events or changes in business 

 

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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 31,2007 the company determined that its long-lived assets are recoverable.

 

*Stock-Based Compensation*

 

Effective January 1, 2006, we adopted SFAS No. 123(revised 2004), *Share Based Payment*,or SFAS 123(R), which is a revision of SFAS 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 SFAS No. 95 *Statement of CashFlows.*  SFAS 123(R) requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the income statement based on their fair values.Pro forma disclosure is no longer an alternative.

 

SFAS 123(R) requires nonpublic companies thatused the minimum value method in SFAS 123 for either recognition or pro formadisclosures to apply SFAS 123(R) using the prospective-transition method.As such, 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 value method.

 

The determination of thefair value of share-based payment awards is affected by the company’s stockprice. Since inception and until November 7, 2007, since the company wasnot publicly traded, the company considered the sales price of common stock inprivate placements to unrelated third parties as a measure of the fair value ofits common stock. The company started trading on November 8, 2007therefore after such date it will use the market price of its common stock todetermine fair value of share-based payment awards.

 

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 15% during2007 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 2007 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 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, the FASB issued FASB Staff Position SFAS 123R-3 “Transition ElectionRelated to Accounting for Tax Effects of Share-Based Payment Awards.”  Thecompany has elected to adopt the alternative transition method provided theFASB Staff Position for calculating the tax effects (if any) of stock-basedcompensation expense pursuant to SFAS 123R.  The alternative transitionmethod includes simplified methods to establish the beginning balance of theadditional paid-in capital pool related to the tax effects of employeestock-based compensation, and to determine the subsequent impact to the additionalpaid-in capital pool and the consolidated statements of operations and cashflows of the tax effects of employee stock-based compensation awards that areoutstanding upon adoption of SFAS 123R.

 

*Revenue Recognition*

 

Revenue from energy contracts is recognized whenelectricity, heat, and chilled water is produced by the cogeneration systemsonsite. The company bills each month based on various meter readings installedat each site. The amount of energy produced by on-site energy systems isinvoiced, as determined by a contractually defined formula. We recognizerevenue that relates to multiple element contracts in accordance with EITF00-21, *Accounting for Revenue Arrangementswith Multiple Deliverables*. Revenue to which this guidance appliesincludes a contract that consists of the sale of equipment, installation,energy, and maintenance. When a sales arrangement contains multiple elements,revenue is allocated to each element based upon its relative fair value. Fairvalue is determined based on the price of a deliverable sold on a standalonebasis.

 

As a by-product of our energy business, in some casesthe customer may choose to have us construct the system for them rather thanhave it owned by American DG Energy. In this case we account for revenue andcosts using the percentage-of-completion method of accounting. Under thepercentage-of-completion method of accounting, revenues are recognized byapplying percentages of completion to the total estimated revenues for therespective contracts. Costs are recognized as incurred. The percentages ofcompletion are determined by relating the actual cost of work performed to dateto the current estimated total cost at completion of the respective contracts.When the estimate on a contract indicates a loss, the company’s policy is torecord the entire expected loss, regardless of the percentage of completion. Incertain instances, revenue from unresolved claims is recorded when, in theopinion of management, realization of such revenue is probable and 

 

19

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can be reliably estimated, only to the extent of actual costs incurred.Otherwise, revenue from claims is recorded in the year in which such claims areresolved. Costs and estimated earnings in excess of related billings representsthe excess of contract costs and profit recognized to date on thepercentage-of-completion accounting method over billings to date on certaincontracts. Billings in excess of related costs and estimated earningsrepresents the excess of billings to date over the amount of contract costs andprofits recognized to date on the percentage-of-completion accounting methodfor certain contracts. Customers may buy out their long term obligation underenergy contracts and purchase the underlying equipment from the company. Anyresulting gain on these transactions is recognized over the payment period inthe accompanying consolidated statements of operations. Revenues from operationand maintenance services, including shared savings are recorded when providedand verified.

 

*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 indetermining our provision for income taxes, our deferred tax assets andliabilities and any valuation allowance recorded against our deferred taxassets. As of December 31, 2007, there was no deferred income tax asset onour books. We recorded a valuation allowance of $2,302,000 against the entiregross deferred income tax asset; due to uncertainties related to our ability toutilize our net operating loss carry forwards before they expire. The valuationallowance is based on our estimates of taxable income by jurisdiction in whichwe operate and the period over which our deferred tax assets will berecoverable. In the event that actual results differ from these estimates or weadjust these estimates in future periods we may need to establish an additionalvaluation allowance which could materially impact our financial position andresults of operations.

 

**Results of Operations for the Years Ended December 31,2007 and December 31, 2006**

 

*Fiscal 2007Compared with Fiscal 2006*

 

*Revenues*

 

Revenuesin 2007 were $5,847,020, an increase of $2,672,694 (84%) from 2006. Revenuesincreased primarily as a result of full year operation of our energy systemsinstalled in 2006, new energy systems installed in 2007, a contract buyout andour turnkey installation plus business.

 

As of December 31, 2007, we had installed energysystems, representing approximately 3,645 kW, 29.2 MMBtu’s of heat and hotwater and 600 tons of cooling. Our revenues commence as new energy systemsbecome operational. During the first quarter of 2007, we started on a $1.6million energy system turnkey installation plus project and in 2007 we earned$1,335,000 in revenue based on percentage of completion basis. Unlike ourtraditional energy sales model, in a turnkey installation plus project ourrevenue is earned in two methods: we perform the installation and earn revenueon a percentage of completion basis and we sell on-going operation servicesover an extended period of time that includes a portion of the energy savingsdelivered by the energy systems.

 

Effective March 7, 2007, there were new airquality and permitting requirements in New Jersey that required adding emissioncontrol equipment on our already existing 18 cogeneration systems operating inNew Jersey and any new energy systems we install in that state. In order tointerpret and comply with the new emission requirements, we retained anindependent environmental engineering consultant to review our existinginstallations, as well as all new construction. Of the existing 18 systemspreviously identified, a total of 9 systems in two locations were affected bythe new regulations. The first location at a hospital has been outfitted withcommercially available dry catalyst technology, all permits have been obtainedand the project has returned to full capacity and is generating revenue. Thesecond location at a large housing complex was in the final permitting phase atyear-end 2007 and we expect a successful return of those units during thesecond quarter of 2008. The estimated lost revenue from those two locations wasapproximately $499,000 during 2007.

 

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* *

*Cost of Sales*

* *

Costof sales, including depreciation, in 2007 was $4,583,568, an increase of$1,843,033 (67%) from 2006. Included in the cost of sales was depreciationexpense of $363,233 in 2007, compared with $316,515 in 2006; the increase isdue to additional sites coming on line, costs related to a contract buyout andcosts incurred on the turnkey project referred to above. Our cost of salesconsist of the natural gas fuel required to operate our energy systems,construction, contract buyout costs, the cost of maintenance, and minimalcommunications costs. The cost of natural gas is the largest component of ourcost of sales and changes in natural gas prices can affect our margins. During2007, our gross margins increased to 22% compared to 14% in 2006, as a resultof our efforts to increase the efficiency of our operations and our growingchiller business.

 

*OperatingExpenses*

 

Ourgeneral and administrative expenses consist of executive staff, accounting andlegal expenses, office space, audit services, general insurance and otheradministrative expenses. In 2007, our general and administrative expenses were$1,423,775 compared to $1,646,134 in 2006. The decrease in the general andadministrative expenses of $222,359 was primarily due to a lower non-cashcompensation expense of $330,335 in 2007, compared with $664,134, which wasoffset by an increase in general insurance and additional SEC filing fees in2007.

 

Ourselling expenses consist of sales staff, commissions, marketing, travel andother selling related expenses including provisions for bad debt write-offs. Wesell energy using both direct sales and commissioned agents. Our marketingeffort consisted of trade shows, print literature, media relations and eventdriven direct mail. During 2007, our selling expenses were $415,545 compared to$331,916 in 2006. The increase in the selling expenses was primarily due to theaddition of a part time employee and a new salesperson.

