QuestAir Technologies Inc.
Annual Report
For the Year Ended September 30, 2008
Additional information relating to the Company, including a copy of the Company’s Annual Information
Form, can be found on SEDAR at www.sedar.com.
President’s Message
2008 was a transformational year for QuestAir. We expanded our reach into the biogas market while
significantly improving our financial results over fiscal 2007, with a 63% increase in revenue to $11.4
million and a 33% reduction in cash burn to $7.1 million for fiscal 2008.
The dramatic reduction in cash usage in the second half of the fiscal year confirmed that the measures we
undertook at mid-year to reduce our operating expenses had an immediate, decisive effect. We ended the
year with a cash balance of $9.6 million, providing us with growth capital that will allow us to weather
the economic crisis that has unfolded over the past few months.
The gains we made in fiscal 2008 were achieved in a challenging business environment that included an
extremely strong Canadian dollar, tightening credit conditions and delays in European subsidies for the
biogas upgrading industry.
Strong progress in the biogas market
We made substantial headway in the biogas market during the year, signing supply and distribution
agreements with two of our repeat customers - Phase 3 Developments and Investments LLC in the United
States and Verdesis Suisse SA in Europe. These partners are strong supporters of QuestAir’s products,
having integrated our pressure swing adsorption (“PSA”) systems into their biogas upgrading plants. In
April 2008, we announced an order from Phase 3 to provide an M-3200 PSA system to the Hilarides
Dairy in Lindsay, California. The PSA unit will be integrated into a commercial scale plant designed to
generate renewable compressed natural gas (“CNG”) vehicle fuel from agricultural waste.
Also during the year, we received two new orders from Verdesis for M-3200 methane purification
systems to be installed in Europe. Both systems will purify methane generated from anaerobic digestion
of organic waste.
In 2008 we expanded our product offering in the biogas market to include integrated upgrading plants that
incorporate all the equipment necessary to produce compressed, purified renewable natural gas from raw
biogas. In addition, we plan to offer value-added services including plant operating contracts and
maintenance contracts. By expanding our product and services offering in the biogas market, we expect to
increase the size of our addressable market and create sustained recurring revenue streams from each
upgrading plant that we sell.
In July 2008, the British Columbia Government announced funding for several clean energy projects
through the Innovative Clean Energy (“ICE”) Fund. We expect to supply biogas upgrading plants for two
of these projects, including a $1.1 million biogas upgrading project at the Lions Gate Wastewater
Treatment Plant in West Vancouver. This project will recover and upgrade biogas generated from the
digestion of municipal sewage. We are working with Terasen Gas, the principle natural gas distributor in
the province of B.C., and Metro Vancouver, the owner of the waste water treatment facility, on this
project. It is expected to supply renewable energy to heat approximately 100 homes.
In September 2008, we signed a Memorandum of Understanding with Terasen Gas to work jointly on the
development of projects to produce supplies of biomethane from organic waste. Renewable natural gas
generated from these projects would be injected into the existing pipeline system operated by Terasen Gas
for distribution to homes and businesses.
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In the hydrogen purification market, we secured a number of orders for H-3200 PSA systems, including
the sale of two systems for hydrogen plants in Mexico and Russia and three hydrogen PSA units to
Iwatani for the Japanese market. However, we did not achieve our objective of growing the hydrogen
PSA business in fiscal 2008.
In the refinery hydrogen market, we achieved a substantial technical success with the completion of the
field test of the H-6200 hydrogen purifier at an ExxonMobil affiliate refinery in France. However, our
marketing efforts in the refinery market were impacted by the recent drop in oil prices and delays in
certain target customer projects, affecting our near-term H-6200 sales prospects. During 2008 we also
announced a new engineering service contract with ExxonMobil Research and Engineering (“EMRE”)
valued at US$6.35 million, which will allow for the further development and commercialization of
QuestAir’s rapid-cycle PSA technology.
2009 Outlook and Milestones
Looking forward to fiscal 2009, we face a challenging near-term economic environment in certain target
markets.
In the biogas market, growth prospects in Europe remain strong. Recently introduced subsidies for biogas
upgrading projects in Germany are expected to drive significant growth in that market in 2009. In the
North American biogas market, the recent fall in natural gas prices from historic highs is expected to have
some impact on marginal biogas projects, particularly some single farm projects where the economies of
scale are not as strong. We believe that the longer term macro-economic drivers of the biogas market in
North America remain strong, and a growing number of gas utilities and governments in North America
are actively supporting the development of biogas upgrading projects as a source of renewable natural
gas. In addition, the production of renewable CNG vehicle fuel from biogas represents a significant value-
added end use of biogas that we expect will drive additional growth in the biogas upgrading market.
In the hydrogen market, we expect that demand for purification solutions in the oil refining and steel
manufacturing sectors will decline due to the current economic climate. However, this may mean that
capital projects will be scaled back in some cases, resulting in the purchase of smaller capacity hydrogen
plants or purification systems – a market where we have a competitive advantage. The economic climate
has also affected our business in the refinery hydrogen market. Oil prices have declined significantly from
their peak in July 2008. In turn, many oil refineries have delayed capital projects and reduced capital
spending. While we believe that the market opportunity for the H-6200 refinery hydrogen purifier
remains strong, we expect some delay in the development of additional H-6200 projects. At present, we
do not have adequate visibility to forecast an H-6200 sale in fiscal 2009.
