2003 ANNUAL REPORT company profile BioteQ is a Canadian industrial process company that has BioteQ's business plan is to focus on its core water developed the patented BioSulphide® Process for water treatment technologies in the development, construction treatment and sulphide reagent production. BioteQ is and operation of waste water treatment plants. The currently focused on applications of its technology in the Company can operate on three commercial bases: design, mining industry where BioteQ's process plants allow the build, own and operate; design, build and transfer; and treatment of acid contaminated water with concurrent third party process license. The Company has built and recovery of saleable metals from the water. Water from owns three commercial water treatment plants in the US the process plants can be discharged to the environment and Canada at the Caribou Mine in New Brunswick or recycled for industrial re-use. In addition, chemical (Breakwater Resources Ltd.), the Raglan Mine in northern grade sulphide reagent can be produced on demand from Quebec (Falconbridge Limited), and at the Copper Queen BioteQ's p rocess. Potent ial revenue streams fro m Mine in Arizona (joint venture with Phelps Dodge BioteQ's technologies are plant sales, recovered metals, Corporation). treatment fees, and sulphide reagent sales. BioteQ's process plants can treat metal-laden acid in Montreal and an operating joint venture in Arizona. The contaminated water, including acid rock drainage (ARD), Company is listed on the TSX Venture Exchange under the BioteQ is based in Vancouver, Canada with a branch office contaminated surface and ground waters, metallurgical symbol BQE. bleed streams and sulphate-rich municipal and industrial water. BioteQ is currently focused on metal contaminated Annual Meeting mine drainage, one of the most significant challenges The Annual General meeting of Shareholders will be held fac ing the min ing ind ust ry wor ldw ide . Bio teQ 's on April 22, 2004 at 2pm at the Conference Centre, Second technologies can offer significant environmental and Floor, 888 Dunsmuir Street, Vancouver,B.C. economic benefits when compared with conventional lime treatment of the same acid waste streams, including: • reduction or elimination of metal-laden sludge by- TABLE OF CONTENTS products, Company Profile front inside cover • sale of valuable contained metals which can off-set treatment costs or, in some cases, result in a profit from the water treatment plant, President’s Message to Shareholders Overview of Technologies Projects • overall reduction of long term water treatment costs Management Discussion and Analysis and environmental liability. 1 3 5 8 Front Cover… BioSulphide® Process Plant under construction for copper recovery at the Copper Queen Mine, Bisbee, Arizona, in joint venture with Phelps Dodge Corporation (photograph by Michael Bratty) Management’s Responsibility for Financial Reporting 11 Auditor’s Report and Consolidated Financial Statements 12 Company Information back inside cover BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT president’s message to shareholders 2003 was a defining year for BioteQ and its staff towards meeting the goals set out in our business plan that is, to build and operate water treatment plants incorporating our unique biological treatment process. The Company signed a contract with Falconbridge Limited for the construction of a plant at the Raglan Mine in northern Quebec, completed in November, and entered into a joint venture agreement with Phelps Dodge Corporation for the construction of a plant at their Copper Queen Mine, Bisbee, Arizona, which is scheduled for commissioning in Commercial Highlights early 2004. Combined with our Caribou plant in New During the last two years BioteQ has been successful in Brunswick, these two new plants provide BioteQ with the conv ers ion fro m a res ear ch org ani zat ion to confirmation of our businessplan: commercial operations, starting in early 2004. The • BioteQ has an environmental process that is of interest Caribou Mine during 2002 provided a commercial scale to major mining companies and is accepted by demonstration of our capabilities and the commercial commissioning and operation of our first plant at the regulators, confidence to finance and construct the Raglan and Bisbee projects in 2003. Commercial highlights for the • BioteQ has the internal expertise to design, procure company in the last year include: and construct plants in a variety of locations within • Completion of our second commercial plant, at Raglan, tight cost and schedule constraints, and commencement of revenues from Falconbridge • Based on the contract terms in place for operation of venture with Phelps Dodge Corporation, and the rapid the three plants during 2004, we anticipate producing increase in copper price to coincide with commissioning financial results that show we will start being cash of this plant in 2004 flow positive from operations. • Continued development of our international pipeline of • Construction of our third commercial plant, in joint projects of more than 30 prospects, in various stages of engineering and evaluation • After reviewing potential applications in Quebec as a result of our partnership with SOQUEM Inc., four projects have been identified for detailed follow up. Financing Highlights In addition to the commercial successes and growth, 2003 was highlighted by advances in corporate finance. To meet its obligations for construction projects in 2003, the Company completed two new equity financings priced at $0.70 per share, totaling $4,118,000 (net of costs). In addition, the Company signed a debt financing agreement BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 01 president’s message to shareholders with HSBC Bank Canada to provide senior debt project Expectations for 2004 financing for the Raglan plant, for up to $800,000. Based on our existing commercial contracts and joint venture agreements, the Company expects continued Personnel Highlights growth in 2004, highlighted by: The Company was pleased to add additional personnel • operation of our Raglan and Bisbee plants during 2003 to contribute to the growth of the Company • expansion of our Caribou operation and management including: David Lindeman, a senior project engineer of two waste water treatment plants under contract previously at AMEC, a Vancouver based engineering with Breakwater Resources contractor; Pascale St-Germain, a project biologist • positive cash flow from operations previously with Noranda, joined our Montreal office as a • project debt financing from HSBC Bank Canada consultant; Ian MacLean, previously at the Caribou Mine, • two new commercial contracts from our project joined BioteQ full time to manage our Caribou plant; Max pipeline and SOQUEM partnership Nodwe ll, a recen t UBC gradu ate in metal lurgi cal • expansion of marketing and project development into engineering, joined us late in 2003 to begin training as a China and South America project engineer; and Doreen Jeffery signed on as our • strategic partnerships to increase our project capacity much needed Administrator. in engineering and construction as well as plant operations and management 2003 was a significant year of transition for the Company. The construction of two new plants was an important step in its long term business plan, although contract delays prevented the expected commissioning of the two new plants until 2004. The Company now has the people, proven technology and financial strength to continue to build its business towards long term earnings from operations. I would like to thank our employees, directors and business partners for their unselfish dedication to meeting the challenges of 2003. I look forward to an Safety exciting and prosperous 2004. The Company was very active in construction activities during 2003 and continued to adhere to strict safety On behalf of the Board of Directors regulations and policy. The Company reported no safety incidents at its projects in 2003 and we will continue to strive for safety excellence in the future for construction and operations. Brad Marchant President & CEO Vancouver, Canada Feb 5, 2004 P. 02 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT overview of