 

Ourengineering expenses consisted of technical staff and other engineering relatedexpenses. The role of engineering is to evaluate potential customer sites basedon technical and economic feasibility, manage the installed base of energy systemsand oversee each new installation project. During 2007 our engineering expenseswere $329,139 compared to $308,921 in 2006. The increase was due to theaddition of a new engineer.

 

*OperatingIncome*

 

Operatingincome in 2007 was a loss of $905,007 as compared with a loss of $1,853,180 in2006. The improvement was due to the increased sales, gross profit improvementand a decrease in non-cash compensation expense.

 

*OtherIncome (Expense), Net*

 

Thecompany reported other expense, net, of $213,050 in 2007 and other expense,net, of $200,327 in 2006. Other income (expense), net, includes interestincome, interest expense, and other items. Interest and other income was$271,950 in 2007 compared to $110,953 in 2006. The increase was primarily dueto additional funds raised and invested. Interest expense is related to theconvertible debenture issued in 2006 and was $485,000 in the 2007 compared to$311,280 in 2006.

 

*Provision for Income Taxes*

 

The company did not have a taxprovision or benefit in 2007 and 2006, respectively, since both periods hadlosses.

 

*Minority Interest*

 

In2002, the company and AES-NJ Cogen Inc. of New Jersey created a limitedliability company named American DG New York LLC (“ADGNY”) to develop projectsin the New York and New Jersey area. The company owns 51% of ADGNY.  Both partners in ADGNY share in the profitsof the business. The percentage share of the profit is based on the partner’sinvestment in each individual project. The company’s investments in ADGNYprojects have ranged from 51% to 80%. The minority interest expense representsour partner’s share of profits in the entity. On our balance sheet, minorityinterest represents our partner’s investment in the entity, plus its share ofafter tax profits less any cash distributions. The company reported minorityinterest of $364,833 in 2007 and $19,283 in 2006. The increase in minorityinterest share of their earnings is due to the overall increase in jointventure profits.

 

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

 

Consolidatedworking capital at December 31, 2007 was $5,555,696, compared with$3,375,980 at December 31, 2006. Included in working capital were cash andcash equivalents of $5,057,482 at December 31, 2007, compared with$3,420,446 at December 31, 2006. The increase in working capital was aresult of additional funds raised through a private placement of our commonstock and the exercise of various warrants and stock options. Cash used byoperating activities was

 

 

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$1,143,080in 2007 compared with cash used of $912,786 in 2006.

 

Thecompany’s short and long-term receivables balance increased to $767,229, in2007 from $284,398 at December 31, 2006 using $482,831 of cash, due to theaccounting treatment of the sale of equipment with a three year paymentschedule and an additional receivable from a turnkey project. The company’s duefrom related parties short and long-term increased to $570,374 in 2007 from$121,896 at December 31, 2006, using $448,478 of cash to the company dueto notes issued to our minority interest partner. Our prepaid and other currentassets decreased to $77,853 in 2007 providing $6,814 of cash due to the timingof insurance billings.

 

Accountspayable increased to $354,091 in 2007, compared with $115,125 at December 31,2006 providing 238,965 of cash due to additional construction in process. Ouraccrued expenses and other current liabilities including accrued interestexpense decreased to $339,740 in 2007 from $420,302 at December 31, 2006using $80,561 of cash. The decrease was due to deferred revenue recognizedtogether with audit and legal expenses that were accrued in relationship to thecompany’s public offering. During the period we accrued an additional $120,500of expense related to future interest payments.

 

During2007, the primary investing activities of the company’s operations wereexpenditures for the purchase of property, plant and equipment for the company’senergy system installations. The company used a net of $1,121,419 for purchasesof energy systems. The company’s financing activities provided $3,901,535 ofcash, net of costs, in 2007 primarily from the sale of common stock andwarrants.

 

Thecompany believes that its existing resources, including cash and cashequivalents and future cash flow from operations, are sufficient to meet theworking capital requirements of its existing business for the foreseeablefuture, including the next 12 months. However, as we continue to grow ourbusiness by adding more energy systems, our cash requirements will increase. Webelieve that our cash and cash equivalents and our ability to control certaincosts, including those related to general and administrative expenses willenable us to meet our anticipated cash expenditures through the end of 2008.Beyond January 1, 2009 we may need to raise additional capital through adebt financing or an equity offering to meet our operating and capital needs.

 

**Seasonality**

 

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

 

**Off Balance Sheet Arrangements**

 

The company has no material off balance sheetarrangements.

 

**Item 7A. Quantitative and QualitativeDisclosures about Market Risk**

 

Not applicable.

 

**Item 8. Financial Statements and SupplementaryData**

 

The information required by this item is included inItem 15 of this Annual Report on Form 10-K.

 

**Item9. Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure**

 

None.

 

**Item9A(T).  Controls and Procedures**

 

*Management’sevaluation of disclosure controls and procedures:*

 

OurChief Executive Officer and Chief Financial Officer, after evaluating theeffectiveness of our “disclosure controls and procedures” (as defined in theSecurities 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”) have concludedthat as of the Evaluation Date, our Disclosure Controls were effective toprovide reasonable assurance that information required to be disclosed in ourreports filed or submitted under the Exchange Act is recorded, processed,summarized and reported within the time periods specified by the SEC, and thatmaterial information relating to our company and any consolidated

 

 

 

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subsidiariesis made known to management, including our Chief Executive Officer and ChiefFinancial Officer, particularly during the period when our periodic reports arebeing prepared to allow timely decisions regarding required disclosure.

 

This annual report does not include an attestationreport of the company’s registered public accounting firm regarding internalcontrol over financial reporting. Management’s report was not subject toattestation by the company’s registered public accounting firm pursuant totemporary rules of the SEC that permit the company to provide onlymanagement’s report in this annual report.

 

*Changes in internal controls:*

 

In connection with theevaluation referred to in the foregoing paragraph, we have identified no changein our internal control over financial reporting that occurred during the yearended December 31, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

*Inherent Limitations onEffectiveness of Controls:*

 

There is a lack of segregation of duties at thecompany due to the small number of employees dealing with generaladministrative and financial matters and general controls over informationtechnology security and user access. This constitutes a material weakness infinancial reporting. Furthermore, the company did not have personnel with anappropriate level of accounting knowledge, experience and training in theselection, application and implementation of GAAP as it relates to complextransactions and financial reporting requirements. At this time, management hasdecided that, considering the employees involved and the control procedures inplace, the risks associated with such lack of segregation are insignificant,and the potential benefits of adding additional employees to clearly segregateduties do not justify the expenses associated with such increases. Managementwill continue to evaluate this segregation of duties.

 

The company had 11 employees as of December 31,2007. Only one of those individuals is in the finance function, other than theChief Financial Officer. This individual is responsible for receiving anddistributing cash, billing, processing transactions, recording journal entries,reconciling accounts, and preparing the financial statements and relateddisclosures. He also has check signing authority, for transactions under$2,000. As a result, there is the potential for this individual to knowingly orunknowingly misappropriate assets or misstate our financial statements. Tomitigate these risks, the company has put in place procedures where the ChiefExecutive Officer, the President and the Chief Financial Officer have checksigning authority.  In addition theyreview and approve all material contracts, transactions and related journalentries. They are also responsible for reviewing and approving monthlyfinancials and related reconciliations, budget to actual comparisons and theinformation required to be disclosed by the company in all reports we have andwill file under the Exchange Act.

