HEAD OFFICE: 355 Burrard Street, Suite 1700 Vancouver, BC, Canada V6C 2G8 Tel: 604-685-1243 Fax 604-685-7778 Email: bioteq@bioteq.ca ENVIRONMENTAL TECHNOLOGIES INC. www.bioteq.ca ANNUAL REPORT 2002 company profile BioteQ Environmental Technologies Inc. is an industrial process technology company that has developed the patented BioSulphide Process™ for water treatment and sulphide reagent pro- duction. The company is currently focused on applications of its technology in the mining industry where the process allows the treatment of acid and metal contaminated water with concurrent recovery of saleable metals from the water. Such contaminated water, or acid waste- water, is often termed Acid Rock Drainage (ARD) and is one of the most critical environmental challenges facing the mining industry. The BioteQ process can produce significant environmental benefits by reducing or eliminating toxic metal emissions to the environment and the long-term environmental liabilities associated with the storage of metal-laden products from conventional water treatment processes. Rev- enues from the sale of metal products recovered from the ARD and other contaminated water streams can offset water treatment costs or, in some cases, result in water treatment for a profit. BioteQ will operate on three commercial bases: design, build, own and operate; design, build and transfer with process royalties; or third party license. The Company is moving forward to develop larger commercial projects, following the construction in 2001 of its first commercial plant at the Caribou Mine near Bathurst, New Brunswick, and operation of the plant to treat metal-contaminated mine water during 2002. BioteQ is based in Vancouver, Canada and is currently listed on the TSX Venture Exchange under the symbol BQE. Annual Meeting The Annual General Meeting of Shareholders will be held on April 29, 2003, at 2 pm at the Conference Centre, Second Floor, 888 Dunsmuir Street, Vancouver B.C. Directors P. Bradley Marchant President & CEO of the Company North Vancouver, B.C. Head Office company information 355 Burrard Street, Suite 1700 Vancouver, BC, Canada V6C 2G8 Tel: 604-685-1243 Fax 604-685-7778 Email: bioteq@bioteq.ca George W. Poling Chairman of the Board of Directors West Vancouver, B.C Kelvin Dushnisky Director of Regulatory Affairs, Barrick Gold Corporation Oakville, Ontario Anthony Kana Financial Services Consultant Vancouver, B.C. Clement Pelletier President & CEO Rescan Environmental Services Ltd. Vancouver, B.C. Ian Telfer Chairman & CEO Wheaton River Minerals Ltd. Vancouver, B.C. Kenneth Williamson Independent Consultant Toronto, Ontario Investor Relations Tel: 1-800-537-3073 Email: investor@bioteq.ca Legal Council McCullough O’Connor Irwin Vancouver, B.C Auditors PriceWaterhouseCoopers Vancouver, B.C. Transfer Agent Pacific Corporate Trust Vancouver, B.C Stock Exchange Toronto Venture Exchange Symbol: “BQE” Website www.bioteq.ca contents Company Profile President’s Message to Shareholders Overview of Technologies Other Technology Initiatives Projects Management Discussion and Analysis Management’s Responsibility for Financial Reporting Auditors’ Report and Consolidated Financial Statements Company Information front inside cover 1 3 4 5 7 9 10 back inside cover Officers and Management P. Bradley Marchant President & CEO Richard W. Lawrence Executive Vice President John York Chief Financial Officer David Kratochvil Manager, Engineering and Development ANNUAL ANNUAL REPORT REPORT BIOTEQ BIOTEQ consolidated financial statements president’s message to shareholders We are pleased to present the Annual Report and Financial Statements for the year ended December 31, 2002. During 2002 BioteQ was successful in operating its first plant and is now moving forward to develop larger commercial projects. The commissioning and operation of our first plant, located at the Caribou Mine in New Brunswick, provided BioteQ with the fol- lowing milestones: • Demonstration of our water treatment tech- nology on a commercial scale • Demonstration of metal recovery from a highly variable and complex acid drainage • Signing of an agreement with Noranda’s Brunswick Mine to purchase the concen- trate produced at Caribou • Engineering, construction, operations and maintenance experience for future commer- cial projects • A definitive marketing tool for potential users of our technology The Company recognizes the invaluable role of the management of Breakwater Resources and the staff at the Caribou Mine in providing the opportunity and support to BioteQ to build the plant. In addition, the ongoing input and sup- port from local and provincial regulators was important in the successful operation at Caribou. BioteQ’s first commercial plant located at the Caribou Mine, New Brunswick. Highlights from 2002 include: • Completion of Caribou expansion engineering Commercial Highlights • Contract signed with Falconbridge for piloting and engineering for a possible commercial plant at their Raglan mine in Quebec • Completion of an evaluation of several potential projects with Phelps Dodge and signing of an agreement with Phelps Dodge to complete detailed engineering for a possible com- mercial plant at Bisbee in Southern Arizona • Completion of a report that identifies a new market target for BioteQ - the sulphide reagent business • Completion of an independent analysis of our Partial Oxidation Burner for hydrogen pro- duction that confirms the commercial potential for hydrogen supply from low grade fuels and provides specific markets for commercial exploitation The Company was fortunate to attract additional key people to the company during 2002: Michael Bratty, a graduate of McGill University, joined BioteQ in August. Mike has several years experience in the design and engineering of water treatment plants and recently completed a Masters degree in Chemical Engineering. He immediately reported to the Raglan site in North- ern Quebec to operate our pilot plant as well as complete the preliminary engineering study for Raglan. Mike is now based in Montreal to provide a presence in our growing eastern activities. Personnel Highlights 1 BIOTEQ ANNUAL 28 REPORT BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 14 Commitments The company is committed to minimum annual lease payments for office premises of $7,800 for 2003. 15 Short-term investments Included in short-term investments is the amount of $27,068 which is held in trust for payment of the balance of the first year’s interest on the convertible debentures. 16 Subsequent event On January 15, 2003, the company completed an over-allotment on the private placement by issuing a further 940,000 units for gross proceeds of $470,000. Issue costs amounted to $66,100 of which $23,500 was the value of issuing 47,000 units as a fee to the agent. In addition, the agent received 94,000 common share purchase warrants. Each warrant entitles the holder to acquire one additional common share for a period of two years from the issue date at a price of $0.65 in the first year and $0.75 in the second year. (15) president’s message to shareholders consolidated financial statements Personnel Highlights (continued) Expectations for 2003 Ian Telfer, Chairman and CEO of Wheaton River Minerals, joined our board of directors in November and was instrumental in directing the Company through the recent financing with Canaccord. We are looking forward to Ian’s ongoing involvement, combining his special talents in corporate finance and the mining industry. The Company has a very simple goal for 2003 - to engineer and construct commercial plants. We are now behind our original timeline for commercialization as we had expected to build a second plant in 2002. However, with our current projects and staff we anticipate the construc- tion and commissioning of two new commercial plants this year. In addition, our project list is maturing and the number of advanced projects for potential commercialization has increased substantially since last year, providing a clear pipeline for future project growth. BioteQ has recently signed a partnership with SOQUEM INC. in Quebec to assess over 60 potential sites during 2003 for possible application of our process. Additional project approvals are expected during 2003 to keep our commercial plant pipeline growing. It is a difficult transition from development to operations for any company and requires a unique combination of technical, financial and management skills. BioteQ is now poised to complete its original commercialization plan to build a successful operating company in the environmental business based on solid commercial projects and growing earnings from operations. Once again, the employees and directors deserve special recognition for the advancement of the Company during 2002. On behalf of the Board of Directors P. Bradley Marchant President and CEO Vancouver, Canada, March 14, 2003 ANNUAL 2 REPORT 27 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 The reconciliation of income tax attributable to operations computed at the statutory tax rates to income tax expense (recovery), using a 39.62% (2000 - 44.62%) statutory tax rate, at December 31, is: 2002 $ 2001 $ Income tax at statutory rates (428,306) (306,122) Non-deductible expenses 3,566 8,924 Non-capital loss carried forward and available to offset taxable income in future years 385,503 297,198 Share issue costs 39,237 - - - 12 Scientific research tax credit refund During 2001, the company received $207,446 in non-refundable Scientific Research tax credits from Canada Customs and Revenue Agency related to 1999 research and development expenditures. These credits were not deducted from the related costs during 1999, as reasonable assurance of realization did not exist. As a result, $200,352 has been credited to the 2001 statement of operations and $7,094 has been credited to property, plant and equipment. 13 Financial instruments Fair value of financial instruments The company’s financial instruments include short-term investments, government grant receivable, other assets, and accounts payable and accrued liabilities. The fair values of these financial instruments approximate their carrying value. Credit risk exposure The company’s exposure to credit risk is as indicated by the carrying value of its government grant receivable. The company mitigates this risk by reviewing and monitoring this balance. Interest rate exposure The Series A debentures bear interest at a fixed rate. Management considers that no events have occurred subsequent to the issuance of these debentures that would indicate that the fair value differs substantially from the carrying value. (14) consolidated financial statements overview of technologies Water Treatment Protection of water quality has become one of the most important environmental challenges facing the mining industry. Although new mining projects can be designed to minimize impacts to the environment, many existing and abandoned mining operations have water quality prob- lems. The principal cause of water contamination is acid rock drainage (ARD), which is gener- ated when residual sulphide minerals in waste rock, tailings and other mine components and products are exposed to air and water. These reactions can produce acidity and elevated con- centrations of metals in drainage and seepage that can adversely affect surface and groundwater resources. To meet regulatory criteria for water quality in the receiving environment, many mine opera- tors must consider treatment of mine water and other effluents prior to discharge. The current estimated clean up costs for acidic drainage from mining alone in the US and Canada is US$72 billion and $5 billion, respectively, from hundreds of operating, closed and abandoned mine sites. The industry generally uses a process in which lime is added to remove metals and neu- tralize acidity in ARD and other acidic effluents. This treatment method produces water that usually meets current discharge requirements but produces a sludge product that still contains the toxic metals that were present in the contaminated water. The metals are therefore not recovered in a usable form and the sludge product must be stored and monitored in perpetuity, usually at the mine site and can represent a long term environmental liability. In addition, the treated water from lime plants contains residual sulphate concentrations which can be harmful to aquatic organisms. Many jurisdictions are introducing or considering new sulphate water dis- charge standards which cannot be met by lime treatment. BioteQ owns and has developed the patented BioSulphide Process™, an anaerobic biological process, for a number of water treatment and metal recovery applications. In 2001, the Com- pany entered into a Technology Cooperation Agreement with Paques Biosystems BV of the Netherlands, which markets the related Thiopaq® technology. Paques has significant experi- ence in the design, construction and commercialization of anaerobic water treatment systems, mainly in Europe. The Agreement enables the companies to utilize their mutual knowledge and experience in a number of water treatment and related applications, utilizing BioSulphide- Thiopaq technology. BioteQ and Paques Technology Agreement The BioSulphide-Thiopaq technology is used to remove toxic metals selectively from water by precipitating them as sulphide products. The purpose for doing this might be exclusively envi- ronmental or there might also be an economic incentive to recover metal products for sale. In some cases, recovery of metals as part of a metallurgical operation might be the sole purpose. The range of applications for the technology is broad, therefore, and includes: BioSulphide- Thiopaq Technology • Treatment of ARD with concurrent selective recovery of metals • Treatment and metal recovery from other contaminated surface waters and groundwaters • Treatment of refinery and smelter waste streams • Recovery of metals for revenue as an alternative to conventional processes • Process control by treatment of bleed streams for metallurgical process enhancement • Treatment of industrial, municipal, surface waters and groundwaters water with high sul- phate ANNUAL 26 REPORT 3 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (13) 10 Related party transactions and balances At December 31, 2002, a director holds $100,000 of the convertible debentures (note 8) issued on September 5, 2002. 11 Tax loss carry-forward As at December 31, 2002, the company has approximately $1,260,000 of research and development expenditures available for unlimited carry-forward, undeducted expenditures for tax purposes of $1,248,000 related primarily to share issue costs and property, plant and equipment, and $46,000 of investment tax credits, all of which may be used to reduce future Canadian income taxes otherwise payable. The company has accumulated losses of approximately $2,401,000 for income tax purposes which may be deducted in the calculation of taxable income in future years. The losses expire as follows: $ 2004 172,000 2005 230,000 2006 43,000 2007 139,000 2008 844,000 2009 973,000 2,401,000 As at December 31, 2002, the company’s future tax assets and liabilities were as follows: 2002 $ 2001 $ Property, plant and equipment 792 (41,325) Financing costs 261,096 175,740 Research and development expense carryforwards 499,212 548,100 Non-capital loss carry-forwards 951,276 621,180 Total future tax assets 1,712,376 1,303,695 Valuation allowance (1,712,376) (1,303,695) Total future tax assets - - No income tax benefits related to the future tax assets have been recognized in the accounts as their realization does not meet the requirements of “more likely than not” under the liability method tax allocation. overview of technologies consolidated financial statements BioSulphide- Thiopaq Technology (continued) The BioSulphide-Thiopaq technology can produce very low residual concentrations of the metals in the process effluent. The recovered metal sulphides can represent a significant rev- enue stream which can either offset operating costs or result in profitable operation. The technology can also be used in combination with other water treatment processes for more comprehensive treatment. For example, application of the technology upstream of an exist- ing lime treatment plant can not only produce a revenue stream through the recovery of metal products but can also reduce lime consumption and reduce the volume of the sludge produced. In addition, the sludge would no longer contain the toxic heavy metals which are removed in the BioSulphide-Thiopaq plant and shipped offsite. Long term liabilities associated with sludge disposal would be significantly reduced. Simplified flowsheet of BioSulphide-Thiopaq Process showing reduction of sul- phur to produce sulphide reagent for the precipitation and recovery of a single metal sulphide product In the BioSulphide-Thiopaq process, metals such as copper, nickel and zinc can be precipitated and