technologies Water Treatment and Metal Recovery Protection of water quality has become one of the most important environmental challenges facing the mining, metallurgical and related industries. Although new mining projects and metallurgical processes can be designed to minimize impacts to the environment, many existing and abandoned mining operations and metallurgical facilities have water quality problems. The principal cause of water contamination in mining is acid rock drainage (ARD), which is generated when residual sulphide minerals in waste rock, tailings and other mine components and products are exposed to air and water. The BioSulphide® Process These reactions can produce acidity and elevated BioteQ's approach to water treatment and metal recovery concentrations of metals in drainage and seepage that can is to precipitate metals using sulphide reagent generated adversely affect surface and groundwater resources. by its patented BioSulphide® Process. In addition to Water can be contaminated due to similar reactions in pr od uc in g wa te r wi th ve ry lo w re si du al me ta l wastesfrom other industries. concentrations, the anaerobic biological process can be used for selective removal of toxic metals from water by To meet regulatory criteria for water quality in the precipitating them as high-grade sulphide products. The receiving environment, many operators of mines and process can, therefore , be applied exclusively for metallurgical plants must consider treatment of mine envir onme ntal purpo ses, or for exclu sivel y metal water and effluents prior to discharge. The most widely recovery, or both concurrently. The range of applications used treatment process has been one in which lime is for the technology includes: added to remove metals and neutralize acidity in ARD and other acidic effluents. This treatment method produces water that has usually met discharge criteria although many jurisdictions have introduced, or are considering, more stringent discharge standards, which might be difficult to meet. • 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 The quantities of valuable metals contained in conventional processes contaminated mine water and effluents can be significant but these cannot be recovered by lime treatment. Instead, the metals are captured into a sludge product that must be stored and managed to prevent the release of the metals back into the environment. Metal recovery from the • Process control by treatment of bleed streams for metallurgical process enhancement • Treatment of industrial, municipal, surface waters and groundwater with high sulphate sludge is, in virtually all cases, uneconomic and sludges • Supply of high grade sulphide reagent for usually remain as a long term environmental liability. industrial use BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 03 overview of technologies Metals recovered by the process can represent a systems utilizing elemental sulphur. Sulphate reduction significant revenue stream which can either offset should be considered, therefore, only for applications operating costs or result in profitable operation. The where sulphate concentrations must be lowered for technology can also be used in combination with other environmental or process recycle purposes. For metal water treatment processes for more comprehensive removal for environmental and/or metal recovery treatment. For example, application of the technology applications, sulphur reduction is preferred. Metal upstream of an existing lime treatment plant can not only pre cip ita tio n and rec ove ry is car rie d out usi ng produce a revenue stream through the recovery of metal conventional precipitation, solid-liquid separation and products, but can also reduce lime consumption and filtration equipment. 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® plant and shipped offsite. Long term liabilities associated with sludge disposal would be eliminated or significantly reduced. Bioreactor Sulphur and Reagents Contactor Clarifier Simplified flowsheet of BioSulphide® Process showing reduction of sulphur to produce sulphide reagent for the precipitation and recovery of a single metal sulphide product Contaminated Water Treated Water Filter Metal Sulphide Product In the BioSulphide® process, metals such as copper, Other Technology Initiatives nickel and zinc can be precipitated and separated from Partial Oxidation Burner for Hydrogen Production contaminated water into saleable metal products utilizing The Company has developed a partial oxidation system biogenic sulphide reagent produced in a bioreactor. The (POS) which produces hydrogen-rich gas using most fossil biogenic sulphide is produced by reduction of sulphur fuels (diesel, natural gas, propane). The POS was species such as elemental sulphur or sulphate, with the developed to produce the gas for use as an efficient addition of ethanol or hydrogen as an electron donor. In ele ctr on don or for Bio teQ 's biol ogi cal red uct ion the case of sulphate reduction, the contaminated water technologies. Studies and independent assessments itself can provide the sulphur source but capital and carried out since 2001 have also indicated the potential operating costs are higher for sulphate reduction than for for its use as a fuel processor for fuel cells. A 2002 report P. 04 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT overview of technologies by Fuel Cell Intelligence, Ltd. concluded that it should be capital and operating costs compared with sulphur relatively easy to integrate the POS technology with both reduction. Consequently, the niche market for biological solid oxide and molten carbonate fuel cells. Waste heat sulphate reduction is limited to industrial effluent cases generated by the POS could also be used to maintain the where sulphate concentrations must be reduced below operating temperature of the fuel cells or for cogeneration those that can be produced in lime plants due to new applications such as space heating and water heating. regulations and where the cost of expensive sulphide The ability of the BioteQ system to process diesel fuel produced biologically can be offset by the recovery of simply and economically is viewed as a major advantage metals. In this capacity, sulphate reduction has a unique of the technology. Using the POS system as a pre- advantage over lime treatment, since the latter cannot processor for advanced gas turbines was also identified produce effluents with sulphate concentrations lower as a potentially commercially attractive application. The than around 1600 mg/L. In contrast, sulphate reduction addition of small quantities of hydrogen to the fuel intake removes metals to very low concentrations, can reduce of a gas turbine should result in improvements in sulphate to well below any foreseeable future standard, efficiency and reduction in emissions of oxides of and produces its own alkalinity. nitrogen. This study will assist the company with the technical and market direction for commercial feasibility analysis of the POS burner. P R O J E C T S Sulphate Reduction Caribou, New Brunswick, Canada Although the biological reduction of elemental sulphur to Caribou is a zinc mine owned by produce sulphide reagent has formed the basis of the Breakwater Resources Ltd., which three commercial plants constructed to date, the is currently not operating due to BioSulphide Process® was initially developed to exploit low metal prices. The mine the biological reduction of sulphate. BioteQ has gained operates a lime plant to treat significant sulphate reduction expertise through underground mine drainage. The operating large scale pilot plants and has carried out Company reached an agreement advanced engineering for selected projects. Interest in with Breakwater in June 2001 to sulphate reduction in the mining sector has, however, construct a treatment plant to remove metals from the been low, particularly in North America where the mine drainage upstream of the existing lime plant. The company has focused its attention in these early years. plant was designed to recover zinc together with copper, The Company is, however, receiving more enquiries cadmium and lead from the acidic mine drainage to concerning projects in which the reduction of TDS (total