 

Our management, includingour Chief Executive Officer and Chief Financial Officer, do not expect that ourDisclosure Controls or our internal control over financial reporting willprevent or detect all error and all fraud. A control system, no matter how welldesigned and operated, can provide only reasonable, not absolute, assurancethat the control system’s objectives will be met. The design of a control systemmust reflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Further, because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that misstatements due to error or fraud will notoccur or that all control issues and instances of fraud, if any, within thecompany have been detected. These inherent limitations include the realitiesthat judgments in decision-making can be faulty and that breakdowns can occurbecause of simple error or mistake. Controls can also be circumvented by theindividual acts of some persons, by collusion of two or more people, or bymanagement override of the controls. The design of any system of controls isbased in part on certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions. Projections of any evaluation ofcontrols effectiveness to future periods are subject to risks. Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures.

 

**Item9B.  Other Information**

 

None.

 

 

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**PART III**

 

**Item10. Directors, Executive Officers and Corporate Governance**

 

Theinformation required by Item 10 is incorporated by reference to the ourdefinitive Proxy Statement for our 2008 annual meeting of shareholders (“ProxyStatement”), which will be filed not later than 120 days after the end of ourfiscal year.

 

**Item 11. ExecutiveCompensation**

 

Theinformation required by Item 11 is incorporated by reference to the ProxyStatement, which will be filed not later than 120 days after the end of ourfiscal year.

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters**

 

Theinformation required by Item 12 is incorporated by reference to the ProxyStatement, which will be filed not later than 120 days after the end of ourfiscal year.

 

**Item13.  Certain Relationships and RelatedTransactions**

 

Theinformation required by Item 13 is incorporated by reference to the ProxyStatement, which will be filed not later than 120 days after the end of ourfiscal year.

 

**Item14.  Principal Accountant Fees andServices**

 

Theinformation required by Item 14 is incorporated by reference to the ProxyStatement, which will be filed not later than 120 days after the end of ourfiscal year.

 

 

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**PART IV**

 

**Item 15.  Exhibits and Financial Statement Schedules**

 

(a)                                  Index ToFinancial Statements and Financial Statements Schedules:

 

Reportof Independent Registered Public Accounting Firm Vitale Caturano & CompanyLtd as of March 14, 2008

 

ConsolidatedBalance Sheets as of December 31, 2007 and December 31, 2006

 

ConsolidatedStatements of Operations for the years ended December 31, 2007 and December 31,2006

 

ConsolidatedStatements of Stockholders’ Equity for the years ended December 31, 2007and December 31, 2006

 

ConsolidatedStatements of Cash Flows for the years ended December 31, 2007 and December 31,2006

 

Notesto Consolidated Financial Statements

 

Allother schedules for which provision is made in the applicable accountingregulations of the Securities and Exchange Commission are not required underthe related instructions, or are inapplicable, and therefore have been omitted.

 

 

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| (b)        | 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*                |       | American Distributed Generated Inc. 2001  Stock Incentive Plan                           |
|       |                 |       |                                                                                     |
|       | 10.4#                |       | 2005 Stock Incentive Plan                                                                |
|       |                 |       |                                                                                     |
|       | 10.5*+               |       | Facilities, Support Services and  Business Agreement with Tecogen Inc.                   |
|       |                 |       |                                                                                     |
|       | 10.6*                |       | Operating Agreement of American DG  New York LLC                               |
|       |                 |       |                                                                                     |
|       | 10.7*                |       | Form of Energy Purchase Agreement                                                   |
|       |                 |       |                                                                                     |
|       | 10.8*                |       | 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 |

 

----

*    Incorporated by reference from the registrant’s Form 10-SB, asamended, 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

 

 

26

----

 

 

**SIGNATURES**

 

Inaccordance 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 18, 2008.

 
|   |                          |
|--------|-------------------------------|
|   | 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) |
|   |                          |

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the issuer and in the capacities and on the dates indicated.

 
| Signature                 |   | Title                                        |   | Date                |   |
|---------------------------|--------|----------------------------------------------|--------|---------------------|--------|
|                      |   |                                         |   |                |   |
| /s/ GEORGE N. HATSOPOULOS |   | Chairman of the Board                        |   | March 18, 2008 |   |
| George N. Hatsopoulos     |   |                                         |   |                |   |
|                      |   |                                         |   |                |   |
| /s/ JOHN N. HATSOPOULOS   |   | Chief Executive Officer                      |   | March 18, 2008 |   |
| John N. Hatsopoulos       |   |                                         |   |                |   |
|                      |   |                                         |   |                |   |
| /s/ ANTHONY S. LOUMIDIS   |   | Chief Financial Officer (Principal Financial |   | March 18, 2008 |   |
| Anthony S. Loumidis       |   | and Accounting Officer)                      |   |                |   |
|                      |   |                                         |   |                |   |
| /s/ BARRY J. SANDERS      |   | President and Chief Operating Officer        |   | March 18, 2008 |   |
| Barry J. Sanders          |   |                                         |   |                |   |
|                      |   |                                         |   |                |   |
| /s/ EARL R. LEWIS         |   | Director                                     |   | March 18, 2008 |   |
| Earl R. Lewis             |   |                                         |   |                |   |
|                      |   |                                         |   |                |   |
| /s/ CHARLES T. MAXWELL    |   | Director                                     |   | March 18, 2008 |   |
| Charles T. Maxwell        |   |                                         |   |                |   |
|                      |   |                                         |   |                |   |
| /s/ ALAN D. WEINSTEIN     |   | Director                                     |   | March 18, 2008 |   |
| Alan D. Weinstein         |   |                                         |   |                |   |

 

 

27

----

 

 

**Report of Independent RegisteredPublic Accounting Firm**

 

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

 

We have audited the accompanying consolidated balance sheets ofAmerican DG Energy Inc. and subsidiaries (collectively, the “Company”) as of December 31,2007 and December 31, 2006, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for the years ended December 31,2007 and December 31, 2006. These financial statements are the responsibilityof the Company’s management. Our responsibility is to express an opinion on theconsolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting. An audit includes consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred toabove, present fairly, in all material respects, the financial position ofAmerican DG Energy Inc. and subsidiaries at December 31, 2007, and December 31,2006, and the results of their operations and their cash flows for the yearsended December 31, 2007, and December 31, 2006, in conformity withaccounting principles generally accepted in the United States of America.

 

As discussed in Note 2 to the consolidated financial statements, theCompany adopted the provisions of Statement of Financial Accounting Standard No. 123(R),“Share-Based Payment”, effective January 1, 2006.

 
|                                      |   |
|-------------------------------------------|--------|
| /s/ VITALE, CATURANO & CO., LTD. |   |
|                                      |   |
| Boston, Massachusetts                     |   |
| March 14, 2008                       |   |

 

 

 

F-1

----

 

 