QuestAir well positioned going forward
Despite current economic conditions, I am confident that QuestAir is well positioned going forward from
a cash, product and strategy standpoint. Fiscal 2009 will be an important year in terms of building out our
biogas-focused strategy while ensuring that we continue to serve our core customers in the hydrogen
market. Our efforts to grow the biogas business, particularly the emphasis we are placing on expanding
our channels to market and selling complete solutions, will not be reflected in our financial results
immediately. However, we expect that substantial progress will be made in fiscal 2009 to implement our
biogas-focused growth strategy, which will translate into improved financial performance in future years.
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Turning to our financial outlook, our strong order backlog as at September 30, 2008 will support forecast
revenues in fiscal 2009 in the range of $10 million to $12 million, compared to $11.4 million in fiscal
2008. Our continued focus on prudent cash management and reducing investment in self-funded research
and development will deliver further reductions in cash burn in fiscal 2009. We are forecasting cash used
in operations and capital expenditures of $4 million to $5 million, down from $7.1 million in fiscal 2008.
In closing, I would like to thank all of our employees for their hard work, dedication and achievements
throughout the year. QuestAir’s competitive advantage is based largely on the world-leading expertise of
our people, and I am grateful to work with such a bright and dedicated group of professionals on a daily
basis.
Sincerely,
(signed)
Andrew G. Hall
President & CEO
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Management Discussion & Analysis for the year ended September 30, 2008
The following management discussion and analysis (“MD&A”), dated December 3, 2008 (with the
exception of the ‘Outstanding Share Data’, which is dated November 30, 2008) should be read in
conjunction with the Company’s audited financial statements and related notes therein that are prepared in
accordance with Canadian generally accepted accounting principles (“Canadian GAAP”). All financial
information is stated in Canadian dollars, unless otherwise indicated. Additional information regarding
QuestAir Technologies Inc. (“QuestAir” or “the Company”), can be found on the System for Electronic
Document Analysis and Retrieval (SEDAR) at www.sedar.com.
Forward Looking Statements
This MD&A contains forward-looking statements, including statements regarding the future success of
our business, technology, and market opportunities. Forward-looking statements typically contain words
such as “believes”, “expects”, “anticipates”, “continue”, “could”, “indicates”, “plans”, “will”, “intends”,
“may”, “projects”, “schedule”, “would” or similar expressions suggesting future outcomes or events,
although not all forward-looking statements contain these identifying words. Examples of such statements
include, but are not limited to, statements concerning: (i) expectations regarding the Company’s future
success in the biogas and other markets; (ii) the key market drivers and other factors that are expected to
impact the Company’s performance; (iii) future financial results; (iv) the expected actions of the thir d
parties described herein; (v) the expected use of proceeds from previous financings and other cash
resources; and (vi) the business and financial outlook of the Company for fiscal 2009. In addition, this
MD&A contains financial outlook information that is intended to provide general guidance for readers
based on management’s current estimates, but which is based on numerous assumptions and may prove to
be incorrect and therefore such financial outlook information should not be relied upon by readers. These
statements are neither promises nor guarantees, but involve known and unknown risks and uncertainties
that may cause our actual results, level of activity, performance or achievements to be materially different
from any future results, levels of activity, performance or achievements expressed in or implied by these
statements. These risks include, but are not limited to, risks related to revenue growth, operating results,
industry and products, technology, competition, general economic conditions and those factors described
in detail herein under the heading ‘Risks & Uncertainties’.
The forward-looking statements contained herein are also based on assumptions that management
believes are current and reasonable, including but not limited to, assumptions regarding: (i) trends in
certain market segments and the economic climate generally; (ii) the financial strength of our customers;
(iii) the value of the Canadian dollar; and (iv) the expected expenses of the Company going forward. The
Company cannot assure readers that actual results will be consistent with the statements contained in this
MD&A. The forward-looking statements and financial outlook information contained herein are made as
of the date of this MD&A and are expressly qualified in their entirety by this cautionary statement.
Except to the extent required by law, the Company undertakes no obligation to publicly update or revise
any such statements to reflect any change in our expectations or in events, conditions, or circumstances on
which any such statements may be based, or that may affect the likelihood that actual results will differ
from those described herein.
Our Vision, Strategy and Core Business
Vision and Strategy
QuestAir’s strategic goal is to become a leader in the development, manufacture and supply of pressure
swing adsorption (“PSA”) systems and integrated gas plants for upgrading biogas to either pipeline or
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vehicle -fuel grade renewable natural gas. Biogas is a methane-containing renewable energy source
created from organic material in municipal and agricultural waste. Our near-term focus is on smaller
capacity systems for single farm anaerobic digesters and smaller landfill gas projects, although we offer a
complete range of products up to very large landfill and multi-farm digester projects.
Our strategy to achieve this goal has the following key elements:
1. Expanding our offering over time to include value-added services such as gas plant operating
contracts and maintenance contracts to biogas project developers;
2. Leveraging key relationships with leading channel partners and project developers;
3. Investing prudently in product development to enhance the competitiveness of our gas purification
products;
4. Marketing our hydrogen PSA systems to existing customers and applications where we have a
compelling competitive advantage. This includes the H-6200 refinery hydrogen purifier, which we
developed in collaboration with ExxonMobil Research and Engineering (“EMRE”); and
5. Pursuing profitable customer-funded engineering and research and development contracts to enhance
QuestAir’s rapid-cycle PSA technology and develop longer term growth opportunities for the
Company.