augment the overall water treatment. The plant was dissolved solids), caused by elevated sulphate started up in November 2001 and by January 2002 had concentrations, is desirable both in North America and reached a steady state operating capacity required to elsewhere in the world due to more attention by regulators meet water treatment needs at that time of the year. on the long term impact of sulphate into receiving waters. High rate H S generation by sulphate reduction is more 2 that the process can accommodate highly variable technologically complex and expensive in terms of both contaminated water quality. Metal recovery exceeded The plant operated throughout 2002 and demonstrated BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 05 projects design expectations for copper. Zinc recovery was within design expectations, even though metal concentrations in the feed water of up to 100% over design were experienced. The high metal loadings resulted in the plant not being able to treat the entire mine water flow at all times. However, the rate of sulphide generation in the bioreactor per unit volume of mine drainage exceeded design expectations and overall metal treatment exceeded design capacity per unit volume of the mine drainage. During its operation in 2002, the plant recovered nearly 35 tonnes of zinc concentrate, which also contains copper, cadmium and lead. The concentrate was delivered and accepted for sale at the nearby Brunswick Mine under contract with Noranda. Concentrate production was suspended at the end of October 2002 Bisbee, Arizona, U.S. due to the site owner’s planned shut-down of minewater Foll owin g eval uati on of seve ral pote ntia l proj ect collection and treatment. These operations remained shut opportunities in the southwestern US, BioteQ signed a down through 2003 while the mine workings were flooded joint venture agreement with Phelps Dodge Corporation in and it is now anticipated that water treatment will restart October 2002 to carry out an engineering study with in April 2004. Phelps Dodge leading to the construction and operation of a BioSulphide® plant at Phelps' Bisbee property in On January 26, 2004, the Company signed a new southern Arizona. The Bisbee project will recover copper agreement with CanZinco Ltd., (a wholly owned subsidiary from the drainage of a large low-grade stockpile, which of Breakwater Resources Limited) which will provide the Company control of all aspects of water management at the Caribou and Restigouche sites of CanZinco in New Brunswick and which replaces the previous agreements regarding the Caribou site. The contract is for an initial term of six years and will commence after a three month transition period, during which time the definitive details of an operating agreement will be finalized. In addition, a project to re-treat tailings containing soluble copper and zinc, stored at the Caribou site by a previous operator, will commence at CanZinco's option. Tailings re-treatment is expected to commence in 2005 and the Company plans to modify its biological reduction plant during 2004 to continue treatment of the mine drainage and to also historically has been under leach with copper being recovered by cementation with iron. Basic engineering for the Bisbee plant was completed in March 2003 and the project proceeded following the signing of an Operating Agreement between the companies in June and a Construction Agreement with the Joint Venture Company, Copreco LLC, which is owned equally by BioteQ and Phelps Dodge. Plant construction at Bisbee was largely completed in February 2004 to the point of commencement of plant commissioning. The Company estimates that commissioning will take approximately three months to reach the acceptance retreat the tailings. BioteQ owns the metals recovery criteria established by the Joint Venture for completion of treatment plant and all metals recovered will be owned by the plant. The current estimate of total construction cost BioteQ. is $US 2,550,000. P. 06 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT projects Based on the recent increase in the price of copper, up to Construction of the plant was completed in November $US 1.30 per pound of copper, BioteQ has revised the 2003 in readiness for full duty during the water treatment revenue estimate from BioteQ's share of the project season in 2004. The treatment plant design provides for a which, combined with current contracts for consumable capacity to treat at least 140 cubic meters of water per supplies and copper product refining, shows that BioteQ's hour and BioteQ expects to treat a minimum of 530,000 capital paybackis now less than two years. cubic meters of water each year, on average, during the operating season between May and November. The plant will recover the nickel in the contaminated water to produce a nickel-rich concentrate that can be transported with the Raglan production concentrate for refining off site. The nickel-rich product from the BioteQ plant will also contain minor amounts of other heavy metals that will be removed from the waste water to allow discharge of the treated water to the environment. It is the objective that in the future the BioteQ treatment process will replace the existing lime treatment plant. BioteQ provided for all capital costs of the plant, which, as of December 31, 2003, Raglan, Québec, Canada Falconbridge Limited operate the Raglan Mine located on was $1,570,000. BioteQ owns the plant, and charges a the Ungava Peninsula in northern Quebec, and extracts fixed fee on a monthly basis for the plant capital recovery nickel ore, which is processed at site and shipped as a as well as a variable monthly fee for water treatment. nickel sulphide concentrate to Sudbury. Following successful piloting at the site during 2002, BioteQ The BioSulphide® plant at Raglan will have the following completed its feasibility study in early 2003 for a project to potential benefits: construct a water treatment plant to treat contaminated • elimination of sludge production and storage water at the site. The Company agreed to commercial • improved treated water quality terms with Falconbridge in April 2003 for the construction • revenue from nickel recovery will partially offset of a BioSulphide® treatment plant. treatment costs The contaminated water arises due to the oxidation of • reduced overall water treatment costs residual sulphide minerals in open pits and waste rock piles, as well as contact of mine water with exposed metal Project Pipeline • more reliable cold weather treatment bearing minerals in the underground operations. The The Company is evaluating over 30 potential commercial water has a neutral pH but contains elevated acidity levels projects for water treatment and metal recovery in in the form of dissolved nickel and must be treated before Canada, USA, Europe, Asia, Australia and South America. it is discharged to local receiving waters. Currently the These projects are in various stages of development from water is stored in a collection basin, is treated for initial scoping and due diligence to advanced approximately four months of the year in a low-density engineering. sludge lime treatment plant and discharged on a campaign basis to the receiving waters. BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 07 management discussion and analysis The following discussion and analysis should be read in potential projects and also from monthly fees which conjunction with the audited consolidated financial commenced late in the year when the Raglan plant was statements of the Corporation for the year ended completed. December 31, 2003. Description of Business General and Administrative costs for 2003 were $985,452 compared to $585,229 for 2002. The increase was due to BioteQ is a Canadian industrial process technology generally higher costs in all categories, due to increased company that has developed the patented BioSulphide® corporate activity, including activity caused by the two Process for water treatment and sulphide reagent new contracts, which were both built largely in 2003. production. The process allows the treatment of acid More specifically, management services increased by contaminated water with concurrent recovery of saleable $126,000, due partially to one person being added to metals from the water. administrative support, business development and travel costs increased by $93,000 and legal and audit costs BioteQ has met its 2003 objective of building two new increased by $56,000. In addition, a move to larger plants and now owns, either solely or in joint venture, premises increased rental costs by $27,000, insurance three commercial plants. The Company continues to costs rose by $32,000. The Company anticipates the 2004 market its process at a number of other sites in North general and administrative costs to be similar, in total, to America and elsewhere. 