separated from contaminated water into saleable metal products utilizing biogenic sulphide reagent produced in a bioreactor. The biogenic sulphide is produced by reduction of sulphur species such as elemental sulphur or sulphate, with the addition of ethanol or hydrogen as an electron donor. In the case of sulphate reduction, the contaminated water itself can provide the sulphur source but capital and operating costs are higher for sulphate reduction than for systems utilizing elemental sulphur. Sulphate reduction should be considered, therefore, only for applications where sulphate concentrations must be lowered for environmental or process recycle purposes. For metal removal for environmental and/or metal recovery applications, sulphur reduction is preferred. Metal precipitation and recovery is carried out using conven- tional precipitation, solid-liquid separation and filtration equipment. other technology initiatives Partial Oxidation Burner for Hydrogen Production Hydrogen can be an efficient electron donor for BioteQ’s reduction technologies and can be supplied by steam reforming or from the partial oxidation system (POS) developed by BioteQ to provide the hydrogen-rich gas, using most fossil fuels (diesel, natural gas, propane). The POS has the added advantage of supplying excess heat to maintain the biological sulphate reduc- tion reactor at an optimum temperature for bacterial growth. The soot produced in the burner might also have potential value as carbon black used in a number of industrial sectors. In 2001, the Canadian Institute for Market Intelligence in cooperation with the National Research Council provided an independent assessment of BioteQ’s POS technology as a pos- sible fuel processor for fuel cells. This study showed that BioteQ’s POS might be highly com- petitive with current steam reforming technology as a fuel processor for high temperature fuel ANNUAL 4 REPORT 25 BIOTEQ EffluentSulphurNutrientsContaminated WaterMetal SulphideProductH2SAlkali source (if required)ClarifierBioreactorContactor BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (12) On April 22, 2002, the company granted 100,000 options to a consultant in return for investor relations services. At the date of grant, the market value of the underlying shares was $0.45 and the option exercise price was $0.54. At December 31, 2002, 33,333 options had vested. The company has recorded an expense of $30,317 during the year based on the fair value of the options. On September 5, 2002, the company granted 46,154 common share purchase warrants to the agent of the Series A debentures offering for services rendered (note 8). The warrants are convertible into the same number of common shares at a price of $0.65 per common share until September 4, 2004. The company has recorded an expense of $9,199 during the year based on the fair value of the warrants at the date of grant. On December 20, 2002, the company granted the agent for the private placement, common share purchase warrants to buy 406,000 common shares at a price of $0.65 within the first year and $0.75 within the second year from the grant date. The company has treated these costs as share issue costs based on their fair value. See note 9. During 2001, Underwriter options were exercised to purchase 100,000 common shares at a price of $0.20 per share, which were issued in relation to the company’s initial public offering in December 1999. The agent for the company’s December 2001 public offering has been granted an option for 2 years to acquire 130,000 common shares at the offering price of $0.50. During 2001, the company granted 300,000 options to a consultant in return for investor relations services. At the date of grant the market value of the underlying shares was $0.67 and the option exercise price was $0.58. At December 31, 2001, 200,000 options had vested. The company has recorded an expense of $18,000 during the year based on the intrinsic value of the options at the date of grant with a credit to contributed surplus. If the company had used an option pricing model to fair value the options at the date of grant, the expense would have been $80,000. The contract ceased in 2002, the vested options were not exercised and therefore were cancelled. Escrow shares The shares issued at December 31, 2002 include the following held in escrow: a) 7,000,000 performance shares which will be released from escrow based upon the cash flow performance of Biomet determined on an annual basis in accordance with the policies of the exchange. Biomet must generate a cash flow of $0.30 for each performance share to be released from escrow. Any performance shares which have not been released within 10 years from issuance will be cancelled and returned to the company’s treasury. b) 333,330 seed shares for release in December 2003. These shares are the remaining seed shares being released annually for the three years after completion of the company’s qualifying transaction, which occurred on December 20, 2000. consolidated financial statements other technology initiatives cells and included recommendations for potentially competitive commercial markets. In 2002 the Company continued its evaluation of the commercial potential of the POS in conjunction with high temperature hydrogen fuel cells to a greater depth by entering into a contract with Fuel Cell Intelligence, Ltd., for an independent analysis of the potential. This study will provide the company with the technical and market direction for commercial feasibility analysis of the POS burner. Partial Oxidation Burner for Hydrogen Production (continued) In 2001, BioteQ acquired ownership of the GypCIX process, a low cost ion-exchange technol- ogy for the removal of sulphate, calcium, magnesium and other ions from water. Products of the process are reusable/dischargeable water and solid gypsum that might also have value, depending on local market potential. GypCIX has the potential of being the most cost-effective alternative for sulphate removal, utilizing lower cost lime and sulphuric acid for resin regeneration. The Company continues to seek applications although demand for sulphate reduction in North America is predicted to remain low until regulatory pressure is increased to limit sulphate concentrations in effluents discharged to the environment to a higher degree as experienced in Europe and elsewhere. The GypCIX Process - for Sulphate Removal and Desalination projects Caribou is a zinc mine owned by Breakwater Resources Ltd. located near Bathurst, New Bruns- wick, which is currently not operating due to low metal prices. The mine continues to operate a lime plant to treat underground mine drainage, which has an average flow of 700 m3/day. The mine also has a sizeable deposit of old tailings, stored separately by the previous operator, containing significant quantities of pyrite, zinc and copper. Over the years these tailings have become a source of acidity and soluble metals due to oxidation and require remediation. Caribou, New Brunswick, Canada BioteQ reached an agreement with Breakwater in June 2001 to construct a Stage 1 treatment plant to remove metals from the mine drainage upstream of the existing lime plant. The plant was designed to recover zinc together with copper, cadmium and lead from the acidic mine drainage to augment the lime plant. The plant was constructed on schedule and 5% below budget and incorporated a bioreactor - contactor - PLC module constructed in Vancouver together with some new and existing Caribou mill equipment for the metal product dewatering circuit. The plant was started up in November 2001 and by February 2002 had reached a steady state operating capacity required to meet water treatment needs at that time of the year. The plant has contended with unpredictable and highly variable metal content in water to be treated. At times, the metal concentrations in the plant feed ranged from one and a half to over twice the design quantity so that the plant was not always able to treat the entire mine water flow. However, the rate of sulphide generation in the bioreactor per unit volume of mine drain- age exceeded design expectations. As a consequence, overall metal treatment exceeded design capacity per unit volume of the mine drainage. Copper removal and recovery has exceeded design expectations, with consistent concentrations of <0.01 parts per million in the treated water. The zinc recovery has also been within design expectations, although recovery was often incomplete due to the high metal loadings in the feed. The Caribou plant has demonstrated that the BioSulphide-Thiopaq process can accommodate highly variable contaminated water quality. Plant availability at Caribou was 98% during the last quarter of operation and has consistently demonstrated effective metal removal and recov- ery. The only downtime for the BioteQ plant was for scheduled preventative maintenance pur- poses. ANNUAL 24 REPORT 5 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 The following table summarizes information about common share options outstanding at December 31: Range of exercise price $ Number of outstanding at December 31 Weighted average remaining contractual life (years) Weighted average exercise price $ 2001 0.54 - 0.67 2,150,000 4.2 0.63 2002 0.50 - 0.67 2,600,000 3.6 0.61 Had compensation expense for stock options been determined by a fair value method in accordance with the provision of CICA Handbook Section 3870, the company’s loss for the year-end December 31, 2002 would have been reduced to the pro forma amount indicated below: 2002 $ Loss - reported 1,081,034 Loss - pro forma 1,317,922 Loss per share - as reported 0.09 Loss per share - pro forma 0.11 The fair value of stock option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: 2002 Expected dividend yield 0% Expected stock price volatility 86% Risk-free interest rate 3.95% Expected life of options (years) 5 The weighted fair value average price and weighted average exercise price of options granted in the years indicated were as follows: Weighted fair value average price $ Weighted average exercise price $ 2002 0.47 0.54 2001 0.59 0.63 (11) projects consolidated financial statements Caribou, New Brunswick, Canada (continued) During its operation in 2002, the Stage 1 plant recovered nearly 35 tonnes of zinc concentrate, which also contains copper, cadmium and lead. The concentrate was delivered and accepted for sale to the nearby Brunswick Mine under contract with Noranda. Concentrate production was suspended at the end of October due to the planned shut-down of minewater collection and treatment during the winter at Caribou in order to flood the underground mine. This is a one- time change in operating practice that will result in simplified collection of the minewater for delivery to the treatment plant and overall cost savings for minewater treatment in the longer term. Breakwater’s water treatment operations will resume once flooding of the underground mine is complete from spring run-off this year. Of long term environmental significance, the toxic metal content of sludge from the down- stream lime plant was significantly reduced. At typical feed water concentrations, more than 150 tonnes per year of combined zinc, copper, cadmium and lead would be delivered off-site for sale rather than be discharged into the environment with the lime plant sludge. Treated water has been discharged to local receiving waters within the guidelines of existing permits. Based on the recent operating results detailed engineering for final budget purposes and other due diligence for the expansion of the Caribou plant can be completed over the winter. The expansion plant will include re-processing of tailings at Caribou, left by previous operators, concurrently with acidic mine drainage. Bisbee, Arizona, U.S. In January 2002, BioteQ signed a letter of intent with Phelps Dodge Miami Inc. to form a joint venture with Phelps in connection with the construction and operation of a BioSulphide- Thiopaq plant for selective recovery of copper from acidic ground water prior to treatment of the water in an existing lime plant. The Miami LOI with Phelps has been superseded by an agreement signed to evaluate application of the technology at Phelps’ Bisbee property in southern Arizona. The BioteQ plant at Bisbee would selectively recover copper from circulating water from exist- ing stockpiles. This plant would be similar to the plant already operational at the Caribou Mine in New Brunswick where copper recovery has been over 99% since startup. The initial capacity of a plant at Bisbee would be designed for approximately 3 million pounds per year copper recovered. It is anticipated that the copper recovered at Bisbee will be sent to the Miami smelter, operated by Phelps Dodge, for further refining under commercially com- petitive terms. Construction of a BioteQ plant would take approximately 6 months following detailed engineering. The application of BioteQ’s technology at Bisbee could provide immedi- ate economic benefit from copper recovery and several long term potential economic and envi- ronmental benefits. An agreement was signed with Phelps Dodge in 2002 to initiate detailed engineering for the project, the costs for which are shared on a 50/50 joint basis. The detailed engineering has been completed in 2003 and a definitive joint venture operating agreement is being prepared while final approvals are being sought to move ahead with construction. Raglan, Québec, Canada BioteQ is evaluating application of the BioSulphide-Thiopaq technology for water treatment at the Raglan mine owned by Societe Miniere Raglan du Québec Ltee (SMRQ), a subsidiary of Falconbridge Limited. The mine, located on the Ungava Peninsula in northern Québec, extracts nickel ore, which is processed at site and shipped as a nickel sulphide concentrate to ANNUAL 6 REPORT 23 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 a) In December 2001, the company completed a public offering of 1,300,000 commons at $0.50 per share. The prospectus document also qualified the issuance of 1,100,000 common shares upon the exercise of 1,100,000 previously issued special warrants at $0.50 per share (the Offering). Gross proceeds from the Offering were $650,000 with issue costs of $206,446 relating to agent’s commissions and other expenses of the Offering. b) On June 18, 2001, the company completed a private placement of 1,100,000 special warrants at a price of $0.50 for gross proceeds of $550,000, with issue costs of approximately $32,000. The special warrants entitle the holder, upon exercise, to obtain common shares of the company, without payment of any further consideration. On November 27, 2001, the special warrants were exercised and 1,100,000 common shares of the company were issued. c) On December 20, 2002, the company completed a private placement of 4,060,000 units at a price of $0.50 for gross proceeds of $2,030,000. Issue costs amounted to $382,012, of which $101,500 were settled with the issue of 203,000 units and $47,892 were settled with the issue of 406,000 warrants. Each unit comprised one common share and one non-transferable common share purchase warrant. Each warrant entitles the holder to acquire one additional common share for a period of two years from the issue date at a price of $0.65 in the first year and $0.75 in the second year. Of the gross proceeds, $1,642,501 was attributable to the common shares and $387,499 was attributable to the non-transferable common share purchase warrants. d) Stock options The company has a stock option plan available to directors, employees and consultants. Under the plan, 3,790,714 shares are available for issue. Options vest at the minimum rate of 33% every six months from award and have a maximum term of five years from the date of the grant. A summary of the change in the company’s stock option plan for the year is as follows: 2002 2001 Number of options Weighted average exercise price $ Number of options Weighted average exercise price $ Outstanding - January 1 2,150,000 0.63 200,000 0.20 Options granted 750,000 0.54 2,150,000 0.63 Options exercised - - (200,000) 0.20 Options cancelled (300,000) 0.58 - - Outstanding - December 31 2,600,000 0.61 2,150,000 0.63 Exercisable at December 31 2,000,000 0.63 716,666 0.63 Available for future grant pursuant to company’s stock option plan at December 31 1,190,714 831,176 (10) consolidated financial statements projects Sudbury. Oxidation of residual sulphide minerals in open pits and waste rock piles, as well as contact of mine water with exposed metal bearing minerals in the underground operations, results in the contamination of drainage at the site. The water has a neutral pH but contains elevated acidity levels in the form of dissolved nickel and must be treated before it is discharged to local receiving waters. Currently the water is stored in a collection basin, is treated for approximately 4 months of the year in a low-density sludge lime treatment