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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-K**

 

| **x**                                                 | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|-------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                            | ** **                                                                                              |
| **For the fiscal year ended  December 31, 2008** |
| ** **                                            |
| **or**                                                |
| ** **                                            | ** **                                                                                              |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 0-52294**

 

**AMERICANDG ENERGY INC.**

(Exact name of Registrantas specified in its charter)

 

| **Delaware**                              | ** ** | **04-3569304**                     |
|-------------------------------------------|------------|------------------------------------|
| (State of incorporation  or organization) |       | (IRS Employer  Identification No.) |
|                                      |       |                               |
| **45 First Avenue**                       | ** ** | ** **                         |
| **Waltham, Massachusetts**                | ** ** | **02451**                          |
| (Address of Principal  Executive Offices) |       | (Zip Code)                         |

 

Registrant’sTelephone Number, Including Area Code: **(781) 622-1120**

Securitiesregistered pursuant to Section 12(b) of the Act: **None**

Securitiesregistered pursuant to Section 12(g) of the Act:

 

| **Title of each class**         | ** ** | **Name of each exchange on which registered** |
|---------------------------------|------------|-----------------------------------------------|
| Common  Stock, $0.001 par value |       | OTC  Bulletin Board                           |

 

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Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o   Nox

 

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Securities Act. Yes o   Nox

 

Indicate by check mark whether 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, (or for such shorterperiod that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x   Noo

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or an amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company.  See thedefinitions of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of 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 mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   Nox

 

As of June 30, 2008, the aggregate market valueof the voting shares of the registrant held by non-affiliates on the OTCBulletin Board was approximately $19,733,695 based on a closing price per shareof $1.43. For purposes of this calculation, an aggregate of 20,119,709 sharesof common stock held directly or by affiliates of the directors and officers ofthe registrant have been included in the number of shares held by affiliates.

 

As of March 20, 2009 theregistrant’s shares of common stock outstanding were: 34,034,496.

 

**DOCUMENTS INCORPORATED BYREFERENCE**

** **

Certain information required by in Items 10, 11, 12, 13 and 14 of Part IIIof this Annual Report on Form 10-K is incorporated by reference from our definitiveProxy Statement for our 2009 Annual Meeting of Shareholders scheduled to beheld on May 29, 2009.

 

 

 

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**WARNINGCONCERNING FORWARD-LOOKING STATEMENTS**

** **

THISANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THEMEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND OTHERFEDERAL SECURITIES LAWS. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON OURPRESENT INTENT, BELIEFS OR EXPECTATIONS, AND ARE NOT GUARANTEED TO OCCUR AND MAY NOTOCCUR. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN ORIMPLIED BY OUR FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS.

 

WEGENERALLY IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS “MAY,” “WILL,”“SHOULD,” “EXPECTS,” “PLANS,” “ANTICIPATES,” “COULD,” “INTENDS,” “TARGET,” “PROJECTS,”“CONTEMPLATES,” “BELIEVES,” “ESTIMATES,” “PREDICTS,” “POTENTIAL” OR “CONTINUE”OR THE NEGATIVE OF THESE TERMS OR OTHER SIMILAR WORDS. THESE STATEMENTS AREONLY PREDICTIONS. THE OUTCOME OF THE EVENTS DESCRIBED IN THESE FORWARD-LOOKINGSTATEMENTS IS SUBJECT TO KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHERFACTORS THAT MAY CAUSE OUR, OUR CUSTOMERS’ OR OUR INDUSTRY’S ACTUALRESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIEDBY THESE FORWARD-LOOKING STATEMENTS, TO DIFFER.

 

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 FROMTHE PROJECTIONS BASED ON THESE ASSUMPTIONS. AS A RESULT, OUR MARKETS MAY NOTGROW AT THE RATES PROJECTED BY THESE DATA, OR AT ALL. THE FAILURE OF THESEMARKETS TO GROW AT THESE PROJECTED RATES MAY HAVE A MATERIAL ADVERSEEFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION AND THEMARKET PRICE OF OUR COMMON STOCK.

 

SEE“ITEM 1A. RISK FACTORS,” “MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” AND “BUSINESS,”AS WELL AS OTHER SECTIONS IN THIS REPORT, THAT DISCUSS SOME OF THE FACTORS THATCOULD CONTRIBUTE TO THESE DIFFERENCES. THE FORWARD-LOOKING STATEMENTS MADE INTHIS ANNUAL REPORT ON FORM 10-K RELATE ONLY TO EVENTS AS OF THE DATE OFWHICH THE STATEMENTS ARE MADE. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO UPDATE OR RELEASEANY FORWARD- LOOKING STATEMENTS AS A RESULT OF NEW INFORMATION, FUTURE EVENTSOR OTHERWISE.

 

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**AMERICAN DG ENERGY INC.**

**ANNUAL REPORT ON FORM 10-K**

**FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008**

** **

**TABLEOF 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  the 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 Condition and Results of Operations. |   |   |
|              |   |   |   |   |
| 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, and Director Independence. |   |   |
|              |   |   |   |   |
| Item 14.          |   | Principal  Accountant Fees and Services. |   |   |
|              |   |   |   |   |
| **PART IV**  | ** ** | ** ** |
|              |   |   |   |   |
| Item 15.          |   | Exhibits and  Financial Statement Schedules. |   |   |

 

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**PART I**

** **

**Item 1.  Business.**

** **

**General**

 

AmericanDG Energy Inc. (“American DG Energy”, the “company”, “we”, “our” or “us”) distributes,owns and operates clean, on-site energy systems that produce electricity, hotwater, heat and cooling. Our business model is to own the equipment that weinstall at customers’ facilities and to sell the energy produced by thesesystems to the customers on a long-term contractual basis. We call thisbusiness the American DG Energy “On-Site Utility”.

 

Weoffer natural gas powered cogeneration systems that are highly reliable andenergy efficient. Our cogeneration systems produce electricity from an internalcombustion engine driving a generator, while the heat from the engine andexhaust is recovered and typically used to produce heat and hot water for useat the site. We also distribute and operate water chiller systems for buildingcooling applications that operate in a similar manner, except that the engine’spower drives a large air-conditioning compressor while recovering heat for hotwater. Cogeneration systems reduce the amount of electricity that the customermust purchase from the local utility and produce valuable heat and hot waterfor the site to use as required.  Bysimultaneously providing electricity, hot water and heat, cogeneration systemsalso have a significant, positive impact on the environment by reducing thecarbon or CO2 produced by offsetting the traditional energysupplied by the electric grid and conventional hot water boilers.

 

DistributedGeneration of electricity or DG, or often referred to as cogeneration systems,or combined heat and power systems, or CHP, is an attractive option forreducing energy costs and increasing the reliability of available energy. DGhas  been successfully implemented byothers in large industrial installations over 10 Megawatts, or MW, where themarket has been growing for several years, and is increasingly being acceptedin smaller size units because of technology improvements, increased energycosts and better DG economics. We believe that our target market (users of upto 1 MW) has been barely penetrated and that the reduced reliability of the utilitygrid, increasing cost pressures experienced by energy users, advances in new,low cost technologies and DG-favorable legislation and regulation at the stateand federal level will drive our near-term growth and penetration into ourtarget market. The company maintains a website at www.americandg.com, but ourwebsite address included in this Annual Report on Form 10-K is a textualreference only and the information in the website is not incorporated byreference into this Annual Report on Form 10-K.

 

Thecompany was incorporated as a Delaware corporation on July 24, 2001 toinstall, own, operate and maintain complete DG systems and other complementarysystems at customer sites and sell electricity, hot water, heat and coolingenergy under long-term contracts at prices guaranteed to the customer to bebelow conventional utility rates.As of December 31, 2008, we had installed energy systems, representingapproximately 4,240 kilowatts, or kW, 32.4 million British thermal units, orMMBtu’s, of heat and hot water and 600 tons of cooling. kW is a measure ofelectricity generated, MMBtu is a measure of heat generated and a ton is ameasure of cooling generated. Due to the high efficiency CHP systems, the Environmental ProtectionAgency, or EPA, has recognized them as a means to improve the environment. Wehave estimated that our currently installed energy systems running at 100%capacity have the potential to produce approximately 24,200 metric tonsof carbon equivalents, less than typical separate heat and power systems,resulting in emissions reductions equivalent to planting 6,600 acres of forestor removing the emissions of 4,100 automobiles.

 

Webelieve that our primary near-term opportunity for DG energy and equipmentsales is where commercial electricity rates exceed $0.12 per kW hour, or kWh,which is predominantly in the Northeast and California. These areas representapproximately 15% of the U.S. commercial power market, with electricityrevenues in excess of $20.0 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, or EIA, in 2000 detailed the prospective CHPmarket in the commercial and institutional sectors(1) and in theindustrial sectors(2). These data sets were used to estimate the CHP marketpotential in the 100 kW to 1 MW size range. These target market segmentscomprise 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 Combined Heat and Power in theCommercial/Institutional Sector;* Prepared for the Energy InformationAdministration; Prepared by ONSITE SYCOM Energy Corporation; January 2000

 

(2) *The Market and Technical Potential for Combined Heat and Power in theIndustrial Sector;* Prepared for the Energy InformationAdministration; Prepared by ONSITE SYCOM Energy Corporation; January 2000

 

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Webelieve that the largest number of potential DG users in the U.S. require lessthan 1 MW of electric power and less than 1,200 tons of cooling capacity. Weare able to design our systems to suit a particular customer’s needs because ofour ability to place multiple units at a site. This approach is part of whatallows our products and services to meet changing power and cooling demandsthroughout the day (also from season-to-season) and greatly improves efficiencythrough a customer’s varying high and low power requirements.

 

American DG Energypurchases energy equipment from various suppliers. The primary type ofequipment used is a natural gas-powered, reciprocating engine provided byTecogen Inc., or Tecogen. Tecogen is a leading manufacturer of natural gas,engine-driven commercial and industrial cooling and cogeneration systemssuitable for a variety of applications, including hospitals, nursing homes andschools.

 

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 the U.S.has evolved over many decades into an inefficient and increasingly unreliablestructure. Power for lighting, air conditioning, refrigeration, communicationsand computing demands comes almost exclusively from centralized power plants servingusers through a complex grid of transmission and distribution lines andsubstations. Even with continuous improvements in central station generationand transmission technologies, today’s power industry is only about 33%efficient(3) meaning that it discharges to the environment roughly twiceas much heat as the amount of electrical energy delivered to end-users. Sincecoal accounts for more than half of all electric power generation, theseinefficiencies are a major contributor to rising atmospheric CO2 emissions. As countermeasuresare sought to limit global warming, pressures against coal will favor thedeployment of alternative energy technologies.

 

On-site boilers and furnaces burning eithernatural gas or petroleum distillate fuels produce most thermal energy for spaceheating and hot water services. This separation of thermal and electricalenergy supply services has persisted despite a general recognition that CHP canbe significantly more energy efficient than central generation of electricityby itself. Except in large-scale industrial applications (e.g., paper andchemical manufacturing), cogeneration has not attained general acceptance. Thiswas due, in part, to the long-established monopoly-like structure of theregulated utility industry. Also, the technologies previously available forsmall on-site cogeneration systems were incapable of delivering thereliability, cost and environmental performance necessary to displace or evensubstantially modify the established power industry structure.

 

Thecompetitive balance began to change with the passage of the Public UtilityRegulatory Policy Act of 1978, a federal statute that has opened the door togradual deregulation of the energy market by the individual states. In 1979,the accident at Three Mile Island effectively halted the massive program ofnuclear power plant construction that had been a centerpiece of the electricgenerating strategy among U.S. utilities for two decades. Several factorscaused utilities’ capital spending to fall drastically, including wellpublicized cost overruns at nuclear plants, an end to guaranteed financialreturns on costly new facilities, and growing uncertainty over which powerplant technologies to pursue. Recently, investors have become increasinglyreluctant to support the risks of the long-term construction projects requiredfor new conventional generating and distribution facilities.

 

Becauseof these factors, electricity reserve margins have declined, and thereliability of service has begun to deteriorate, particularly in regions ofhigh economic growth. Widespread acceptance of computing and communicationstechnologies by consumers and commercial users has further increased the demandfor electricity, while also creating new requirements for very high powerquality and reliability. At the same time, technological advances in emissioncontrol, microprocessors and internet technologies have sharply altered thecompetitive balance between centralized and DG. These fundamental shifts ineconomics and requirements are key to the emerging opportunity for DG equipmentand services.

** **

**TheRole of DG**

 

DG,or cogeneration, is the production of two sources or two types of energy(electricity or cooling and heat) from a single energy source (natural gas). Weuse technology that utilizes a low-cost, mass-produced, internal combustionengine 

 

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(3) *Energy Information Administration, Voluntary Reporting of GreenhouseGases*, 2004, Section 2, Reducing Emissions from Electric Power,Efficiency Projects: Definitions and Terminology, page 20

 

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from General Motors, used primarily in lighttrucks and sport utility vehicles, that is modified to run on natural gas. Theengine spins either a standard generator to produce electricity, or aconventional compressor to produce cooling. For heating, since the workingengine generates heat, we capture the byproduct heat with a heat exchanger andutilize the heat for facility applications in the form of space heating and hotwater for buildings or industrial facilities. This process is very similar toan automobile, where the engine provides the motion to the automobile and thebyproduct heat is used to keep the passengers warm during the winter months.For refrigeration or cooling, standard available equipment uses an electricmotor to spin a conventional compressor to make cooling. We replace theelectric motor with the same modified engine that runs on natural gas to spinthe compressor to run a refrigeration cycle and produce cooling.

 

DGrefers to the application of small-scale energy production systems, includingelectricity generators, at locations in close proximity to the end-use loadsthat they serve. Integrated energy systems, operating at user sites butinterconnected to existing electric distribution networks, can reduce demand onthe nation’s utility grid, increase energy efficiency, avoid the waste inherentin long distance wire and cable transmission of electricity, 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, or the DOE. The DOE has stated its position onthis issue as 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 totraditional energy 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 DG of multiple energy services,compared with traditional centralized generation and distribution ofelectricity alone, include the following:

 

·                  Greatlyincreased overall energy efficiency (typically over 80% versus less than 33% forthe existing power grid).

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  Abilityto remotely monitor, control and dispatch energy services on a real-time basisusing advanced switchgear, software, microprocessor and internet modalities.Through our on-site energy products and services, energy users are able tooptimize, in real time, the mix of centralized and distributedelectricity-generating resources.

 

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

 

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

 

·                  Thebase-rate of an electric utility is determined by a certain number ofsubscribers. DG at a significant scale will reduce the number of subscribersand therefore it may increase the base-rate for the electric utility for itscustomer base.