Core Business
QuestAir is a developer and supplier of advanced gas purification systems. Our products target a range of
energy and industrial markets. Our primary focus is in the biogas upgrading market, although we also
market PSA systems in the oil refining, industrial hydrogen and natural gas processing markets.
Our compact, modular gas purification products incorporate proprietary PSA technology and offer
significant economic and operational benefits over competing gas purification technologies, including
reduced capital, installation and operating costs. Our proprietary technology is protected by 57 granted
patents covering 27 distinct inventions and 61 pending patent applications covering 12 distinct inventions in
the United States, Canada, and certain European, Asian, and other countries.
QuestAir has approximately 50 employees located at our facility and corporate headquarters in Burnaby,
Canada. We market and support our products on a global basis from our Burnaby facility.
Products, Markets & Customers
Biogas: QuestAir’s PSA systems are used to remove impurities such as carbon dioxide and water vapor
from biogas, generating pipeline- or compressed natural gas (“CNG”)-grade methane. System integrators
such as Phase 3 Renewables LLC (“Phase 3”), Verdesis Suisse SA (“Verdesis”) and SCS Engineers
currently integrate QuestAir’s M-3100 and M-3200 PSAs into biogas upgrading plants that produce
purified renewable natural gas from raw biogas. In fiscal 2008 we signed supply agreements with both
Verdesis and Phase 3 to support our growth in both the European and US biogas markets.
In 2008 we expanded our product offering to include integrated upgrading plants that include all the
equipment necessary to produce compressed purified renewable natural gas from raw biogas. We are
marketing these plants as a turn-key upgrading solution directly to biogas project developers. In addition,
we plan to offer value-added services including plant operating contracts and maintenance contracts. By
expanding our product and services offering, we expect to increase the size of our addressable market, the
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paths to market, and the dollar value of equipment orders, and provide the opportunity to generate
recurring revenue streams over the lifetime of the equipment.
In 2008 we signed a Memorandum of Understanding with Terasen Gas (“Terasen”) to support Terasen’s
request for expressions of interest (“RFEOI”) in the development of biogas upgrading projects in British
Columbia. We expect that our first sales of integrated biogas upgrading plants will include projects
arising from Terasen’s RFEOI.
To date we have sold 10 methane PSA systems for integration into biogas upgrading plants in Europe and
North America, including two projects that produce renewable CNG vehicle fuel from biogas.
Industrial Hydrogen: We also sell our H-3100 and H-3200 range of hydrogen PSAs for use in on-site
hydrogen plants, and for recovering hydrogen from various off-gas streams in the petrochemical industry.
Since 1997 we have sold more than 100 hydrogen PSA systems to over 45 customers in North America,
Latin America, Asia and Europe.
We market and distribute our products directly to customers, and we also have non-exclusive distribution
agreements with leading hydrogen plant vendors including Iwatani International and Mitsubishi Kakoki
Kaisha. We also have a manufacturing license agreement for our hydrogen purifiers with Hydro-Chem, a
leading global supplier of hydrogen plants in the intermediate capacity range.
Our industrial hydrogen PSAs use the same mechanical platform as our biogas PSAs, which allows us to
leverage product improvements or new product designs in both markets.
Hydrogen for Oil Refining: We have developed proprietary ‘rapid cycle’ PSA technology which we have
incorporated into our large capacity H-6200 hydrogen purifier. The H-6200 was developed in
collaboration with EMRE for use in a range of potential applications in the oil refining and petrochemical
industries. A prototype of the H-6200 hydrogen purifier (the “prototype plant”) was field tested at an
ExxonMobil refinery in France in 2008, and has entered commercial service following the successful
conclusion of the test. Data from this test will be used to help market this product to other refineries
around the world.
The H-6200 offers customers the benefits of a smaller footprint and lower cost relative to competitive
products. The product has a skid-mounted, modular design which makes it easy to install and lowers the
total erected cost compared to competitive products. Importantly, the H-6200 offers refineries a cost-
effective way to increase their available hydrogen by allowing refineries to recover hydrogen from
hydrogen-containing waste streams. In addition, the H-6200 hydrogen purifier can be integrated with
existing hydrotreating equipment in order to debottleneck production, allowing refineries to process more
oil and improve the ir operational efficiency.
In 2006 we signed a marketing agreement with EMRE that covers the marketing of the H-6200 hydrogen
purifier to third party customers in the oil refining industry. The agreement outlines the roles that each
party will play in the marketing process, and how the commercial gain from the sales of the product will
be shared between QuestAir and EMRE.
Key Market Drivers
We believe that there are a number of key market drivers that will have an important impact on
QuestAir’s long term prospects and our ability to create shareholder value:
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• Demand for renewable energy: Environmental concerns regarding glo bal warming and climate
change have collectively increased the demand for renewable energy sources such as biogas. Purified
or ‘upgraded’ biogas provides natural gas utilities and users with a renewable source of natural gas
supply and the ability to reduce the carbon footprint of their supply base.