**AMERICAN DG ENERGY ANDSUBSISIARIES**

***CONSOLIDATED BALANCE SHEETS***

 
| ** **                                                                                                                                                                           | ** ** | **December 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                           |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| **ASSETS**                                                                                                                                                                           | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Current assets                                                                                                                                                                       |       |                        |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                           |       | $                           | 5,057,482  |                        | $          | 3,420,446 |   |
| Accounts  receivable, net                                                                                                                                                            |       | 693,818                     |       | 284,398                     |       |
| Due from related  party, current                                                                                                                                                     |       | 420,374                     |       | 121,896                     |       |
| Prepaid and  other current assets                                                                                                                                                    |       | 77,853                      |       | 84,667                      |       |
| Total current assets                                                                                                                                                                 |       | 6,249,527                   |       | 3,911,407                   |       |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| Property, plant, and equipment, net                                                                                                                                                  |       | 5,291,310                   |       | 4,430,624                   |       |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| Accounts receivable, long- term                                                                                                                                                      |       | 73,411                      |       | —                      |       |
| Due from related party, long-term                                                                                                                                                    |       | 150,000                     |       | —                      |       |
| **TOTAL ASSETS**                                                                                                                                                                     |       | 11,764,248                  |       | 8,342,031                   |       |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                        | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Current liabilities                                                                                                                                                                  |       |                        |       |                        |       |
| Accounts payable                                                                                                                                                                     |       | 354,091                     |       | 115,125                     |       |
| Accrued expenses  and other current liabilities                                                                                                                                      |       | 339,740                     |       | 420,302                     |       |
| Total current liabilities                                                                                                                                                            |       | 693,831                     |       | 535,427                     |       |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| Convertible debentures                                                                                                                                                               |       | 6,025,000                   |       | 6,075,000                   |       |
| Redeemable common stock, $0.001 par value; 450,000  shares                                                                                                                           |       |                        |       |                        |       |
| issued and  outstanding at December 31, 2006                                                                                                                                    |       | —                      |       | 315,000                     |       |
| Total liabilities                                                                                                                                                                    |       | 6,718,831                   |       | 6,925,427                   |       |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| Minority interest                                                                                                                                                                    |       | 1,058,786                   |       | 682,388                     |       |
|                                                                                                                                                                                 |       |                        |       |                        |       |
| Stockholders’ equity                                                                                                                                                            |       |                        |       |                        |       |
| Common stock,  $0.001 par value; 50,000,000 shares authorized; 32,805,924 and 25,567,250  issued and outstanding at December 31, 2007 and December 31, 2006,  respectively |       | 32,806                      |       | 25,567                      |       |
| Additional paid-  in- capital                                                                                                                                                        |       | 11,394,289                  |       | 6,659,448                   |       |
| Common stock  subscription                                                                                                                                                           |       | —                      |       | 6,775                       |       |
| Accumulated  deficit                                                                                                                                                                 |       | (7,440,464                  | )          | (5,957,574                  | )          |
| Total  Stockholders’ Equity                                                                                                                                                     |       | 3,986,631                   |       | 734,216                     |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                  |       | $                           | 11,764,248 |                        | $          | 8,342,031 |   |

 

See accompanyingnotes to consolidated financial statements

 

 

F-2

----

 

 

**AMERICAN DG ENERGY ANDSUBSISIARIES**

***CONSOLIDATED STATEMENTS OF OPERATIONS***

 
| ** **                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                                                          |       |                  |       |   |   |
| Net Sales                                                     |       | $                     | 5,847,020  |   | $ | 3,174,326 |   |
|                                                          |       |                  |       |   |   |
| Cost of sales                                                 |       |                  |       |   |   |
| Fuel,  construction and maintenance                           |       | 4,220,335             |       | 2,424,020 |   |
| Depreciation expense                                          |       | 363,233               |       | 316,515 |   |
|                                                          |       | 4,583,568             |       | 2,740,535 |   |
| Gross profit                                                  |       | 1,263,452             |       | 433,791 |   |
|                                                          |       |                  |       |   |   |
| Operating expenses                                            |       |                  |       |   |   |
| General and  administrative                                   |       | 1,423,775             |       | 1,646,134 |   |
| Selling                                                       |       | 415,545               |       | 331,916 |   |
| Engineering                                                   |       | 329,139               |       | 308,921 |   |
|                                                          |       | 2,168,459             |       | 2,286,971 |   |
| Loss from operations                                          |       | (905,007              | )          | (1,853,180 | ) |
|                                                          |       |                  |       |   |   |
| Other income (expense)                                        |       |                  |       |   |   |
| Interest &  other income                             |       | 271,950               |       | 110,953 |   |
| Interest expense                                              |       | (485,000              | )          | (311,280 | ) |
|                                                          |       | (213,050              | )          | (200,327 | ) |
|                                                          |       |                  |       |   |   |
| Net loss before minority interest                             |       | (1,118,057            | )          | (2,053,507 | ) |
|                                                          |       |                  |       |   |   |
| Minority interest                                             |       | (364,833              | )          | (19,283 | ) |
| Net loss                                                      |       | $                     | (1,482,890 | ) | $ | (2,072,790 | ) |
|                                                          |       |                  |       |   |   |
| Net loss per share — basic and diluted                   |       | $                     | (0.05      | ) | $ | (0.09 | ) |
|                                                          |       |                  |       |   |   |
| Weighted average shares outstanding — basic and  diluted |       | 31,589,274            |       | 23,608,362 |   |

 

See accompanyingnotes to consolidated financial statements

 

 

F-3

----

 

**AMERICANDG ENERGY AND SUBSISIARIES**

***CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY***

 
| ** **                                           | ** ** | **Common   Stock** | ** ** | **Additional   Paid-In Capital** | ** ** | **Common   Stock Subscription** | ** ** | **Accumulated Deficit** | ** ** | **Total**  | ** ** |
|------------------------------------------------------|------------|--------------------|------------|----------------------------------|------------|---------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                                           | ** ** | ** **         | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** **              | ** ** | ** ** | ** ** |
| 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    |       |
|                                                 |       |               |       |                             |       |                            |       |                    |       |       |       |
| Reclass of redeemable common stock                   |       | 450                |       | 314,550                          |       | —                          |       | —                  |       | 315,000    |       |
| Conversion of  convertible debenture to common stock |       | 60                 |       | 49,941                           |       | —                          |       | —                  |       | 50,000     |       |
| Sale of common stock, net of costs                   |       | 5,682              |       | 3,886,536                        |       | —                          |       | —                  |       | 3,892,218  |       |
| Issuance of restricted stock                         |       | 737                |       | (210                             | )          | 225                             |       | —                  |       | 752        |       |
| Common stock subscription                            |       | 10                 |       | 6,990                            |       | (7,000                          | )          | —                  |       | —     |       |
| Stock based compensation expense                     |       | —             |       | 330,335                          |       | —                          |       | —                  |       | 330,335    |       |
| Exercise of stock options                            |       | 100                |       | 6,900                            |       | —                          |       | —                  |       | 7,000      |       |
| Exercise of warrants                                 |       | 200                |       | 139,800                          |       | —                          |       | —                  |       | 140,000    |       |
| Net loss                                             |       | —             |       | —                           |       | —                          |       | (1,482,890              | )          | (1,482,890 | )          |
| Balance at December 31, 2007                    |       | 32,806             |       | $                                | 11,394,289 |                            | $          | —                  |       | $          | (7,440,464 | ) | $ | 3,986,631 |   |

 

See accompanyingnotes to consolidated financial statements

 

 

F-4

----

 