 

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

 

Also,DG systems possess significant positive environmental impact. The EPA hascreated a Combined Heat and Power Partnership to promote the benefits of DGsystems. The company is a member of this Partnership. The following statementis 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 (CO**2), as well ascriteria air pollutants like nitrogen oxides (NO**x) and sulfur dioxide (SO**2), are reduced.”*

** **

**The DG Market Opportunity**

 

We believe that our primary near-term opportunity forDG energy and equipment sales is where commercial electricity rates exceed$0.12 per kWh, which is predominantly in the Northeast and California. Theseareas represent approximately 15% of the U.S. commercial power market,with electricity revenues in excess of $20 billion per year (see Figure 1.on page 6). Attractive DG economics are currently attainable inapplications that include hospitals, nursing homes, multi-tenant residentialhousing, hotels, schools and colleges, recreational facilities, food processingplants, dairies and other light industrial facilities. Two CHP market analysisreports sponsored by the EIA in 2000 detailed the prospective CHP market in thecommercial and institutional sectors(4) and in the industrial sectors(5).These data sets were used to estimate the CHP market potential in the 100 kW to1 MW size range. These target market segments comprise over 163,000 sitestotaling 12.2 million kW of prospective DG capacity. This is theequivalent of an $11.7 billion annual electricity market plus a$7.3 billion heat and hot water energy market, for a combined marketpotential of $19 billion.

 

Asshown in Figure 1 on page 6, there are substantial variations in theelectric rates paid by commercial and institutional customers throughout theU.S. In high-cost regions, monthly payments for energy services suppliedby on-site DG projects yield rapid paybacks (e.g., often 3-5 years)on an 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 in Figure 1 on page 6. Althoughpaybacks on DG projects would be less rapid in such regions, future rateincreases are expected to improve DG economics.

 

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(4) *The Market and Technical Potential for Combined Heat and Power in theCommercial/Institutional Sector*; Prepared for the Energy InformationAdministration; Prepared by ONSITE SYCOM Energy Corporation; January 2000

 

(5) *The Market and Technical Potential for Combined Heat and Power in theIndustrial Sector;* Prepared for the Energy InformationAdministration; Prepared by ONSITE SYCOM Energy Corporation; January 2000

 

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Figure 1

 

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

*** ***

   

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

 

**Business Model**

 

Weare a DG onsite energy company that sells energy in the form of electricity,heat, hot water and air conditioning under long-term contracts with commercial,institutional and light industrial customers. We install our systems at no costto our customers and retain ownership of the system. Because our systemsoperate at over 80% efficiency (versus less than 33% for the existingpower grid), we are able to sell the energy produced by these systems toour customers at prices below their existing cost of electricity (or airconditioning), heat and hot water. Our cogeneration systems consist of naturalgas-powered internal combustion engines that drive an electrical generator toproduce electricity and that capture the engine heat to produce space heatingand hot water. Our energy systems also can be configured to drive a compressorthat produces air conditioning and that also captures the engine heat. As of December 31,2008, we had 56 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 capital 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 CHP product and energy options.  Ourprimary energy and products are listed below:

 

·                  EnergySales

·                  Electricity

·                  Thermal(Hot Water, Heat and Cooling)

 

·                  EnergyProducing Products

·                  CogenerationPackages

·                  Chillers

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

·                  AlternativeEnergy Equipment (e.g., solar, fuel cells, etc.)

 

·                  Turnkey Installation Energy ProducingProducts with Incentives

·                  Other Revenue Opportunities

 

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***Energy Sales***

 

Forcustomers seeking an alternative to the outright purchase of CHP equipment, wewill install, maintain, finance, own and operate complete on-site CHP systemsthat supply, on a long-term, contractual basis, electricity and other energyservices. We sell the energy to customers at a guaranteed discount rate to therates charged by conventional utility suppliers. Customers are billed monthly.Our customers benefit from a reduction in their current energy bills withoutthe capital costs and risks associated with owning and operating a cogenerationor chiller system. Also, by outsourcing the management and financing of on-siteenergy facilities to us, they can reap the economic advantages of DG withoutthe need for retaining specialized in-house staff with skills unrelated totheir core business. Customers benefit from our On-Site Utility in a number ofways:

 

·                  Guaranteed lower price for energy

·                  Only pay for the energy they use

·                  No capital costs for equipment, engineeringand installation

·                  No equipment operating costs for fuel andmaintenance

·                  Immediate cash flow improvement

·                  Significantgreen impact by the reduction of carbon produced

·                  No staffing, operations and equipmentresponsibility

 

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

 

Inregions where high electricity rates prevail, such as the Northeast, monthlypayments for CHP energy services can yield attractive paybacks (e.g. often 3-5years) on our investments in On-Site Utility projects. The price of natural gashas a minor effect on the financial returns obtained from our energy servicecontracts because the value of hot water and other thermal services producedfrom the recovered heat generated by the internal combustion engine in ouron-site DG system will increase in proportion to higher fuel costs. Thisrecovered energy, which comprises up to 60 % of the total heating value of fuelsupplied to our CHP equipment, displaces fuel that would otherwise be burned inconventional boilers. Each of our customer sites becomes a profit center. Theexample below presents the energy supplied by two 75 kW cogeneration units andthe economics of a typical energy service contract where we supply 80% of thesite’s heat and hot 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 |   |

 

Theexample reflects an American DG Energy investment of $345,000 with a payback in4 years or a 25% internal rate of return. The example also reflects a 2% ofexpected annual increase in energy costs that should occur over the 15-yearperiod.

 

Sinceinception in 2001 and through December 31, 2008, the company has enteredinto 43 agreements for the supply of on-site energy services, primarily withhealthcare, housing facilities, apartments and athletic facilities in theNortheast.

*** ***

***EnergyProducing Products***

 

Wetypically offer cogeneration units sized to produce 75 kW to 100 kW ofelectricity and water chillers sized to produce 200 to 400 tons of cooling. Forcogeneration, we prefer a modular design approach to allow us to group multipleunits together to serve customers with considerably larger power requirements.Often, cogeneration units are conveniently dispersed within a large operation,such as a hospital or campus, serving multiple process heating systems thatwould 

 

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otherwise be impractical to serve from a singlelarge machine. The equipment we select often yield overall energy efficienciesin excess of 80% (from our equipment supplier’s specifications).

 

Manyother DG technologies are challenged by technical, economic and reliabilityissues associated with systems that generate power using solar, micro-turbineor fuel cell technologies, which have not yet proven to be economical fortypical customer needs. When alternative energy technologies mature to thepoint that they are both reliable and economical, we will employ them for thebest-fit applications.

*** ***

***Service and Installation***

 

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

 

For the occasionalcustomers that want to own the CHP system themselves, we offer our “turn-key”option whereby we provide equipment, systems engineering, installation,interconnect approvals, on-site labor and startup services needed to bring thecomplete CHP system on-line. For some customers, we are also paid a fee to operatethe systems and may receive a portion of the savings generated from theequipment.

** **

***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 inelectricity production during periods of peak usage throughout a utilityterritory. We have also received grants and incentives from state organizationsand natural gas companies for our installed energy systems.

 

**Sales and Marketing**

 

Our On-Site Utilityservices are 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 andoperators in healthcare, hospitality, large residential, athletic facilitiesand certain industrial sites. This includes national accounts and othercustomer groups having a common set of energy requirements at multiplelocations.

 

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, or ADGNY, with AES-NJ Cogen Co., or AES-NJ,an established developer 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 CHP 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.

 

The U.S. government has been developing and refiningvarious funding opportunities related to its economic recovery or stimulusinitiatives. While the final decision has not been determined as of the date ofthis Annual Report on Form 10-K, it appears that “shovel ready” projectsrelated to energy and the environment will hold great prominence. Also, thereappears to be interest in upgrading government buildings. The company’s CHPsystems would fit very well with any of these programs. Other than fundingopportunities related to the economic recovery or stimulus initiatives, theredoes not appear to be any new government regulations that will affect thecompany.

 

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**Competition**

 

We believe that the maincompetition for our DG products is the established electric utilityinfrastructure. DG is beginning to gain acceptance in regions where energycustomers are dissatisfied with the cost and reliability of traditionalelectricity service. These end-users, together with growing support from statelegislatures and regulators, are creating a favorable climate for the growth ofDG that is overcoming the objections of established utility providers. In ourtarget markets, we compete with large utility companies such as ConsolidatedEdison in New York City and Westchester County, Long Island Power Authority inLong Island, New York, Public Service Gas and Electric in New Jersey, and NSTARand National Grid in Massachusetts.

 

Engine manufacturers sell DG unitsthat range in size from a few kW’s to many MW’s in size. Those manufacturersare predominantly greater than 1 MW and include Caterpillar, Cummins, andWaukesha. In many cases, we view these companies as potential suppliers ofequipment and not as competitors. For example, we are currently installing aWaukesha unit at a customer site.

 

The alternative energy market isemerging rapidly. Many companies are developing alternative and renewableenergy sources including solar power, wind power, fuel cells andmicro-turbines. Some of the companies in this sector include General Electric,BP, Shell, Sun Edison and Evergreen Solar (in the solar energy space); PlugPower and Fuel Cell Energy (in the fuel cell space); and Capstone, IngersollRand and Elliott Turbomachinery (in the micro-turbine space). The effect ofthese developing technologies on our business is difficult to predict; however,when their technologies become more viable for our target markets, we may beable to adopt their technologies into our business model.

 

There are a number of energyservice companies that offer related services. These companies include Siemens,Honeywell and Johnson Controls. In general, these companies seek large, diverseprojects for electric demand reduction for campuses that include buildinglighting and controls, and electricity (in rare occasions) or cooling. Becauseof their overhead structures, these companies often solicit large projects andstay away from individual properties. Since we focus on smaller projects forenergy supply, we are well suited to work in tandem with these companies whenthe opportunity arises.

 

There are also a few local emerging cogeneration developersand contractors that are attempting to offer services similar to ours. To besuccessful, they will need to have the proper experience in equipment andtechnology, installation contracting, equipment maintenance and operation, siteeconomic evaluation, project financing and energy sales plus the capability tocover a broad region.

** **

**Material Contracts**

 

In January 2006, thecompany entered into the 2006Facilities, Support Services and Business Agreement, or the Agreement, withTecogen, to provide the company with certain office and business supportservices for a period of one year, renewable annually by mutual agreement. Thecompany also shares personnel support services with Tecogen. The company isallocated its share of the cost of the personnel support services based uponthe amount of time spent by such support personnel while working on the company’sbehalf. To the extent Tecogen is able to do so under its current plans andpolicies, Tecogen includes the company and its employees in several of itsinsurance and benefit programs. The costs of these programs are charged to thecompany on an actual cost basis. Under this agreement, the company receivespricing based on a volume discount if it purchases cogeneration and chiller productsfrom Tecogen. For certain sites, the company hires Tecogen to service itsTecogen chiller and cogeneration products. In January and May 2008,we amended the Agreement with Tecogen. Under the amendments, Tecogen providesthe company with office space and utilities at a monthly rate of $2,053 and$2,780, respectively. Subsequent to year-end, on January 2009, the companyassumed additional space and amended the office space and utilities to amonthly rate of $4,838.

 

Wehave sales representation rights to Tecogen’s products and services. In NewEngland, we have exclusive sales representation rights to their cogenerationproducts. We have granted Tecogen sales representation rights to our On-SiteUtility energy service in California.

** **

**Government Regulation**

 

We are not subject to extensivegovernment regulation. Weare required to file for local construction permits (electrical, mechanical andthe like) and utility interconnects, and we must make various local and statefilings related to environmental emissions.

 

The U.S. government hasbeen developing and refining various funding opportunities related to itseconomic recovery or stimulus initiatives. While the final decision has notbeen determined as of the date of this Annual Report on Form 10-K, itappears that “shovel ready” projects related to energy and the environment willhold great prominence. Also,

 

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there appears to beinterest in upgrading government buildings. The company’s CHP systems would fitvery well with any of these programs. Other than funding opportunities relatedto the economic recovery or stimulus initiatives, there does not appear to beany new government regulations that will affect the company.

 

**Employees**

 

Asof December 31, 2008, we employed eleven active full-time employees andtwo part-time employees. We believe that our relationship with our employees issatisfactory. None of our employees are represented by a collective bargainingagreement.

 

**Item 1A. Risk Factors.**

 

Our business facesmany risks. The risks described below may not be the only risks we face.Additional risks that we do not yet know of, or that we currently think areimmaterial, may also impair our business operations or financial results. Ifany of the events or circumstances described in the following risks occurs, ourbusiness, financial condition or results of operations could suffer and thetrading price of our common stock could decline. Investors and prospectiveinvestors should consider the following risks and the information containedunder the heading ”Warning Concerning Forward-Looking Statements” beforedeciding whether to invest in our securities.

** **

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

 

We have incurred losses in each ofour fiscal years since inception. Losses continued to be incurred in 2008.There is no assurance that profitability will be achieved in the near term, ifat all.

** **

**Because unfavorable utilityregulations make the installation of our systems more difficult or lesseconomical, any slowdown in the utility deregulation process would be animpediment to the growth of our business.**

 

Inthe past, many electric utility companies have raised opposition to DG, acritical element of our On-Site Utility business. Such resistance has generallytaken the form of unrealistic standards for interconnection, and the use oftargeted rate structures as disincentives to combined generation of on-site powerand heating or 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 on-site 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.

** **

**Our onsite utility conceptis largely unproven and may not be accepted by a sufficient number ofcustomers.**

 

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

** **

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

 

Theeconomic viability of DG projects is dependent upon the price spread betweenfuel and electricity prices. Volatility in one component of the spread, thecost of natural gas and other fuels (e.g., propane or distillate oil) can bemanaged to a greater or lesser extent by means of futures contracts. However,the regional rates charged for both base load and peak electricity services maydecline periodically due to excess capacity arising from over-building ofutility power plants or recessions in economic activity. Any sustained weaknessin electricity prices could significantly limit the market for ourcogeneration, cooling equipment and On-Site Utility energy services.

 

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**We may fail to make sales tocertain prospective customers because of resistance from facilities managementpersonnel to the outsourcing of their service function.**

 

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

** **

**Future governmentregulations, such as increased emissions standards, safety standards and taxes,may adversely impact the economics of our business.**

 

Theoperation of DG equipment at our customers’ sites may be subject to futurechanges in federal, state and local laws and regulations (e.g., emissions,safety, taxes, etc.). Any such new or substantially altered rules andstandards may adversely affect our revenues, profits and general financialcondition.

** **

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

 

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

** **

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

 

Ourbusiness may be limited by competition from energy services companies arisingfrom the breakup of conventional regulated electric utilities. Suchcompetitors, both in the equipment and energy services sectors, are likely tohave far greater financial and other resources than us, and could possessspecialized market knowledge with existing channels of access to prospectivecustomer locations. We may be unable to successfully compete against thosecompetitors.