• Energy Security: Concerns regarding energy security in both Europe and North America have
prompted the development of domestic (and in many cases renewable) energy sources. Biogas
generated from municipal waste at landfills and waste water treatment facilities, or from agricultural
waste on farms, is a secure, domestic source of energy.
• Waste Management: Animal manure represents a significant source of air emissions (odor and
volatile organics) and groundwater contamination in the agricultural sector worldwide. Anaerobic
digestion of this waste material generates a more environmentally benign solid that can be spread
directly on crop land, with a lower risk of groundwater contamination. This anaerobic digestion
process produces raw biogas which is available for upgrading to renewable natural gas.
• Commodity Prices: The long-term trend of ris ing natural gas prices has improved the economics of
upgrading biogas to pipeline or vehicle -fuel quality. In the oil refining market, which is significant
user of natural gas, rising input prices have focused attention on technologies for increasing the
efficiency of the refining processes, and for processing unexploited sources of natural gas.
• Government incentives and regulations: Governments have provided direct incentives and/or funding
for the development of biogas upgrading projects. In Canada, provincial governments have each
introduced financial incentives for biogas upgrading projects in Ontario, Alberta and British
Columbia. Likewise, a number of US state governments have introduced renewable energy portfolio
standards and have increased the demand for renewable natural gas as a fuel for the centralized
generation of renewable electricity. In Europe, the German Government amended its German
Renewable Energy (“EEG”) Act in June 2008 to provide direct subsidies for the production of
renewable natural gas from biogas. Similarly, in the oil refining market, government regulations
mandating reduced sulphur levels in transportation fuels have driven the demand for hydrogen in the
oil refining industry to desulphurize crude oil feedstocks.
Key Performance Indicators
Management uses a number of key performance indicators to monitor and assess the implementation of
our strategy and the achievement of our goals. These performance indicators include both quantitative and
qualitative measures of performance, as follows:
• Sales Bookings and Backlog: QuestAir recognizes revenue from the sale of gas purification systems
and engineering service contracts. While revenue from the sale of long-term production type contracts
and engineering service contracts is recognized on a percentage-of-completion basis over the life of
the contract, revenue from the sale of our commercial gas purification systems is only recognized
once the systems have been installed, commissioned and accepted by the customer1. Given the typic al
lead times of six to 12 months between receipt of an order for a gas purification system and
installation and commissioning, recognized revenues do not give a current view of our commercial
performance. Consequently, we monitor sales bookings and changes in backlog as more current
measures of our commercial performance. Sales bookings are defined as signed orders supported by a
firm purchase order, while backlog represents the future revenue from signed orders that have not yet
been recognized as revenue.
1 Refer to the ‘Critical Accounting Policies and Estimates’ section of the MD&A for an overview of QuestAir’s revenue recognition
policy.
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• Cash Burn: We balance the need to conserve cash in order to limit dilution arising from potential
future equity financings with the need to invest in the future growth of our business, which requires
investments in research and development, sales and marketing activities and manufacturing capacity.
We monitor ‘cash used in operations and capital requirements’ as a measure of our operational cash
burn. It should be noted that this is a non-GAAP measure, and a reconciliation to GAAP measures is
provided in the ‘Liquidity and Capital Resources’ section of this MD&A.
• Product Delivery On Time and On Budget: QuestAir tracks its performance against expected delivery
dates and product costs for each PSA unit delivered to customers. On time delivery is a key
contributor to customer satisfaction and timely recognition of revenue. Monitoring the costs for each
product sold allows us to closely track expected margins to actual and thereby detect costing issues
promptly.
• Progress Against Key Product Development Timelines and Milestones: The timing and technical
progress of our key development programs, including the ongoing engineering service contracts with
EMRE, will have a critical impact on our future revenue growth and profitability. Consequently we
closely monit or progress made in each development program relative to key program milestones and
timelines.
• Patents & Intellectual Property: QuestAir’s competitive advantage is driven in large part by our
technical leadership and strong intellectual property position. We monitor the breadth and quality of
our patent portfolio relative to those of our competitors as an important measure of our technical
competitive advantage.
Resources and Capabilities
We have the following resources and capabilities at our disposal in order to execute our growth strategy:
• Non Capital Resources: A significant portion of our sustainable competitive advantage is derived
from our proprietary PSA technology and strong suite of intellectual property. Our technology
leadership and the value proposition of our products are driven directly by the innovation and
technical expertise of our employees, and consequently, our human resources are our most critical
non-capital resource.
• Financial Resources: At September 30, 2008, QuestAir had cash resources and short term
investments totaling $9.6 million (including $0.3 million of restricted cash), in addition to US$1.8
million available under our credit facilit ies with Comerica Bank. At the forecast cash burn rate, we
have sufficient financial resources to fund our operations for more than 12 months.
• Systems and Processes: We evaluate our management and control systems against evolving corporate
governance regulations and guidelines. We follow a rigorous product management process to manage
our key development programs to ensure that all new products meet customer specifications, quality
requirements and delivery timelines. In addition, the relevant components of our commercial PSA
products are certified to the standards of the Canadian Standards Association (CSA) and Underwriters
Laboratory (UL), and conform to the legal requirements of the European Union (CE).
• Partnerships with Market Leaders: A key element of our strategy is to leverage the resources,
technical expertise and distribution channels of our development partners and customers. We have
established distribution agreements with Phase 3, Verdesis, Iwatani, Mitsubishi, and Hydro-Chem,
while in the oil refining market we have a strong partnership and working relationship with EMRE.