**AMERICAN DG ENERGY ANDSUBSISIARIES**

***CONSOLIDATEDSTATEMENTS OF CASH FLOWS***

 
| ** **                                                                        | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                        | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                                                                              |       |                  |       |   |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net loss                                                                          |       | $                     | (1,482,890 | ) | $ | (2,072,790 | ) |
| *Adjustments to reconcile net loss to net cash  used in by operating activities:* | * *   | * *              | * *   | * * | * * |
| Depreciation and  amortization                                                    |       | 368,952               |       | 316,515 |   |
| Gain on sale of  capital assets                                                   |       | (108,219              | )          | — |   |
| Minority  interest in net income of consolidated subsidiaries                     |       | 364,833               |       | 19,283 |   |
| Amortization of  deferred financing costs                                         |       | 8,526                 |       | 6,028 |   |
| Provision for  losses on accounts receivable                                      |       | (21,411               | )          | 57,000 |   |
| Non cash  interest expense                                                        |       | 120,500               |       | 121,500 |   |
| Stock-based  compensation                                                         |       | 330,335               |       | 664,134 |   |
|                                                                              |       |                  |       |   |   |
| *Changes in operating assets and liabilities*                                     | * *   | * *              | * *   | * * | * * |
| (Increase)  decrease in:                                                          |       |                  |       |   |   |
| Accounts  receivable, net                                                         |       | (461,420              | )          | (179,386 | ) |
| Due from related  party                                                           |       | (298,478              | )          | (95,146 | ) |
| Prepaid assets                                                                    |       | (1,712                | )          | 46,928 |   |
| Increase  (decrease) in:                                                          |       |                  |       |   |   |
| Accounts payable                                                                  |       | 238,965               |       | 47,152 |   |
| Accounts  payable- affiliate                                                      |       | —                |       | (34,782 | ) |
| Accrued expenses  and other current liabilities                                   |       | (201,061              | )          | 190,778 |   |
| Net cash used in  operating activities                                            |       | (1,143,080            | )          | (912,786 | ) |
|                                                                              |       |                  |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Purchases of  property and equipment                                              |       | (1,548,419            | )          | (2,354,181 | ) |
| Proceeds from  sale of property and equipment                                     |       | 427,000               |       | — |   |
| Net cash used in investing activities                                             |       | (1,121,419            | )          | (2,354,181 | ) |
|                                                                              |       |                  |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Proceeds from  issuance of restricted stock                                       |       | 752                   |       | 63 |   |
| Proceeds from  common stock subscription                                          |       | —                |       | 7,000 |   |
| Proceeds from  exercise of warrants                                               |       | 140,000               |       | 490,000 |   |
| Minority  distribution from consolidated subsidiaries                             |       | 11,565                |       | 147,580 |   |
| Due from related  party long-term                                                 |       | (150,000              | )          | — |   |
| Proceeds from  sale of common stock and warrants, net of costs                    |       | 3,892,218             |       | 572,166 |   |
| Proceeds from  exercise of stock options                                          |       | 7,000                 |       | 3,500 |   |
| Proceeds from  sale of convertible debenture net of                               |       |                  |       |   |   |
| issuance cost  and conversion of notes payable                                    |       | —                |       | 5,382,612 |   |
| Net cash provided by financing activities                                         |       | 3,901,535             |       | 6,602,921 |   |
|                                                                              |       |                  |       |   |   |
| Net increase in cash and cash equivalents                                         |       | 1,637,036             |       | 3,335,954 |   |
| Cash and cash equivalents, beginning of year                                      |       | 3,420,446             |       | 84,492 |   |
| Cash and cash equivalents, ending of year                                         |       | $                     | 5,057,482  |   | $ | 3,420,446 |   |
|                                                                              |       |                  |       |   |   |
| **Supplemental disclosures of cash flows  information:**                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Cash paid during the year for:**                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| Interest                                                                          |       | $                     | 485,000    |   | $ | 311,280 |   |
| Income taxes                                                                      |       | $                     | 28,144     |   | $ | 21,448 |   |
|                                                                              |       |                  |       |   |   |
| **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 |   |
| Conversion of convertible debenture to common stock                               |       | $                     | 50,000     |   | $ | — |   |

 

See accompanyingnotes to consolidated financial statements

 

F-5

----

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

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

** **

American DG Energy Inc. (“AmericanDG Energy”, the “company”, “ADGE” or “we”) distributes and operates on-sitecogeneration systems that produce both electricity and heat. Our business is toown the equipment that we install at customers’ facilities and to sell theenergy produced by these systems to the customers on a long-term contractualbasis. We call this business the American DG Energy “On-Site Utility”.

 

The company wasincorporated as a Delaware corporation on July 24, 2001 to install, own,operate and maintain complete DG systems and other complementary systems atcustomer sites and sell electricity, hot water, heat and cooling energy underlong-term contracts at prices guaranteed to the customer to be belowconventional utility rates. American DG Energy has been operating as asubsidiary of American Distributed Generation Inc. since 2003, along withTecogen Inc. (“Tecogen”). In December 2005, the Board of Directors ofAmerican Distributed Generation Inc. decided to distribute to its shareholdersall of the outstanding shares of Tecogen in the form of a stock dividend.American DG Energy merged with American Distributed Generation Inc. and thecompany then changed its name to American DG Energy Inc. As of December 31,2007, we had installed energy systems, representing approximately 3,645 kW(kilowatt), 29.2 MMBtu’s (million British thermal units) of heat and hot waterand 600 tons of cooling. Kilowatt (kW) is a measure of electricity generated,MMBtu is a measure 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. As of December 31, 2007, we had 47 energy systemsoperational.

 

We have experienced totalnet losses since inception of approximately $7.4 million. For the foreseeablefuture, we expect to experience continuing operating losses and negative cashflows from operations as our management executes our current business plan. Thecash and cash equivalents available at December 31, 2007 will providesufficient working capital to meet our anticipated expenditures includinginstallations of new equipment for the next twelve months however, as wecontinue to grow our business by adding more energy systems, the cashrequirements will increase. We believe that our cash and cash equivalentsavailable at December 31, 2007 and our ability to control certain costs,including those related to general and administrative expenses will enable usto meet our anticipated cash expenditures through January 1, 2009. Beyond January 1,2009 we 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 2007 we raised approximately $4.1 million through aprivate placement of our common stock and the exercise of various warrants andstock options. If we are unable to raise additional capital in 2009 we may needto terminate certain of our employees and adjust our current business plan.Financial considerations may cause us to modify planned deployment of newenergy systems and we may decide to suspend installations until we are able tosecure additional working capital. We will evaluate possible acquisitions of,or investments in, businesses, technologies and products that are complementaryto our business, however, we currently have no such discussions.

 

Thecompany’s operations are comprised of one business segment. Our business isselling energy in the form of electricity, heat, hot water and cooling to ourcustomers under long-term sales agreements. 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.

 

 

F-6

----

 

 

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

 

*Principles of Consolidation*

 

Theaccompanying consolidated financial statements include the accounts of AmericanDG Energy, its wholly owned subsidiary American DG Energy, Inc. and its51% 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”), after elimination of all material intercompany accounts,transactions and profits. Investee entities in which American DG Energy, Inc.owns directly or indirectly 50% or more of the membership interests have beenconsolidated as a result of the company’s control over the investee entities.All significant intercompany accounts and transactions are eliminated. Minorityinterests in the net assets and earnings or losses of consolidated Investeeentities are reflected in the caption “Minority interest” in the accompanyingconsolidated financial statements. Minority interest adjusts the consolidatedresults of operations to reflect only American DG Energy’s share of theearnings or losses of the consolidated Investee entities. Upon dilution ofownership below 50%, the accounting method is adjusted to the equity or costmethod of accounting, as appropriate, for subsequent periods. In January 2006,the company entered into an agreement with Hermany Farms to liquidate theentity. The assets and liabilities were distributed in accordance with theterms of the limited liability company agreement. The process to liquidateHermany was completed on December 29, 2006.

 

Thecompany evaluates the applicability of Financial Accounting Standards Board (“FASB”)Interpretation No. 46 (Revised) “Consolidation of Variable InterestEntities” (FIN 46(R)) to partnerships and joint ventures at the inception ofits participation to ensure its accounting is in accordance with theappropriate standards. The company has contractual interests in Tecogen anddetermined that Tecogen was a Variable Interest Entity (VIE), as defined by FIN46R; however, the company was not considered the primary beneficiary and doesnot have any exposure to loss as a result of its involvement with Tecogen.Therefore, Tecogen was not consolidated in our Consolidated FinancialStatements through December 31, 2007. See Note 8 for further discussion.

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

*Revenue Recognition*

 

Revenue from energycontracts is recognized when electricity, heat, and chilled water is producedby the cogeneration systems onsite. The company bills each month based onvarious meter readings installed at each site. The amount of energy produced byon-site energy systems is invoiced, as determined by a contractually definedformula. We recognize revenue that relates to multiple element contracts inaccordance with EITF 00-21, *Accounting forRevenue Arrangements with Multiple Deliverables*. Revenue to whichthis guidance applies includes a contract that consists of the sale of equipment,installation, energy, and maintenance. When a sales arrangement containsmultiple elements, revenue is allocated to each element based upon its relativefair value. Fair value is determined based on the price of a deliverable soldon a standalone basis.