** **

**Future technology changes may render obsolete various elements ofequipment comprising our On-Site Utility installations.**

 

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

** **

**We have limited historicaloperating results upon which to base projections of future financialperformance, making it difficult for prospective investors to assess the valueof our stock.**

 

Ourexperience is primarily on-site energy services, and we have only a few yearsof actual operating experience. These limitations make developing financialprojections more difficult. We will expand our business infrastructure based onthese projections. If these projections prove to be inaccurate, we will sustainadditional losses and will jeopardize the success of our business.

** **

**We will need to raise additional capital forour business, which will dilute existing shareholders.**

 

Additional financings will be required to implement our overallbusiness plan. We will need additional capital. Equity financings will dilutethe percentage ownership of our existing shareholders. Our ability to raise anadequate amount of capital and the terms of any capital that we are able toraise will be dependent upon our progress in implementing demonstrationprojects and related marketing service development activities. If we do notmake adequate progress, we may be unable to raise adequate funds, which willlimit our ability to expand our business. If the terms of any equity financingsare unfavorable, the dilutive impact on our shareholders might be severe.

** **

**We may make acquisitions that could harm ourfinancial performance.**

 

In order to expedite development of our corporate infrastructure,particularly with regard to equipment installation and service functions, weanticipate the future acquisition of complementary businesses. Risks associatedwith such acquisitions include the disruption of our existing operations, lossof key personnel 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.

 

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**We are controlled by a small group ofmajority shareholders, and our minority shareholders will be unable to effectchanges in our governance structure or implement actions that requireshareholder approval, such as a sale of the company.**

 

George Hatsopoulos and John Hatsopoulos, who are brothers,beneficially own a majority of our outstanding shares of common stock. Thesestockholders have the ability to control various corporate decisions, includingour direction and policies, the election of directors, the content of ourcharter and bylaws and the outcome of any other matter requiring shareholderapproval, including a merger, consolidation and sale of substantially all ofour assets or other change of control transaction. The concurrence of ourminority shareholders will not be required for any of these decisions.

** **

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

 

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

### ** **

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

 

Historically, valuations of many companies in 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 further deteriorate, we may be unable tofinance our additional funding needs in the private or the public markets.There can be no assurance that any future offering will be consummated or, ifconsummated, will be at a share price equal or superior to the price paid byour investors even if we meet our technological and marketing goals.

** **

**Our common stock is quoted on the****OTC Bulletin Board, orOTCBB, which may have an unfavorable impact on our stock price and liquidity*.***

 

Ourcommon stock is quoted on the OTCBB. The OTCBB is a regulated quotation servicethat displays real-time quotes, last-sale prices and volume information inover-the-counter equity securities. An over-the-counter equity securitygenerally is any equity that is not listed or traded on NASDAQ or a nationalsecurities exchange. The OTCBB is a significantly more limited market thanthe New York Stock Exchange or NASDAQ system. The quotation of our shares onthe OTCBB 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 on the OTCBB isoften thin and characterized by wide fluctuations in trading prices, due tomany factors that may have little to do with our operations or businessprospects. Moreover, the OTCBB is not a stock exchange, and trading ofsecurities on the OTCBB is often more sporadic than the trading of securitieslisted on a quotation system or a stock exchange.

** **

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

 

The market price of ourcommon stock could decline as a result of sales by our existing stockholders ofshares of common stock in the market or the perception that these sales couldoccur. These sales might also make it more difficult for us to sell equitysecurities at a time and price that we deem appropriate and thus inhibit ourability to raise additional capital when it is needed.

 

**Becausewe do not intend to pay cash dividends, our stockholders will receive nocurrent income from holding our stock.**

 

We have paid no cashdividends on our capital stock to date and we currently intend to retain ourfuture earnings, if any, to fund the development and growth of our business. Inaddition, the terms of any future debt or credit facility may preclude us frompaying these dividends. As a result, capital appreciation, if any, of ourcommon stock will be your sole source of gain for the foreseeable future. Wecurrently expect to retain earnings for use in the operation and expansion ofour business, and therefore do not anticipate paying any cash dividends for theforeseeable future.

 

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**Our ability to access capital forthe repayment of debts and for future growth is limited as the financialmarkets are currently in a period of disruption and recession and the companydoes not expect these conditions to improve in the near future.**

 

Currentlyand throughout 2008, the financial markets have experienced very difficultconditions and volatility as well as significant adverse trends. Thedeteriorating conditions in these markets have resulted in a decrease inavailability of corporate credit and liquidity and have led indirectly to theinsolvency, closure or acquisition of a number of major financial institutionsand have contributed to further consolidation within the financial servicesindustry. A continued recession or a depression could adversely affect thefinancial condition and results of operations of the company. Morespecifically, these market conditions could also adversely affect the amount ofrevenue we report, require us to increase our allowances for losses, result inimpairment charges and valuation allowances that decrease our net income andequity, and reduce our cash flows from operations. Furthermore, our ability to continueto access capital could be impacted by various factors including general marketconditions and the continuing slowdown in the economy, interest rates, theperception of our potential future earnings and cash distributions, anyunwillingness on the part of lenders to make loans to us and any deteriorationin the financial position of lenders that might make them unable to meet theirobligations to us.

 

**Trading of our common stock is restricted by theSecurities and Exchange Commission’s, or the SEC’s, “penny stock” regulationswhich may limit a stockholder’s ability to buy and sell our stock.**

 

TheSEC has adopted regulations which generally define “penny stock” to be anyequity security that has a market price less than $5.00 per share or anexercise price of less than $5.00 per share, subject to certain exceptions. Oursecurities are covered by the penny stock rules, which impose additional salespractice requirements on broker-dealers who sell to persons other thanestablished customers and accredited 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 SEC that provides information about penny stocks and the natureand level of risks in the penny stock market. The broker-dealer also mustprovide the customer with current bid and other quotations for the penny stock,the compensation of the broker-dealer and its salesperson in the transaction andmonthly account statement showing the market value of each penny stock held inthe customer’s account. The bid and offer quotations, and the broker-dealer andsalesperson compensation information, must be given to the customer orally orin writing prior to effecting the transaction and must be given to the customerin writing before or with the customer’s confirmation. In addition, the pennystock rules require that prior to a transaction in a penny stock nototherwise exempt from these rules, the broker-dealer must make a specialwritten determination that the penny stock is a suitable investment for thepurchaser and receive the purchaser’s written agreement to the transaction.These disclosure and suitability requirements may have the effect of reducing thelevel of trading activity in the secondary market for a stock that is subjectto these penny stock rules. Consequently, these penny stock rules mayaffect the ability of broker-dealers to trade our securities. We believe thatthe penny stock rules discourage investor interest in and limit themarketability of our capital stock. Trading of our capital stock is restrictedby the SEC’s “penny stock” regulations which may limit a stockholder’s abilityto buy and sell our stock.

 

**There has been a material weakness in our financial controlsand procedures, which could harm our operating results or cause us to fail tomeet our reporting obligations.**

 

Asof the end of the period covered by this report, our Chief Executive Officerand Chief Financial Officer have performed an evaluation of controls andprocedures and concluded that our controls are effective to give reasonableassurance that the information required to be disclosed by our company inreports that we file under the Securities Exchange Act of 1934, as amended, orthe Exchange Act, is recorded, processed, summarized and reported as whenrequired. However, there is a lack of segregation of duties at the company dueto the small number of employees dealing with general administrative andfinancial matters. Furthermore, the company did not have personnel with anappropriate level of accounting knowledge, experience and training in theselection, application and implementation of U.S. Generally Accepted AccountingPrinciples, or GAAP, as it relates to complex transactions and financialreporting requirements. This constitutes a material weakness in financialreporting. Any failure to implement effective internal controls could harm ouroperating results or cause us to fail to meet our reporting obligations. Inadequateinternal controls could also cause investors to lose confidence in our reportedfinancial information, which could have a negative effect on the trading priceof our common stock, and may require us to incur additional costs to improveour internal control system.

 

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**Item 1B. Unresolved Staff Comments.**

 

None.

** **

**Item 2.  Properties.**

 

Ourheadquarters are located in Waltham, Massachusetts and consist of 2,702 squarefeet of office and storage space that are leased from Tecogen. The leaseexpires on March 31, 2014. We believe that our facilities are appropriateand adequate for our current needs.

** **

**Item 3.  Legal Proceedings.**

 

Weare not currently a party to any material litigation, and we are not aware ofany pending or threatened litigation against us that could have a materialadverse affect on our business, operating results or financial condition.

** **

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

 

None.

 

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**PART II**

 

**Item 5.****          ****Market for Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.**

** **

**Market**

 

Our common stockstarted trading on November 8, 2007 on the OTCBB under the symbol “ADGE”.OTCBB market quotations reflect inter-dealer prices, without retail mark-up,mark-down or commissions and may not necessarily represent actual transactions.During the period ended December 31, 2007, the high price was $1.25 andthe low price was $0.83 as reported by the OTCBB. The following table setsforth the high and low per share sales prices for our common stock for each ofthe quarters in the period beginning January 1, 2008 through December 31,2008 as reported by the OTCBB.

 
| **Quarter Ended**   | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------|------------|----------|------------|---------|------------|
|                     |       |     |       |    |       |
| March 31,  2008     |       | $        | 1.09       |    | $          | 0.73 |   |
| June 30,  2008      |       | $        | 1.92       |    | $          | 1.01 |   |
| September 30,  2008 |       | $        | 2.05       |    | $          | 1.35 |   |
| December 31,  2008  |       | $        | 2.31       |    | $          | 1.65 |   |

 

The closing price of our common stock asreported on the OTCBB on March 16, 2009 was $1.70.

** **

**Holders**

 

As of March 16,2009, there were approximately 71 holders of record of our common stock. As of March 16,2009, there were approximately 243 beneficial holders of our common stock.

 

**Dividends**

 

We have never declared orpaid any cash dividends on shares of our common 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.

 

**Recent Sales of Unregistered Securities**

 

Set forth below is information regardingcommon stock issued, warrants issued and stock options granted by the companyduring fiscal year 2008. Also included is the consideration, if any, wereceived and information relating to the section of the Securities Act of 1933,as amended, or the Securities Act, or rule of the SEC, under whichexemption from registration was claimed.

* *

*Common Stock and Warrants*

 

In 2008, the company raised $707,000 through theexercise of 1,010,000 warrants at a price of $0.70 per share. The warrantexercises were done exclusively by 17 accredited investors, representing 3.1%of the total shares then outstanding.

 

In 2008, two holders of the company’s 8% ConvertibleDebenture, elected to convert $150,000 of the outstanding principal amount ofthe debenture into 178,572 shares of common stock.

 

OnFebruary 24, 2009, the company sold a warrant to purchase shares of thecompany’s common stock to an accredited investor, for a purchase price of$10,500. The warrant, which expires on February 24, 2012, gives theinvestor the right but not the obligation to purchase 50,000 shares of thecompany’s common stock at an exercise price per share of $3.00.

 

Allof such investors were accredited investors, and such transactions were exemptfrom registration under the Securities Act under Section 4(2) and/orRegulation D thereunder.

 

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*RestrictedStock Grants*

 

In December 2008, the company made a restrictedstock grant to one employee by permitting him to purchase an aggregate of40,000 shares of common stock, representing 0.1% of the total shares thenoutstanding at a price of $0.001 per share. Those shares have a vestingschedule of four years.

 

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

 

*Stock Options*

 

In December 2008, the company grantednonqualified options to purchase 100,000 shares of the common stock to one employee at $1.95 per share. Thoseoptions have a vesting schedule of 4 years and expire in 10 years. The grant ofsuch options was exempt from registration under Rule 701 under theSecurities Act.

 

 No underwriterswere involved in the foregoing sales of securities. All purchasers of shares ofour convertible debentures and warrants described above represented to us inconnection with their purchase that they were accredited investors and madecustomary investment representations. All of the foregoing securities aredeemed restricted securities for purposes of the Securities Act.

 

**Rule 144**

 

Under Rule 144 underthe Securities Act, 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. Salesunder Rule 144 during this time period are still subject to therequirement that current public information is available about us for at least90 days prior to the sale. After such person beneficially owns shares of ourcommon stock for a period of one year or more, the person is entitled to sellan unlimited number of shares without complying with the public informationrequirement or any of the other provisions of Rule 144. As of March 20,2009, 843,572 shares of common stock held by non-affiliates were eligible forresale under amended Rule 144.

** **

**Item 6. Selected Financial Data.**

 

Not applicable.

 

**Item 7. ****Management’s Discussion and Analysis of Financial Condition and Resultsof Operation.**

 

*You should read the following discussion and analysis of ourfinancial condition and results of operations together with our financialstatements and related notes appearing elsewhere in this Annual Report on Form 10-K.Some of the information contained in this discussion and analysis or set forthelsewhere in this Annual Report on Form 10-K, including information withrespect to our plans and strategy for our business, includes forward-lookingstatements that involve risks and uncertainties. You should review “Item 1A.Risk Factors” beginning on page 10 of this Annual Report on Form 10-Kfor a 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.*

 

Recently,there has been a slowdown in the economy, a decline in the availability offinancing from the capital markets, and a widening of credit spreads which has,or may in the future, adversely affect us to varying degrees. Such conditionsmay impact our ability to meet obligations to our suppliers and other thirdparties. These market conditions could also adversely affect the amount ofrevenue we report, require us to increase our allowances for losses, result inimpairment charges and valuation allowances that decrease our net income andequity, and reduce our cash flows from operations. In addition, theseconditions or events could impair our credit rating and our ability to raiseadditional capital.

 

**Overview**

 

We derive sales from selling energyin the form of electricity, heat, hot water and cooling to our customers underlong-term energy sales agreements (with a typical term of 10 to 15 years). Theenergy systems are owned by us and are installed in our customers’ buildings.Each month 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 customers’ 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 ourcustomers’ local energy utility that month. Our revenues commence as new energysystems become operational. As of December 31,2008, we had 56 energy systems operational.

 

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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 case,we 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.

 

We have experienced totalnet losses since inception of approximately $9.7 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, 2008 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, 2008 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, 2010. Beyond January 1,2010, we may need to raise additional capital through a debt financing orequity offering to meet our operating and capital needs. There can be noassurance, however, that we will be successful in our fundraising efforts orthat additional funds will be available on acceptable terms, if at all.

 

In2008, we raised $707,000 through the exercise of various warrants. If we areunable to raise additional capital in 2010 we may need to terminate certain ofour employees and adjust our current business plan. Financial considerationsmay cause us to modify planned deployment of new energy systems and we maydecide to suspend installations until we are able to secure additional workingcapital. We will evaluate possible acquisitions of, or investments in,businesses, technologies and products that are complementary to our business;however, we are not currently engaged in such discussions.