2003. Operating Results Development costs amounted to $187,208 (net of During 2003, like 2002, the Company has continued to government grants of $29,383), compared to $465,607 in emphasize marketing its water treatment process. 2002 (net of government grants of $184,182). The Success was achieved in the first half of 2003 with the decrease was largely due to $142,000 for the cost of start- signing of contracts to construct two significant new up, operating and testing at the Caribou plant in 2002, treatment plants. This was a few months later than which did not operate in 2003 and lower marketing/ expected and prevented commissioning or operation in engineering costs by $116,000, since resources were 2003, however both plants are expected to be fully directed to new plant construction in 2003. operational in the first half of 2004. The Company has a current project list of over 30 potential sites which could Interest income increased in 2003 by $32,000 due to benefit from the Company's technology. These projects increased cash balances and interest expense increased range from early stage enquiries where an initial review of due to a full year of interest being paid in 2003, with potential has been completed, to advanced stage projects associated accretion costs, on the 10% debentures issued where either preliminary or detailed engineering has been in September 2002. finalised and the decision to construct plants is imminent. The Company incurred a loss for the year of $1,174,305, 2002 a director invested $100,000 in BioteQ's convertible compared to $1,081,034 in 2002. Revenue for the year of debentures. Interest is paid twice annually at a rate of 10% $89,239 was earned from engineering services for per annum. The Company has one related party transaction. During P. 08 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT management discussion and analysis A new accounting policy will be adopted in 2004. The Bisbee plant Company will adopt the new recommendations for the In June 2003, the Company entered into a joint venture accounting for stock-based compensation in CICA with Phelps Dodge Corporation to construct and operate a Handbook Section 3870 and will expense all amounts copper recover plant at their site in Bisbee, Arizona. determined by the fair value based method at the time BioteQ was appointed contractor to build the plant with an options are issued. Raglan plant estimated cost before contingency of US$1,900,000, to be equally shared. BioteQ agreed to fund any cost overruns. By December 31, 2003 US$1,800,000 had been A contract was signed in April 2003 to build a water spent on the project, with an additional amount of treatment plant to operate at Falconbridge's Raglan site in approximately US$750,000 remaining to be spent. Much northern Quebec. The client was keen to see the plant of the overrun can be attributed to the extremely high operational for 2004, therefore with the constraints of standard of construction and safety required by our transportatio n to the area and the short summer partner on their site. Although the overrun is significant, a construction period, there was pressure to move quickly. first class plant has been built , inclu ding many The plant was completed in November 2003, in readiness enhancements to the plant for the safest possible for full operation in 2004. The Company has funded operation. construction and owns the plant. The contract provides for a fixed monthly fee of $24,500, which has already In late February 2004, commissioning of the plant has commenced on completion of construction and a commenced and is expected to last approximately three treatment fee based on the quantity of water processed. months before full operation is achieved. The latest The treatment fee of $1.06 per cubic metre of water operating estimates for the plant at the current copper processed will commence when the plant is started up and price of US$1.30 and with current costs, indicate a plant performs as designed, anticipated in mid-2004. The fixed payback less than the original estimate of two years. The monthly fee is unconditional for nine payments, but plant was designed to recover approximately 3 million thereafter depends on satisfactory plant performance. pounds of copper per year from the drainage from a large, BioteQ expects to treat a minimum of 530,000 cubic low-grade stockpile, which is estimated to contain over meters of water during the typical May to November 300 million pounds of copper. operating season. Caribou plant The plant was estimated to cost $1,375,000 and by The Company's plant has not operated since late 2002, completion in November 2003, the company had incurred due to the site owner shutting down minewater collection costs of $1,570,000. The hardware components of the and treatment. Their original intention was to restart water treatment plants are relatively straightforward and operations in the spring, however the shutdown was actual costs were in line with estimates. The overruns have extended in order to fill the underground workings with occurred in the construction labour and the building to contaminated water. This is expected to be complete in house the plant, due largely to difficulty and costs of April 2004 and then water treatment will recommence. construction in the north of Quebec. Particularly, weather conditions caused significant extra cost in erection of the steel building. BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 09 management discussion and analysis In January 26, 2004, the Company signed an agreement until cash flow commences, which is expected in the with the owner to control all aspects of water management second quarter of 2004. at both Caribou and an adjacent site, commencing in the second quarter of 2004. The Company will earn fees for Early in 2004, the Company finalised arrangements with managing the sites and will own all metals recovered from HSBC Bank Canada for debt refinancing of its Raglan it s tr ea tm en t pl an t. Th e Co mp an y wi ll sp en d project. The Company has received $200,000 in 2004 of a approximately $70,000 to modify its plant in 2004, to $800,000 loan, with interest payable at prime plus 1.5%, continue treatment of the mine drainage and to also which will be fully drawn when the plant operates enable treatment of tailings containing copper and zinc, successfully on start-up with the spring thaw and is stored at the site. repayable over 4 years. The Company anticipates this financing arrangement will provide the basis for similar Liquidity and Capital Resources debt financing of future projects. At December 31, 2003, the Company had cash of $2,798,226, an increase of $1,021,769 compared to The Company is expecting that the two new projects, $1,776,457 at December 31, 2002. During 2003, the which should both be fully commissioned by mid-year, will Company raised $4,536,929, net of cash expenses, from move BioteQ to positive cash flow and therefore ensure issues of shares and warrants, compared to $2,111,051 adequate resources for the coming year, in conjunction raised from equity and debenture financing in 2002. The with existingcash balances. Company also received $29,383 (2002-$152,340) from government funds in support of demonstrating the Risks and Uncertainties company's innovative environmental technology at the Any new commercial application of the BioSulphide® Caribou plant. This arrangement ceased on March 31, Process will have certain construction and process risks 2003 and repayments calculated at 2% of revenues will associated with building and operating a new plant. commencein 2004. Revenue will depend on the successful operation