We believe that these relationships are a source of competitive advantage for QuestAir.
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Business Overview
Fiscal 2008 was in many ways a transformational year for QuestAir.
During the year, we made substantial headway in the biogas market. We signed two supply and
distribution agreements in our primary geographic markets: Phase 3 in the United States and Verdesis in
Europe. These two companies have been repeat customers and strong supporters of QuestAir’s products,
having integrated our PSAs into their biogas upgrading plants.
In April 2008, we announced an order from Phase 3 to provide an M-3200 PSA to the Hilarides Dairy in
Lindsay, California. Our PSA will be integrated into a plant designed to generate renewable biomethane
fuel from agricultural waste. This will be the first commercial scale plant generating transportation fuel
from anaerobic digestion of manure in North America.
Also during the year, we received two new orders from Verdesis for methane purification systems to be
installed in Europe. Both systems will purify methane generated from anaerobic digestion of organic
waste. One installation will be used by a consortium of Swiss farmers while the other will be fed with
waste from an industrial application. Verdesis will be providing turn-key plants to both customers, which
incorporate QuestAir’s M-3200 units.
We have also seen encouraging progress in the Canadian biogas market. In July, the British Columbia
Government announced funding for several clean energy projects through the Innovative Clean Energy
(“ICE”) Fund. We expect to supply biogas upgrading plants for two of these projects, including a $1.1
million biogas upgrading project at the Lions Gate Wastewater Treatment Plant in West Vancouver. The
project will recover and upgrade biogas generated from the digestion of municipal sewage. We are
working with Terasen, the local gas utility, and Metro Vancouver (the owner of the waste water treatment
facility) on this project, which is expected to supply renewable energy to heat approximately 100 homes.
In September, we entered into a Memorandum of Understanding with Terasen, to work jointly on the
development of potential projects to produce supplies of biomethane from organic waste. Renewable
natural gas generated from these projects would be injected into Terasen’s existing pipeline system for
distribution to homes and businesses.
In the hydrogen purification market, we made less progress than anticipated during fiscal 2008. We
secured a number of orders for our H-3200 PSAs, including the sale of two H-3200 PSAs for hydrogen
plants in Mexico and Russia and three hydrogen PSAs sold to Iwatani for the Japanese market. However,
we did not achieve our objective of growing the hydrogen PSA business in fiscal 2008. In the refinery
hydrogen market, we achieved a substantial technical success with the completion of the field test of our
H-6200 hydrogen purifier at an ExxonMobil affiliate refinery in France. However, our marketing efforts
in the refinery market were impacted by the recent drop in oil prices, as well as by delays in certain target
customer projects that impacted near-term H-6200 sales prospects. Consequently, we did not meet our
objective of securing our first commercial order of an H-6200 during the year.
We took measures during fiscal 2008 to continue to reduce our operating costs. In March 2008, we
announced a corporate reorganization that included the elimination of 13 full time positions, which is
expected to result in annualized savings of $1.25 million. Importantly, we also announced a new
engineering service contract with EMRE valued at US$6.35 million, to allow for the further development
and commercialization of QuestAir’s rapid-cycle PSA technology. This agreement has allowed us to
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redeploy resources towards customer-funded development activities, substantially reducing our research
and development expenses going forward.
The combination of the new agreement with EMRE and the cost-saving measures allowed us to revise our
financial guidance for fiscal 2008. In March 2008, we raised our forecasted revenue guidance for fiscal
2008 to a range of $11 million to $12 million, from prior guidance of $9 million to $10 million. At the
same time, we lowered our guidance for cash used in operations and capital expenditures for fiscal 2008
to be in the range of $6.5 million to $7.5 million, compared to prior guidance of less than $8 million. As
is discussed in more detail below, our financial results for fiscal 2008 were within these revised guidance
ranges.
In the third quarter of the fiscal year, we successfully completed an equity offering, raising gross proceeds
of $9 million. The subsequent credit crisis and collapse of the equity markets highlights the importance
of having completed the offering when we did. The funds raised provide substantial liquidity to the
Company with which to weather the current economic crisis.
In December 2007, we published a number of operational and financial milestones for fiscal 2008. The
table below summarizes our performance against these milestones:
Milestone
1. Enhance our commercial footprint in the
biogas market
2. Grow our industrial hydrogen business
3. Secure first purchase order for a
commercial H-6200 hydrogen purifier
Progress
As discussed above, we made considerable progress in the
biogas purification market. We exceeded our target of signing
at least one distribution agreement with a biogas developer, by
entering into supply and distribution agreements with Phase 3
and Verdesis. However, we did not meet our objective of
securing at least three new customers in this market.
During the year, we did not increase the total value of our
hydrogen business, and did not secure as many large system
sales as we expected.
Although the field test of the H-6200 prototype was successfully
completed in March 2008, we were not able to secure a
purchase order for the first commercial H-6200 hydrogen
purifier.
4. Increase recognized revenue to between $9
and $10 million in fiscal 2008
As noted above, in March 2008 we increased our revenue
guidance for fiscal 2008 to $11 to $12 million, which was
achieved.
5. Manage cash used in operations and capital
expenditures to less than $8 million
As noted above, in March 2008 we reduced our cash usage
guidance for fiscal 2008 to $6.5 to $7.5 million, which was
achieved.