plant. Raglan, Québec, Canada (continued) Following successful piloting at site during 2002, BioteQ is now working under contract with SMRQ on the first phase of engineering to evaluate the replacement of the existing lime plant with the Bioteq technology. The Company is evaluating over 30 potential commercial projects for water treatment and metal recovery in Canada, USA, Europe, Australasia and South America. These projects are in various stages of development from initial scoping and due diligence to advanced engineering. Project Pipeline management discussion and analysis The following discussion and analysis should be read in conjunction with the audited consoli- dated financial statements of the Corporation for the year ended December 31, 2002. BioteQ is a Canadian industrial process technology company that has developed the patented BioSulphide Process™ for water treatment and sulphide reagent production. The process allows the treatment of acid contaminated water with concurrent recovery of saleable metals from the water. Description of Business BioteQ has completed construction and commissioning of a commercial scale plant at the Caribou Mine in New Brunswick for selective copper and zinc recovery and is continuing to market its Process at a number of other sites in North America and elsewhere. During 2001 and 2002, the Company has continued the development of the Process. In late 2001 the company built its first commercial scale plant which operated through most of 2002 and provided an essential demonstration of the Company and the Process’s capability. In 2002, there has been significant effort to market the Process at a large number of sites in North America and abroad, with the result that the Company has a potential project list of over 30 sites which could benefit from the Company’s technology. These projects range from early stage enquiries with initial scoping and due diligence, to two advanced stage projects where either preliminary or detailed engineering has been finalized and the decision to construct plants is imminent. Because the Company is dealing in the majority of cases with large organiza- tions and endeavouring to sign contracts for the long-term operation of plants at their sites, the process of reaching a definitive decision has been slower than expected, however the process demonstration at the Caribou plant has proved an invaluable tool in 2002 and the building of additional plants would eliminate any lasting concerns of the Company’s capability. The operating loss for the year was $1,081,034 compared to $684,064 for 2001. The major rea- sons for the increase were as follows. General and Administrative costs for 2002 were $596,573 compared to $645,862 for 2001. The reduction was due to lower legal and investor relations costs by $120,000, offset by slightly higher costs in all other categories while the company was progressing from public company start-up in December 2000. Development expenses amounted to $465,607 (net of government grants of $184,182), compared to $277,072 in 2001 (no government grants were received in 2001). The increase was due to $147,000 for the cost Operating Results 7 BIOTEQ ANNUAL 22 REPORT BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 9 Capital stock, warrants and contributed surplus Authorized 100,000,000 common shares without par value Issued and outstanding Common stock Warrants Contributed surplus Number of shares Amount $ Amount $ Amount $ Total $ Balance - December 31, 2000 15,905,884 2,655,770 - - 2,655,770 Shares issued for cash Stock options 300,000 60,000 - - 60,000 Underwriters oversubscription option 270,000 135,000 - - 135,000 Public offering (a) 1,300,000 650,000 - - 650,000 Shares issued on exercise of special warrants (b) 1,100,000 550,000 - - 550,000 Share issuance costs - (238,446) - - (238,446)Issuance of stock options for services rendered - - - 18,000 18,000 Balance - December 31, 2001 18,875,884 3,812,324 - 18,000 3,830,324 Shares issued for accounts payable 77,686 38,843 - - 38,843 Private placement for cash (c) 4,060,000 1,642,501 387,499 - 2,030,000 Share issuance costs (c) - (278,476) (103,536) - (382,012)Units issued in settlement of issue costs (c) 203,000 77,554 23,946 - 101,500 Warrants issued in settlement of issue costs (c) - - 47,892 - 47,892 Issuance of stock options and warrants for services rendered - - - 39,516 39,516 Balance - December 31, 2002 23,216,570 5,292,746 355,801 57,516 5,706,063 (9) management discussion and analysis consolidated financial statements of start-up, operating and testing at the Caribou plant and an increased effort and expense of marketing the Process, amounting to $95,000. Other development costs were lower by $53,000. During 2001 the Company received Scientific Research tax credit refunds of $207,446 relating to a prior year. The refunds were credited to the statement of operations for $200,352 and $7,094 was credited to Property, Plant and Equipment. No related refunds were received in 2002 and no further refunds are available to the Company in the future. Caribou Operations Since plant start-up in late 2001, the water chemistry of the plant feed provided by Breakwater Resources Ltd (“Breakwater”) has not matched the plant design criteria. The actual metal load- ings of zinc and iron in the feed water have far exceeded the anticipated levels provided during the plant design phase. Consequently, at times, the plant could not meet the original water flow performance criteria. As a result, the removal of zinc was often incomplete and/or plant feed flow was less than the original design specifications, although copper removal was consistently greater than 99.5%. Despite this, the plant has exceeded expectations on a steady state basis in other operating criteria, such as the rate of sulphide generation per unit volume of mine drain- age, and adaptability of plant controls to wide fluctuations in feed composition. The opera- tion has enabled the Company to enhance the bioreactor vessel design supplied by Paques to increase sulphur reduction capacity at Caribou and for all future designs and installations. Furthermore, despite the bioreactor capacity limitation, the Caribou plant performed well for a consistent period, provided excellent metal removal from the treated water at steady state, delivered 35 tonnes of concentrate offsite for processing and had minimal downtime with an overall operating availability of 95% during steady state operations. The site owner has shut water delivery down for the winter in order to flood the underground mine as part of closure procedures. 2003 Operations General and administrative expenses during 2003 are expected to be somewhat more than 2002, due largely to a need for administrative support during this growing stage, the increased cost of insurance and to a new contract with an investor relations company. Development costs should be significantly less in 2003 due to a later reopening at Caribou after the winter shutdown and the possibility of the project progressing to the expansion phase. In addition, lower marketing costs are expected as the project pipeline matures. The Company is anticipating it will be completing construction of two new commercial plants before the end of the year, at least one of which is expected to be producing revenue and cash flow in the last quarter. During 2002, the Company raised $313,671, net of expenses, from an issue of convertible debentures. Late in the year, a further $1,797,380 (net of cash issue costs) was raised from a private placement of units priced at $0.50 (the units comprised one common share and one warrant to buy an additional share). The Company also received $152,340 from government grants in support of demonstrating the company’s innovative environmental technology at the Caribou plant. A further $49,048 is a receivable at year-end. At December 31, 2002 the Com- pany had cash of $1,776,457 and working capital of $1,681,867. The Company is expecting to finalize completion of a commercial agreement to build a second plant for application of the BioSulphide Process™ in the very near future. The Company has already investigated the opportunities for project financing, which it intends to utilize for upcoming projects. The Company believes it has adequate working capital to carry it into 2004 when it expects cash flow from operations will have commenced. Liquidity and Capital Resources ANNUAL 8 REPORT 21 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 The company has had the following cumulative transactions since inception with related parties: 2002 $ 2001 $ Included in cumulative development costs: Intangible assets purchased from shareholders 20 20 Interest charged by a shareholder 4,284 4,284 Provision of engineering services by shareholders 265,383 265,383 Laboratory expenses incurred by shareholders 68,356 68,356 The amounts paid for the services are based on their exchange amount. 8 Series A debentures On September 5, 2002, the company completed a private placement of unsecured Series A debentures (debentures) of $400,000 to fund working capital and plant construction. After deducting issue costs of $86,329, the proceeds of the issue amounted to $313,671. Each debenture matures on October 31, 2007 and bears interest at the rate of 10% per annum, payable semi-annually. The principal is convertible at the option of the holder into common shares of BioteQ at $0.65 per common share. Under the terms of the Trust Indenture, the conversion price is adjusted if the company declares and pays a stock dividend, subdivides its outstanding common shares into a greater number of common shares, or consolidates its outstanding common shares into a lesser number of common shares. The conversion price will also be adjusted when the company fixes a record date for dividend distribution or the issuance of equity instruments with exercise prices less than the fair value at the grant date. After two years from the issuance date, the company may redeem the debentures if the common shares have traded for 30 consecutive days at 200% of the conversion price. The debentures are being accounted for in accordance with their substance and are presented in the financial statements in their component parts, measured at their respective fair values at the time of issue. The liability component has been calculated as the present value of the required interest payments discounted at a rate approximating the interest rate that would have been applicable to non-convertible debt at the time the debentures were issued. $ Issue price 400,000 Less: Liability component (277,109) Shareholders’ equity component 122,891 Less: Issue costs applicable to shareholders’ equity component (26,763) Net amount classified as shareholders’ equity at issuance 96,128 Interest on the liability component is $21,124, of which $8,193 represents accretion of the liability component. (8) consolidated financial statements management discussion and analysis Any new commercial application of the BioSulphide Process™ will have certain construction and other risks associated with building and operating a new plant. Revenue will fluctuate with the price of the commodities being reco, vered and the exchange rate for the United States dollar. Operating costs will be largely dependent on the cost of consumables and power, which may fluctuate. The Company will be selecting projects which demonstrate good profit margins which should allow for the adverse effect of price changes. Risks and Uncertainties The economics of some projects under review by the Company are based largely on estimates of metals to be recovered. Although there is often a significant amount of data upon which estimates can be based, there can never be absolute certainty as to the continuity of flow of water to be treated, nor the concentrations of metals contained therein. The year 2003 will be significant for the Company. It expects to start building projects with good profitability and cash flow. The Company has enough working capital to last well into 2004 and expects to be able to project finance a significant portion of new plants. The Com- pany appears well placed to start the operating phase of its development. Outlook management’s responsibility for financial reporting The management of BioteQ Environmental Technologies Inc. is responsible for the prepara- tion of the consolidated financial statements as well as the financial and other information contained in the annual report. Management maintains an internal control system to provide reasonable assurance as to the reliability of financial information and the safeguarding of assets. The consolidated financial statements are prepared in accordance with generally accepted accounting principals in Canada and necessarily include amounts determined in accordance with estimates and judgments made by management. The external auditors, PriceWaterhouseC- oopers, Chartered Accountants, express their opinion on the consolidated financial statements in the annual report. The Board of Directors, through the Audit Committee, is responsible for ensuring that man- agement fulfils its responsibilities for financial reporting and internal control. The financial statements of the Company have been approved by the Board of Directors. P. Bradley Marchant President and CEO John York Chief Financial Officer ANNUAL 20 REPORT 9 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 7 Development costs Cumulative development costs incurred to date are as follows (notes 3 and 4): 2002 $ 2001 $ Laboratory process development Labour costs 734,822 734,822 Laboratory operations 308,636 308,636 Patents 33,546 33,546 Other 56,350 56,350 Investment tax credit (67,287) (67,287) 1,066,067 1,066,067 Pilot plants Labour costs 149,033 149,033 Pilot plant operations 437,495 437,495 Other 66,670 66,670 Amortization of pilot plants 318,483 248,244 971,681 901,442 Marketing - engineering labour and sundry 466,123 154,331 Government grant (62,659) - 403,464 154,331 Caribou Plant Commissioning 248,018 - Amortization of Caribou plant 19,740 - Government grant (121,523) - 146,235 - Interest 7,706 7,706 2,595,153 2,129,546 Development costs to December 31, 2000 were deferred. In 2001, these deferred costs were written off and charged to opening deficit as a change in accounting policy as described in note 4. All development costs incurred in 2002 and 2001 have been charged to the statement of operations. (7) consolidated financial statements consolidated financial statements ANNUAL 10 REPORT 19 BIOTEQ PricewaterhouseCoopers LLP Chartered Accountants 250 Howe Street, Suite 700 Vancouver, British Columbia Canada V6C 3S7 Telephone +1 (604) 806 7000 Facsimile +1 (604) 806 7806 January 31, 2003 Auditors’ Report To the Shareholders of BioteQ Environmental Technologies Inc. We have audited the consolidated balance sheets of BioteQ Environmental Technologies Inc. (a development stage company) as at December 31, 2002 and 2001 and the consolidated statements of operations and deficit and cash flows for the years ended December 31, 2002 and 2001. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2002 and 2001 and the results of its operations and its cash flows for the years ended December 31, 2002 and 2001 in accordance with Canadian generally accepted accounting principles. Chartered Accountants Vancouver, B.C. PricewaterhouseCoopers refers to the Canadian firm of PricewaterhouseCoopers LLP and the other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (6) At December 31, 2002, reasonable assurance existed that the company had complied with the terms and conditions of the IRAP grant. As a result, $49,048 (2001 - $187,004) has been recorded as a government grant receivable and as a reduction in development expenses and $nil (2001 - $187,004) is recorded as a reduction of the cost of property, plant and equipment. 