 

The company’s operations are comprised of one businesssegment. Our business is selling energy in the form of electricity, heat, hotwater and cooling to our customers under long-term sales agreements. Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

** **

**RecentAccounting Pronouncements**

 

InDecember 2007, the Financial Accounting Standards Board, or FASB, issuedStatement of Financial Accounting Standards No. 141(R) “BusinessCombinations”, or SFAS No. 141(R), which requires changes in theaccounting and reporting of business acquisitions. The statement requires anacquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in purchased entities, measured at their fair values atthe date of acquisition based upon the definition of fair value outlined inStatement of Financial Accounting Standards No. 157, or SFAS No. 157.SFAS No. 141(R) is effective for the company for acquisitions thatoccur beginning in 2009. The effects of SFAS No. 141(R) on our financialstatements will depend on the extent that the company makes businessacquisitions in the future.

 

InDecember 2007, the FASB issued Statement of Financial Accounting StandardsNo. 160, “Noncontrolling Interests in Consolidated Financial Statements anAmendment of ARB No. 51”, or SFAS No. 160, which requires changes inthe accounting and reporting of noncontrolling interests in a subsidiary, alsoknown as minority interest. The statement clarifies that a minority interest ina subsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements. SFAS No. 160is effective for the company at the beginning of 2009. The company iscontinuing to review provisions of SFAS No. 160 which is effective the firstquarter of fiscal 2009, and expects this new accounting standard to result inchanges in the presentation of minority interests in the financial statementsconsistent with the new standard.

 

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InFebruary 2008, the FASB issued FASB Staff Position No. 157-2, or FSP No. 157-2,  which delays the effective date of SFAS No. 157for all nonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). SFAS No. 157 establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements.FSP No. 157-2 partially defers the effective date of SFAS No. 157 tofiscal years beginning after November 15, 2008, and interim periods withinthose fiscal years for items within the scope of this FSP No. 157-2. Theadoption of SFAS No. 157 for all nonfinancial assets and nonfinancialliabilities is effective for us beginning January 1, 2009. The companydoes not expect SFAS No. 157 to have a material impact on its results ofoperations and financial condition.

 

InMarch 2008, the FASB issued Statement of Financial Accounting Standards No. 161,“Disclosures about Derivative Instruments and Hedging Activities — an amendmentof Statement of Financial Accounting Standards No. 133”, or SFAS No. 161.SFAS No. 161 changes the disclosure requirements for derivativeinstruments and hedging activities. This standard requires enhanced disclosuresabout how and why an entity uses derivative instruments, how instruments are accountedfor under Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and how derivatives andhedging activities affect an entity’s financial position, financial performanceand cash flows. This standard is effective for fiscal years beginning after November 15,2008. The company does not expect SFAS No. 161 to have a material impacton its results of operations and financial condition.

 

InMay 2008, FASB issued Statement of Financial Accounting Standards No. 162,**“TheHierarchy of Generally Accepted Accounting Principles”, or SFAS No. 162.SFAS No. 162 identifies the sources of accounting principles and theframework for selecting the principles to be used in the preparation offinancial statements that are presented in conformity with GAAP in theU.S. SFAS No. 162 is effective 60 days following the SEC’s approval of thePublic Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly inConformity with Generally Accepted Accounting Principles.” The companydoes not expect SFAS No. 162 to have a material impact on its results ofoperations and financial condition.

 

**Critical Accounting Policies**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the U.S. 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”, or FIN No. 46-R, provides the principlesto consider in determining when variable interest entities must be consolidatedin the financial 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 No. 46-R requires a variable interest entity to be consolidated by acompany if that company is subject to a majority of the risk of loss from thevariable interest entity’s activities or is entitled to receive a majority ofthe entity’s residual returns, or both. A company that consolidates a variableinterest entity is called the primary beneficiary of that entity. The companyevaluates the applicability of FIN No. 46-R to partnerships and jointventures at the inception of its participation to ensure its accounting is inaccordance with the appropriate standards.

 

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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 the Note 7 - Related Party footnote to thecompany’s consolidated financial statement for discussion of the company’sinvolvement with Tecogen.

 

*Related Party Transactions*

 

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, 2014.

 

OnJanuary 1, 2008, via amendment No.1, and on May 15, 2008, viaamendment No.2, the company amended its Agreement with Tecogen that providewith certain office and business support services for a period of one year,renewable annually by mutual agreement. The amendments revised the rentallocation whereby Tecogen provides the company with office space and utilitiesto a flat rate of $2,053 and $2,780 per month, respectively. Subsequent toyear-end, on January 1, 2009, via amendment No.3 the company assumedadditional space and revised the rent allocation to a flat rate of $4,838 permonth.

 

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.

 

OnFebruary 15, 2007, the company loaned the minority interest partner in theADGNY $20,000 by signing a two year loan agreement earning interest at 12% perannum. On April 1, 2007, the company loaned an additional $75,000 to thesame 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*account in the accompanying balance sheet and aresecured by the partner’s minority interest. On October 11, 2007, weextended to our minority interest partner a line of credit of $500,000. At December 31,2008, $265,012 was outstanding and due to the company under the combination ofthe above agreements.

 

OurChief Financial Officer devotes part of hisbusiness time to the affairs of GlenRose Instruments Inc., or GlenRose, andpart of his salary is reimbursed by GlenRose. Also, our Chief Executive Officeris the Chairman of the Board and a significant investor in GlenRose and did notreceive a salary, bonus or any other compensation from GlenRose in 2008.

 

*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 Statement of Financial AccountingStandards No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, or SFAS No. 144. SFAS No. 144 requires therecognition of impairment of long-lived assets in the event the net book valueof such assets exceeds the estimated future undiscounted cash flowsattributable to such assets. If impairment is indicated, the asset is writtendown to its estimated fair value based on a discounted cash flow analysis. Thecompany reviews long-lived assets for impairment annually or whenever events orchanges in business circumstances indicate that the carrying value of theassets may not be fully recoverable or that the useful lives of the assets areno longer appropriate. At December 31, 2008 the company determined thatits long-lived assets are recoverable.

* *

*Stock-Based Compensation*

 

Effective January 1, 2006, we adopted Statementof Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment”, or SFAS No. 123(R),which is a revision of Statement of Financial Accounting Standards No. 123,“Accounting for Stock BasedCompensation”, or SFAS No. 123. SFAS No. 123(R) supersedesAccounting Principles Board No. 25, “Accounting for Stock Issued to Employees”, or APB No. 25,and Statement of Financial Accounting Standards No. 95 “Statement of Cash Flows”, or SFAS No. 95.SFAS No. 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values. Pro forma disclosure is no longer analternative.

 

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SFAS No. 123(R) requires nonpublic companiesthat used the minimum value method in SFAS No. 123 for either recognitionor pro forma disclosures to apply SFAS No. 123(R) using theprospective-transition method. As such, since we were not a public company asof the adoption date, we will continue to apply APB No. 25 in futureperiods to equity awards outstanding at the date of SFAS No. 123(R)’sadoption that were measured using the minimum value method.

 

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 commonstock to determine fair value of share-based payment awards.

 

SFAS No. 123(R) alsorequires companies to utilize an estimated forfeiture rate when calculating theexpense for the period, whereas, SFAS No. 123 permitted companies torecord forfeitures based on actual forfeitures, which was our historical policyunder SFAS No. 123. 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 2008 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.

 

OnNovember 10, 2005, the FASB issued Statement of Financial AccountingStandards Staff Position No. 123R-3 “Transition Election Related toAccounting for Tax Effects of Share-Based Payment Awards”, or SFAS No. 123R-3. The company has elected to adopt the alternative transition method provided bythe FASB Staff Position for calculating the tax effects (if any) of stock-basedcompensation expense pursuant to SFAS No. 123(R). The alternativetransition method includes simplified methods to establish the beginningbalance of the additional paid-in capital pool related to the tax effects ofemployee stock-based compensation, and to determine the subsequent impact tothe additional paid-in capital pool and the consolidated statements ofoperations and cash flows of the tax effects of employee stock-basedcompensation awards that are outstanding upon adoption of SFAS No. 123(R).

* *

*Revenue Recognition*

 

Revenuefrom energy contracts is recognized when electricity, heat, and chilled wateris produced by the cogeneration systems on-site. The company bills each monthbased on various meter readings installed at each site. The amount of energyproduced by on-site energy systems is invoiced, as determined by acontractually defined formula. Under certain energy contracts, the customer directlyacquires the fuel to power the systems and receives credit for that expensefrom the company. The credit is recorded as revenue and cost of fuel. Werecognize revenue that relates to multiple element contracts in accordance withEmerging Issues Task Force 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables”. Revenue to whichthis guidance applies includes a contract that consists of the sale ofequipment, installation, energy and maintenance. When a sales arrangementcontains multiple elements, revenue is allocated to each element based upon itsrelative fair value. Fair value is determined based on the price of adeliverable sold on 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 case,we 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 billingsand unbilled revenue represent the excess of contract costs and profitrecognized to date on the percentage-of-completion accounting method overbillings to date on certain contracts. Billings in excess of related costs andestimated earnings represents the excess of billings to date over the amount ofcontract costs and profits recognized to date on the percentage-of-completionaccounting method for certain contracts. Customers may buy out their long-termobligation under energy contracts and purchase the underlying equipment fromthe company. Any resulting gain on these transactions is recognized in theconsolidated statements of operations. Revenues from operation and maintenanceservices, including shared savings are recorded when provided and verified.

 

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*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 depreciation and certainaccrued liabilities for tax and accounting purposes. These differences resultin deferred tax assets and liabilities, which are included within ourconsolidated balance sheet. We must then assess the likelihood that ourdeferred tax assets will be recovered from future taxable income and to theextent we believe that recovery is not likely, we must establish a valuationallowance. To the extent we establish a valuation allowance or increase thisallowance in a period, we must include an expense within the tax provision inthe consolidated statement of 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, 2008, there was no deferred income tax asset onour books. We recorded a valuation allowance of $3,056,000 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 anadditional valuation allowance which could materially impact our financialposition and results of operations.

** **

**Results ofOperations for the Years Ended December 31, 2008 and December 31,2007**

 

*Fiscal 2008 Compared with Fiscal 2007*

 

*Revenues*

 

Revenuesin 2008 were $6,579,437 as compared to $5,847,020 for the same period in 2007,an increase of $732,417 or 12.5%. The increase in revenues was primarily due toan increase in our core On-Site Utility energy business revenues that increasedto $5,140,503 as compared to $3,266,915 for the same period in 2007, anincrease of 57.3%.

 

During2008, we were operating 56 energy systems at 30 locations in the Northeast,representing 4,240 kW of installed electricity plus thermal energy, compared to46 energy systems at 23 locations, representing 3,120 kW of installedelectricity plus thermal energy for the same period in 2007. Our revenues percustomer on a monthly basis is based on the sum of the amount of energyproduced by our energy systems and the published price of energy (electricity,natural gas or oil) from our customers’ local energy utility that month lessthe discounts we provide our customers. Our revenues commence as new energysystems become operational.

 

*Costof Sales*

 

Costof sales, including depreciation, in 2008 were $5,733,175 as compared to$4,583,568 for the same period in 2007, an increase of $1,149,607 or 25.1%.Included in the cost of sales was depreciation expense of $596,915 in 2008,compared to $363,233 in 2007. Also included were our costs for certain turn-keyinstallation projects. Our cost of sales for our core On-Site Utility businessconsists of fuel required to operate our energy systems, the cost ofmaintenance, and minimal communications costs. During 2008, our gross marginswere 12.9% compared to 21.6% in 2007, primarily due to increased installationcosts on the completion of two turn-key installation projects that wereaggressively pursued in order to enter new markets. Our On-Site Utility energymargins excluding depreciation were 27.7% in 2008 as compared to 32.7% duringthe same period in 2007. In absolute dollars the On-Site Utility energy marginin 2008 was $1,427,318 as compared to $1,066,771 for the same period in 2007.

 

*OperatingExpenses*

 

Ourgeneral and administrative expenses consist of executive staff, accounting andlegal expenses, office space, general insurance and other administrativeexpenses. Our general and administrative expenses in 2008 were $1,504,968compared to $1,423,775 in 2007, an increase of $81,193 or 5.7%. The increase inthe general and administrative expenses was primarily due to increase intravel, legal expenses and the addition of a part time employee, offset byefficient expense control. Our general and administrative expenses includenon-cash compensation expense, in accordance with SFAS No. 123(R), relatedto the issuance of restricted stock and option awards to our employees.

 

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 marketing 

 

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effortsconsisted of trade shows, print literature, media relations and event drivendirect mail. Our selling expenses in 2008 were $533,874 compared to $415,545 in2007, an increase of $118,329 or 28.5%. The increase in our selling expenseswas primarily due to additional sales expenses to generate new business.

 

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 energysystems and oversee each new installation project. Our engineering expenses in2008 were $401,361 compared to $329,139 in 2007, an increase of $72,223 or21.9%. The engineering expenses increased primarily due to the addition of anew engineer and a service technician.

 

*OperatingIncome*

 

Operatingincome in 2008 was a loss of $1,593,941 compared to a loss of $905,007 in 2007.The increase in the operating loss was primarily due to increased installationcosts on the completion of two turn-key installation projects that wereaggressively pursued in order to enter new markets. These events negativelyimpacted our operating income, but had no affect on our core On-Site Utilityenergy business. Our non-cash compensation expense in accordance with SFAS No. 123(R) relatedto the issuance of restricted stock and option awards to our employees was$364,231 in 2008, compared to $330,335 in 2007.

 

*OtherIncome (Expense), Net*

 

Ourother income (expense), net, in 2008 was $334,717 compared to $213,050 in 2007.Other income (expense), net, includes interest income, interest expense andother items. Interest and other income was $139,690 in 2008 compared to$271,950 in 2007. The decrease was primarily due to a lower cash balance anddue to lower yields on our invested funds. Interest expense was $474,407 in2008 compared to $485,000 in 2007, due to interest on our convertible debentureissued in 2006.

 

*Provision for Income Taxes*

 

Due to the profitability of ourjoint venture ADG NY, the company had a provision for certain state taxes of$34,087 in 2008. The tax provision in 2007 was not material. No benefit to thecompany’s losses has been provided in either period.

 

*Minority Interest*

 

In 2002, the company andAES-NJ Cogen Inc. of New Jersey created ADG NY to develop projects in the NewYork and New Jersey area. The company owns 51% of ADGNY. Both partners in ADGNYshare in the profits of the business. The percentage share of the profit isbased on the partner’s investment in each individual project. The company’sinvestments in ADGNY projects have ranged from 51% to 80%. The minorityinterest expense represents our partner’s share of profits in the entity. Onour balance sheet, minority interest represents our partner’s investment in theentity, plus its share of after tax profits less any cash distributions. Thecompany reported minority interest expense of $305,336 in 2008 and $364,833 in2007. The decrease in minority interest share of their earnings is due to theoverall decrease in joint venture volume and profits.