of the plants and will fluctuate with the price of the commodities The Company used its cash resources to fund its 2003 being recovered and the exchange rate for the United operating loss of $1,067,663, net of non-cash items States dollar. Operating costs will be largely dependent (2002-$932,002), and to fund the building of two new on the cost of consumables and power, which may water treatment plants with expenditures in 2003 of fluctuate. The Company will be selecting projects which $2,831,601 (2002-$5,339). The Bisbee plant was demonstrate good profit margins which should allow for incomplete at December 31, 2003, with approximately the adverse effect of price changes. $900,000 remaining to be spent by the Company. The economics of some projects under review by the As a result of the financings and plant expenditures, Company are based largely on estimates of metals to be working capital at the year-end showed an improvement recovered. Although there is often a significant amount of to $2,447,000 from $1,682,000 in 2002. These resources data upon which estimates can be based, there can never will be used to complete Bisbee, commence operations at be absolute certainty as to the continuity of flow of water both new plants and fund other corporate operating costs to be treated and the concentrations of metals contained. P. 10 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT management discussion and analysis Outlook looking statements. Such forward-looking statements The year of 2004 marks a significant change for the involve a number of known and unknown risks, Company. After many years of development, the Company uncertainties and other factors which may cause the has now built three significant projects, which are actual results, performance or achievements of the planned to be fully operational by mid-year and should Company to be materially different from any future results, contribute significantly for a number of years. The performance or achievements expressed or implied by Company is actively reviewing new projects, with the such forward-looking statements. Readers are cautioned expectation of new contracts in the near future. not to place undue reliance on these forward-looking statements, which speak only as of the date the Cautionary Note Regarding Forward-Looking Statements statements were made and readers are advised to Certain statements contained in the foregoing consider such forward-looking statements in light of the Management's Discussion and Analysis and elsewhere in risks set forth above. this Annual Report to Shareholders constitute forward- management’s responsibility for financial reporting The management of BioteQ Environmental Technologies Inc. is responsible for the preparation 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 judgements made by management. The external auditors, PriceWaterhouseCoopers, 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 management 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 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 11 auditors’ report To the Shareholders of BioteQ Environmental Technologies Inc. PricewaterhouseCoopers LLP Chartered Accountants PricewaterhouseCoopers Place 250 Howe Street, Suite 700 Vancouver, British Columbia Canada V6C 3S7 Telephone +1 (604) 806 7000 Facsimile +1 (604) 806 7806 We have audited the consolidated balance sheets of BioteQ Environmental Technologies Inc. (a development stage company) as at December 31, 2003 and 2002 and the consolidated statements of operations and deficit and cash flows for the years then ended. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on 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, 2003 and 2002 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants Vancouver, B.C. February 13, 2004 (except for note 16, which is as of February 23, 2004) 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. P. 12 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT consolidated balance sheets As at December 31, 2003 and 2002 Assets Current assets Cash Short-term investments Trade receivables Receivable from joint venture partner Government grant receivable (note 6) Sales tax receivable and other Property, plant and equipment (note 7) Deferred financing costs Liabilities Current liabilities Accounts payable and accrued liabilities Liability component of Series A debentures (note 9) Shareholders' Equity Capital stock, warrants and contributed surplus (note 10) Equity component of Series A debentures (note 9) Deficit Going concern (note 2) Commitments (note 14) Subsequent event (note 16) Approved by the Board of Directors 2003 2002 $ 2,798,226 $ 1,776,457 - 27,068 56,362 424,009 - 231,023 - - 49,048 95,760 3,509,620 1,948,333 3,261,804 77,434 516,182 70,596 6,848,858 2,535,111 1,062,820 309,882 1,372,702 266,446 285,302 551,748 10,373,161 5,706,063 96,128 96,128 (4,993,133) (3,818,828) 5,476,156 1,983,363 $ 6,848,858 $ 2,535,111 Director Director BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 13 consolidated statements of operations and deficit For the years ended December 31, 2003 and 2002 Revenue Operating expenses Operating costs Amortization of property, plant and equipment Amortization of deferred financing costs General and administrative expenses Development costs Loss from operations Interest income Interest expense Loss for the year Deficit - Beginning of year Deficit - End of year 2003 2002 $ 89,239 $ - 25,550 22,390 11,914 985,452 187,208 - 7,374 3,970 585,229 465,607 1,232,514 1,062,180 1,143,275 1,062,180 (36,393) 67,423 (4,194) 23,048 1,174,305 1,081,034 3,818,828 2,737,794 4,993,133 3,818,828 Loss per share - basic and diluted $ (0.06) $ (0.09) P. 14 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT consolidated statements of cash flows For the years ended December 31, 2003 and 2002 Cash flows from operating activities Loss for the year Items not affecting cash Amortization of property, plant and equipment Amortization of deferred financing costs Accretion of Series A debentures Stock-based compensation Other Change in non-cash working capital items Cash flows from financing activities Issuance of common shares and warrants Share issuance costs Exercise of warrants and options Issuance of Series A debentures Series A debenture issuance costs Financing costs Cash flows from investing activities Purchase of property, plant and equipment Cash receipts from third parties credited to property, plant and equipment Increase in cash Cash - Beginning of year Cash - End of year Supplemental cash flow information Interest paid Non-cash financing and investing activities 2003 2002 $ (1,174,305) $ (1,081,034) 85,979 11,914 24,580 - (15,831) 331,356 97,353 3,970 8,193 39,516 - 4,917 (736,307) (927,085) 5,105,299 (568,370) 71,500 - - (18,752) 2,030,000 (232,620) - 400,000 (86,329) (15,000) 4,589,677 2,096,051 (2,831,601) - (2,831,601) (5,339) 17,205 11,866 1,021,769 1,180,832 1,776,457 595,625 2,798,226 1,776,457 42,843 14,855 Share capital issued in exchange for settlement of accounts payable 58,669 38,843 Government assistance receivable credited to property, plant and equipment Units issued in settlement of issue costs (note 10) - 228,695 17,205 101,500 Warrants issued in settlement of issue costs (note 10) $ 153,546 $ 47,892 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 15 notes to consolidated financial statements December 31, 2003 and 2002 1 Company operations BioteQ Environmental Technologies Inc. (BioteQ or the company) 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 operated in 2002. During 2003, the company commenced construction of two commercial plants, one of which was completed in 2003. The company is continuing to concentrate on marketing the Process. The principal operations of the company will be to build process plants and earn revenues from plant sales, recovered metals, fees and process licenses. 2 Going concern The company may require further capital to continue 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 from operations and arrange additional financing through equity and/or debt 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. There is no assurance that this financing, or cash flow from operations, 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 subsidiaries, Biomet and BioteQ Arizona, Inc. The accounts of the joint venture in which the company holds an interest are proportionately consolidated. All intercompany transactions and balances have been eliminated. 