6 Property, plant and equipment 2002 $ 2001 $ Pilot plants 351,193 351,193 Less: Accumulated amortization (311,293) (241,054) 39,900 110,139 Office equipment 41,594 36,599 Less: Accumulated amortization (19,347) (11,973) 22,247 24,626 Water treatment plant - Caribou Mine - net 473,775 490,636 Less: Accumulated amortization (19,740) - 454,035 490,636 516,182 625,401 To date, the company has received $258,537 from third parties and $22,764 in investment tax credits which are offset against the cost of the pilot plants. Government assistance of $204,209 has been offset against the cost of the water treatment plant at the Caribou Mine. Amortization expense for the year ended December 31, 2002 amounted to $97,353 (2001 - $75,021). In 2002, $89,979 (2001 - $70,238) relates to the amortization of the pilot plants and the Caribou Mine water treatment plant and has been included within development expenses on the statement of operations. The recoverability of the company’s pilot plants is dependent on future revenue from current marketing and proposal efforts. Management currently anticipates future cash flows will cover the current carrying value of the assets and no writedown is required. The outcome of the above is currently unknown and there is uncertainty as to the recoverability of the assets. The recoverability of the water treatment plant is dependent upon successful continual operation of the plant and attainment of set performance criteria. consolidated financial statements consolidated financial statements ANNUAL 18 REPORT 11 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Consolidated Balance Sheets As at December 31, 2002 and 2001 pproved by the Board of Directors A ___________________________________ Director ___________________________________ Director 2002 $ 2001 $ Assets Current assets Cash 1,776,457 595,625 Short-term investments (note 15) 27,068 - Government grant receivable (note 5) 49,048 187,004 Other 95,760 78,030 1,948,333 860,659 Property, plant and equipment (note 6) 516,182 625,401 Deferred financing costs 70,596 - 2,535,111 1,486,060 Liabilities Current liabilities Accounts payable and accrued liabilities 266,446 393,530 Liability component of Series A debentures (note 8) 285,302 - 551,748 393,530 Shareholders’ Equity Capital stock, warrants and contributed surplus (note 9) 5,706,063 3,830,324 Equity component of Series A debentures (note 8) 96,128 - Deficit (3,818,828) (2,737,794) 1,983,363 1,092,530 2,535,111 1,486,060 Going concern (note 2) Commitments (note 14) Subsequent event (note 16) BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (5) The Agreement consists of two phases. Under the first phase, the company is required to construct a BioSulphide ProcessTM plant and operate the plant until it is commissioned and achieves certain performance criteria. This plant will be used to treat the acid mine drainage at the Caribou Mine. When the plant meets the specified performance criteria for a period of 60 days, Breakwater will become the operator, responsible for all costs. The company will be entitled to 50% of the cost savings realized by Breakwater, as a result of its use of the BioSulphide ProcessTM plant. As at December 31, 2001, the plant construction was complete and commissioning commenced during 2002. The second phase, which was amended by letter in June 2002, provides for the construction of a larger plant. The second phase includes both the treatment of the acid mine drainage treated in the first phase and treatment of mine tailings deposited by previous operators at the Caribou site. The company will provide for all new capital requirements for the plant expansion. Under the second phase, the company is entitled to 50% of the cost savings realized by Breakwater, 100 % of the Net Smelter Return earned from the sale of concentrate produced by the BioSulphide ProcessTM plant, and a treatment fee of $100,000 per year. As at December 31, 2002, there has been no approval from Breakwater or the company for the implementation of the second phase of the Agreement. Bisbee agreement In October 2002, the company signed an agreement with Phelps Dodge Corporation for the formation of a 50:50 joint venture to construct a BioSulphide ProcessTM plant for copper recovery at the Bisbee property in Arizona, USA, owned by Phelps Dodge Corporation. The agreement also provides for BioteQ to perform detailed construction engineering for the Bisbee project. The study, providing definitive capital and operating costs, sensitivities and project scheduling, is expected to be completed in March 2003. A construction decision is expected by March 2003 at which time the definitive Joint Venture Operating agreement would be established. Costs for the study will be shared equally. As at December 31, 2002, no joint venture was legally formed. Government grant receivable The company has entered into an agreement with National Research Council Canada, Industrial Research Assistance Program (IRAP), to provide funds to assist in developing and operating the BioSulphide ProcessTM plant at the Caribou Mine. The maximum IRAP contribution is the lesser of $427,580 and 33% of the total cost incurred in the performance of the work. Funding for the project is repayable in the form of royalties at 2% of all gross revenues of the company from January 1, 2004. This repayment will be calculated and paid quarterly until January 1, 2010. The maximum repayment will be $641,370. During the year, the company received $339,343 (2001 - $nil) of government assistance. Of this amount, $187,004 has been recorded against the government grant receivable outstanding as at December 31, 2001, $135,134 has been recorded as a reduction to development expenses, and $17,205 has been recorded as a reduction of the cost of property, plant and equipment. consolidated financial statements consolidated financial statements ANNUAL 12 REPORT 17 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Consolidated Statements of Operations and Deficit For the years ended December 31, 2002 and 2001 2002 $ 2001 $ General and administrative expenses Management services 250,663 222,598 Legal and audit 68,119 116,754 Investor relations 41,348 113,367 Rent 46,973 38,846 Travel 41,814 41,970 Office costs and other 26,057 22,917 Directors fees and expenses 53,813 51,104 Insurance 38,508 20,189 Transfer agent and filing fees 17,934 13,334 Amortization 11,344 4,783 596,573 645,862 Development costs (note 7) 465,607 277,072 Scientific research tax credit refund (note 12) - (200,352) Interest expense (income) - net 18,854 (36,518) Loss for the year 1,081,034 686,064 Deficit - Beginning of year As previously reported 2,737,794 199,256 Change in accounting policy (note 4) - 1,852,474 2,737,794 2,051,730 Deficit - End of year 3,818,828 2,737,794 Loss per share - basic and diluted (0.09) (0.07) BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (4) Future income taxes The Company accounts for income taxes using the liability method of tax allocation. Future income taxes are recognized for the future income tax consequences attributable to differences between the carrying values of assets and liabilities and their respective income tax bases. Future income tax assets and liabilities are measured using substantively enacted income tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in rates is included in income in the period that includes the enactment date. Future income tax assets are recorded in the financial statements if realization is considered more likely than not. 4 Changes in accounting policy Development expenses On January 1, 2001, the company adopted the provisions of Accounting Guideline No. 11 (AcG-11), “Enterprises in the Development Stage” of the CICA Handbook. AcG-11 requires that all development stage companies must comply with the CICA Handbook Section 3450 (Section 3450), “Research and Development Costs”. Under Section 3450, companies may only capitalize development costs if they meet the following criteria: the product or process is clearly defined and costs attributable thereto can be defined; the technical feasibility of the process has been established; management of the company has indicated its intention to produce and market the process; the future market has been clearly defined; and adequate resources exist, or are expected to be available, to complete the project. At January 1, 2001, it was determined that adequate resources did not exist in order to support continued deferral of the research and development costs, as required by Section 3450. Accordingly, this change in accounting policy has been applied retroactively with restatement, and therefore the full amount of the deferred development costs recorded at December 31, 2000, $1,852,474, has been charged to opening deficit. 5 Development agreements and government grant receivable Caribou agreement On June 6, 2001, the company entered into a Development Agreement with Breakwater Resources Ltd. (Breakwater), which was replaced by an Agreement dated August 14, 2001 (the Agreement). The Agreement outlines the terms and conditions for installation of commercial BioSulphide ProcessTM plants at Breakwater’s Caribou Mine in New Brunswick. consolidated financial statements consolidated financial statements ANNUAL 16 REPORT 13 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (3) Loss per share In 2001, the company adopted the CICA Handbook Section 3500, “Earnings Per Share”, on a retroactive basis. The new standard requires the presentation of both basic and diluted earnings per share on the face of the income statement. Under the new standard, loss per share is calculated using the weighted average number of shares outstanding during the period, excluding performance based escrow shares, and diluted loss per share is calculated to reflect the dilutive effect of exercising outstanding stock options by application of the treasury stock method. The effect of adopting this new policy for the year ended December 31, 2001 was to increase basic and diluted loss per share by $0.03. For the years ended December 31, 2002 and 2001, the company excluded potential common share equivalents from the loss per share calculation as they were considered anti-dilutive. Stock-based compensation Effective January 1, 2002, the company adopted the new recommendations of the CICA Handbook Section 3870, “Stock-Based Compensation and Other Stock-Based Payments”. The company accounts for all stock-based payments to non-employees granted on or after January 1, 2002 using the fair value based method. Under the fair value based method, stock-based payments to non-employees are measured at the fair value of the equity instruments issued. No compensation cost is recorded for the company stock-based employee compensation awards. Consideration paid by employees on the exercise of stock options is recorded as share capital. The company discloses the proforma effect of accounting for stock options awarded to employees under the fair value based method. Government assistance and investment tax credits Government assistance is recorded when reasonable assurance exists that the company has complied with the terms and conditions of the approved grant program. Government assistance is either recorded as a reduction of the cost of the applicable property, plant and equipment or credited in the statement of operations as determined by the nature of the assistance. Where assistance is contingently repayable, the repayment of these funds is treated as either an increase in the cost of the asset or as a royalty expense, in the year that it is incurred, as determined by the original accounting treatment of the assistance. Investment tax credits are accounted for using the cost reduction approach. Investment tax credits arising from research and development are deducted from the related costs in the period during which the expenditures are incurred provided there is reasonable assurance of realization. Investment tax credits arising from the acquisition of property, plant and equipment are deducted from the cost of those assets with amortization calculated on the net amount. BioteQ Environmental Technologies Inc. (a development stage company) Consolidated Statements of Cash Flows For the years ended December 31, 2002 and 2001 2002 $ 2001 $ Cash flows from operating activities Loss for the year (1,081,034) (686,064) Items not affecting cash Amortization of property, plant and equipment 97,353 75,021 Amortization of deferred financing costs 3,970 - Accretion of Series A debentures 8,193 - Stock-based compensation 39,516 18,000 Change in non-cash working capital items 4,917 109,634 (927,085) (483,409) Cash flows from financing activities Issuance of common shares and warrants for cash 2,030,000 - Issuance of common shares for cash - 845,000 Share issuance costs (232,620) (206,790) Issuance of Series A debentures 400,000 - Series A debentures issuance costs (86,329) - Issuance of special warrants for cash - 550,000 Special warrants issuance costs - (31,656) Financing costs (15,000) - 2,096,051 1,156,554 Cash flows from investing activities Purchase of property, plant and equipment (5,339) (702,998) Cash receipts from third parties credited to property, plant and equipment 17,205 7,094 11,866 (695,904) Increase (decrease) in cash 1,180,832 (22,759) Cash - Beginning of year 595,625 618,384 Cash - End of year 1,776,457 595,625 Supplemental cash flow information Interest paid 14,855 6,518 Non-cash financing and investing activities Share capital issued in exchange for settlement of accounts payable 38,843 - Government assistance receivable credited to property, plant and equipment 17,205 187,004 Units issued in settlement of issue costs (note 9) 101,500 - Warrants issued in settlement of issue costs (note 9) 47,892 - consolidated financial statements consolidated financial statements ANNUAL 14 REPORT 15 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (1) 1 Company operations BioteQ Environmental Technologies Inc. (BioteQ) is a company in the development stage. Biomet Mining Corporation (Biomet), BioteQ’s wholly owned subsidiary, acquired a patent from related parties in 1997 for a process to treat metal-laden, sulphate-rich waste water streams for acid neutralization and metal recovery. The result, the BioSulphide Process™ (the Process), has been developed to the stage of building the first commercial scale plant which was operational in 2002. The company is now concentrating on marketing the Process. The principal operations of the company will be to establish process plants and earn revenues from recovered metals, fees and process licenses. 2 Going concern The company may require further capital to finalize the commercialization and marketing of the Process. These consolidated financial statements have been prepared on a going concern basis, which assumes that the company will be able to meet its commitments, continue its operations and realize its assets and discharge its liabilities in the normal course of business. These financial statements do not reflect adjustments to carrying values of assets and liabilities that may be necessary should the company be unable to achieve sufficient cash flows to continue as a going concern. Such adjustments could be material. The company’s ability to carry on as a going concern is dependent upon its ability to achieve cash flows and arrange additional financing to establish process plants and maintain general operations. The company has raised working capital through the sale of equity and issuance of debt but may require additional project financing to establish process plants. However, there is no assurance that this financing will be available to the company; accordingly, there is doubt about the company’s ability to continue as a going concern. 3 Significant accounting policies Generally accepted accounting principles These consolidated financial statements are prepared in accordance with generally accepted accounting principles in Canada. Principles of consolidation The consolidated financial statements include the accounts of BioteQ and its wholly owned operating subsidiary, Biomet. All material intercompany transactions and balances have been eliminated. BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (2) Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting year. Actual results could differ from those estimates. Cash Cash consists of cash on deposit and term deposits with maturities at the date of acquisition of three months or less. Short-term investments Short-term investments are recorded at the lower of cost or net realizable value. Property, plant and equipment Expenditures on property, plant and equipment are stated at cost, net of grants and contractual amounts received under feasibility studies. Amortization has been provided for in the financial statements using the following rates and methods: Office equipment 5 years straight-line Pilot plants 5 years straight-line Water treatment plant - Caribou Mine 20 years straight-line Costs relating to property, plant and equipment in the course of construction will be capitalized. Upon commissioning, these costs will be amortized over the useful life of the asset. Deferred development costs The company continues to develop the Process. The majority of costs incurred since inception by the company have been associated with its development. As a result, prior to January 1, 2001, all expenses incurred by the company were deferred with the exception of legal, audit, and other administrative expenses that are not attributable to the development of the Process. All amounts received from third parties in connection with testing during the development stage were netted against development costs. Beginning January 1, 2001, in accordance with Section 3450, “Research and Development Costs,” of the Canadian Institute of Chartered Accountants (CICA) Handbook, the company expenses all costs associated with research and development activities in the statement of operations in the period in which they are incurred, unless the criteria for deferral of development costs have been met. consolidated financial statements consolidated financial statements ANNUAL 14 REPORT 15 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (1) 1 Company operations BioteQ Environmental Technologies Inc. (BioteQ) is a company in the development stage. Biomet Mining Corporation (Biomet), BioteQ’s wholly owned subsidiary, acquired a patent from related parties in 1997 for a process to treat metal-laden, sulphate-rich waste water streams for acid neutralization and metal recovery. The result, the BioSulphide Process™ (the Process), has been developed to the stage of building the first commercial scale plant which was operational in 2002. The company is now concentrating on marketing the Process. The principal operations of the company will be to establish process plants and earn revenues from recovered metals, fees and process licenses. 