**** ****

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

 

Consolidatedworking capital at December 31, 2008 was $3,122,139, compared to$5,555,696 at December 31, 2007. Included in working capital were cash,cash equivalents and short-term investments of $2,445,112 at December 31,2008, compared to $5,057,482 at December 31, 2007. The decrease in workingcapital was a result of cash needed to fund operations.

 

Cashused by operating activities was $957,469 in 2008 compared to cash used of$1,143,080 in 2007. The company’s short and long-term receivables balance, includingunbilled revenue, increased to $1,046,319, in 2008 compared to $767,229 at December 31,2007, due to increased sales volume, resulting in a decrease in cash of$279,090. Amount due to the company from related parties, short and long-term,decreased to $297,417 in 2008 compared to $570,374 at December 31, 2007,providing $272,957 of cash to the company due to payments received from ourminority interest partner. Our prepaid and other current assets increased to$163,121 in 2008 compared to $77,853 at December 31, 2007, using $85,268of cash primarily due to prepaid insurance and prepaid taxes.

 

Accountspayable decreased to $270,852 in 2008, compared to $354,091 at December 31,2007, using $83,239 of cash due to timing of vendor invoices. Our accruedexpenses and other current liabilities including accrued interest expense 

 

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increasedto $384,340 in 2008 compared to $339,740 at December 31, 2007, providing$44,600 of the company’s cash offset by an accrual of $117,500 for futureinterest payments. Our due to related party increased to $166,560 in 2008 dueto orders for new equipment.

 

During2008, 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 $2,279,782 for purchases andinstallation of energy systems and $761,614 for short-term investments. Thecompany’s financing activities provided $624,881 of cash, net of costs, in 2008from the exercise of common stock warrants, offset by distributions to ourminority interest partner.

 

The company’s On-SiteUtility energy program allows customers to reduce both their energy costs andsite carbon production by deploying CHP technology on its customers’ premisesat no cost. Therefore the company is capital intensive. The company believesthat its existing resources, including cash and cash equivalents and futurecash flow from operations, are sufficient to meet the working capitalrequirements of its existing business for the foreseeable future, including thenext 12 months. We believe that our cash and cash equivalents and our abilityto control certain costs, including those related to general and administrativeexpenses, will enable us to meet our anticipated cash expenditures through theend of 2009. Beyond January 1, 2010, as we continue to grow our businessby adding more energy systems, our cash requirements will increase. We may needto raise additional capital through a debt financing or an equity offering tomeet our operating and capital needs for future growth.

 

Our ability to continueto access capital could be impacted by various factors including general marketconditions and the continuing slowdown in the economy, interest rates, theperception of our potential future earnings and cash distributions, anyunwillingness on the part of lenders to make loans to us and any deteriorationin the financial position of lenders that might make them unable to meet theirobligations to us. If these conditions continue and we cannot raise fundsthrough a public or private debt financing, or an equity offering, our abilityto grow our business may be negatively affected. In such case, the company mayneed to suspend any new installation of energy systems and significantly reduceits operating costs until market conditions improve.

** **

**Seasonality**

 

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

 

**Inflation**

 

We install, maintain,finance, own and operate complete on-site CHP systems that supply, on along-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. Our customers benefit from a reduction in theircurrent energy bills without the capital costs and risks associated with owningand operating a CHP or chiller system. Inflation will cause an increase in therates charged by conventional utility suppliers, and since we bill ourcustomers based on the electric utility rates, our pricing will increase intandem and positively affect our revenue. However, inflation might cause bothour investment and cost of goods sold to increase, therefore lowering ourreturn on investment and depressing our gross margins.

** **

**Off Balance Sheet Arrangements**

 

The company has no material off balance sheet arrangements.

 

**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.

 

**Item 9. Changes in and Disagreements withAccountants on Accounting and Financial Disclosure.**

 

None

 

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**Item 9A(T). Controls and Procedures.**

 

*Management’sEvaluation of Disclosure Controls and Procedures:*

 

Our Chief Executive Officer and Chief Financial Officer, afterevaluating the effectiveness of our “disclosure controls and procedures” (asdefined in the Exchange Act) Rules 13a-15(e) and 15d-15(e);collectively, “Disclosure Controls”) as of the end of the period covered bythis Annual Report on Form 10-K (the “Evaluation Date”) have concludedthat as of the Evaluation Date, our Disclosure Controls were not 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 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.

 

*Changesin Internal Control Over Financial Reporting:*

 

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, 2008 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

*Reportof Management on Internal Control over Financial Reporting:*

 

The management of thecompany is responsible for establishing and maintaining adequate internalcontrol over financial reporting in accordance with Exchange Act Rules 13a-15(f) and15d-15(f).  Management conducted anevaluation of our internal control over financial reporting based on theframework and criteria established in *InternalControl—Integrated Framework*, issued by the Committee of SponsoringOrganizations of the Treadway Commission. This evaluation included review ofthe documentation of controls, evaluation of the design effectiveness ofcontrols, testing of the operating effectiveness of controls and a conclusionof this evaluation. Based on this evaluation, management concluded that thecompany’s internal control over financial reporting was not effective as of December 31,2008.

 

There is a lack ofsegregation of duties at the company due to the small number of employeesdealing with general administrative and financial matters and general controlsover information technology security and user access. This constitutes amaterial weakness in financial reporting. 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. At this time,management has decided that considering the employees involved and the controlprocedures in place, there are risks associated with such lack of segregation,but 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 13employees as of December 31, 2008. Other than the Chief Financial Officer,only two individuals are in the finance function, one of which is part-time.These individuals are responsible for receiving and distributing cash, billing,processing transactions, recording journal entries, reconciling accounts andpreparing the financial statements and related disclosures. One individual hascheck signing authority for transactions under $2,000. As a result, there isthe potential for that individual to knowingly or unknowingly misappropriateassets or misstate our financial statements. To mitigate these risks, thecompany has put in place procedures where the Chief Executive Officer, thePresident and the Chief Financial Officer have check signing authority. Inaddition, they review and approve all material contracts, transactions and relatedjournal entries. 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 filed underthe 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 controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs. Further,because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that misstatements due to error orfraud will not occur or that all control issues and instances of fraud, if any,within the company have been detected. These inherent limitations include therealities that judgments in decision-making can be faulty and that breakdownscan occur because of simple error or mistake. Controls can also be circumventedby the individual acts of some persons, by collusion of two or more people, orby management override of the controls. The design of any system of controls isbased in part on certain assumptions about 

 

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the likelihood of futureevents, and there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions. Projections of anyevaluation of controls’ 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.

 

This Annual Report on Form 10-Kdoes not include an attestation report of the company’s registered publicaccounting firm regarding internal control over financial reporting. Management’sreport was not subject to attestation by the company’s registered publicaccounting firm pursuant to temporary rules of the SEC that permit thecompany to provide only management’s report in this Annual Report on Form 10-K.

 

**Item 9B.  OtherInformation.**

 

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 2009 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, and Director Independence.**

 

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 To Financial Statements and Financial Statements Schedules:                                                             |
|--------|-------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                          |
|   | Report of  Independent Registered Public Accounting Firm Vitale, Caturano & Company,  P.C. as of March 20, 2009 |
|   |                                                                                                                          |
|   | Consolidated Balance  Sheets as of December 31, 2008 and December 31, 2007                                          |
|   |                                                                                                                          |
|   | Consolidated  Statements of Operations for the years ended December 31, 2008 and  December 31, 2007                 |
|   |                                                                                                                          |
|   | Consolidated  Statements of Stockholders’ Equity for the years ended December 31, 2008  and December 31, 2007  |
|   |                                                                                                                          |
|   | Consolidated  Statements of Cash Flows for the years ended December 31, 2008 and  December 31, 2007                 |
|   |                                                                                                                          |
|   | Notes to  Consolidated Financial Statements                                                                                   |

 
| All  other schedules for which provision is made in the applicable accounting  regulations of the SEC are not required under the related instructions, or are  inapplicable, and therefore have been omitted. |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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b)                                     Exhibits

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 3.1         |       | Certificate of Incorporation (incorporated by  reference from the registrant’s Form 10-SB, as amended, originally filed  with the Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 3.2         |       | By-laws (incorporated by reference from the  registrant’s Form 10-SB, as amended, originally filed with the  Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 4.1         |       | Form of Warrant (incorporated by reference from  the registrant’s Form 10-SB, as amended, originally filed with the  Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 4.2         |       | Warrant to Purchase Shares of Common Stock dated  February 24, 2009 (incorporated by reference from the registrant’s  current report on Form 8-K, filed with the Securities and Exchange  Commission on February 26, 2009).                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.1        |       | Audit Committee Charter (incorporated by reference  from the registrant’s Form 10-SB, as amended, originally filed with the  Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.2        |       | Compensation Committee Charter (incorporated by  reference from the registrant’s Form 10-SB, as amended, originally filed  with the Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.3        |       | American Distributed Generated Inc. 2001 Stock  Incentive Plan (incorporated by reference from the registrant’s  Form 10-SB, as amended, originally filed with the Securities and  Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.4        |       | 2005 Stock Incentive Plan (incorporated by reference  from our definitive proxy statement for the 2008 Annual Meeting of  shareholders originally filed on April 29, 2008).                                                                                                                                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.5        |       | Facilities, Support Services and Business Agreement  with Tecogen Inc. (incorporated by reference from the registrant’s  Form 10-SB, as amended, originally filed with the Securities and  Exchange Commission on October 3, 2006. Confidential treatment has been  granted for portions of this document. The confidential portions have been  omitted and have been filed separately, on a confidential basis, with the  Securities and Exchange Commission). |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.6        |       | Amendment to Facilities, Support Services and  Business Agreement with Tecogen Inc. dated April 1, 2008 (incorporated  by reference from the registrant’s Form 10-Q, filed with the Securities  and Exchange Commission for the quarter ended March 31, 2008).                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.7#       |       | Amendment No. 2 to Facilities, Support Services  and Business Agreement with Tecogen Inc. dated May 15, 2008.                                                                                                                                                                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.8#       |       | Amendment No. 3 to Facilities, Support Services  and Business Agreement with Tecogen Inc. dated January 2, 2009.                                                                                                                                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.9        |       | Operating Agreement of American DG New York LLC  (incorporated by reference from the registrant’s Form 10-SB, as amended,  originally filed with the Securities and Exchange Commission on  October 3, 2006).                                                                                                                                                                                                                                                   |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.10       |       | Form of Energy Purchase Agreement (incorporated  by reference from the registrant’s Form 10-SB, as amended, originally  filed with the Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.11       |       | Form of 8% Senior Convertible Debenture Due  2011 (incorporated by reference from the registrant’s Form 10-SB, as  amended, originally filed with the Securities and Exchange Commission on  October 3, 2006).                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 14.1        |       | Code of Business Conduct and Ethics (incorporated by  reference from the registrant’s Form 10-SB, as amended, originally filed  with the Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 21.1        |       | List of subsidiaries (incorporated by reference from  the registrant’s Form 10-SB, as amended, originally filed with the  Securities and Exchange Commission on October 3, 2006).                                                                                                                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 23.1#       |       | Consent of Vitale, Caturano & Co., P.C.                                                                                                                                                                                                                                                                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 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                                                                                                                                                                                                                                                                                                                                                                                       |

 

----

| # |   | Filed herewith. |
|---|--------|-----------------|

 

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Exchange Act, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, on March 20, 2009.

 

 
|        | 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) |

 

 

Pursuantto the requirements of the Exchange Act, this report has been signedbelow by the following persons on behalf of the registrant and in the capacityand on the dates indicated.

 
| Signature                 | ** ** | **Title**                                    | ** ** | **Date**            |
|---------------------------|------------|----------------------------------------------|------------|---------------------|
|                      |       |                                         |       |                |
| /s/ GEORGE N. HATSOPOULOS |       | Chairman of the Board                        |       | March 20, 2009 |
| George N. Hatsopoulos     |       |                                         |       |                |
|                      |       |                                         |       |                |
| /s/ JOHN N. HATSOPOULOS   |       | Chief Executive Officer                      |       | March 20, 2009 |
| John N. Hatsopoulos       |       |                                         |       |                |
|                      |       |                                         |       |                |
| /s/ ANTHONY S. LOUMIDIS   |       | Chief Financial Officer (Principal Financial |       | March 20, 2009 |
| Anthony S. Loumidis       |       | and Accounting Officer)                      |       |                |
|                      |       |                                         |       |                |
| /s/ BARRY J. SANDERS      |       | President and Chief Operating Officer        |       | March 20, 2009 |
| Barry J. Sanders          |       |                                         |       |                |
|                      |       |                                         |       |                |
| /s/ EARL R. LEWIS         |       | Director                                     |       | March 20, 2009 |
| Earl R. Lewis             |       |                                         |       |                |
|                      |       |                                         |       |                |
| /s/ CHARLES T. MAXWELL    |       | Director                                     |       | March 20, 2009 |
| Charles T. Maxwell        |       |                                         |       |                |
|                      |       |                                         |       |                |
| /s/ ALAN D. WEINSTEIN     |       | Director                                     |       | March 20, 2009 |
| Alan D. Weinstein         |       |                                         |       |                |

 

29

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**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 31,2008 and December 31, 2007, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for the years then ended.These financial statements are the responsibility of the Company’s management.Our responsibility is to express an opinion on the consolidated financialstatements 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 of theCompany at December 31, 2008, and December 31, 2007, and the resultsof their operations and their cash flows for the years then ended, inconformity with accounting principles generally accepted in the United Statesof America.