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. P. 16 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT notes to consolidated financial statements December 31, 2003 and 2002 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 Pilot plants Water treatment plants 5 years straight-line 5 years straight-line 10 - 20 years straight-line Costs relating to property, plant and equipment in the course of construction are capitalized. Upon commissioning, these costs will be amortized over the useful life of the asset. The company evaluates the carrying value of property, plant and equipment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The company recognizes an impairment loss when it is probable that estimated future non-discounted cash flows of the underlying asset will be less than the carrying value of the asset. Financing costs Costs incurred to obtain debt financing are deferred and amortized over the terms of the underlying debt. Costs incurred to obtain equity financing are applied against the proceeds when the related shares are issued. Revenue Revenue from the company's water treatment plants vary depending on the company's agreement with the various mining companies and can include: • revenue from managing and operating the plants recognized as the services are performed • revenue from concentrate sales recognized when the title of the concentrate passes to the customer and collection of proceeds is reasonable assured • lease revenue on the plants recognized over the term of the lease contract. Fees from engineering services are recognized as the services are rendered. Development costs The company expenses all costs associated with 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. BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 17 notes to consolidated financial statements December 31, 2003 and 2002 Government assistance 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 an increase to expense, in the year it is incurred, as determined by the original accounting treatment of the assistance. Loss per share 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, warrants or equivalents by application of the treasury stock method. For the years ended December 31, 2003 and 2002, the company excluded potential common share equivalents from the loss per share calculation as they were considered anti-dilutive. 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. Stock-based compensation Effective January 1, 2002, the company adopted the new recommendations of the Canadian Institute of Chartered Accountants (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 stock-based employee compensation awards. Consideration paid by employees on the exercise of stock options is recorded as share capital. The company discloses the pro forma effect of accounting for stock options awarded to employees under the fair value based method. 4 Development agreements The SOQUEM Inc. Partnership In March 2003, the company signed a memorandum of understanding with SOQUEM Inc., a wholly owned subsidiary P. 18 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT notes to consolidated financial statements December 31, 2003 and 2002 of SGF Mineral Inc., to build and operate BioSulphide® plants in Quebec. During 2003, the company incurred costs of $33,694 in researching potential plant sites in Quebec. If results of the research are positive, the company and SOQUEM Inc. will form a partnership to build and operate the plants. Raglan agreement On April 15, 2003, the company entered into a 10-year agreement to construct and operate a BioSulphide® plant at the Raglan mine owned by Falconbridge Limited (Falconbridge) in northern Quebec. The contract provides for a plant with a design capacity to treat at least 530,000 cubic meters of water per year. Construction of the plant was completed in November 2003 and cost the company $1,570,000. Under the contract, the company charges a fixed monthly fee of $24,500 and an operating fee based on cubic meters of water treated. The operating fee will be charged when the plant commences operations in 2004. The fees are subject to certain conditions and performance criteria that must be met by either Falconbridge or by the company, although the fixed monthly fee is unconditional for nine payments. During the year, the company recorded $49,000 of revenue related to the contract. After 63 months from installation of the plant, Falconbridge has the option to purchase the plant at BioteQ's cost, less straight-line depreciation at 5% per annum, in which case the contract would cease and BioteQ would be entitled to an ongoing technology fee. Caribou agreement In 2001, the company entered into a development agreement with Breakwater Resources Ltd. (Breakwater). The agreement provided for the installation of a BioSulphide® plant at Breakwater's Caribou mine in New Brunswick. Construction of the plant was completed in 2001 and commissioned in 2002. During 2003, the BioSulphide® plant was not operated due to different water management objectives of Breakwater and the company. On January 26, 2004, the company signed a new agreement to control all aspects of water management at the site. The new agreement with CanZinco Ltd. (a wholly owned subsidiary of Breakwater) provides for the operation of mine dewatering water collection and treatment at both the Caribou and Restigouche sites in New Brunswick. The agreement replaces all previous agreements regarding the Caribou site. The contract is for an initial term of six years and will commence after a three-month transition period during which the definitive details of an operating agreement will be finalized. 5 Bisbee Joint Venture In June 2003, the company signed an operating agreement with Phelps Dodge Corporation (PD) for the operation of a 50:50 joint venture water processing project at PD's Bisbee property in southern Arizona. The plant will recover copper from a low-grade process stream. The operating and capital costs of the project will be shared equally; however, the company has provided a capital cost guarantee to PD that PD's contribution will not exceed 50% of US$1,900,000, the estimated capital cost before contingency. During July 2003, the company completed a construction contract with the joint venture operating company, Copreco, LLC, for the construction, management and commissioning of the Bisbee plant. The company is managing the project during construction and for the first year of operation. At December 31, 2003, the company's 50% proportionate BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 19 notes to consolidated financial statements December 31, 2003 and 2002 interest in the joint venture is represented in the consolidated financial statements by property, plant and equipment of $1,210,757 and a current liability of $424,099. Cash used in investing activities was $1,210,757 and cash provided by operating activities was $424,009. During the year, there were no revenue or expenses of the joint venture. The total estimated capital cost of the project upon completion is US$2,550,000. 6 Government assistance In June 2001, the company entered into an agreement with the National Research Council Canada, Industrial Research Assistance Program (IRAP) to provide funds to assist in developing and operating the Process plant at the Caribou mine. The maximum IRAP contribution was the lesser of $427,580 and 33% of the total cost incurred in the performance of the work to March 31, 2003. 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 $78,431 (2002 - $339,343) of government assistance. Of this amount, $49,048 (2002 - $187,004) has been recorded against the government grant receivable outstanding as at December 31, 2002, $29,383 (2002 - $135,134) has been recorded as a reduction to development expenses, and in 2002, $17,205 has been recorded as a reduction of the cost of property, plant and equipment. 