2 Going concern The company may require further capital to finalize the commercialization and marketing of the Process. These consolidated financial statements have been prepared on a going concern basis, which assumes that the company will be able to meet its commitments, continue its operations and realize its assets and discharge its liabilities in the normal course of business. These financial statements do not reflect adjustments to carrying values of assets and liabilities that may be necessary should the company be unable to achieve sufficient cash flows to continue as a going concern. Such adjustments could be material. The company’s ability to carry on as a going concern is dependent upon its ability to achieve cash flows and arrange additional financing to establish process plants and maintain general operations. The company has raised working capital through the sale of equity and issuance of debt but may require additional project financing to establish process plants. However, there is no assurance that this financing will be available to the company; accordingly, there is doubt about the company’s ability to continue as a going concern. 3 Significant accounting policies Generally accepted accounting principles These consolidated financial statements are prepared in accordance with generally accepted accounting principles in Canada. Principles of consolidation The consolidated financial statements include the accounts of BioteQ and its wholly owned operating subsidiary, Biomet. All material intercompany transactions and balances have been eliminated. BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (2) Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting year. Actual results could differ from those estimates. Cash Cash consists of cash on deposit and term deposits with maturities at the date of acquisition of three months or less. Short-term investments Short-term investments are recorded at the lower of cost or net realizable value. Property, plant and equipment Expenditures on property, plant and equipment are stated at cost, net of grants and contractual amounts received under feasibility studies. Amortization has been provided for in the financial statements using the following rates and methods: Office equipment 5 years straight-line Pilot plants 5 years straight-line Water treatment plant - Caribou Mine 20 years straight-line Costs relating to property, plant and equipment in the course of construction will be capitalized. Upon commissioning, these costs will be amortized over the useful life of the asset. Deferred development costs The company continues to develop the Process. The majority of costs incurred since inception by the company have been associated with its development. As a result, prior to January 1, 2001, all expenses incurred by the company were deferred with the exception of legal, audit, and other administrative expenses that are not attributable to the development of the Process. All amounts received from third parties in connection with testing during the development stage were netted against development costs. Beginning January 1, 2001, in accordance with Section 3450, “Research and Development Costs,” of the Canadian Institute of Chartered Accountants (CICA) Handbook, the company expenses all costs associated with research and development activities in the statement of operations in the period in which they are incurred, unless the criteria for deferral of development costs have been met. consolidated financial statements consolidated financial statements ANNUAL 16 REPORT 13 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (3) Loss per share In 2001, the company adopted the CICA Handbook Section 3500, “Earnings Per Share”, on a retroactive basis. The new standard requires the presentation of both basic and diluted earnings per share on the face of the income statement. Under the new standard, loss per share is calculated using the weighted average number of shares outstanding during the period, excluding performance based escrow shares, and diluted loss per share is calculated to reflect the dilutive effect of exercising outstanding stock options by application of the treasury stock method. The effect of adopting this new policy for the year ended December 31, 2001 was to increase basic and diluted loss per share by $0.03. For the years ended December 31, 2002 and 2001, the company excluded potential common share equivalents from the loss per share calculation as they were considered anti-dilutive. Stock-based compensation Effective January 1, 2002, the company adopted the new recommendations of the CICA Handbook Section 3870, “Stock-Based Compensation and Other Stock-Based Payments”. The company accounts for all stock-based payments to non-employees granted on or after January 1, 2002 using the fair value based method. Under the fair value based method, stock-based payments to non-employees are measured at the fair value of the equity instruments issued. No compensation cost is recorded for the company stock-based employee compensation awards. Consideration paid by employees on the exercise of stock options is recorded as share capital. The company discloses the proforma effect of accounting for stock options awarded to employees under the fair value based method. Government assistance and investment tax credits Government assistance is recorded when reasonable assurance exists that the company has complied with the terms and conditions of the approved grant program. Government assistance is either recorded as a reduction of the cost of the applicable property, plant and equipment or credited in the statement of operations as determined by the nature of the assistance. Where assistance is contingently repayable, the repayment of these funds is treated as either an increase in the cost of the asset or as a royalty expense, in the year that it is incurred, as determined by the original accounting treatment of the assistance. Investment tax credits are accounted for using the cost reduction approach. Investment tax credits arising from research and development are deducted from the related costs in the period during which the expenditures are incurred provided there is reasonable assurance of realization. Investment tax credits arising from the acquisition of property, plant and equipment are deducted from the cost of those assets with amortization calculated on the net amount. BioteQ Environmental Technologies Inc. (a development stage company) Consolidated Statements of Cash Flows For the years ended December 31, 2002 and 2001 2002 $ 2001 $ Cash flows from operating activities Loss for the year (1,081,034) (686,064) Items not affecting cash Amortization of property, plant and equipment 97,353 75,021 Amortization of deferred financing costs 3,970 - Accretion of Series A debentures 8,193 - Stock-based compensation 39,516 18,000 Change in non-cash working capital items 4,917 109,634 (927,085) (483,409) Cash flows from financing activities Issuance of common shares and warrants for cash 2,030,000 - Issuance of common shares for cash - 845,000 Share issuance costs (232,620) (206,790) Issuance of Series A debentures 400,000 - Series A debentures issuance costs (86,329) - Issuance of special warrants for cash - 550,000 Special warrants issuance costs - (31,656) Financing costs (15,000) - 2,096,051 1,156,554 Cash flows from investing activities Purchase of property, plant and equipment (5,339) (702,998) Cash receipts from third parties credited to property, plant and equipment 17,205 7,094 11,866 (695,904) Increase (decrease) in cash 1,180,832 (22,759) Cash - Beginning of year 595,625 618,384 Cash - End of year 1,776,457 595,625 Supplemental cash flow information Interest paid 14,855 6,518 Non-cash financing and investing activities Share capital issued in exchange for settlement of accounts payable 38,843 - Government assistance receivable credited to property, plant and equipment 17,205 187,004 Units issued in settlement of issue costs (note 9) 101,500 - Warrants issued in settlement of issue costs (note 9) 47,892 - consolidated financial statements consolidated financial statements ANNUAL 12 REPORT 17 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Consolidated Statements of Operations and Deficit For the years ended December 31, 2002 and 2001 2002 $ 2001 $ General and administrative expenses Management services 250,663 222,598 Legal and audit 68,119 116,754 Investor relations 41,348 113,367 Rent 46,973 38,846 Travel 41,814 41,970 Office costs and other 26,057 22,917 Directors fees and expenses 53,813 51,104 Insurance 38,508 20,189 Transfer agent and filing fees 17,934 13,334 Amortization 11,344 4,783 596,573 645,862 Development costs (note 7) 465,607 277,072 Scientific research tax credit refund (note 12) - (200,352) Interest expense (income) - net 18,854 (36,518) Loss for the year 1,081,034 686,064 Deficit - Beginning of year As previously reported 2,737,794 199,256 Change in accounting policy (note 4) - 1,852,474 2,737,794 2,051,730 Deficit - End of year 3,818,828 2,737,794 Loss per share - basic and diluted (0.09) (0.07) BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (4) Future income taxes The Company accounts for income taxes using the liability method of tax allocation. Future income taxes are recognized for the future income tax consequences attributable to differences between the carrying values of assets and liabilities and their respective income tax bases. Future income tax assets and liabilities are measured using substantively enacted income tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in rates is included in income in the period that includes the enactment date. Future income tax assets are recorded in the financial statements if realization is considered more likely than not. 4 Changes in accounting policy Development expenses On January 1, 2001, the company adopted the provisions of Accounting Guideline No. 11 (AcG-11), “Enterprises in the Development Stage” of the CICA Handbook. AcG-11 requires that all development stage companies must comply with the CICA Handbook Section 3450 (Section 3450), “Research and Development Costs”. Under Section 3450, companies may only capitalize development costs if they meet the following criteria: the product or process is clearly defined and costs attributable thereto can be defined; the technical feasibility of the process has been established; management of the company has indicated its intention to produce and market the process; the future market has been clearly defined; and adequate resources exist, or are expected to be available, to complete the project. At January 1, 2001, it was determined that adequate resources did not exist in order to support continued deferral of the research and development costs, as required by Section 3450. Accordingly, this change in accounting policy has been applied retroactively with restatement, and therefore the full amount of the deferred development costs recorded at December 31, 2000, $1,852,474, has been charged to opening deficit. 5 Development agreements and government grant receivable Caribou agreement On June 6, 2001, the company entered into a Development Agreement with Breakwater Resources Ltd. (Breakwater), which was replaced by an Agreement dated August 14, 2001 (the Agreement). The Agreement outlines the terms and conditions for installation of commercial BioSulphide ProcessTM plants at Breakwater’s Caribou Mine in New Brunswick. consolidated financial statements consolidated financial statements ANNUAL 18 REPORT 11 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Consolidated Balance Sheets As at December 31, 2002 and 2001 pproved by the Board of Directors A ___________________________________ Director ___________________________________ Director 2002 $ 2001 $ Assets Current assets Cash 1,776,457 595,625 Short-term investments (note 15) 27,068 - Government grant receivable (note 5) 49,048 187,004 Other 95,760 78,030 1,948,333 860,659 Property, plant and equipment (note 6) 516,182 625,401 Deferred financing costs 70,596 - 2,535,111 1,486,060 Liabilities Current liabilities Accounts payable and accrued liabilities 266,446 393,530 Liability component of Series A debentures (note 8) 285,302 - 551,748 393,530 Shareholders’ Equity Capital stock, warrants and contributed surplus (note 9) 5,706,063 3,830,324 Equity component of Series A debentures (note 8) 96,128 - Deficit (3,818,828) (2,737,794) 1,983,363 1,092,530 2,535,111 1,486,060 Going concern (note 2) Commitments (note 14) Subsequent event (note 16) BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (5) The Agreement consists of two phases. Under the first phase, the company is required to construct a BioSulphide ProcessTM plant and operate the plant until it is commissioned and achieves certain performance criteria. This plant will be used to treat the acid mine drainage at the Caribou Mine. When the plant meets the specified performance criteria for a period of 60 days, Breakwater will become the operator, responsible for all costs. The company will be entitled to 50% of the cost savings realized by Breakwater, as a result of its use of the BioSulphide ProcessTM plant. As at December 31, 2001, the plant construction was complete and commissioning commenced during 2002. The second phase, which was amended by letter in June 2002, provides for the construction of a larger plant. The second phase includes both the treatment of the acid mine drainage treated in the first phase and treatment of mine tailings deposited by previous operators at the Caribou site. The company will provide for all new capital requirements for the plant expansion. Under the second phase, the company is entitled to 50% of the cost savings realized by Breakwater, 100 % of the Net Smelter Return earned from the sale of concentrate produced by the BioSulphide ProcessTM plant, and a treatment fee of $100,000 per year. As at December 31, 2002, there has been no approval from Breakwater or the company for the implementation of the second phase of the Agreement. Bisbee agreement In October 2002, the company signed an agreement with Phelps Dodge Corporation for the formation of a 50:50 joint venture to construct a BioSulphide ProcessTM plant for copper recovery at the Bisbee property in Arizona, USA, owned by Phelps Dodge Corporation. The agreement also provides for BioteQ to perform detailed construction engineering for the Bisbee project. The study, providing definitive capital and operating costs, sensitivities and project scheduling, is expected to be completed in March 2003. A construction decision is expected by March 2003 at which time the definitive Joint Venture Operating agreement would be established. Costs for the study will be shared equally. As at December 31, 2002, no joint venture was legally formed. Government grant receivable The company has entered into an agreement with National Research Council Canada, Industrial Research Assistance Program (IRAP), to provide funds to assist in developing and operating the BioSulphide ProcessTM plant at the Caribou Mine. The maximum IRAP contribution is the lesser of $427,580 and 33% of the total cost incurred in the performance of the work. Funding for the project is repayable in the form of royalties at 2% of all gross revenues of the company from January 1, 2004. This repayment will be calculated and paid quarterly until January 1, 2010. The maximum repayment will be $641,370. During the year, the company received $339,343 (2001 - $nil) of government assistance. Of this amount, $187,004 has been recorded against the government grant receivable outstanding as at December 31, 2001, $135,134 has been recorded as a reduction to development expenses, and $17,205 has been recorded as a reduction of the cost of property, plant and equipment. consolidated financial statements consolidated financial statements ANNUAL 10 REPORT 19 BIOTEQ PricewaterhouseCoopers LLP Chartered Accountants 250 Howe Street, Suite 700 Vancouver, British Columbia Canada V6C 3S7 Telephone +1 (604) 806 7000 Facsimile +1 (604) 806 7806 January 31, 2003 Auditors’ Report To the Shareholders of BioteQ Environmental Technologies Inc. We have audited the consolidated balance sheets of BioteQ Environmental Technologies Inc. (a development stage company) as at December 31, 2002 and 2001 and the consolidated statements of operations and deficit and cash flows for the years ended December 31, 2002 and 2001. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2002 and 2001 and the results of its operations and its cash flows for the years ended December 31, 2002 and 2001 in accordance with Canadian generally accepted accounting principles. Chartered Accountants Vancouver, B.C. PricewaterhouseCoopers refers to the Canadian firm of PricewaterhouseCoopers LLP and the other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (6) At December 31, 2002, reasonable assurance existed that the company had complied with the terms and conditions of the IRAP grant. As a result, $49,048 (2001 - $187,004) has been recorded as a government grant receivable and as a reduction in development expenses and $nil (2001 - $187,004) is recorded as a reduction of the cost of property, plant and equipment. 6 Property, plant and equipment 2002 $ 2001 $ Pilot plants 351,193 351,193 Less: Accumulated amortization (311,293) (241,054) 39,900 110,139 Office equipment 41,594 36,599 Less: Accumulated amortization (19,347) (11,973) 22,247 24,626 Water treatment plant - Caribou Mine - net 473,775 490,636 Less: Accumulated amortization (19,740) - 454,035 490,636 516,182 625,401 To date, the company has received $258,537 from third parties and $22,764 in investment tax credits which are offset against the cost of the pilot plants. Government assistance of $204,209 has been offset against the cost of the water treatment plant at the Caribou Mine. Amortization expense for the year ended December 31, 2002 amounted to $97,353 (2001 - $75,021). In 2002, $89,979 (2001 - $70,238) relates to the amortization of the pilot plants and the Caribou Mine water treatment plant and has been included within development expenses on the statement of operations. The recoverability of the company’s pilot plants is dependent on future revenue from current marketing and proposal efforts. Management currently anticipates future cash flows will cover the current carrying value of the assets and no writedown is required. The outcome of the above is currently unknown and there is uncertainty as to the recoverability of the assets. The recoverability of the water treatment plant is dependent upon successful continual operation of the plant and attainment of set performance criteria. consolidated financial statements management discussion and analysis Any new commercial application of the BioSulphide Process™ will have certain construction and other risks associated with building and operating a new plant. Revenue will fluctuate with the price of the commodities being reco, vered and the exchange rate for the United States dollar. Operating costs will be largely dependent on the cost of consumables and power, which may fluctuate. The Company will be selecting projects which demonstrate good profit margins which should allow for the adverse effect of price changes. Risks and Uncertainties The economics of some projects under review by the Company are based largely on estimates of metals to be recovered. Although there is often a significant amount of data upon which estimates can be based, there can never be absolute certainty as to the continuity of flow of water to be treated, nor the concentrations of metals contained therein. The year 2003 will be significant for the Company. It expects to start building projects with good profitability and cash flow. The Company has enough working capital to last well into 2004 and expects to be able to project finance a significant portion of new plants. The Com- pany appears well placed to start the operating phase of its development. Outlook management’s responsibility for financial reporting The management of BioteQ Environmental Technologies Inc. is responsible for the prepara- tion of the consolidated financial statements as well as the financial and other information contained in the annual report. Management maintains an internal control system to provide reasonable assurance as to the reliability of financial information and the safeguarding of assets. The consolidated financial statements are prepared in accordance with generally accepted accounting principals in Canada and necessarily include amounts determined in accordance with estimates and judgments made by management. The external auditors, PriceWaterhouseC- oopers, Chartered Accountants, express their opinion on the consolidated financial statements in the annual report. The Board of Directors, through the Audit Committee, is responsible for ensuring that man- agement fulfils its responsibilities for financial reporting and internal control. The financial statements of the Company have been approved by the Board of Directors. P. Bradley Marchant President and CEO John York Chief Financial Officer ANNUAL 20 REPORT 9 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 7 Development costs Cumulative development costs incurred to date are as follows (notes 3 and 4): 2002 $ 2001 $ Laboratory process development Labour costs 734,822 734,822 Laboratory operations 308,636 308,636 Patents 33,546 33,546 Other 56,350 56,350 Investment tax credit (67,287) (67,287) 1,066,067 1,066,067 Pilot plants Labour costs 149,033 149,033 Pilot plant operations 437,495 437,495 Other 66,670 66,670 Amortization of pilot plants 318,483 248,244 971,681 901,442 Marketing - engineering labour and sundry 466,123 154,331 Government grant (62,659) - 403,464 154,331 Caribou Plant Commissioning 248,018 - Amortization of Caribou plant 19,740 - Government grant (121,523) - 146,235 - Interest 7,706 7,706 2,595,153 2,129,546 Development costs to December 31, 2000 were deferred. In 2001, these deferred costs were written off and charged to opening deficit as a change in accounting policy as described in note 4. All development costs incurred in 2002 and 2001 have been charged to the statement of operations. (7) management discussion and analysis consolidated financial statements of start-up, operating and testing at the Caribou plant and an increased effort and expense of marketing the Process, amounting to $95,000. Other development costs were lower by $53,000. During 2001 the Company received Scientific Research tax credit refunds of $207,446 relating to a prior year. The refunds were credited to the statement of operations for $200,352 and $7,094 was credited to Property, Plant and Equipment. No related refunds were received in 2002 and no further refunds are available to the Company in the future. Caribou Operations Since plant start-up in late 2001, the water chemistry of the plant feed provided by Breakwater Resources Ltd (“Breakwater”) has not matched the plant design criteria. The actual metal load- ings of zinc and iron in the feed water have far exceeded the anticipated levels provided during the plant design phase. Consequently, at times, the plant could not meet the original water flow performance criteria. As a result, the removal of zinc was often incomplete and/or plant feed flow was less than the original design specifications, although copper removal was consistently greater than 99.5%. Despite this, the plant has exceeded expectations on a steady state basis in other operating criteria, such as the rate of sulphide generation per unit volume of mine drain- age, and adaptability of plant controls to wide fluctuations in feed composition. The opera- tion has enabled the Company to enhance the bioreactor vessel design supplied by Paques to increase sulphur reduction capacity at Caribou and for all future designs and installations. Furthermore, despite the bioreactor capacity limitation, the Caribou plant performed well for a consistent period, provided excellent metal removal from the treated water at steady state, delivered 35 tonnes of concentrate offsite for processing and had minimal downtime with an overall operating availability of 95% during steady state operations. The site owner has shut water delivery down for the winter in order to flood the underground mine as part of closure procedures. 2003 Operations General and administrative expenses during 2003 are expected to be somewhat more than 2002, due largely to a need for administrative support during this growing stage, the increased cost of insurance and to a new contract with an investor relations company. Development costs should be significantly less in 2003 due to a later reopening at Caribou after the winter shutdown and the possibility of the project progressing to the expansion phase. In addition, lower marketing costs are expected as the project pipeline matures. The Company is anticipating it will be completing construction of two new commercial plants before the end of the year, at least one of which is expected to be producing revenue and cash flow in the last quarter. During 2002, the Company raised $313,671, net of expenses, from an issue of convertible debentures. Late in the year, a further $1,797,380 (net of cash issue costs) was raised from a private placement of units priced at $0.50 (the units comprised one common share and one warrant to buy an additional share). The Company also received $152,340 from government grants in support of demonstrating the company’s innovative environmental technology at the Caribou plant. A further $49,048 is a receivable at year-end. At December 31, 2002 the Com- pany had cash of $1,776,457 and working capital of $1,681,867. The Company is expecting to finalize completion of a commercial agreement to build a second plant for application of the BioSulphide Process™ in the very near future. The Company has already investigated the opportunities for project financing, which it intends to utilize for upcoming projects. The Company believes it has adequate working capital to carry it into 2004 when it expects cash flow from operations will have commenced. Liquidity and Capital Resources ANNUAL 8 REPORT 21 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 The company has had the following cumulative transactions since inception with related parties: 2002 $ 2001 $ Included in cumulative development costs: Intangible assets purchased from shareholders 20 20 Interest charged by a shareholder 4,284 4,284 Provision of engineering services by shareholders 265,383 265,383 Laboratory expenses incurred by shareholders 68,356 68,356 The amounts paid for the services are based on their exchange amount. 8 Series A debentures On September 5, 2002, the company completed a private placement of unsecured Series A debentures (debentures) of $400,000 to fund working capital and plant construction. After deducting issue costs of $86,329, the proceeds of the issue amounted to $313,671. Each debenture matures on October 31, 2007 and bears interest at the rate of 10% per annum, payable semi-annually. The principal is convertible at the option of the holder into common shares of BioteQ at $0.65 per common share. Under the terms of the Trust Indenture, the conversion price is adjusted if the company declares and pays a stock dividend, subdivides its outstanding common shares into a greater number of common shares, or consolidates its outstanding common shares into a lesser number of common shares. The conversion price will also be adjusted when the company fixes a record date for dividend distribution or the issuance of equity instruments with exercise prices less than the fair value at the grant date. After two years from the issuance date, the company may redeem the debentures if the common shares have traded for 30 consecutive days at 200% of the conversion price. The debentures are being accounted for in accordance with their substance and are presented in the financial statements in their component parts, measured at their respective fair values at the time of issue. The liability component has been calculated as the present value of the required interest payments discounted at a rate approximating the interest rate that would have been applicable to non-convertible debt at the time the debentures were issued. $ Issue price 400,000 Less: Liability component (277,109) Shareholders’ equity component 122,891 Less: Issue costs applicable to shareholders’ equity component (26,763) Net amount classified as shareholders’ equity at issuance 96,128 Interest on the liability component is $21,124, of which $8,193 represents accretion of the liability component. (8) consolidated financial statements projects Sudbury. Oxidation of residual sulphide minerals in open pits and waste rock piles, as well as contact of mine water with exposed metal bearing minerals in the underground operations, results in the contamination of drainage at the site. The water has a neutral pH but contains elevated acidity levels in the form of dissolved nickel and must be treated before it is discharged to local receiving waters. Currently the water is stored in a collection basin, is treated for approximately 4 months of the year in a low-density sludge lime treatment plant. Raglan, Québec, Canada (continued) Following successful piloting at site during 2002, BioteQ is now working under contract with SMRQ on the first phase of engineering to evaluate the replacement of the existing lime plant with the Bioteq technology. The Company is evaluating over 30 potential commercial projects for water treatment and metal recovery in Canada, USA, Europe, Australasia and South America. These projects are in various stages of development from initial scoping and due diligence to advanced engineering. Project Pipeline management discussion and analysis The following discussion and analysis should be read in conjunction with the audited consoli- dated financial statements of the Corporation for the year ended December 31, 2002. BioteQ is a Canadian industrial process technology company that has developed the patented BioSulphide Process™ for water treatment and sulphide reagent production. The process allows the treatment of acid contaminated water with concurrent recovery of saleable metals from the water. Description of Business BioteQ has completed construction and commissioning of a commercial scale plant at the Caribou Mine in New Brunswick for selective copper and zinc recovery and is continuing to market its Process at a number of other sites in North America and elsewhere. During 2001 and 2002, the Company has continued the development of the Process. In late 2001 the company built its first commercial scale plant which operated through most of 2002 and provided an essential demonstration of the Company and the Process’s capability. In 2002, there has been significant effort to market the Process at a large number of sites in North America and abroad, with the result that the Company has a potential project list of over 30 sites which could benefit from the Company’s technology. These projects range from early stage enquiries with initial scoping and due diligence, to two advanced stage projects where either preliminary or detailed engineering has been finalized and the decision to construct plants is imminent. Because the Company is dealing in the majority of cases with large organiza- tions and endeavouring to sign contracts for the long-term operation of plants at their sites, the process of reaching a definitive decision has been slower than expected, however the process demonstration at the Caribou plant has proved an invaluable tool in 2002 and the building of additional plants would eliminate any lasting concerns of the Company’s capability. The operating loss for the year was $1,081,034 compared to $684,064 for 2001. The major rea- sons for the increase were as follows. General and Administrative costs for 2002 were $596,573 compared to $645,862 for 2001. The reduction was due to lower legal and investor relations costs by $120,000, offset by slightly higher costs in all other categories while the company was progressing from public company start-up in December 2000. Development expenses amounted to $465,607 (net of government grants of $184,182), compared to $277,072 in 2001 (no government grants were received in 2001). The increase was due to $147,000 for the cost Operating Results 7 BIOTEQ ANNUAL 22 REPORT BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 9 Capital stock, warrants and contributed surplus Authorized 100,000,000 common shares without par value Issued and outstanding Common stock Warrants Contributed surplus Number of shares Amount $ Amount $ Amount $ Total $ Balance - December 31, 2000 15,905,884 2,655,770 - - 2,655,770 Shares issued for cash Stock options 300,000 60,000 - - 60,000 Underwriters oversubscription option 270,000 135,000 - - 135,000 Public offering (a) 1,300,000 650,000 - - 650,000 Shares issued on exercise of special warrants (b) 1,100,000 550,000 - - 550,000 Share issuance costs - (238,446) - - (238,446)Issuance of stock options for services rendered - - - 18,000 18,000 Balance - December 31, 2001 18,875,884 3,812,324 - 