 

 
| /s/ VITALE, CATURANO & CO., P.C. |   |
|-------------------------------------------|--------|
|                                      |   |
| Boston, Massachusetts                     |   |
| March 20, 2009                       |   |

 

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**AMERICAN DG ENERGY INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

*** ***
| ** **                                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                                                                                                                                                                 |       |                  |       |   |   |
| **ASSETS**                                                                                                                                                                           |       |                  |       |   |   |
| Current assets                                                                                                                                                                       |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                           |       | $                     | 1,683,498  |   | $ | 5,057,482 |   |
| Short-term  investments                                                                                                                                                              |       | 761,614               |       | — |   |
| Accounts  receivable, net                                                                                                                                                            |       | 835,922               |       | 693,818 |   |
| Unbilled revenue                                                                                                                                                                     |       | 204,750               |       | — |   |
| Due from related  party, current                                                                                                                                                     |       | 297,417               |       | 420,374 |   |
| Prepaid and  other current assets                                                                                                                                                    |       | 163,121               |       | 77,853 |   |
| Total current  assets                                                                                                                                                                |       | 3,946,322             |       | 6,249,527 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Property, plant  and equipment, net                                                                                                                                                  |       | 6,983,392             |       | 5,291,310 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Accounts  receivable, long- term                                                                                                                                                     |       | 5,647                 |       | 73,411 |   |
| Due from related  party, long-term                                                                                                                                                   |       | —                |       | 150,000 |   |
| **TOTAL  ASSETS**                                                                                                                                                                    |       | 10,935,361            |       | 11,764,248 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                       |       |                  |       |   |   |
| Current  liabilities                                                                                                                                                                 |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                     |       | 270,852               |       | 354,091 |   |
| Accrued expenses  and other current liabilities                                                                                                                                      |       | 384,340               |       | 339,740 |   |
| Due to related  party                                                                                                                                                                |       | 166,560               |       | — |   |
| Capital lease  obligations                                                                                                                                                           |       | 2,431                 |       | — |   |
| Total current  liabilities                                                                                                                                                           |       | 824,183               |       | 693,831 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Long-term  liabilities                                                                                                                                                               |       |                  |       |   |   |
| Convertible  debentures                                                                                                                                                              |       | 5,875,000             |       | 6,025,000 |   |
| Capital lease  obligations, long-term                                                                                                                                                |       | 14,394                |       | — |   |
| Total  liabilities                                                                                                                                                                   |       | 6,713,577             |       | 6,718,831 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Minority  interest                                                                                                                                                                   |       | 1,317,003             |       | 1,058,786 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Stockholders’  equity                                                                                                                                                           |       |                  |       |   |   |
| Common stock,  $0.001 par value; 50,000,000 shares authorized; 34,034,496 and 32,805,924  issued and outstanding at December 31, 2008 and December 31, 2007,  respectively |       | 34,034                |       | 32,806 |   |
| Additional paid-  in- capital                                                                                                                                                        |       | 12,614,332            |       | 11,394,289 |   |
| Common stock  subscription                                                                                                                                                           |       | (35,040               | )          | — |   |
| Accumulated  deficit                                                                                                                                                                 |       | (9,708,545            | )          | (7,440,464 | ) |
| Total  stockholders’ equity                                                                                                                                                     |       | 2,904,781             |       | 3,986,631 |   |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                 |       | $                     | 10,935,361 |   | $ | 11,764,248 |   |

 

See accompanyingnotes to consolidated financial statements

 

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**AMERICAN DG ENERGY INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                                     |       |                  |       |   |   |
| Net Sales                                                |       | $                     | 6,579,437  |   | $ | 5,847,020 |   |
|                                                     |       |                  |       |   |   |
| Cost of sales                                            |       |                  |       |   |   |
| Fuel,  maintenance and installation                      |       | 5,136,260             |       | 4,220,335 |   |
| Depreciation  expense                                    |       | 596,915               |       | 363,233 |   |
|                                                     |       | 5,733,175             |       | 4,583,568 |   |
| Gross profit                                             |       | 846,262               |       | 1,263,452 |   |
|                                                     |       |                  |       |   |   |
| Operating  expenses                                      |       |                  |       |   |   |
| General and  administrative                              |       | 1,504,968             |       | 1,423,775 |   |
| Selling                                                  |       | 533,874               |       | 415,545 |   |
| Engineering                                              |       | 401,361               |       | 329,139 |   |
|                                                     |       | 2,440,203             |       | 2,168,459 |   |
| Loss from  operations                                    |       | (1,593,941            | )          | (905,007 | ) |
|                                                     |       |                  |       |   |   |
| Other income  (expense)                                  |       |                  |       |   |   |
| Interest and  other income                               |       | 139,690               |       | 271,950 |   |
| Interest expense                                         |       | (474,407              | )          | (485,000 | ) |
|                                                     |       | (334,717              | )          | (213,050 | ) |
|                                                     |       |                  |       |   |   |
| Loss before  minority interest and income taxes          |       | (1,928,658            | )          | (1,118,057 | ) |
|                                                     |       |                  |       |   |   |
| Minority  interest, net of taxes                         |       | (305,336              | )          | (364,833 | ) |
|                                                     |       |                  |       |   |   |
| Net loss before  income taxes                            |       | (2,233,994            | )          | (1,482,890 | ) |
| Provision for  state income taxes                        |       | (34,087               | )          | — |   |
| Net loss                                                 |       | $                     | (2,268,081 | ) | $ | (1,482,890 | ) |
|                                                     |       |                  |       |   |   |
| Net loss per  share - basic and diluted                  |       | $                     | (0.07      | ) | $ | (0.05 | ) |
|                                                     |       |                  |       |   |   |
| Weighted average  shares outstanding - basic and diluted |       | 32,872,006            |       | 30,698,185 |   |

 

See accompanyingnotes to consolidated financial statements

 

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**AMERICANDG ENERGY INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

 
| ** **                                           | ** ** | **Common  Stock  $0.001  Par Value** | ** ** | **Additional  Paid-In Capital** | ** ** | **Common  Stock  Subscription** | ** ** | **Accumulated  Deficit** | ** ** | **Total**  | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|--------------------------|------------|------------|------------|
|                                                 |       |                                 |       |                                 |       |                            |       |                     |       |       |       |
| 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  |       |
|                                                 |       |                                 |       |                                 |       |                            |       |                     |       |       |       |
| Conversion of  convertible debenture to common stock |       | 178                                  |       | 149,822                              |       | —                          |       | —                   |       | 150,000    |       |
| Issuance of  restricted stock                        |       | 40                                   |       | —                               |       | (40                             | )          | —                   |       | —     |       |
| Stock based  compensation expense                    |       | —                               |       | 364,231                              |       | —                          |       | —                   |       | 364,231    |       |
| Exercise of  warrants                                |       | 1,010                                |       | 705,990                              |       | (35,000                         | )          | —                   |       | 672,000    |       |
| Net loss                                             |       | —                               |       | —                               |       | —                          |       | (2,268,081               | )          | (2,268,081 | )          |
| Balance at  December 31, 2008                   |       | $                                    | 34,034     |                                 | $          | 12,614,332                      |       | $                        | (35,040    | )          | $          | (9,708,545 | ) | $ | 2,904,781 |   |

 

See accompanyingnotes to consolidated financial statements

 

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**AMERICAN DG ENERGY INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                     | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                     | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                                                           |       |                  |       |   |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                         |       |                  |       |   |   |
| Net loss                                                                       |       | $                     | (2,268,081 | ) | $ | (1,482,890 | ) |
| *Adjustments  to reconcile net loss to net cash used in operating activities:* |       |                  |       |   |   |
| Depreciation and  amortization                                                 |       | 604,525               |       | 368,952 |   |
| Gain on sale of  capital assets                                                |       | —                |       | (108,219 | ) |
| Minority  interest in net income of consolidated subsidiaries, net of taxes    |       | 305,336               |       | 364,833 |   |
| Provision for  losses on accounts receivable                                   |       | 51,759                |       | 35,589 |   |
| Amortization of  deferred financing costs                                      |       | 8,526                 |       | 8,526 |   |
| Non cash  interest expense                                                     |       | 117,500               |       | 120,500 |   |
| Stock-based  compensation                                                      |       | 364,231               |       | 330,335 |   |
|                                                                           |       |                  |       |   |   |
| *Changes  in operating assets and liabilities*                                 |       |                  |       |   |   |
| (Increase)  decrease in:                                                       |       |                  |       |   |   |
| Accounts  receivable                                                           |       | (330,849              | )          | (518,420 | ) |
| Due from related  party                                                        |       | 272,957               |       | (298,478 | ) |
| Prepaid assets                                                                 |       | (93,794               | )          | (1,712 | ) |
| Increase  (decrease) in:                                                       |       |                  |       |   |   |
| Accounts payable                                                               |       | (83,239               | )          | 238,965 |   |
| Accrued expenses  and other current liabilities                                |       | (72,900               | )          | (201,061 | ) |
| Due to related  party                                                          |       | 166,560               |       | — |   |
| Net cash used in  operating activities                                         |       | (957,469              | )          | (1,143,080 | ) |
|                                                                           |       |                  |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                         |       |                  |       |   |   |
| Purchases of  property and equipment                                           |       | (2,279,782            | )          | (1,548,419 | ) |
| Proceeds from  sale of property and equipment                                  |       | —                |       | 427,000 |   |
| Purchase of  short-term investments                                            |       | (761,614              | )          | — |   |
| Net cash used in  investing activities                                         |       | (3,041,396            | )          | (1,121,419 | ) |
|                                                                           |       |                  |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                         |       |                  |       |   |   |
| Proceeds from  issuance of restricted stock                                    |       | —                |       | 752 |   |
| Proceeds from  exercise of warrants                                            |       | 672,000               |       | 140,000 |   |
| Minority  distribution to consolidated subsidiaries                            |       | (47,119               | )          | 11,565 |   |
| Due from related  party long- term                                             |       | —                |       | (150,000 | ) |
| Proceeds from  sale of common stock and warrants, net of costs                 |       | —                |       | 3,892,218 |   |
| Proceeds from  exercise of stock options                                       |       | —                |       | 7,000 |   |
| Net cash  provided by financing activities                                     |       | 624,881               |       | 3,901,535 |   |
|                                                                           |       |                  |       |   |   |
| Net (decrease)  increase in cash and cash equivalents                          |       | (3,373,984            | )          | 1,637,036 |   |
| Cash and cash  equivalents, beginning of the year                              |       | 5,057,482             |       | 3,420,446 |   |
| Cash and cash  equivalents, ending of the year                                 |       | $                     | 1,683,498  |   | $ | 5,057,482 |   |
|                                                                           |       |                  |       |   |   |
| Supplemental  disclosures of cash flows information:                           |       |                  |       |   |   |
| Cash paid during  the year for:                                                |       |                  |       |   |   |
| Interest                                                                       |       | $                     | 477,422    |   | $ | 485,000 |   |
| Income taxes                                                                   |       | $                     | 86,130     |   | $ | 28,144 |   |
|                                                                           |       |                  |       |   |   |
| Non-cash  investing and financing activities:                                  |       |                  |       |   |   |
| Conversion of  convertible debenture to common stock                           |       | $                     | 150,000    |   | $ | 50,000 |   |
| Acquisition of  equipment under capital lease                                  |       | $                     | 16,825     |   | $ | — |   |

 

See accompanyingnotes to consolidated financial statements

 

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**AMERICAN DG ENERGY INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1 — The company and basis ofpresentation:**

 

American DG Energy Inc. (“AmericanDG Energy”, the “company”, “us” 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”.

 

Thecompany was incorporated as a Delaware corporation on July 24, 2001 toinstall, own, operate and maintain complete DG systems and other complementarysystems at customer sites and sell electricity, hot water, heat and coolingenergy under long-term contracts at prices guaranteed to the customer to bebelow conventional utility rates.As of December 31, 2008, we had installed energy systems, representingapproximately 4,240 kilowatts, or kW, 32.4 million British thermal units, orMMBtu’s, of heat and hot water and 600 tons of cooling. Kilowatt is a measureof electricity generated, MMBtu is a measure of heat generated and a ton is a measureof cooling generated.

 

We derive sales from selling energyin the form of electricity, heat, hot water and cooling to our customers underlong-term energy sales agreements (with a typical term of 10 to 15 years). Theenergy systems are owned by us and are installed in our customers’ buildings.Each month 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 customers’ 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 ourcustomers’ local energy utility that month. Our revenues commence as new energysystems become operational. Asof December 31, 2008, we had 56 energy systems operational.

 

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. Costs and estimated earnings in excess of relatedbillings and unbilled revenue represent the excess of contract costs and profitrecognized to date on the percentage-of-completion accounting method overbillings to date on certain contracts. Billings in excess of related costs andestimated earnings represents the excess of billings to date over the amount ofcontract costs and profits recognized to date on the percentage-of-completionaccounting method for certain contracts. Customers may buy out their long-termobligation under energy contracts and purchase the underlying equipment fromthe company. Any resulting gain on these transactions is recognized in theconsolidated statements of operations. Revenues from operation and maintenanceservices, including shared savings are recorded when provided and verified.

 

We have experienced totalnet losses since inception of approximately $9.7 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, 2008 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, 2008 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, 2010. Beyond January 1,2010, we may need to raise additional capital through a debt financing orequity offering to meet our operating and capital needs. There can be noassurance, however, that we will be successful in our fundraising efforts orthat additional funds will be available on acceptable terms, if at all.

 

In2008, we raised $707,000 through the exercise of various warrants. If we areunable to raise additional capital in 2010 we may need to terminate certain ofour employees and adjust our current business plan. Financial considerationsmay cause us to modify planned deployment of new energy systems and we maydecide to suspend installations until we are able 

 

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**AMERICAN DG ENERGY INC.**

 

to secure additionalworking capital. We will evaluate possible acquisitions of, or investments in,businesses, technologies and products that are complementary to our business;however, we are not currently engaged in such discussions.

 

The company’s operations are comprised of one businesssegment. Our business is selling energy in the form of electricity, heat, hotwater and cooling to our customers under long-term sales agreements. Thepreparation of financial statements in conformity with generally acceptedaccounting principles, or GAAP, requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

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

 

*Principles of Consolidation*

 

The accompanyingconsolidated financial statements include the accounts of the company, itswholly owned subsidiary American DG Energy and its 51% joint venture, AmericanDG New York, LLC, or ADGNY, (referred to hereafter as “Investee entities”),after elimination of all material intercompany accounts, transactions andprofits. Investee entities in which the company owns directly or indirectly 50%or more of the membership interests have been consolidated as a result of thecompany’s control over the Investee entities. Minority interests in the netassets and earnings or losses of consolidated Investee entities are reflectedin the caption “Minority interest” in the accompanying consolidated financialstatements. Minority interest adjusts the consolidated results of operations toreflect only the company’s shares of the earnings or losses of the consolidatedinvestee entities. Upon dilution of ownership below 50%, the accounting methodis adjusted to the equity or cost method of accounting, as appropriate, forsubsequent periods.

 

Thecompany evaluates the applicability of Financial Accounting Standards Board, orFASB, Interpretation No. 46 (Revised) “Consolidation of Variable InterestEntities”, or FIN No. 46(R), to partnerships and joint ventures at theinception of its participation to ensure its accounting is in accordance withthe appropriate standards. The company has contractual interests in Tecogen anddetermined that Tecogen was a Variable Interest Entity, as defined by FIN No. 46(R);however, the company was not considered the primary beneficiary and does nothave any exposure to loss as a result of its involvement with Tecogen.Therefore, Tecogen was not consolidated in our consolidated financialstatements through December 31, 2008. See Note 7 - Related Party for further discussion.

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

*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. Under certainenergy contracts, the customer directly acquires the fuel to power the systemsand receives credit for that expense from the company. The credit is recordedas revenue and cost of fuel. We recognize revenue that relates to multipleelement contracts in accordance with Emerging Issues Task Force 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables”. Revenue to which this guidance applies includesa contract that consists of the sale of equipment, installation, energy andmaintenance. When a sales arrangement contains multiple elements, revenue isallocated to each element based upon its relative fair value. Fair value isdetermined based on the price of a deliverable sold on a standalone basis.