Financial Overview
The financial highlights for the year ended September 30, 2008 are noted below:
• Revenue was $11.4 million for the year, an increase of $4.4 million or 63% compared to fiscal
2007. This is the highest revenue achieved in QuestAir’s history, and represents a substantial
improvement over the prior fiscal year. The growth in revenues was driven by fourth quarter
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performance, with record quarterly revenue of $4.9 million being recognized in the final quarter
of the fiscal year.
• Sales order backlog at September 30, 2008 was $10.9 million, a decrease of $0.2 million, or 2%,
from September 30, 2007.
• Cash used by operations and capital requirements was $7.1 million for the year, a decrease of
$3.4 million or 33% compared to fiscal 2007. Management’s efforts to reduce cash usage in
March 2008 paid off considerably in the second half of the fiscal year, with cash usage for the last
six months of fiscal 2008 totaling $2.1 million compared to $5.2 million in fiscal 2007, and $5.0
million for the first half of fiscal 2008.
• Net loss was $7.6 million ($1.09 per share) for the year, a decrease of $4.8 million or 38% from
$12.4 million ($2.37 per share) in fiscal 2007. The net loss fell considerably as a result of lower
operating expenses and higher margins in fiscal 2008 compared to the prior year.
Selected Financial Information
The following is selected information on QuestAir’s financial performance for the past three fiscal years:
($’000)
Revenue
Net research and development expenses
General and administrative expenses
Net loss
Loss per share
Total assets
Total long-term liabilities
Backlog (unaudited)
For the years ended September 30,
2006
2007
2008
7,558
7,012
11,432
5,092
4,801
3,004
3,311
3,668
3,981
(10,263)
(12,417)
(7,643)
(2.42)
(2.37)
(1.09)
27,682
17,053
17,505
454
228
533
5,044
11,054
10,868
Our revenues have fluctuated over the past three years as a result of timing of revenue recognition on
sales of gas purification systems, as well as fluctuations in the amount of revenue recognized from the
sale of the prototype H-6200 hydrogen purifier (the “prototype plant”) and from engineering service
contracts, both of which are recognized on a percentage-of-completion basis. The fluctuation in revenue
over this time period has been accompanied by growth in sales order backlog, reflecting the growth in the
total volume of business for the Company. Backlog increased 119% in fiscal 2007 as a result of strong
growth in purchase orders for commercial equipment. This level of backlog was sustained in fiscal 2008
in part from the receipt of an engineering service contract valued at US$6.35 million from EMRE to
enable the further development and commercialization of our rapid-cycle PSA technology.
Net research and development (“R&D”) expenses declined over the past three years as certain
development activities were completed and resources were transitioned towards commercial activities,
including the construction of the prototype plant that was sold to an ExxonMobil refinery and work
performed under funded engineering service contracts with EMRE. R&D expenses fell in spite of the fact
that we saw a decrease in offsetting government funding over the past three years. Funding under the
Technology Partnerships Canada (“TPC”) program, which was deducted from gross R&D expenditures in
fiscal 2006 and the first quarter of fiscal 2007, has concluded and no amounts were claimed in fiscal
2008.
General and Administrative (“G&A”) expenses have increased over the past three years, largely due to
restructuring activities in each of fiscal 2007 and 2008. In May 2007 and March 2008 we reorganized our
Page 12 of 63
operations to reduce R&D expenditures, resulting in severance and termination benefits being incurred as
a G&A expense in each of these years. The reduction in development staffing allowed for consolidation
of our facilities at the end of fiscal 2008, which will further reduce our operating expenses going forward.
As a result of these reorganizations, our G&A and R&D expenses are expected to decline in fiscal 2009.
Net loss fluctuations over the past three years are due to reductions in R&D over the three years and to
higher gross profits in 2008. Gross profits in prior years were diminished due to losses being recognized
on the sale of the prototype plant in each of fiscal 2006 and 2007 (see ‘Results of Operations’).
Total assets have fluctuated over the past three years, and include funds raised from QuestAir’s initial
public offering (“IPO”) in fiscal 2005 and the subsequent equity offerin gs in fiscal 2006 and fiscal 2008
as discussed in ‘Use of Proceeds from our Pubic Offerings’. The decrease in fiscal 2007 reflects cash
used in operations in the absence of a financing transaction in the year.
Results of Operations
Revenues
The follow ing table provides a breakdown of our revenues from the sale of gas purification systems and
engineering service contracts for the reported periods:
Gas purification systems
Engineering service contracts
Total revenue
For the years ended September 30,
2007
6,322,595
689,571
7,012,166
2008
7,757,981
3,674,275
11,432,256
Total recognized revenue for fiscal 2008 was the highest in the Company’s history, increasing 63%
compared to the prior period. Revenue from gas purification systems was up 23% year over year, while
revenue from engineering service contracts increased four-fold over the prior year. Recognized revenue
from gas purification systems included a number of biogas purification systems, including an M-3100
system to upgrade anaerobic digester gas created from agricultural waste to pipeline quality methane in
the United States and several M-3200 PSA systems to recover pipeline or vehicle -fuel grade methane
from biogas.