 

As a by-product of ourenergy business, in some cases the customer may choose to have us construct thesystem for them rather than have it owned by American DG Energy. In this casewe account for revenue and costs using the percentage-of-completion method ofaccounting. Under the percentage-of-completion method of accounting, revenuesare recognized by applying percentages of completion to the total estimatedrevenues for the respective contracts. Costs are recognized as incurred. Thepercentages of completion are determined by relating the actual cost of workperformed to date to the current estimated total cost at completion of therespective contracts. When the estimate on a contract indicates a loss, thecompany’s policy is to record the entire expected loss, regardless of thepercentage of completion. In certain instances, revenue from unresolved claimsis recorded when, in the opinion of management, realization of such revenue isprobable and can be reliably estimated, only to the extent of actual costsincurred. Otherwise, revenue from claims is recorded in the year in which suchclaims are resolved. Costs and estimated earnings in excess of related billingsrepresents the excess of contract costs and profit recognized to date on thepercentage-of-completion accounting method over billings to date on certaincontracts. Billings in excess of related costs and estimated earningsrepresents the excess of billings to date over the amount of contract costs andprofits recognized to date on the percentage-of-completion accounting methodfor certain contracts. Customers may buy out their long term obligation underenergy contracts and purchase the underlying equipment from the company. Anyresulting gain on these transactions is recognized over the payment period inthe accompanying consolidated statements of operations. Revenues from operationand maintenance services, including shared savings are recorded when providedand verified.

 

 

F-7

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*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 is not exposed to any significant creditrisk 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 $35,589 and $57,000 at December 31,2007 and 2006 respectively. Included in accounts receivable are amounts fromfour major customers accounting for approximately 59% and 56% of total accountsreceivable for the years ended December 31, 2007 and December 31,2006, respectively. There were sales to three customers accounting forapproximately 41% and 46% of total sales for the years ended December 31,2007 and December 31, 2006, respectively.

 

*Accounts payable*

 

Included in accounts payable are amounts due tofive major vendors accounting for approximately 58% and 66% of total accountspayable for the years ended December 31, 2007 and December 31, 2006,respectively. Purchases from four vendors accounted for approximately 47% and51% of total cost of goods sold for the years ended December 31, 2007, andDecember 31, 2006, respectively.

 

*Supply Concentrations*

 

Approximately 100% of the company’s cogenerationunit purchases for the year ended December 31, 2007 and 2006 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 installation services oncomparable terms. However, in the event of a change of vendor, there could be adelay in installation or maintenance services.

 

*Property and Equipment and Depreciation andAmortization*

 

Property and equipmentare stated at cost. Depreciation and amortization are computed using thestraight-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*

 

EffectiveJanuary 1, 2006, we adopted SFAS No. 123 (revised 2004), Share Based Payment, or SFAS 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(“APB 25”), and amends Financial Accounting Standards Board (“FASB”) Statement No. 95Statement of Cash Flows. SFAS123(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.

 

SFAS123(R) requires nonpublic companies that used the minimum value method inSFAS 123 for either recognition or pro forma disclosures to apply SFAS 123(R) usingthe prospective-transition method. As such, since we were not a public companyas of the adoption date, we will continue to apply APB 25 in future periods toequity awards outstanding at the date of SFAS 123(R)’s adoption that weremeasured using the minimum value method.

 

Duringthe year ended December 31, 2007 the company recognized employee non-cashcompensation expense of $330,335 related to the issuance of restricted stockand stock options. At December 31, 2007 there were 948,875 unvested 

 

 

F-8

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sharesof restricted stock outstanding. The total compensation cost related tounvested restricted stock awards not yet recognized is $834,538. This amountwill be recognized over the next nine years.

 

Thedetermination of the fair value of share-based payment awards is affected bythe company’s stock price. Since inception and until November 7, 2007,since the company was not publicly traded, the company considered the salesprice of common stock in private placements to unrelated third parties as ameasure of the fair value of its common stock. The company started trading on November 8,2007 therefore after such date it will use the market price of its common stockto determine fair value of share-based payment awards.

 

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 15% and 0%during 2007 and 2006 respectively, in determining the expense recorded in theaccompanying consolidated statement of income. Forfeitures are estimated at thetime of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Stock-based compensation expenserecognized in our financial statements in 2007 and thereafter is based onawards that are ultimately expected to vest. We evaluate the assumptions used tovalue our awards on a quarterly basis and if factors change and we employdifferent assumptions, stock-based compensation expense may differsignificantly from what we have recorded in the past. If there are anymodifications or cancellations of the underlying unvested securities, we may berequired to accelerate, increase or cancel any remaining unearned stock-basedcompensation expense.

 

OnNovember 10, 2005, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position SFAS 123R-3 “Transition Election Related toAccounting for Tax Effects of Share-Based Payment Awards.”  The company has elected to adopt thealternative transition method provided the FASB Staff Position for calculatingthe tax effects (if any) of stock-based compensation expense pursuant to SFAS123R.  The alternative transition methodincludes simplified methods to establish the beginning balance of theadditional paid-in capital pool related to the tax effects of employeestock-based compensation, and to determine the subsequent impact to theadditional paid-in capital pool and the consolidated statements of operationsand cash flows of the tax effects of employee stock-based compensation awardsthat are outstanding upon adoption of SFAS 123R.

 

SeeNote 6 for a summary of the restricted stock and stock option activity underour stock-based employee compensation plan for the year ended December 31,2007 and 2006.

 

*Earnings per Common Share*

 

Basic net income (loss)per common share is calculated using the weighted-average number of commonshares outstanding during the period less the weighted-average shares subjectto repurchase. Diluted income (loss) per common share gives effect to dilutivecommon stock subject to repurchase, stock options and warrants (calculatedbased on the treasury stock method), and convertible debt (calculated using anas-if-converted method). We compute basicearnings per share by dividing net income (loss) for the period by the weightedaverage number of shares of common stock outstanding during the period. Forpurposes of calculating diluted earnings per share, we consider our sharesissuable in connection with stock options and warrants to be dilutive commonstock equivalents when the exercise price is less than the average market priceof our common stock for the period. For the year ended December 31, 2007,we excluded 9,503,690 anti-dilutive shares resulting from conversion ofdebentures and exercise of stock options and warrants, and for the year ended December 31,2006 we excluded 7,344,145 anti-dilutive shares resulting from conversion ofdebentures and exercise of stock options.

 

*Other Comprehensive Net Loss*

 

The comprehensive net loss for the years ended December 31,2007 and 2006 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”), *Accounting for the Impairment or Disposal of Long-Lived Assets.*SFASNo. 144 requires the recognition of impairment of long-lived assets in theevent the net book value of such assets exceeds the estimated futureundiscounted cash flows attributable 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 31,2007 the company determined that its long-lived assets are recoverable.

 

 

 

F-9

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*Income Taxes*

 

We account for incometaxes in accordance SFAS No. 109, “Accounting for Income Taxes”. UnderSFAS No. 109, deferred tax assets and liabilities are determined based ondifferences between the financial reporting and tax reporting bases of assetsand liabilities and are measured by applying the enacted tax rates and laws totaxable years in which the differences are expected to reverse. We recognize adeferred tax asset for the tax benefit of net operating loss carry forwardswhen it is more likely than not that the tax benefits will be realized andreduce the deferred tax asset with a valuation reserve when it is more likelythan not that some portion of the tax benefits will not be realized.

 

*Fair Value of Financial Instruments*

 

The company’s financial instruments are cash andcash equivalents, accounts receivable, accounts payable, convertible debenturesand notes due from related party. The recorded values of cash and cashequivalents, accounts receivable, accounts payable and notes due from relatedparty approximate their fair values based on their short-term nature. Thecarrying value of the convertible debentures on the balance sheet at December 31,2007 approximates fair value as the term approximate those currently availablefor similar instruments.