 

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 

 

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**AMERICAN DG ENERGY INC.**

 

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 andunbilled revenue represent the excess of contract costs and profit recognizedto date on the percentage-of-completion accounting method over billings to dateon certain contracts. Billings in excess of related costs and estimatedearnings represents the excess of billings to date over the amount of contractcosts and profits recognized to date on the percentage-of-completion accountingmethod for certain contracts. Customers may buy out their long-term obligationunder energy contracts and purchase the underlying equipment from the company.Any resulting gain on these transactions is recognized in the consolidatedstatements of operations. Revenues from operation and maintenance services,including shared savings are recorded when provided and verified.

 

*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.

 

*Short-Term Investments*

 

Short-term investments consist of certificates of deposit with maturitiesof greater than three months but less than one year. Certificates of depositsare recorded at fair value.

* *

*Accounts Receivable*

 

The company maintains receivable balancesprimarily with customers located throughout New York and New Jersey. Thecompany reviews its customers’ credit history before extending credit andgenerally does not require collateral. An allowance for doubtful accounts is establishedbased upon factors surrounding the credit risk of specific customers,historical trends and other information. Generally, such losses have beenwithin management’s expectations.

 

Accounts receivable are presented net of anallowance for doubtful collections of $51,759 and $35,589 at December 31,2008 and December 31, 2007, respectively. Included in accounts receivableare amounts from four major customers accounting for approximately 45% and 59%of total accounts receivable for the years ended December 31, 2008 and December 31,2007, respectively. There were sales to three customers accounting forapproximately 27% and 41% of total sales for the years ended December 31,2008 and December 31, 2007, respectively.

* *

*Accounts Payable*

 

Included in accounts payable are amounts due tofive major vendors accounting for approximately 51% and 58% of total accountspayable for the years ended December 31, 2008 and December 31, 2007,respectively. Purchases from four vendors accounted for approximately 50% and 47%of total cost of goods sold for the years ended December 31, 2008, and December 31,2007, respectively.

 

*Supply Concentrations*

 

Approximately 100% of the company’s cogenerationunit purchases for the years ended December 31, 2008 and 2007 were fromone vendor (see “Note 7 - Related Party”). We believe there are sufficient alternativevendors available to ensure a constant supply of cogeneration units oncomparable terms. However, in the event of a change in suppliers, there couldbe a delay in obtaining units which could result in a temporary slowdown ofinstalling additional income producing sites. In addition, the majority of thecompany’s units 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 maintenanceare expensed as incurred.

 

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**AMERICAN DG ENERGY INC.**

 

*Stock Based Compensation*

 

Effective January 1, 2006, we adopted Statementof Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment”, or SFAS No. 123(R),which is a revision of Statement of Financial Accounting Standards No. 123,“Accounting for Stock BasedCompensation”, or SFAS No. 123. SFAS No. 123(R) supersedesAccounting Principles Board No. 25, “Accounting for Stock Issued to Employees”, or APB No. 25,and Statement of Financial Accounting Standards No. 95 “Statement of Cash Flows”, or SFAS No. 95.SFAS No. 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values. Pro forma disclosure is no longer analternative.

 

SFAS No. 123(R) requires nonpublic companiesthat used the minimum value method in SFAS No. 123 for either recognitionor pro forma disclosures to apply SFAS No. 123(R) using theprospective-transition method. As such, since we were not a public company asof the adoption date, we will continue to apply APB No. 25 in futureperiods to equity awards outstanding at the date of SFAS No. 123(R)’s adoptionthat were measured using the minimum value method.

 

Thecompany recognized employee non-cash stock based compensation expense of$364,231 and $330,335 related to the issuance of restricted stock and stockoptions at December 31, 2008 and December 31, 2007, respectively. Thetotal compensation cost related to unvested restricted stock awards and stockoption awards not yet recognized is $726,453 at December 31, 2008. Thisamount will be recognized over the weighted average period of six 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 since such date, it has used the market price of its commonstock to 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. Forfeitures are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. Stock-based compensation expense recognized in our financialstatements in 2008 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.

 

OnNovember 10, 2005, the FASB issued Statement of Financial AccountingStandards Staff Position No. 123R-3 “Transition Election Related toAccounting for Tax Effects of Share-Based Payment Awards”, or SFAS No. 123R-3. 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 No. 123(R). The alternativetransition method includes simplified methods to establish the beginningbalance of the additional paid-in capital pool related to the tax effects ofemployee stock-based compensation, and to determine the subsequent impact tothe additional paid-in capital pool and the consolidated statements ofoperations and cash flows of the tax effects of employee stock-basedcompensation awards that are outstanding upon adoption of SFAS No. 123(R).

 

See“Note 5 — Stockholders’ Equity” for a summary of the restricted stock and stockoption activity under our stock-based employee compensation plan for the yearsended December 31, 2008 and December 31, 2007.

 

*Loss per Common Share*

 

Wecompute basic loss per share by dividing net income (loss) for the period bythe weighted average number of shares of common stock outstanding during theperiod. We compute our diluted earnings per common share using the treasurystock method. For purposes of calculating diluted earnings per share, weconsider our shares issuable in connection with convertible debentures, stockoptions and warrants to be dilutive common stock equivalents when the exerciseprice is less than the average market price of our common stock for the period.For the year ended December 31, 2008, we excluded 10,543,049 anti-dilutiveshares resulting from conversion of debentures and exercise of stock options,warrants and unvested restricted stock, and for the year ended December 31,2007, we excluded 12,352,496 anti-dilutive shares resulting from 

 

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**AMERICAN DG ENERGY INC.**

 

conversionof debentures and exercise of stock options, warrants and unvested restrictedstock. All shares issuable for both years were anti-dilutive because of thereported net loss.

 

*Other Comprehensive Net Loss*

 

The comprehensive net loss for the years ended December 31,2008 and 2007 does not differ from the reported loss.

 

*Impairmentof Intangible Assets*

 

The company evaluates the recoverability of itslong-lived assets in accordance with Statement of Financial AccountingStandards No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, or SFAS No. 144. SFAS No. 144 requires therecognition of impairment of long-lived assets in the event the net book valueof such assets exceeds the estimated future undiscounted cash flowsattributable to such assets. If impairment is indicated, the asset is writtendown to its estimated fair value based on a discounted cash flow analysis. Thecompany reviews long-lived assets for impairment annually or whenever events orchanges in business circumstances indicate that the carrying value of theassets may not be fully recoverable or that the useful lives of the assets areno longer appropriate. At December 31, 2008 the company determined thatits long-lived assets are recoverable.

 

*Income Taxes*

 

Income taxes are recordedin accordance Statement of Financial Accounting Standards No. 109, “Accountingfor Income Taxes”, or SFAS No. 109. Under SFAS No. 109, deferred taxassets and liabilities are determined based on differences between thefinancial reporting and tax reporting bases of assets and liabilities and aremeasured by applying the enacted tax rates and laws to taxable years in whichthe differences are expected to reverse. We recognize a deferred tax asset forthe tax benefit of net operating loss carry forwards when it is more likelythan not that the tax benefits will be realized and reduce the deferred taxasset with a valuation reserve when it is more likely than not that someportion of the tax benefits will not be realized.

 

*Fair Value of Financial Instruments*

 

The company’s financial instruments are cash andcash equivalents, short-term investments, accounts receivable, accountspayable, convertible debentures and notes due from related parties. Therecorded values of cash and cash equivalents, accounts receivable, accountspayable and notes due from related parties approximate their fair values basedon their short-term nature. Short-term investments are recorded at fair value.The carrying value of the convertible debentures on the balance sheet at December 31,2008 approximates fair value as the term approximate those currently availablefor similar instruments. See Note 8 for discussion of fair value measurements.

 

*Recent Accounting Pronouncements*

 

In December 2007, the Financial AccountingStandards Board, or FASB, issued Statement of Financial Accounting Standards No. 141(R) “BusinessCombinations”, or SFAS No. 141(R), which requires changes in theaccounting and reporting of business acquisitions. The statement requires anacquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in purchased entities, measured at their fair values atthe date of acquisition based upon the definition of fair value outlined inStatement of Financial Accounting Standards No. 157, or SFAS No. 157.SFAS No. 141(R) is effective for the company for acquisitions thatoccur beginning in 2009. The effects of SFAS No. 141(R) on our financialstatements will depend on the extent that the company makes businessacquisitions in the future.

 

In December 2007, the FASB issued Statement ofFinancial Accounting Standards No. 160, “Noncontrolling Interests inConsolidated Financial Statements an Amendment of ARB No. 51”, or SFAS No. 160,which requires changes in the accounting and reporting of noncontrollinginterests in a subsidiary, also known as minority interest. The statementclarifies that a minority interest in a subsidiary is an ownership interest inthe consolidated entity that should be reported as equity in the consolidatedfinancial statements. SFAS No. 160 is effective for the company at thebeginning of 2009. The company is continuing to review provisions of SFAS No.160 which is effective the first quarter of fiscal 2009, and expects this newaccounting standard to result in changes in the presentation of minorityinterests in the financial statements consistent with the new standard.

 

In February 2008, the FASB issued FASB StaffPosition No. 157-2, or FSP No. 157-2, which delays the effective dateof SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually). SFAS No. 157establishes a framework for 

 

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**AMERICAN DG ENERGY INC.**

 

measuring fair value and expands disclosures about fair value measurements.FSP No. 157-2 partially defers the effective date of SFAS No. 157 tofiscal years beginning after November 15, 2008, and interim periods withinthose fiscal years for items within the scope of this FSP No. 157-2. Theadoption of SFAS No. 157 for all nonfinancial assets and nonfinancialliabilities is effective for us beginning January 1, 2009. The companydoes not expect SFAS No. 157 to have a material impact on its results ofoperations and financial condition.

 

In March 2008, the FASB issued Statement ofFinancial Accounting Standards No. 161, “Disclosures about DerivativeInstruments and Hedging Activities — an amendment of Statement of FinancialAccounting Standards No. 133”, or SFAS No. 161. SFAS No. 161changes the disclosure requirements for derivative instruments and hedgingactivities. This standard requires enhanced disclosures about how and why anentity uses derivative instruments, how instruments are accounted for underStatement of Financial Accounting Standards No. 133, “Accounting forDerivative Instruments and Hedging Activities,” and how derivatives and hedgingactivities affect an entity’s financial position, financial performance andcash flows. This standard is effective for fiscal years beginning after November 15,2008. The company does not expect SFAS No. 161 to have a material impacton its results of operations and financial condition.

 

In May 2008, FASB issued Statement of FinancialAccounting Standards No. 162,**“The Hierarchy of Generally AcceptedAccounting Principles”, or SFAS No. 162. SFAS No. 162identifies the sources of accounting principles and the framework for selectingthe principles to be used in the preparation of financial statements that arepresented in conformity with GAAP in the U.S. SFAS No. 162 is effective60 days following the SEC’s approval of the Public Company Accounting OversightBoard amendments to AU Section 411,“The Meaning of Present Fairly in Conformity with Generally Accepted AccountingPrinciples.” The company does not expect SFAS No. 162 to have amaterial impact on its results of operations and financial condition.

 

**Note 3 — Property plant andequipment:**

 

Property and equipment consists of the followingas of December 31, 2008 and December 31, 2007:

 

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2008**              | ** ** | **2007** | ** ** |
| ** **                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Co-generation  units                  |       | $                     | 7,187,383  |   | $ | 4,128,330 |   |
| Inventory                             |       | 355,851               |       | 86,138 |   |
| Computer  equipment and software      |       | 20,199                |       | 18,089 |   |
| Furniture and  fixtures               |       | 26,846                |       | 906 |   |
| Vehicles                              |       | 37,193                |       | — |   |
|                                  |       | 7,627,472             |       | 4,233,463 |   |
| Less —  accumulated depreciation |       | (1,506,511            | )          | (901,986 | ) |
|                                  |       | 6,120,961             |       | 3,331,477 |   |
| Construction in  progress             |       | 862,431               |       | 1,959,833 |   |
|                                  |       | $                     | 6,983,392  |   | $ | 5,291,310 |   |

 

Depreciation of property and equipmenttotaled $604,525 and $368,952 for the years ended December 31, 2008 and December 31,2007.

 

**Note 4 —Convertible debentures:**

 

InApril and June of 2006, the company issued convertible debenturestotaling $6,075,000 to existing investors (the “debentures”). The debenturesaccrue interest at a rate of 8% per annum and are due five years from theissuance date. The debentures are convertible, at the option of the holder,into a number of shares of common stock as determined by dividing the originaloutstanding amount of the respective debenture by the conversion price ineffect at the time. The initial conversion price of the debenture is $0.84 andis subject to adjustment in accordance with the agreement. As of December 31,2008 the conversion price of the debenture has not been adjusted.

 

In2007, a holder of the company’s 8% Convertible Debentureelected to convert $50,000 of the outstanding principal amount of the debentureinto 59,524 shares of common stock. In2008, two holders of the company’s 8% Convertible Debenture elected to convert$150,000 of the outstanding principal amount of the debentures into 178,572shares of common stock. At December 31, 2008,there were 6,994,049 shares of common stock issuable upon conversion of ouroutstanding convertible debentures.

 

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**AMERICAN DG ENERGY INC.**

 

**Note 5 — Stockholders’ equity:**

* *

*CommonStock*

 

In 2007 the company raisedadditional funds through a private placement of common stock to a limitednumber of accredited investors. In connection with the private placement thecompany sold an aggregate of 5,692,150 shares of common stock at a purchaseprice of $0.70 per share, resulting in net cash proceeds of $3,892,218. In 2008there were no funds raised through sales of common stock.

 

The holders of common stock havethe right to vote their interest on a per share basis. At December 31, 2008, there were34,034,496 shares of common stock outstanding.

 

*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 of3,895,000 shares of common stock at a price of $0.70. The company issued1,030,000, 775,000 and 2,090,000 warrants in 2003, 2004 and 2005 respectively.Each warrant represents the right to purchase one share of common stock for aperiod of three or five years from the date the warrant was issued.

 

During the year ended December 31,2007, investors exercised 200,000 warrants with expiration dates in 2007, forgross proceeds to the company of $140,000 and during the year 575,000 warrantsexpired. During the year ended December 31, 2008, investors exercised1,010,000 warrants with expiration dates in 2008, for gross proceeds to thecompany of $707,000. Of these warrants, 50,000 were exercised towards the endof the year, therefore, the company established a receivable shown as commonstock subscription on the balance sheet and that amount was collected early in2009. During the year 480,000 warrants expired. As of December 31, 2008there were 500,000 fully vested exercisable warrants outstanding at $0.70per share, which expire in 2010.

 

On February 24,2009, the company sold a warrant to purchase shares of the company’s commonstock to an accredited investor, for a purchase price of $10,500. The warrant,which expires on February 24, 2012, gives the investor the right but notthe obligation to purchase 50,000 shares of the company’s common stock at anexercise price per share of $3.00.