The increase in revenue from engineering service contracts reflects the higher value of these contracts in
backlog compared to the prior periods (discussed in more detail below). This trend is expected to continue
for several quarters as a result of the US$6.35 million engineering service contract with EMRE that was
entered into in March 2008, which will elevate the revenue recognized from engineering service contracts
until it is completed in December 2009.
Fluctuations in recognized revenue and the receipt of new sales orders are to be expected in the markets
that we serve. In addition, the timing of receipt of new engineering service contracts can vary from year to
year. As mentioned in the ‘Key Performance Indicators’ section, we believe that both recognized revenue
and changes in our sales order backlog should be monitored together to determine the strength of our
commercial operations.
QuestAir’s sales order backlog is defined as future revenue from signed contracts that have not yet been
recognized as revenue. The following table provides an analysis of the changes in our sales order backlog
for the years ended September 30, 2008 and 2007.
Page 13 of 63
(Unaudited)
Opening Balance
Bookings
Revenue
Adjustments2
Ending Balance
For the year ended September 30,
2008
For the year ended September 30,
2007
Gas Purification
Systems
8,954,635
3,574,586
(7,757,981)
731,202
5,502,442
Engineering
Service
Contracts
2,099,130
6,482,200
(3,674,275)
458,391
5,365,446
Gas
Purification
Systems
4,908,298
10,802,921
(6,322,595)
(433,989)
8,954,635
Engineering
Service
Contracts
135,594
2,809,275
(689,571)
(156,168)
2,099,130
Total
11,053,765
10,056,786
(11,432,256)
1,189,593
10,867,888
Total
5,043,892
13,612,196
(7,012,166)
(590,157)
11,053,765
The total sales order backlog decreased by $185,877, or 1.7%, during fiscal 2008, and the mix of orders in
backlog changed considerably compared to the prior period. The total value of new orders received in the
year was $1,375,470 less than the amount of revenue recognized in the year. This was largely offset by
favourable foreign exchange adjustments of $1,189,593 during the year.
New orders for gas purification systems were markedly lower than the prior year, due to a number of
factors. The strong Canadian dollar for much of fiscal 2008 made the Company’s products less
competitive in the United States, which resulted in lower sales and reduced margins on US denominated
contracts. Further, the Company’s low cash balances prior to completing an equity offering in the third
quarter of fiscal 2008 adversely impacted our ability to secure certain orders due to customer uncertainty
about our financial position. Later in the year, our sales activities were hampered by the credit crisis and
the drop in oil prices, which management believes contributed to certain target customers delayin g
projects. Finally, we did not meet our objective of securing our first commercial order of an H-6200
during the year, contributing to lower PSA bookings.
In the European biogas market, delays in the ratification of government incentives for biogas upgrading
projects in Germany (referred to as the EEG Act) resulted in the delay in a number of biogas projects in
the German market, which directly impacted sales prospects for QuestAir’s PSA systems. In spite of these
challenges, we received several orders for our methane purification products during the year, including an
order for an M-3200 for use in the “Biomethane for Vehicle Fuel” project located at the Hilarides Dairy in
California. Orders for hydrogen purification products included an order valued at approximately $1
million for an H-3100 hydrogen PSA system from Iwatani to be used in a new hydrogen recovery project
in Japan.
During fiscal 2008, we signed a significant engineering service contract with EMRE valued at US$6.35
million, which accounted for the majority of our new engineering service contract bookings in the year.
This new contract has allowed us to redirect resources towards funded development work, lowering our
R&D expenses and cash usage while funding additional development of our rapid-cycle PSA technology.
Gross Profit
The following table provides a calculation of our gross profit for the reported years:
Revenue
2 Includes adjustments for fluctuations in foreign currency exchange rates.
For the years ended September 30,
2007
7,012,166
2008
11,432,256
Page 14 of 63
Cost of goods sold
Gross Profit
Gross Margin (%)
8,030,894
3,401,362
29.8%
7,007,989
4,177
0.1%
Gross profit increased in fiscal 2008 compared to the prior year due in part to an increase in the amount of
revenue recognized on engineering service contracts, which tend to generate higher gross margins than
equipment sales. In addition, gross profit was significantly lower in the prior fiscal year due to losses
being recognized on the sale of the prototype H-6200 plant. Margins are expected to fluctuate from year
to year depending on the mix of revenues recognized from engineering service contracts and gas
purification systems.
Research and Development
The gross R&D expenditures, offsetting government funding and the resulting net R&D expenditures for
the relevant periods were as follows:
Gross R&D Expenditure
Government & Partner Funding
Net R&D Expenditure
For the years ended September 30,
2007
5,175,521
(374,929)
4,800,592
2008
3,004,486
-
3,004,486
In fiscal 2008, management decided to limit the amount of self-funded research and development
activities in order to reduce its operational cash usage. As a result, the Company underwent a
reorganization to reduce development-related staffing and entered into a US$6.35 million engineering
service contract with EMRE to fund additional development of the Company’s rapid-cycle PSA
technologies. The contract has allowed QuestAir to redeploy a significant amount of its human resources
from self-funded research and development activities to funded engineering service contracts. As a result,
w e saw a 37% reduction in net R&D expenditures for fiscal 2008 compared to the prior year.
Government funding recorded in the prior year related to the final claim for eligible expenditures from the
TPC contribution agreement (see also ‘Contingent Off-Balance Sheet Financing Arrangements’).