 

*Recent Accounting Pronouncements*

 

In September 2006,the FASB issued FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 establishes acommon definition of fair value to be used whenever GAAP requires (or permits)assets or liabilities to be measured at fair value, and does not expand the useof fair value in any new circumstances. It also requires expanded disclosureabout the extent to which companies measure assets and liabilities at fairvalue, the information used to measure fair value, and the effect of fair valuemeasurements on earnings. In addition, in February 2007, the FASB issuedFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities-including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 expands theuse of fair value accounting but does not affect existing standards thatrequire assets or liabilities to be carried at fair value. Under FAS 159, acompany may elect to use fair value to measure most financial assets andliabilities and any changes in fair value are recognized in earnings. The fairvalue election is irrevocable and generally made on an instrument-by-instrumentbasis, even if a company has similar instruments that it elects not to measurebased on fair value. Both FAS 157 and FAS 159 will be effective for thecompany on January 1, 2008. On February 12, 2008, the FASB issuedproposed FASB Staff Position No. FAS No. 157-2, “Effective Date ofFASB Statement No. 157” which defers the effective date for allnonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (that is, at least annually) to fiscal years beginning after November 15,2008. The company does not expect the adoption of FAS 157 and FAS 159 will havea material impact on its consolidated financial statements in 2008.

 

In December 2007,the FASB issued FAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51”(“FAS 160”). FAS 160 clarifies the classification in a company’s consolidatedbalance sheet and the accounting for and disclosure of transactions between thecompany and holders of noncontrolling interests. FAS 160 is effective for thecompany January 1, 2009. Early adoption is not permitted. The company doesnot expect the adoption of FAS 160 to have a material impact on itsconsolidated financial statements.

 

**Note 3 — Property plant andequipment:**

 

Property and equipment consists of the followingas of December 31, 2007 and 2006:

 

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                                  |       |                  |       |   |   |
| Computer equipment and software       |       | $                     | 18,089     |   | $ | 12,660 |   |
| Furniture and fixtures                |       | 906                   |       | 906 |   |
| Co-generation units                   |       | 4,214,468             |       | 4,127,872 |   |
|                                  |       | 4,233,463             |       | 4,141,438 |   |
| Less —  accumulated depreciation |       | 901,986               |       | 664,765 |   |
|                                  |       | 3,331,477             |       | 3,476,673 |   |
| Construction in progress              |       | 1,959,833             |       | 953,951 |   |
|                                  |       | $                     | 5,291,310  |   | $ | 4,430,624 |   |

 

Depreciation of property and equipmenttotaled $363,233 and $316,515 for the years ended December 31, 2007 and2006.

 

 

F-10

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**Note 4 — Short-termnotes payable:**

 

On December 31, 2005the company had short-term notes payable to stockholders of $1,250,000. Thenotes were due upon the earlier of either written demand for payment orconsummation of any financing by the company. During the year ended December 31,2006, the company converted $700,000 of the short-term notes to 1,000,000shares of common stock. In addition, the company converted the remaining$550,000 of short-term notes and $100,000 of accrued interest related to thenotes to convertible debentures (see Note 5).

 

**Note 5 —Convertible debentures:**

 

In April and June of2006, the company issued convertible debentures totaling $6,075,000 to existinginvestors (the “debentures”). The debentures accrue interest at a rate of 8%per annum and are due 5 years from the issuance date. The debentures areconvertible, at the option of the holder, into a number of shares of commonstock as determined by dividing the original outstanding amount of therespective debenture by the conversion price in effect at the time. The initialconversion price of the debenture is $0.84 and is subject to adjustment inaccordance with the agreement. As of December 31, 2007 the conversionprice of the debenture has not been adjusted. As of December 31, 2007,there were 7,172,621 shares of common stock issuable upon conversion of ouroutstanding convertible debentures. On October 2, 2007, a holder of the company’s 8%Convertible Debenture elected to convert $50,000 of the outstanding principalamount of the debenture into 59,524 shares of common stock.

 

**Note 6 —Stockholders’ equity:**

 

*Common Stock*

 

In 2006 thecompany raised funds through a private placement of common stock and warrantsto a limited number of accredited investors. In connection with the privateplacement the company sold an aggregate of 901,700 shares of common stock at apurchase price of $0.70 per share, resulting in net cash proceeds or $572,166.In 2007 the company raised additional funds through a private placement ofcommon stock to a limited number of accredited investors. In connection withthe private placement the company sold an aggregate of 5,692,150 shares ofcommon stock at a purchase price of $0.70 per share, resulting in net cashproceeds of $3,892,218. The holders of common stock have the right to votetheir interest on a per share basis. As of December 31, 2007, therewere 32,805,924 shares of common stock outstanding.

 

The company hasalso issued redeemable common stock. The holders of the shares of theredeemable common stock may elect to require the company to redeem theirshares, if certain obligations are not met in accordance with the terms of theredemption agreement. Due to the redemption features, the common stock isclassified separately in the accompanying balance sheet of December 31,2006. At December 31, 2006 the company had outstanding 450,000 shares ofcommon stock subject to redemption at $0.70 per share with various expirationdates. On November 8, 2007, the company common stock started trading onthe Over-The-Counter Bulletin Board, therefore the company’s obligations to theredeemable common stockholders were met and the aforementioned securities wereno longer considered redeemable. The company reclassified the redeemable commonstock into equity.

 

*Warrants*

 

From December 1, 2003 to December 31,2005, the company raised funds through a private placement of shares of commonstock to a limited number of accredited investors. In connection with theprivate placement, the company issued warrants to purchase an aggregate of 3,895,000shares of common stock at a price of $0.70. The company issued 1,030,000,775,000 and 2,090,000 warrants in 2003, 2004 and 2005 respectively. Eachwarrant represents the right to purchase one share of common stock for a periodof three or five years from the date the warrant was issued. During the yearended December 31, 2007, investors exercised 200,000 warrants withexpiration dates in 2007, for gross proceeds to the company of $140,000 andduring the year 575,000 warrants expired. As of December 31, 2007 therewere 1,990,000 fully vested exercisable warrants outstanding at$0.70 per share, which expire between 2008 and 2010.

 

*Stock Awards*

 

During the year ended December 31,2006, the company issued 876,800 shares of common stock to Tecogen employeesand consultants (Note 8). The shares of common stock were fully vested and didnot contain any restrictive provisions. The company accounts for stock basedawards issued to non-employees in accordance with EITF 96-18, *Accounting for Equity Instruments that are Issued to Other ThanEmployees for Acquiring or in Conjunction with Selling, Goods or Services*.The common stock was issued at $0.001 per share when the fair value wasestimated to be $0.70 per share. The company recorded an expense of $612,883 in2006, related to such awards.

 

 

F-11

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*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 1,189,500 restricted shares as of December 31, 2007. Stockoptions, are exercisable within a five-year or ten-year period from the date ofgrant and vest based upon the terms within the individual option grants,usually over a two- or four-year period with an acceleration of the unvestedportion of such options upon a liquidity event, as defined in the company’sstock option agreement. The options are not transferable except by will ordomestic relations order. The option price per share under the Plan is not lessthan the fair market value of the shares on the date of the grant. The numberof securities remaining available for future issuance under the Plan was189,500 at December 31, 2007.