18,000 3,830,324 Shares issued for accounts payable 77,686 38,843 - - 38,843 Private placement for cash (c) 4,060,000 1,642,501 387,499 - 2,030,000 Share issuance costs (c) - (278,476) (103,536) - (382,012)Units issued in settlement of issue costs (c) 203,000 77,554 23,946 - 101,500 Warrants issued in settlement of issue costs (c) - - 47,892 - 47,892 Issuance of stock options and warrants for services rendered - - - 39,516 39,516 Balance - December 31, 2002 23,216,570 5,292,746 355,801 57,516 5,706,063 (9) projects consolidated financial statements Caribou, New Brunswick, Canada (continued) During its operation in 2002, the Stage 1 plant recovered nearly 35 tonnes of zinc concentrate, which also contains copper, cadmium and lead. The concentrate was delivered and accepted for sale to the nearby Brunswick Mine under contract with Noranda. Concentrate production was suspended at the end of October due to the planned shut-down of minewater collection and treatment during the winter at Caribou in order to flood the underground mine. This is a one- time change in operating practice that will result in simplified collection of the minewater for delivery to the treatment plant and overall cost savings for minewater treatment in the longer term. Breakwater’s water treatment operations will resume once flooding of the underground mine is complete from spring run-off this year. Of long term environmental significance, the toxic metal content of sludge from the down- stream lime plant was significantly reduced. At typical feed water concentrations, more than 150 tonnes per year of combined zinc, copper, cadmium and lead would be delivered off-site for sale rather than be discharged into the environment with the lime plant sludge. Treated water has been discharged to local receiving waters within the guidelines of existing permits. Based on the recent operating results detailed engineering for final budget purposes and other due diligence for the expansion of the Caribou plant can be completed over the winter. The expansion plant will include re-processing of tailings at Caribou, left by previous operators, concurrently with acidic mine drainage. Bisbee, Arizona, U.S. In January 2002, BioteQ signed a letter of intent with Phelps Dodge Miami Inc. to form a joint venture with Phelps in connection with the construction and operation of a BioSulphide- Thiopaq plant for selective recovery of copper from acidic ground water prior to treatment of the water in an existing lime plant. The Miami LOI with Phelps has been superseded by an agreement signed to evaluate application of the technology at Phelps’ Bisbee property in southern Arizona. The BioteQ plant at Bisbee would selectively recover copper from circulating water from exist- ing stockpiles. This plant would be similar to the plant already operational at the Caribou Mine in New Brunswick where copper recovery has been over 99% since startup. The initial capacity of a plant at Bisbee would be designed for approximately 3 million pounds per year copper recovered. It is anticipated that the copper recovered at Bisbee will be sent to the Miami smelter, operated by Phelps Dodge, for further refining under commercially com- petitive terms. Construction of a BioteQ plant would take approximately 6 months following detailed engineering. The application of BioteQ’s technology at Bisbee could provide immedi- ate economic benefit from copper recovery and several long term potential economic and envi- ronmental benefits. An agreement was signed with Phelps Dodge in 2002 to initiate detailed engineering for the project, the costs for which are shared on a 50/50 joint basis. The detailed engineering has been completed in 2003 and a definitive joint venture operating agreement is being prepared while final approvals are being sought to move ahead with construction. Raglan, Québec, Canada BioteQ is evaluating application of the BioSulphide-Thiopaq technology for water treatment at the Raglan mine owned by Societe Miniere Raglan du Québec Ltee (SMRQ), a subsidiary of Falconbridge Limited. The mine, located on the Ungava Peninsula in northern Québec, extracts nickel ore, which is processed at site and shipped as a nickel sulphide concentrate to ANNUAL 6 REPORT 23 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 a) In December 2001, the company completed a public offering of 1,300,000 commons at $0.50 per share. The prospectus document also qualified the issuance of 1,100,000 common shares upon the exercise of 1,100,000 previously issued special warrants at $0.50 per share (the Offering). Gross proceeds from the Offering were $650,000 with issue costs of $206,446 relating to agent’s commissions and other expenses of the Offering. b) On June 18, 2001, the company completed a private placement of 1,100,000 special warrants at a price of $0.50 for gross proceeds of $550,000, with issue costs of approximately $32,000. The special warrants entitle the holder, upon exercise, to obtain common shares of the company, without payment of any further consideration. On November 27, 2001, the special warrants were exercised and 1,100,000 common shares of the company were issued. c) On December 20, 2002, the company completed a private placement of 4,060,000 units at a price of $0.50 for gross proceeds of $2,030,000. Issue costs amounted to $382,012, of which $101,500 were settled with the issue of 203,000 units and $47,892 were settled with the issue of 406,000 warrants. Each unit comprised one common share and one non-transferable common share purchase warrant. Each warrant entitles the holder to acquire one additional common share for a period of two years from the issue date at a price of $0.65 in the first year and $0.75 in the second year. Of the gross proceeds, $1,642,501 was attributable to the common shares and $387,499 was attributable to the non-transferable common share purchase warrants. d) Stock options The company has a stock option plan available to directors, employees and consultants. Under the plan, 3,790,714 shares are available for issue. Options vest at the minimum rate of 33% every six months from award and have a maximum term of five years from the date of the grant. A summary of the change in the company’s stock option plan for the year is as follows: 2002 2001 Number of options Weighted average exercise price $ Number of options Weighted average exercise price $ Outstanding - January 1 2,150,000 0.63 200,000 0.20 Options granted 750,000 0.54 2,150,000 0.63 Options exercised - - (200,000) 0.20 Options cancelled (300,000) 0.58 - - Outstanding - December 31 2,600,000 0.61 2,150,000 0.63 Exercisable at December 31 2,000,000 0.63 716,666 0.63 Available for future grant pursuant to company’s stock option plan at December 31 1,190,714 831,176 (10) consolidated financial statements other technology initiatives cells and included recommendations for potentially competitive commercial markets. In 2002 the Company continued its evaluation of the commercial potential of the POS in conjunction with high temperature hydrogen fuel cells to a greater depth by entering into a contract with Fuel Cell Intelligence, Ltd., for an independent analysis of the potential. This study will provide the company with the technical and market direction for commercial feasibility analysis of the POS burner. Partial Oxidation Burner for Hydrogen Production (continued) In 2001, BioteQ acquired ownership of the GypCIX process, a low cost ion-exchange technol- ogy for the removal of sulphate, calcium, magnesium and other ions from water. Products of the process are reusable/dischargeable water and solid gypsum that might also have value, depending on local market potential. GypCIX has the potential of being the most cost-effective alternative for sulphate removal, utilizing lower cost lime and sulphuric acid for resin regeneration. The Company continues to seek applications although demand for sulphate reduction in North America is predicted to remain low until regulatory pressure is increased to limit sulphate concentrations in effluents discharged to the environment to a higher degree as experienced in Europe and elsewhere. The GypCIX Process - for Sulphate Removal and Desalination projects Caribou is a zinc mine owned by Breakwater Resources Ltd. located near Bathurst, New Bruns- wick, which is currently not operating due to low metal prices. The mine continues to operate a lime plant to treat underground mine drainage, which has an average flow of 700 m3/day. The mine also has a sizeable deposit of old tailings, stored separately by the previous operator, containing significant quantities of pyrite, zinc and copper. Over the years these tailings have become a source of acidity and soluble metals due to oxidation and require remediation. Caribou, New Brunswick, Canada BioteQ reached an agreement with Breakwater in June 2001 to construct a Stage 1 treatment plant to remove metals from the mine drainage upstream of the existing lime plant. The plant was designed to recover zinc together with copper, cadmium and lead from the acidic mine drainage to augment the lime plant. The plant was constructed on schedule and 5% below budget and incorporated a bioreactor - contactor - PLC module constructed in Vancouver together with some new and existing Caribou mill equipment for the metal product dewatering circuit. The plant was started up in November 2001 and by February 2002 had reached a steady state operating capacity required to meet water treatment needs at that time of the year. The plant has contended with unpredictable and highly variable metal content in water to be treated. At times, the metal concentrations in the plant feed ranged from one and a half to over twice the design quantity so that the plant was not always able to treat the entire mine water flow. However, the rate of sulphide generation in the bioreactor per unit volume of mine drain- age exceeded design expectations. As a consequence, overall metal treatment exceeded design capacity per unit volume of the mine drainage. Copper removal and recovery has exceeded design expectations, with consistent concentrations of <0.01 parts per million in the treated water. The zinc recovery has also been within design expectations, although recovery was often incomplete due to the high metal loadings in the feed. The Caribou plant has demonstrated that the BioSulphide-Thiopaq process can accommodate highly variable contaminated water quality. Plant availability at Caribou was 98% during the last quarter of operation and has consistently demonstrated effective metal removal and recov- ery. The only downtime for the BioteQ plant was for scheduled preventative maintenance pur- poses. ANNUAL 24 REPORT 5 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 The following table summarizes information about common share options outstanding at December 31: Range of exercise price $ Number of outstanding at December 31 Weighted average remaining contractual life (years) Weighted average exercise price $ 2001 0.54 - 0.67 2,150,000 4.2 0.63 2002 0.50 - 0.67 2,600,000 3.6 0.61 Had compensation expense for stock options been determined by a fair value method in accordance with the provision of CICA Handbook Section 3870, the company’s loss for the year-end December 31, 2002 would have been reduced to the pro forma amount indicated below: 2002 $ Loss - reported 1,081,034 Loss - pro forma 1,317,922 Loss per share - as reported 0.09 Loss per share - pro forma 0.11 The fair value of stock option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: 2002 Expected dividend yield 0% Expected stock price volatility 86% Risk-free interest rate 3.95% Expected life of options (years) 5 The weighted fair value average price and weighted average exercise price of options granted in the years indicated were as follows: Weighted fair value average price $ Weighted average exercise price $ 2002 0.47 0.54 2001 0.59 0.63 (11) overview of technologies consolidated financial statements BioSulphide- Thiopaq Technology (continued) The BioSulphide-Thiopaq technology can produce very low residual concentrations of the metals in the process effluent. The recovered metal sulphides can represent a significant rev- enue stream which can either offset operating costs or result in profitable operation. The technology can also be used in combination with other water treatment processes for more comprehensive treatment. For example, application of the technology upstream of an exist- ing lime treatment plant can not only produce a revenue stream through the recovery of metal products but can also reduce lime consumption and reduce the volume of the sludge produced. In addition, the sludge would no longer contain the toxic heavy metals which are removed in the BioSulphide-Thiopaq plant and shipped offsite. Long term liabilities associated with sludge disposal would be significantly reduced. Simplified flowsheet of BioSulphide-Thiopaq Process showing reduction of sul- phur to produce sulphide reagent for the precipitation and recovery of a single metal sulphide product In the BioSulphide-Thiopaq process, metals such as copper, nickel and zinc can be precipitated and separated from contaminated water into saleable metal products utilizing biogenic sulphide reagent produced in a bioreactor. The biogenic sulphide is produced by reduction of sulphur species such as elemental sulphur or sulphate, with the addition of ethanol or hydrogen as an electron donor. In the case of sulphate reduction, the contaminated water itself can provide the sulphur source but capital and operating costs are higher for sulphate reduction than for systems utilizing elemental sulphur. Sulphate reduction should be considered, therefore, only for applications where sulphate concentrations must be lowered for environmental or process recycle purposes. For metal removal for environmental and/or metal recovery applications, sulphur reduction is preferred. Metal precipitation and recovery is carried out using conven- tional precipitation, solid-liquid separation and filtration equipment. other technology initiatives Partial Oxidation Burner for Hydrogen Production Hydrogen can be an efficient electron donor for BioteQ’s reduction technologies and can be supplied by steam reforming or from the partial oxidation system (POS) developed by BioteQ to provide the hydrogen-rich gas, using most fossil fuels (diesel, natural gas, propane). The POS has the added advantage of supplying excess heat to maintain the biological sulphate reduc- tion reactor at an optimum temperature for bacterial growth. The soot produced in the burner might also have potential value as carbon black used in a number of industrial sectors. In 2001, the Canadian Institute for Market Intelligence in cooperation with the National Research Council provided an independent assessment of BioteQ’s POS technology as a pos- sible fuel processor for fuel cells. This study showed that BioteQ’s POS might be highly com- petitive with current steam reforming technology as a fuel processor for high temperature fuel ANNUAL 4 REPORT 25 BIOTEQ EffluentSulphurNutrientsContaminated WaterMetal SulphideProductH2SAlkali source (if required)ClarifierBioreactorContactor BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (12) On April 22, 2002, the company granted 100,000 options to a consultant in return for investor relations services. At the date of grant, the market value of the underlying shares was $0.45 and the option exercise price was $0.54. At December 31, 2002, 33,333 options had vested. The company has recorded an expense of $30,317 during the year based on the fair value of the options. On September 5, 2002, the company granted 46,154 common share purchase warrants to the agent of the Series A debentures offering for services rendered (note 8). The warrants are convertible into the same number of common shares at a price of $0.65 per common share until September 4, 2004. The company has recorded an expense of $9,199 during the year based on the fair value of the warrants at the date of grant. On December 20, 2002, the company granted the agent for the private placement, common share purchase warrants to buy 406,000 common shares at a price of $0.65 within the first year and $0.75 within the second year from the grant date. The company has treated these costs as share issue costs based on their fair value. See note 9. During 2001, Underwriter options were exercised to purchase 100,000 common shares at a price of $0.20 per share, which were issued in relation to the company’s initial public offering in December 1999. The agent for the company’s December 2001 public offering has been granted an option for 2 years to acquire 130,000 common shares at the offering price of $0.50. During 2001, the company granted 300,000 options to a consultant in return for investor relations services. At the date of grant the market value of the underlying shares was $0.67 and the option exercise price was $0.58. At December 31, 2001, 200,000 options had