 

*Stock Based Compensation*

 

The company has adopted the 2005 Stock Incentive Plan, orthe Plan, under which the board of directors may grant incentive ornon-qualified stock options and stock grants to key employees, directors,advisors and consultants of the company. On April 17, 2008 the boardunanimously amended the Plan, subject to shareholder approval, to increase thereserved shares of common stock issuable under the Plan from 4,000,000 to5,000,000 (the “Amended Plan”). On May 30, 2008, at the company’s annualmeeting, the shareholders voted in favor of an amendment to increase the numberof shares of common stock of the company available for issuance under the Planfrom 4,000,000 to 5,000,000 shares.

 

The maximum number of shares of stock allowable forissuance under the Amended Plan is 5,000,000 shares of common stock, including1,229,500 shares of restricted stock outstanding as of December 31, 2008.Stock options vest based upon the terms within the individual option grants,usually over a two- or ten-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 Amended Plan isnot less than the fair market value of the shares on the date of the grant. Thenumber of securities remaining available for future issuance under the AmendedPlan was 1,061,500 at December 31, 2008.

 

We accountfor stock awards issued to employees in accordance with Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share Based Payment”, or SFAS No.123(R) andhave adopted the prospective application stock based transition method. Duringthe years ended December 31, 2008 and December 31, 2007, the companyrecognized employee non-cash compensation expense of $364,231 and $330,335,respectively, related to the issuance of stock options and restricted stock. AtDecember 31, 2008 there were 720,000 unvested shares of restricted stockoutstanding. At December 31, 2008 the total compensation cost related tounvested restricted stock awards and stock option awards not yet recognized is$726,453. This amount will be recognized over the weighted average period ofsix years.

 

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**AMERICAN DG ENERGY INC.**

 

In 2007 the company granted nonqualified options topurchase 1,156,000 shares of the commonstock to seven employees at $0.90 per share. Of those stock options1,130,000 have a vesting schedule of 10 years and 26,000 stock options have avesting schedule of four years. In 2008, the company granted to one of itsemployees nonqualified options to purchase 100,000 shares of the common stock at $1.95 pershare. Those options have a vesting schedule of four years and expire in ten years. The fair value of the optionsissued in 2008 was $93,977. Stock option activity for the years endedDecember 31, 2008 and 2007 was as follows:

 
| ** **                                      | ** ** | ** **  | ** ** | **Exercise** | ** ** | **Weighted** | ** ** | **Weighted**  | ** ** | ** **    | ** ** |
|-------------------------------------------------|------------|-------------|------------|--------------|------------|--------------|------------|---------------|------------|---------------|------------|
| ** **                                      | ** ** | **Number**  | ** ** | **Price**    | ** ** | **Average**  | ** ** | **Average**   | ** ** | **Aggregate** | ** ** |
| ** **                                      | ** ** | **Of**      | ** ** | **Per**      | ** ** | **Exercise** | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** |
| **Common Stock Options**              | ** ** | **Options** | ** ** | **Share**    | ** ** | **Price**    | ** ** | **Life**      | ** ** | **Value**     | ** ** |
| ** **                                      | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** |
| Outstanding,  December 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         |       |          |       | 83,000        |       |
| 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 and  exercisable, December 31, 2007 |       | 1,011,750   |       |         |       | $            | 0.34       |          |       |          | $          | 570,350 |   |
|                                            |       |        |       |         |       |         |       |          |       |          |       |
| Outstanding,  December 31, 2007            |       | 2,241,000   |       | $0.07-$0.90  |       | $            | 0.63       |          | 7.71 years |          | $          | 607,600 |   |
| Granted                                         |       | 100,000     |       | $1.95        |       | 1.95         |       |          |       |          |       |
| Exercised                                       |       | —      |       | —       |       | —       |       |          |       | —        |       |
| Canceled                                        |       | (12,000     | )          | $0.90        |       | 0.90         |       |          |       |          |       |
| Expired                                         |       | —      |       | —       |       | —       |       |          |       |          |       |
| Outstanding,  December 31, 2008            |       | 2,329,000   |       | $0.07-$1.95  |       | 0.68         |       | 6.95 years    |       | $             | 3,017,920  |   |
| Vested and  Exercisable, December 31, 2008 |       | 1,244,500   |       |         |       | $            | 0.42       |          |       |          | $          | 1,937,660 |   |

 

The aggregate intrinsic value of options outstanding as of December 31,2008 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 of thatdate, and therefore have a negative intrinsic value, have been excluded fromthis amount.

In 2007, the company made restricted stock grants toemployees, board members and consultants by permitting them to purchase anaggregate of 737,000 shares of common stock at a price of $0.001 per share. Outof those shares, 681,000 have a vesting schedule of 25% on January 2, 2008and then 25% on each subsequent anniversary thereafter and 56,000 shares whichvest based on certain gross profit goals as described in the restricted stockpurchase agreement. In 2008, the company made a restricted stock grantto one employee by permitting him to purchase an aggregate of40,000 shares of common stock, at a price of $0.001 per share. The fairvalue of the restricted stock issued in 2008 was $77,960 and vests in fouryears.

 

Restricted stock activity for the years ended December 31, 2008 and2007 was as follows:

 
| ** **                        | ** ** | **Number of**        | ** ** | **Grant Date** | ** ** |
|-----------------------------------|------------|---------------------------|------------|---------------------|------------|
| ** **                        | ** ** | **Restricted Stock** | ** ** | **Fair Value** | ** ** |
|                              |       |                      |       |                |       |
| 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                |       |
|                              |       |                      |       |                |       |
| Granted                           |       | 40,000                    |       | 1.95                |       |
| Vested                            |       | (268,875                  | )          | 0.70                |       |
| Forfeited                         |       | —                    |       | —              |       |
| Unvested,  December 31, 2008 |       | 720,000                   |       | $                   | 0.77       |   |

 

The company’scalculations of stock-based compensation expense for the years ended December 31,2008 and 2007, respectively, were made using theBlack-Scholes option pricing valuation model. The fair value is then amortizedon an accelerated basis over the requisite service periods of the awards, whichis generally the vesting period. Use of a valuation model requires managementto make certain assumptions with respect to selected model inputs. Expectedvolatility was calculated based on the average volatility of 20 companies inthe same industry as the company. The average expected life 

 

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**AMERICAN DG ENERGY INC.**

 

wasestimated using the simplified method for “plain vanilla” options as permittedby SEC Staff Accounting Bulletin No. 107, or SAB No. 107. Theexpected life in years is based on the “simplified” calculation provided for inSAB No. 107. The simplified method determines the expected life in yearsbased on the vesting period and contractual terms as set forth when the awardis made. The company continues to use the simplified method for awards ofstock-based compensation after January 1, 2008 as permitted by SEC StaffAccounting Bulletin No. 110, or SAB No. 110, since it does not havethe necessary historical exercise and forfeiture data to determine an expectedlife for stock options. Originally, the use of the simplified method was due toexpire on December 31, 2007, but SAB No. 110 permits continued use ofthe simplified method if the company concludes that it is not reasonable tobase its estimate of expected term on its experience with historical exercisepatterns. The risk-free interest rate is based on U.S. Treasury zero-couponissues with a remaining term which approximates the expected life assumed atthe date of grant. When options are exercised the company normally issues newshares.

 

The weighted averageassumptions used in the Black-Scholes option pricing model are as follows:

 
| ** **               | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|--------------------------|------------|------------|------------|------------|------------|
| Stock option  awards     |       |       |       |       |       |
| Expected life            |       | 6.25 years |       | 7.71 years |       |
| Risk-free  interest rate |       | 1.62       | %          | 4.14       | %          |
| Expected  volatility     |       | 48.34      | %          | 48.26      | %          |

 

**Note 6 — Employee benefit plan:**

 

The company has adefined contribution retirement plan, or the Retirement Plan which qualifiesunder Section 401(k) of the Internal Revenue Code, or the IRC. Underthe Retirement Plan, employees meeting certain requirements may elect tocontribute a percentage of their salary up to the maximum allowed by the IRC.The company matches a variable amount based on participant contributions up toa maximum of 4.5% of each participant’s salary. The company contributed $31,717and $27,138 to the Retirement Plan for the years ended December 31, 2008and 2007, respectively.

 

**Note 7 — 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, 2014.

 

In January 2006, thecompany entered into the 2006Facilities, Support Services and Business Agreement, or the Agreement, withTecogen, to provide the company with certain office and business supportservices for a period of one year, renewable annually by mutual agreement. In January andMay 2008, we amended the Agreement with Tecogen. Under the amendments,Tecogen provides the company with office space and utilities at a monthly rateof $2,053 and $2,780, respectively. Subsequent to year-end, on January 2009,the company assumed additional space and amended the office space and utilitiesto a monthly rate of $4,838.

 

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.

 

OnFebruary 15, 2007, the company loaned the minority interest partner inADGNY $20,000 by signing a two year loan agreement earning interest at 12% perannum. On April 1, 2007, the company loaned an additional $75,000 to thesame 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 from related partyaccount in the accompanying balance sheet and are secured by the partner’sminority interest. On October 11, 2007, we extended to our minorityinterest partner a line of credit of $500,000. At December 31, 2008,$265,012 was outstanding and due to the company under the combination of theabove agreements.

 

Thecompany’s Chief Financial Officer devotespart of his business time to the affairs of GlenRose Instruments Inc., orGlenRose, and part of his salary is reimbursed by GlenRose. Also, the company’sChief Executive Officer is the Chairman of the Board and a significant investorin GlenRose and did not receive a salary, bonus or any other compensation fromGlenRose in 2008.

 

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**AMERICAN DG ENERGY INC.**

 

**Note 8 —Fair value measurements:**

 

SFAS No. 157 defines and establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements.In accordance with SFAS No. 157, we have categorized our financial assetsand liabilities, based on the priority of the inputs to the valuationtechnique, into a three-level fair value hierarchy as set forth below. If theinputs used to measure the financial instruments fall within different levelsof the hierarchy, the categorization is based on the lowest level input that issignificant to the fair value measurement of the instrument. The three levelsof the hierarchy are defined as follows:

 

*Level 1*— Unadjusted quoted prices in active markets for identicalassets or liabilities. We currently do not have any Level 1 financial assets orliabilities.

 

*Level 2—*Observable inputs other than quoted prices included inLevel 1. Level 2 inputs include quoted prices for identical assets orliabilities in non-active markets, quoted prices for similar assets orliabilities in active markets and inputs other than quoted prices that areobservable for substantially the full-term of the asset or liability.

 

*Level 3*— Unobservable inputs reflecting management’s own assumptionsabout the input used in pricing the asset or liability. We currently do nothave any Level 3 financial assets or liabilities.

 

At December 31, 2008, the company had $761,614 inshort-term investments that are comprised of Certificates of Deposits which arecategorized as Level 2. The Company determines the fair value ofcertificates of deposits using information provided by the issuing bank whichincludes discounted expected cash flow estimates using current market ratesoffered for deposits with similar remaining maturities. The unrealized lossduring the year was not material.

 

**Note 9 — Income taxes:**

 

Areconciliation of federal statutory income tax provision to the company’sactual provision for the years ended December 31, 2008 and December 31,2007, respectively, are as follows:

 
| ** **                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
|                                   |       |     |       |     |       |
| Benefit at  federal statutory tax rate |       | $        | (760,000   | )        | $          | (504,000 | ) |
| Unbenefited  operating losses          |       | 760,000  |       | 504,000  |       |
| Tax expense                            |       | $        | —     |     | $          | — |   |

 

Thecomponents of net deferred tax assets recognized in the accompanying balancesheets at December 31, 2008 and December 31, 2007, respectively, areas follows:

 
| ** **                        | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
|                              |       |       |       |       |       |
| Net operating  loss carryforwards |       | $          | 3,149,000  |       | $          | 2,196,000 |   |
| Accrued expenses  and other       |       | 178,000    |       | 118,000    |       |
| Depreciation                      |       | (271,000   | )          | (12,000    | )          |
|                              |       | 3,056,000  |       | 2,302,000  |       |
| Valuation  allowance              |       | (3,056,000 | )          | (2,302,000 | )          |
| Net deferred tax  asset           |       | $          | —     |       | $          | — |   |

 

Asof December 2008, the company has federal and state loss carryforwards ofapproximately $8,500,000 and $4,900,000, respectively, which may be used tooffset future federal and state taxable income, expiring at various datesthrough 2028.

 

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.

 

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**AMERICAN DG ENERGY INC.**

 

Thecompany adopted FASB interpretation No. 48, “Accounting for Uncertainty in Income Taxes- an interpretationof FASB Statement No. 109”, effectiveJanuary 1, 2007. The adoption of this statement had no effect on thecompany’s financial position. The company has no uncertain tax positions as ofeither the date of the adoption, or as of December 31, 2008. The companyhas no amounts recorded for interest and penalties in the accompanying December 31,2008 and December 31, 2007 consolidated statements of operations. Thecompany’s tax years 2005 to 2007 remain subject to examination by major taxjurisdictions.

** **

**Note 10 —Commitments and contingencies:**

 

In January 2006, thecompany entered into the Agreementwith Tecogen to provide the company with certain office and businesssupport services for a period of one year, renewable annually by mutualagreement. The company also shares personnel support services with Tecogen. Thecompany is allocated its share of the cost of the personnel support servicesbased upon the amount of time spent by such support personnel while working onthe company’s behalf. To the extent Tecogen is able to do so under its currentplans and policies, Tecogen includes the company and its employees in severalof its insurance and benefit programs. The costs of these programs are chargedto the company on an actual cost basis. Under this agreement, the companyreceives pricing based on a volume discount if it purchases cogeneration andchiller products from Tecogen. For certain sites, the company hires Tecogen toservice its Tecogen chiller and cogeneration products. In January and May 2008,we amended the Agreement with Tecogen. Under the amendments, Tecogen providesthe company with office space and utilities at a monthly rate of $2,053 and$2,780, respectively. Subsequent to year-end, in January 2009, the companyassumed additional space and amended the office space and utilities to amonthly rate of $4,838.

 

The company is the lesseeof certain equipment under capital lease expiring in 2013. The following is aschedule of future minimum lease payments, together with the present value ofthe net minimum lease payments under capital leases as of December 31,2008.

 
| ** **                               | ** ** | **Payments** | ** ** |
|------------------------------------------|------------|--------------|------------|
| 2009                                     |       | $            | 5,221      |   |
| 2010                                     |       | 5,221        |       |
| 2011                                     |       | 5,221        |       |
| 2012                                     |       | 5,221        |       |
| 2013                                     |       | 5,221        |       |
| Total lease  payments                    |       | 26,105       |       |
| Less: Amount  representing interest      |       | (9,280       | )          |
| Present value of  minimum lease payments |       | $            | 16,825     |   |

 

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