 

We account for stock awards issued toemployees in accordance with FASB Statement No. 123 (Revised 2004),Share-Based Payment (SFAS 123(R)) and have adopted the prospective applicationtransition method. Duringthe years ended December 31, 2007 and December 31, 2006, the companyrecognized employee non-cash compensation expense of $330,335 and $664,134,respectively, related to the issuance of stock options and restricted stock. AtDecember 31, 2007 there were 948,875 unvested shares of restricted stockoutstanding. At December 31, 2007, the total compensation cost related tounvested restricted stock awards not yet recognized is $834,538. This amountwill be recognized over the next five years. In 2007 the company grantednonqualified options to purchase 1,156,000 shares of the common stock to 7 employees at $0.90 per share. Of thosestock options 1,130,000 have a vesting schedule of 10 years and 26,000 stockoptions have a vesting schedule of 4 years. Stock option activity for the year ended December 31, 2007 and 2006was 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 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   |       |         |       |         |       |          |       |          |       |
|                                                   |       |        |       |         |       |         |       |          |       |          |       |
| Outstanding, December 31, 2006                    |       | 1,620,000   |       | $            | 0.07-$0.70 |         | $          | 0.26          |       | 6.29 years    |       | $ | 705,600 |   |
| Granted                                                |       | 1,156,000   |       | $            | 0.90       |         | $          | 0.90          |       |          |       |   |   |
| Exercised                                              |       | (100,000    | )          | $            | 0.07       |         | $          | 0.07          |       |          |       |   |   |
| Canceled                                               |       | (25,000     | )          | $            | 0.70       |         | $          | 0.70          |       |          |       |   |   |
| Expired                                                |       | (410,000    | )          | $            | 0.07-$0.70 |         | $          | 0.07          |       |          |       |   |   |
| Outstanding, December 31, 2007                    |       | 2,241,000   |       | $            | 0.07-$0.90 |         | $          | 0.63          |       | 7.71 years    |       | $ | 607,600 |   |
| Vested & Exercisable, December 31,  2007 |       | 1,011,750   |       |         |       |         |       |          |       |          |       |

 

The aggregate intrinsic value of options outstanding as of December 31,2007 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 excluded fromthis amount.

 

In 2006, the company made restricted stock grants to 9employees by permitting them to purchase an aggregate of 287,500 shares ofcommon stock at a price of $0.001 per share. Out of those shares, 257,500 havea vesting schedule of 25% 180 days after the company’s Initial Public Offeringand then 25% on each subsequent anniversary thereafter, and 30,000 shares havea vesting schedule of 100% one year after the Initial Public Offering.

 

In 2007, the company made restricted stock grants to employees,board members and consultants by permitting them to purchase an aggregate of737,000 shares of common stock at a price of $0.001 per share. Out of thoseshares, 681,000 have a vesting schedule of 25% one year after the company’sInitial Public Offering and then 25% on each subsequent anniversary thereafter,and 56,000 shares vest 180 days after the company’s Initial Public Offeringtogether with certain gross profit goals as described in the agreement.

 

F-12

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Restricted stock activity for the year ended December 31, 2007 and2006 was as follows:

 

| ** **                       | ** ** | **Number of**        | ** ** | ** **                | ** ** |
|----------------------------------|------------|----------------------|------------|---------------------------|------------|
| **Restricted Stock**             | ** ** | **Restricted Stock** | ** ** | **Grant Date Fair Value** | ** ** |
|                             |       |                 |       |                      |       |
| Unvested, December 31, 2005 |       | —               |       | —                    |       |
| Granted                          |       | 287,500              |       | $                         | 0.70       |   |
| Vested                           |       | —               |       | —                    |       |
| Forfeited                        |       | —               |       | —                    |       |
| Unvested, December 31, 2006 |       | 287,500              |       | 0.70                      |       |
|                             |       |                 |       |                      |       |
| Granted                          |       | 737,000              |       | 0.70                      |       |
| Vested                           |       | (60,625              | )          | 0.70                      |       |
| Forfeited                        |       | (15,000              | )          | 0.70                      |       |
| Unvested, December 31, 2007 |       | 948,875              |       | $                         | 0.70       |   |

 

**Note 7 — Employee benefit plan:**

 

The company has adefined contribution retirement plan (the “Plan”) which qualifies under Section 401(k) ofthe Internal 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 onparticipant contributions up to a maximum of 4.5% of each participant’s salary.The company contributed $27,138 and $16,273 to the Plan for the years ended December 31,2007 and 2006, respectively.

 

**Note 8 — Related party:**

 

Thecompany purchases the majority of its cogeneration units from Tecogen, anaffiliate company sharing similar ownership. In addition, Tecogen pays certainoperating expenses, including benefits and payroll, on behalf of the companyand the company leases office space from Tecogen. These costs were reimbursedby the company. Tecogen has a sublease agreement for the office building, whichexpires on March 31, 2009.

 

InJanuary 2007, the company entered into a Facilities, Support Services andBusiness Agreement with Tecogen, to provide the company with certain office andbusiness support services for a period of one year, renewable annually bymutual agreement (Note 10).

 

Thecompany has sales representation rights to Tecogen’s products and services. InNew England, the company has exclusive sales representation rights to Tecogen’scogeneration products. The company has granted Tecogen sales representationrights to its on-site utility energy service in California.

 

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

 

OnFebruary 15, 2007, the company loaned the minority interest partner in theNY LLC $20,000 by signing in a two year loan agreement earning interest at 12%per annum. On April 1, 2007, the company loaned an additional $75,000 tothe same minority interest partner by signing a two year note agreement earninginterest at 12% per annum, and on May 16, 2007, the company loaned anadditional $55,000 to the same partner by signing a two year note agreementunder the same terms. All notes are classified in the *Due fromrelated party-long term*account in the accompanying balance sheetand are secured by the partner’s minority interest. On October 11, 2007 weextended to our minority interest partner a line of credit not to exceed$500,000. At December 31, 2007, $403,810 was outstanding and due to thecompany.

 

**Note 9 — Income taxes:**

 

Areconciliation of federal statutory income tax provision to the company’sactual provision for the years ended December 31, 2007 and December 31,2006 respectively are as follows:

 

 

F-13

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| ** **                            | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |
| Benefit at federal statutory tax rate |       | $        | (504,000   | )        | $          | (705,000 | ) |
| Unbenefited operating losses          |       | 504,000  |       | 705,000  |       |
| Tax Expense                           |       | $        | —     |     | $          | — |   |

 

Thecomponents of net deferred tax assets recognized in the accompanying balancesheets at December 31, 2007 and December 31, 2006 respectively are asfollows:

 

| ** **                       | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|
|                             |       |       |       |       |       |
| Net Operating Loss Carryforwards |       | $          | 2,196,000  |       | $          | 1,734,000 |   |
| Accrued Expenses and other       |       | 118,000    |       | 41,000     |       |
| Depreciation                     |       | (12,000    | )          | (45,000    | )          |
|                             |       | 2,302,000  |       | 1,730,000  |       |
| Valuation allowance              |       | (2,302,000 | )          | (1,730,000 | )          |
| Net deferred tax asset           |       | $          | —     |       | $          | — |   |

 

Asof December 2007, the company has federal and state loss carryforwards ofapproximately $5,797,000 and $4,249,000, respectively, which may be used tooffset future federal and state taxable income, expiring at various datesthrough 2027.

 

Managementhas determined that it is more likely than not that the company will notrecognize the benefits of the federal and state deferred tax assets and as aresult has recorded a valuation allowance against the entire net deferred taxasset. If the company should generate sustained future taxable income, againstwhich these tax attributes may be recognized, some portion or all of thevaluation allowance would be reversed.

 

Thecompany adopted FIN 48 effective January 1, 2007. The adoption of thisstatement had no effect on the company’s financial position. The company has nouncertain tax positions as of either the date of the adoption, or as of December 31,2007.

 

**Note 10 —Commitments and contingencies:**

 

In January 2007, thecompany entered into a Facilities, Support Services and Business Agreement withTecogen, to provide the company with certain office and business support servicesfor a period of one year, renewable annually by mutual agreement. Under the 2007business agreement we revised the rent allocation whereby Tecogen provides thecompany with office space and utilities at a flat rate of $2,294 per month. The company also shares personnelsupport services with Tecogen. The company is allocated its share of the costof the personnel support services based upon the amount of time spent by suchsupport personnel while working on the company’s behalf. To the extent Tecogen isable to do so under its current plans and policies, Tecogen includes thecompany and its employees in several of its insurance and benefit programs. Thecosts 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-14

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