vested. The company has recorded an expense of $18,000 during the year based on the intrinsic value of the options at the date of grant with a credit to contributed surplus. If the company had used an option pricing model to fair value the options at the date of grant, the expense would have been $80,000. The contract ceased in 2002, the vested options were not exercised and therefore were cancelled. Escrow shares The shares issued at December 31, 2002 include the following held in escrow: a) 7,000,000 performance shares which will be released from escrow based upon the cash flow performance of Biomet determined on an annual basis in accordance with the policies of the exchange. Biomet must generate a cash flow of $0.30 for each performance share to be released from escrow. Any performance shares which have not been released within 10 years from issuance will be cancelled and returned to the company’s treasury. b) 333,330 seed shares for release in December 2003. These shares are the remaining seed shares being released annually for the three years after completion of the company’s qualifying transaction, which occurred on December 20, 2000. consolidated financial statements overview of technologies Water Treatment Protection of water quality has become one of the most important environmental challenges facing the mining industry. Although new mining projects can be designed to minimize impacts to the environment, many existing and abandoned mining operations have water quality prob- lems. The principal cause of water contamination is acid rock drainage (ARD), which is gener- ated when residual sulphide minerals in waste rock, tailings and other mine components and products are exposed to air and water. These reactions can produce acidity and elevated con- centrations of metals in drainage and seepage that can adversely affect surface and groundwater resources. To meet regulatory criteria for water quality in the receiving environment, many mine opera- tors must consider treatment of mine water and other effluents prior to discharge. The current estimated clean up costs for acidic drainage from mining alone in the US and Canada is US$72 billion and $5 billion, respectively, from hundreds of operating, closed and abandoned mine sites. The industry generally uses a process in which lime is added to remove metals and neu- tralize acidity in ARD and other acidic effluents. This treatment method produces water that usually meets current discharge requirements but produces a sludge product that still contains the toxic metals that were present in the contaminated water. The metals are therefore not recovered in a usable form and the sludge product must be stored and monitored in perpetuity, usually at the mine site and can represent a long term environmental liability. In addition, the treated water from lime plants contains residual sulphate concentrations which can be harmful to aquatic organisms. Many jurisdictions are introducing or considering new sulphate water dis- charge standards which cannot be met by lime treatment. BioteQ owns and has developed the patented BioSulphide Process™, an anaerobic biological process, for a number of water treatment and metal recovery applications. In 2001, the Com- pany entered into a Technology Cooperation Agreement with Paques Biosystems BV of the Netherlands, which markets the related Thiopaq® technology. Paques has significant experi- ence in the design, construction and commercialization of anaerobic water treatment systems, mainly in Europe. The Agreement enables the companies to utilize their mutual knowledge and experience in a number of water treatment and related applications, utilizing BioSulphide- Thiopaq technology. BioteQ and Paques Technology Agreement The BioSulphide-Thiopaq technology is used to remove toxic metals selectively from water by precipitating them as sulphide products. The purpose for doing this might be exclusively envi- ronmental or there might also be an economic incentive to recover metal products for sale. In some cases, recovery of metals as part of a metallurgical operation might be the sole purpose. The range of applications for the technology is broad, therefore, and includes: BioSulphide- Thiopaq Technology • Treatment of ARD with concurrent selective recovery of metals • Treatment and metal recovery from other contaminated surface waters and groundwaters • Treatment of refinery and smelter waste streams • Recovery of metals for revenue as an alternative to conventional processes • Process control by treatment of bleed streams for metallurgical process enhancement • Treatment of industrial, municipal, surface waters and groundwaters water with high sul- phate ANNUAL 26 REPORT 3 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 (13) 10 Related party transactions and balances At December 31, 2002, a director holds $100,000 of the convertible debentures (note 8) issued on September 5, 2002. 11 Tax loss carry-forward As at December 31, 2002, the company has approximately $1,260,000 of research and development expenditures available for unlimited carry-forward, undeducted expenditures for tax purposes of $1,248,000 related primarily to share issue costs and property, plant and equipment, and $46,000 of investment tax credits, all of which may be used to reduce future Canadian income taxes otherwise payable. The company has accumulated losses of approximately $2,401,000 for income tax purposes which may be deducted in the calculation of taxable income in future years. The losses expire as follows: $ 2004 172,000 2005 230,000 2006 43,000 2007 139,000 2008 844,000 2009 973,000 2,401,000 As at December 31, 2002, the company’s future tax assets and liabilities were as follows: 2002 $ 2001 $ Property, plant and equipment 792 (41,325) Financing costs 261,096 175,740 Research and development expense carryforwards 499,212 548,100 Non-capital loss carry-forwards 951,276 621,180 Total future tax assets 1,712,376 1,303,695 Valuation allowance (1,712,376) (1,303,695) Total future tax assets - - No income tax benefits related to the future tax assets have been recognized in the accounts as their realization does not meet the requirements of “more likely than not” under the liability method tax allocation. president’s message to shareholders consolidated financial statements Personnel Highlights (continued) Expectations for 2003 Ian Telfer, Chairman and CEO of Wheaton River Minerals, joined our board of directors in November and was instrumental in directing the Company through the recent financing with Canaccord. We are looking forward to Ian’s ongoing involvement, combining his special talents in corporate finance and the mining industry. The Company has a very simple goal for 2003 - to engineer and construct commercial plants. We are now behind our original timeline for commercialization as we had expected to build a second plant in 2002. However, with our current projects and staff we anticipate the construc- tion and commissioning of two new commercial plants this year. In addition, our project list is maturing and the number of advanced projects for potential commercialization has increased substantially since last year, providing a clear pipeline for future project growth. BioteQ has recently signed a partnership with SOQUEM INC. in Quebec to assess over 60 potential sites during 2003 for possible application of our process. Additional project approvals are expected during 2003 to keep our commercial plant pipeline growing. It is a difficult transition from development to operations for any company and requires a unique combination of technical, financial and management skills. BioteQ is now poised to complete its original commercialization plan to build a successful operating company in the environmental business based on solid commercial projects and growing earnings from operations. Once again, the employees and directors deserve special recognition for the advancement of the Company during 2002. On behalf of the Board of Directors P. Bradley Marchant President and CEO Vancouver, Canada, March 14, 2003 ANNUAL 2 REPORT 27 BIOTEQ BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 The reconciliation of income tax attributable to operations computed at the statutory tax rates to income tax expense (recovery), using a 39.62% (2000 - 44.62%) statutory tax rate, at December 31, is: 2002 $ 2001 $ Income tax at statutory rates (428,306) (306,122) Non-deductible expenses 3,566 8,924 Non-capital loss carried forward and available to offset taxable income in future years 385,503 297,198 Share issue costs 39,237 - - - 12 Scientific research tax credit refund During 2001, the company received $207,446 in non-refundable Scientific Research tax credits from Canada Customs and Revenue Agency related to 1999 research and development expenditures. These credits were not deducted from the related costs during 1999, as reasonable assurance of realization did not exist. As a result, $200,352 has been credited to the 2001 statement of operations and $7,094 has been credited to property, plant and equipment. 13 Financial instruments Fair value of financial instruments The company’s financial instruments include short-term investments, government grant receivable, other assets, and accounts payable and accrued liabilities. The fair values of these financial instruments approximate their carrying value. Credit risk exposure The company’s exposure to credit risk is as indicated by the carrying value of its government grant receivable. The company mitigates this risk by reviewing and monitoring this balance. Interest rate exposure The Series A debentures bear interest at a fixed rate. Management considers that no events have occurred subsequent to the issuance of these debentures that would indicate that the fair value differs substantially from the carrying value. (14) consolidated financial statements president’s message to shareholders We are pleased to present the Annual Report and Financial Statements for the year ended December 31, 2002. During 2002 BioteQ was successful in operating its first plant and is now moving forward to develop larger commercial projects. The commissioning and operation of our first plant, located at the Caribou Mine in New Brunswick, provided BioteQ with the fol- lowing milestones: • Demonstration of our water treatment tech- nology on a commercial scale • Demonstration of metal recovery from a highly variable and complex acid drainage • Signing of an agreement with Noranda’s Brunswick Mine to purchase the concen- trate produced at Caribou • Engineering, construction, operations and maintenance experience for future commer- cial projects • A definitive marketing tool for potential users of our technology The Company recognizes the invaluable role of the management of Breakwater Resources and the staff at the Caribou Mine in providing the opportunity and support to BioteQ to build the plant. In addition, the ongoing input and sup- port from local and provincial regulators was important in the successful operation at Caribou. BioteQ’s first commercial plant located at the Caribou Mine, New Brunswick. Highlights from 2002 include: • Completion of Caribou expansion engineering Commercial Highlights • Contract signed with Falconbridge for piloting and engineering for a possible commercial plant at their Raglan mine in Quebec • Completion of an evaluation of several potential projects with Phelps Dodge and signing of an agreement with Phelps Dodge to complete detailed engineering for a possible com- mercial plant at Bisbee in Southern Arizona • Completion of a report that identifies a new market target for BioteQ - the sulphide reagent business • Completion of an independent analysis of our Partial Oxidation Burner for hydrogen pro- duction that confirms the commercial potential for hydrogen supply from low grade fuels and provides specific markets for commercial exploitation The Company was fortunate to attract additional key people to the company during 2002: Michael Bratty, a graduate of McGill University, joined BioteQ in August. Mike has several years experience in the design and engineering of water treatment plants and recently completed a Masters degree in Chemical Engineering. He immediately reported to the Raglan site in North- ern Quebec to operate our pilot plant as well as complete the preliminary engineering study for Raglan. Mike is now based in Montreal to provide a presence in our growing eastern activities. Personnel Highlights 1 BIOTEQ ANNUAL 28 REPORT BioteQ Environmental Technologies Inc. (a development stage company) Notes to Consolidated Financial Statements December 31, 2002 and 2001 14 Commitments The company is committed to minimum annual lease payments for office premises of $7,800 for 2003. 15 Short-term investments Included in short-term investments is the amount of $27,068 which is held in trust for payment of the balance of the first year’s interest on the convertible debentures. 16 Subsequent event On January 15, 2003, the company completed an over-allotment on the private placement by issuing a further 940,000 units for gross proceeds of $470,000. Issue costs amounted to $66,100 of which $23,500 was the value of issuing 47,000 units as a fee to the agent. In addition, the agent received 94,000 common share purchase warrants. Each warrant entitles the holder to acquire one additional common share for a period of two years from the issue date at a price of $0.65 in the first year and $0.75 in the second year. (15) company profile BioteQ Environmental Technologies Inc. is an industrial process technology company that has developed the patented BioSulphide Process™ for water treatment and sulphide reagent pro- duction. The company is currently focused on applications of its technology in the mining industry where the process allows the treatment of acid and metal contaminated water with concurrent recovery of saleable metals from the water. Such contaminated water, or acid waste- water, is often termed Acid Rock Drainage (ARD) and is one of the most critical environmental challenges facing the mining industry. The BioteQ process can produce significant environmental benefits by reducing or eliminating toxic metal emissions to the environment and the long-term environmental liabilities associated with the storage of metal-laden products from conventional water treatment processes. Rev- enues from the sale of metal products recovered from the ARD and other contaminated water streams can offset water treatment costs or, in some cases, result in water treatment for a profit. BioteQ will operate on three commercial bases: design, build, own and operate; design, build and transfer with process royalties; or third party license. The Company is moving forward to develop larger commercial projects, following the construction in 2001 of its first commercial plant at the Caribou Mine near Bathurst, New Brunswick, and operation of the plant to treat metal-contaminated mine water during 2002. BioteQ is based in Vancouver, Canada and is currently listed on the TSX Venture Exchange under the symbol BQE. Annual Meeting The Annual General Meeting of Shareholders will be held on April 29, 2002, at 2 pm at the Conference Centre, Second Floor, 888 Dunsmuir Street, Vancouver B.C. Directors P. Bradley Marchant President & CEO of the Company North Vancouver, B.C. Head Office company information 355 Burrard Street, Suite 1700 Vancouver, BC, Canada V6C 2G8 Tel: 604-685-1243 Fax 604-685-7778 Email: bioteq@bioteq.ca George W. Poling Chairman of the Board of Directors West Vancouver, B.C Kelvin Dushnisky Director of Regulatory Affairs, Barrick Gold Corporation Oakville, Ontario Anthony Kana Financial Services Consultant Vancouver, B.C. Clement Pelletier President & CEO Rescan Environmental Services Ltd. Vancouver, B.C. Ian Telfer Chairman & CEO Wheaton River Minerals Ltd. Vancouver, B.C. Kenneth Williamson Independent Consultant Toronto, Ontario Investor Relations Tel: 1-800-537-3073 Email: investor@bioteq.ca Legal Council McCullough O’Connor Irwin Vancouver, B.C Auditors PriceWaterhouseCoopers Vancouver, B.C. Transfer Agent Pacific Corporate Trust Vancouver, B.C Stock Exchange Toronto Venture Exchange Symbol: “BQE” Website www.bioteq.ca contents Company Profile President’s Message to Shareholders Overview of Technologies Other Technology Initiatives Projects Management Discussion and Analysis Management’s Responsibility for Financial Reporting Auditors’ Report and Consolidated Financial Statements Company Information front inside cover 1 3 4 5 7 9 10 back inside cover Officers and Management P. Bradley Marchant President & CEO Richard W. Lawrence Executive Vice President John York Chief Financial Officer David Kratochvil Manager, Engineering and Development ANNUAL ANNUAL REPORT REPORT BIOTEQ BIOTEQ HEAD OFFICE: 355 Burrard Street, Suite 1700 Vancouver, BC, Canada V6C 2G8 Tel: 604-685-1243 Fax 604-685-7778 Email: bioteq@bioteq.ca ENVIRONMENTAL TECHNOLOGIES INC. www.bioteq.ca ANNUAL REPORT 2002