7 Property, plant and equipment Pilot plants Less: Accumulated amortization Office equipment Less: Accumulated amortization Water treatment plants - net Less: Accumulated amortization Water treatment plant in progress 2003 $ 351,193 (351,193) - 73,939 (28,652) 45,287 2,044,071 (56,514) 1,987,557 1,228,960 3,261,804 2002 $ 351,193 (311,293) 39,900 41,594 (19,347) 22,247 473,775 (19,740) 454,035 - 516,182 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 $221,414 has been offset against the cost of the water treatment plant at the Caribou Mine. Amortization expense for the year ended December 31, 2003 amounted to $85,979 (2002 - $97,353). In 2003, $63,589 (2002 - $89,979) relates to the amortization of the pilot plants and the Caribou Mine water treatment plant and has been included within development costs on the statement of operations. P. 20 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT notes to consolidated financial statements December 31, 2003 and 2002 The recoverability of the water treatment plants is dependent upon successful continual operation of the plants and attainment of set performance criteria. 8 Development costs Cumulative development costs incurred to date are as follows: Laboratory process development Labour costs Laboratory operations Patents Other Investment tax credit Pilot plants Labour costs Pilot plant operations Other Amortization of pilot plants Marketing - engineering labour and sundry Government grant Caribou plant Commissioning Amortization Government grant Interest Total cumulative development costs 2003 $ 760,557 320,605 33,546 71,900 (67,287) 1,119,321 149,033 369,302 66,670 358,383 943,388 621,864 (84,242) 537,622 260,218 43,429 (129,323) 174,324 7,706 2,782,361 All development costs are charged to the statement of operations. The company has had the following cumulative transactions since inception with related parties: Included in cumulative development costs: Intangible assets purchased from shareholders Interest charged by a shareholder Provision of engineering services by shareholders Laboratory expenses incurred by shareholders The amounts paid for the services are based on their exchange amount. 2003 $ 20 4,284 265,383 68,356 2002 $ 734,822 308,636 33,546 56,350 (67,287) 1,066,067 149,033 437,495 66,670 318,483 971,681 466,123 (62,659) 403,464 248,018 19,740 (121,523) 146,235 7,706 2,595,153 2002 $ 20 4,284 265,383 68,356 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 21 notes to consolidated financial statements December 31, 2003 and 2002 9 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 in 2002 Less: Liability component Shareholders' equity component Less: Issue costs applicable to shareholders' equity component Net amount classified as shareholders' equity at issuance in 2002 $ 400,000 (277,109) 122,891 (26,763) 96,128 Interest expense on the liability component is $64,580 (2002 - $21,124), of which $24,580 (2002 - $8,193) represents accretion of the liability component. All cash interest incurred to date related to the debentures has been paid. P. 22 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT notes to consolidated financial statements December 31, 2003 and 2002 10 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, 2001 18,875,884 3,812,324 Shares issued for accounts payable 77,686 38,843 - - Private placement for cash (a) 4,060,000 1,642,501 387,499 Share issuance costs (a) Units issued in settlement of issue - (278,476) (103,536) costs (a) 203,000 77,554 23,946 Warrants issued in settlement of issue costs (a) Issuance of stock options and warrants for services rendered - - - - 47,892 18,000 3,830,324 - - - - - 38,843 2,030,000 (382,012) 101,500 47,892 - 39,516 39,516 Balance - December 31, 2002 23,216,570 5,292,746 355,801 57,516 5,706,063 Private placement for cash (b) 940,000 389,619 80,381 Share issuance costs (b) Units issued in settlement of issue - (61,741) (21,399) costs (b) 47,000 19,481 Warrants issued in settlement of issue costs (b) - - Shares issued for accounts payable 93,125 58,669 4,019 8,725 - Private placement for cash (c) 3,764,713 2,031,137 604,162 Share issuance costs (c) Units issued in settlement of issue - (294,865) (166,374) costs (c) 158,135 85,317 Warrants issued in settlement of issue costs (c) - - 25,378 78,385 Public offering for cash (d) Share issuance costs (d) Units issued in settlement of issue 2,857,142 1,728,438 271,562 - (282,860) (123,372) costs (d) 135,000 71,905 Warrants issued in settlement of issue costs (d) - - Exercise of warrants and options 140,000 71,500 22,595 66,436 - - - - - - - - - - - - - - - 470,000 (83,140) 23,500 8,725 58,669 2,635,299 (461,239) 110,695 78,385 2,000,000 (406,232) 94,500 66,436 71,500 Balance - December 31, 2003 31,351,685 9,109,346 1,206,299 57,516 10,373,161 a) 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 were $382,012, of which $101,500 was settled with the issue of 203,000 units and $47,892 was 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. BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 23 notes to consolidated financial statements December 31, 2003 and 2002 b) On January 15, 2003, the company completed an over-allotment on the above private placement by issuing a further 940,000 units for gross proceeds of $470,000. Issue costs were $83,140, of which $23,500 was settled with the issue of 47,000 units and $8,725 was settled with the issue of 94,000 warrants. c) During October and November 2003, the company completed a unit private placement of 3,764,713 units at $0.70 per unit for gross proceeds of $2,635,299. Issue costs were $461,239, of which $110,695 was settled with the issue of 158,135 units and $78,385 was settled with the issue of 376,471 warrants. Each unit comprises 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 at a price of $0.85 during the first year and $1.00 during the second year. Of the gross proceeds, $2,031,137 was attributable to the common shares and $604,162 was attributable to the non- transferable common share purchase warrants. d) During November 2003, the company completed a public offering of 2,857,142 units at a price of $0.70 per unit for gross proceeds of $2,000,000. Issue costs were $406,232, of which $94,500 was settled with the issue of 135,000 units and $66,436 was settled with the issue of 285,714 warrants. Each unit comprises one common share and one- half of one non-transferable share purchase warrant. Each warrant entitles the holder to purchase one additional common share for a period of two years at a price of $0.85 during the first year and $1.00 during the second year. Of the gross proceeds, $1,728,438 was attributable to the common shares and $271,562 was attributable to the non- transferable common share purchase warrants. e) 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: 2003 Weighted average exercise price $ 0.61 0.72 0.65 0.64 0.62 Number 2,600,000 850,000 (200,000) 3,250,000 2,583,329 2003 Weighted average exercise price $ 0.63 0.54 0.58 0.61 0.63 Number 2,150,000 750,000 (300,000) 2,600,000 2,000,000 Outstanding - January 1 Options granted Options cancelled Outstanding - December 31 Exercisable at December 31 Available for future grant pursuant to company's stock option plan at December 31 540,714 1,190,714 The following table summarizes information about common share options outstanding at December 31: Range of exercise prices $ Number outstanding at December 31 Weighted average remaining contractual life (years) Weighted average exercise price $ 2002 2003 0.50 - 0.67 0.50 - 0.72 2,600,000 3,250,000 3.6 3.1 0.61 0.64 P. 24 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT notes to consolidated financial statements December 31, 2003 and 2002 Had compensation expense for stock options been determined by a fair value based method in accordance with the provision of CICA Handbook Section 3870, the company's loss for the year would have been reduced to the pro forma amount indicated below: Loss - reported Loss - pro forma as previously reported Adjustment Loss - pro forma as restated Loss per share - as reported Loss per share - pro forma as previously reported and restated 2003 $ 1,174,305 1,475,882 - 1,475,882 0.06 0.08 2002 $ 1,081,034 1,317,922 (192,448) 1,125,474 0.09 0.09 The 2002 pro forma loss has been restated to recognize compensation expense over the vesting period. The fair value of stock options granted is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: Expected dividend yield Expected stock price volatility Risk-free interest rate Expected life of options (years) 2003 0% 73% 3.90% 3 2002 0% 86% 3.95% 5 The weighted fair value average price and weighted average exercise price of options granted in the years indicated were as follows: 2002 2003 Weighted fair value Weighted average average exercise price exercise price $ 0.47 0.72 $ 0.54 0.72 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, 2003, all the options had vested. The company recorded an expense of $30,317 during 2002 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. 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 recorded an expense of $9,199 during 2002 based on the fair value of the warrants at the date of grant. BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 25 notes to consolidated financial statements December 31, 2003 and 2002 f) Warrants As at December 31, 2003, the following warrants were outstanding. Outstanding - January 1 Granted Cancelled Number 4,845,154 7,229,604 (130,000) Outstanding - December 31 11,944,758 2003 Weighted average exercise price $ 0.74 0.90 0.50 0.84 2002 Weighted average exercise price $ 0.50 0.75 0.50 0.74 Number 370,000 4,715,154 (240,000) 4,845,154 On December 20, 2002, the company granted the agent for a 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. On January 15, 2003, an overallotment of the private placement resulted in a further 94,000 warrants being granted. The company has treated these costs as share issue costs based on their fair value. In October and November 2003, the company granted the agent for the private placement, common share purchase warrants to buy 376,471 common shares at a price of $0.85 within the first year and $1.00 within the second year from the grant date. The company has treated these costs as share issue costs based on their fair value. On November 18, 2003, the company granted the agent for the public offering, common share purchase warrants to buy 285,714 common shares at a price of $0.85 within the first year and $1.00 within the second year from the grant date. The company has treated these costs as share issue costs based on their fair value. g) Escrow shares The shares issued at December 31, 2003 include 7,000,000 performance shares which will be released from escrow based upon the cash flow performance of the company determined annually in accordance with the policies of the exchange. The company must generate a cash flow of $0.30 for each performance share to be released from escrow. Any performance shares that have not been released within 10 years from issuance will be cancelled and returned to the company's treasury. 11 Related party transactions and balances At December 31, 2003, a director holds $100,000 of the convertible debentures (note 9) issued on September 5, 2002. 12 Tax loss carry-forward As at December 31, 2003, the company has approximately $888,000 of research and development expenditures available for unlimited carry-forward, $4,324,000 of undeducted expenditures for tax purposes related primarily to share issue costs and property, plant and equipment, and $86,000 of investment tax credits, expiring 2008 to 2010, all of which may be used to reduce future Canadian income taxes otherwise payable. P. 26 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT notes to consolidated financial statements December 31, 2003 and 2002 The company has accumulated losses of approximately $4,427,000 for income tax purposes which may be deducted in the calculation of taxable income in future years. The losses expire as follows: 2004 2005 2006 2007 2008 2009 2010 $ 115,000 312,000 43,000 466,000 1,036,000 1,145,000 1,310,000 4,427,000 As at December 31, 2003, the company's future tax assets and liabilities were as follows: Property, plant and equipment Financing costs Research and development expense carry-forwards Non-capital loss carry-forwards Total future tax assets Valuation allowance Total future tax assets 2003 $ 78,000 272,000 372,000 1,577,000 2,299,000 (2,299,000) - 2002 $ 792 261,096 499,212 951,276 1,712,376 (1,712,376) - 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 of tax allocation. The reconciliation of income tax attributable to operations computed at the statutory tax rates to income tax expense (recovery), using a 37.62% (2002 - 39.62%) statutory tax rate, at December 31 is: Income tax recovery at statutory rates Change in valuation allowance Share issue costs Difference between current and future tax rates Non-deductible expenses and other 13 Financial instruments Fair value of financial instruments 2003 $ (441,774) 586,624 (209,321) 45,980 18,491 - 2002 $ (428,306) 408,681 (115,676) 68,495 66,806 - The company's financial instruments include cash, short-term investments, trade receivables, receivable from joint venture partner, government grant receivable, sales tax receivable and other, and accounts payable and accrued liabilities. Given the short-term nature of these items, the fair values of these financial instruments approximate their carrying values. BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT P. 27 notes to consolidated financial statements December 31, 2003 and 2002 Credit risk exposure The company's exposure to credit risk is as indicated by the carrying value of its receivables. The company mitigates this risk by reviewing and monitoring these balances. 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 Commitments The company is committed to minimum annual lease payments for office premises and equipment as follows: 2004 2005 2006 $ 83,000 77,000 50,000 The company is committed to spend an additional amount of approximately $900,000 to complete the Bisbee plant. 15 Segmented information The company currently has one operating segment (see note 1). Geographic disclosures are as follows: Revenue Canada U.S. Other Property, plant and equipment Canada U.S. 16 Subsequent event Debt financing agreement 2003 $ 49,000 10,169 30,070 89,239 2002 $ - - - - 2,032,844 1,228,960 3,261,804 516,182 - 516,182 Early in 2004, the company finalized a financing agreement for a $800,000 demand non-revolving loan. Proceeds from the loan will be used to refinance the Raglan plant. The first advance of $200,000 was received on February 23, 2004. The second advance of $600,000 is receivable when the Raglan plant commences operations and meets certain performance criteria. Interest will be charged, at the company's option, at the prime rate plus 1.5% or at the bank's fixed cost of funds plus 3%. As security for the loan, the company has provided a fixed first charge over all its property in Quebec and a general security interest in all personal property of the company. The company has also assigned the monthly fixed fee payments from Falconbridge as security for the monthly repayment to the Lender. P. 28 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT corporate information Directors Head Office P. Bradley Marchant President & CEO of the Company Vancouver, B.C. George W. Poling Chairman of the Board of Directors of the Company Senior Vice President Rescan Environmental Services Ltd. Vancouver, B.C. Kelvin P.M. Dushnisky Vice President, Regulatory Affairs Barrick Gold Corporation Toronto, Ontario Anthony T. Kana Financial Services Consultant Vancouver, B.C. Clement A. Pelletier President & CEO Rescan Environmental Services Ltd. Vancouver, B.C. Ian W. Telfer Chairman & CEO Wheaton River Minerals Ltd. Vancouver, B.C. Kenneth F. Williamson Independent Consultant Dwight, Ontario Officers and Management P. Bradley Marchant President & CEO Richard W. Lawrence Executive Vice President John C. York Chief Financial Officer David Kratochvil Manager, Engineering and Development 355 Burrard Street, Suite 1700 Vancouver, B.C., Canada V6C 2G8 Tel: 604-685-1243 Fax: 604-685-7778 Email: bioteq@bioteq.ca Montreal Office 1010 Sherbrooke Street W., Suite 1800 Montreal, Quebec H3A 2R7 Tel: 514-849-7559 Fax: 514-221-3308 Investor Relations Tel: 1-800-537-3073 Email: investor@bioteq.ca Legal Counsel 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 BIOTEQ ENVIRONMENTAL TECHNOLOGIES INC. 2003 ANNUAL REPORT 355 Burrard Street, Suite 1700 Vancouver, B.C., V6C 2G8, Canada Tel: (604) 685-1243 Fax: (604) 685-7778 email: bioteq@bioteq.ca website: www.bioteq.ca