General and Administrative
G&A expenses increased in fiscal 2008 to $3,981,456 from $3,667,755 for the prior year. In each of fiscal
2008 and 2007, the Company restructured operations and terminated employees, resulting in severance
costs and termination benefits of $955,080 and $564,030 being recorded in G&A expenses in fiscal 2008
and 2007 respectively. Higher restructuring costs in fiscal 2008 were partially offset by lower stock-based
compensation expense in the current fiscal year. Stock-based compensation expense decreased 35% to
$297,131 in fiscal 2008, as several options became fully vested or were forfeited during the prior and
current fiscal years.
Sales and Marketing
Sales and marketing expenses were $1,796,842 for fiscal 2008, a decrease of 15% compared to
$2,117,706 for the prior year. The reduction in sales and marketing expenses for fiscal 2008 reflects a
decrease in variable selling costs resulting from lower gas purification equipment orders compared to the
prior year.
Operations
This is the first fiscal year that “Operations” appears as a caption on our financial statements, and is the
result of the restructuring undertaken in the prior fiscal year to increase resources dedicated to
commercial activities and to reduce R&D expenditures. Consistent with our accounting policy,
Page 15 of 63
comparative amounts have been reclassified where necessary to conform to the presentation adopted in
the current fiscal year. Included in Operations are expenses related to supply chain management,
shipping and receiving, quality management and non-development related engineering activities.
Operations expenses were $1,478,150 for fiscal 2008 compared to $936,951 for the prior year, with the
increase primarily due to the addition of human resources to the department.
Amortization
Amortization expenses decreased 14% to $734,121 in fiscal 2008 as a result of certain capital assets
becoming fully amortized during the year.
Other Income and Expense
Other income and expense netted to an expense of $49,240 for fiscal 2008 compared to $47,752 in the
prior year. Royalty expense includes a $495,037 unconditional, one-time payment to TPC related to the
amendment agreement entered into during fiscal 2008. Interest income and gains from foreign exchange
fluctuations and embedded derivatives partially offset other expenses in the current year.
Net Loss
Net loss declined 38% in fiscal 2008 compared to the prior year, reflecting the higher gross profit in the
year as well as lower R&D expenses. Net loss for fiscal 2008 was $7,642,933 or $1.09 per share,
compared to $12,417,412, or $2.37 per share, for the prior year. Loss per share is calculated based on the
weighted average number of common shares outstanding through the year. Loss per share decreased in
the current year as a result of a decrease in the net loss compared to the prior year and an increase in the
weighted average number of common shares outstanding upon completion of our equity financing in June
2008 (refer to ‘Outstanding Share Data’).
Capital Expenditures
Capital expenditures net of government funding and proceeds on sale (“Net CAPEX”) for fiscal 2008
were $342,926 compared to $412,249 for the prior year. Net CAPEX were higher in the prior year due to
the addition of a three-year capital lease in fiscal 2007. It is expected that capital expenditures will
fluctuate from year to year depending on the requirements of specific product development programs and
administrative needs.
Use of Proceeds from Our Public Offerings
We disclosed our expectations regarding the use of the net proceeds of our IPO in our prospectus dated
December 14, 2004. In addition, we disclosed our expectations regarding the use of the net proceeds of
our subsequent equity offerings in our prospectuses dated May 23, 2006 and May 7, 2008. Net cash
proceeds from the IPO were $11,694,571, while net cash proceeds from the equity offerings in 2006 were
$18,410,751 and in 2008 were $7,918,882. As at September 30, 2008, we had used $28,415,902 of this
amount to fund our operating activities. As at September 30, 2008, $1,689,420 from the 2006 equity
offering and the entire $7,918,882 net proceeds from the 2008 equity offering remain available for the
uses described in the prospectuses, and we intend to use these funds as described in the prospectuses.
However, circumstances may arise which may result in a reallocation of funds for sound business reasons.
The table below compares the estimated use of proceeds disclosed in our May 2006 prospectus to the
actual results as at September 30, 2008.
Use of Proceeds Noted in Prospectus
Prospectus Comment
Actual Use to
September 30, 2008
Sales and Marketing:
To drive sales growth and expand the
22%
Page 16 of 63
Approximately 25%
Company’s market channels
Research and Development:
Approximately 40%
Capital Expenditures:
Approximately 15%
To develop and commercialize
products for the Company’s
hydrogen, methane and fuel cell
related markets
Working capital, general corporate
purposes:
Approximately 20%
In conjunction with funds from
operations, for working capital and
general corporate purposes.
43%
4%
31%
The proportion of spending on working capital and general corporate purposes was higher than expected
as a result of costs associated with the reorganization of operations during fiscal 2007 and 2008 as well as
increased costs associated with the prototype plant in fiscal 2007. This increase was offset by lower-than-
expected spending on capital assets, as required investments in manufacturing-related equipment have
been lower than previously expected.
Summary of Quarterly Results
(Unaudited, $ ‘000 except loss per share
data)
Total Revenues
Gas Purification Systems
Eng. Service Contracts
% Gross Margin
R&D (net)
General & Administrative
Net Loss
Net Loss per share
Net CAPEX
Cash used in Operations & Net CAPEX
Backlog
Gas Purification Systems
Eng. Service Contracts
2008
Sep
30
4,864
3,747
1,117
21%
704
1,138
1,613
(0.14)
57
1,582
10,868
5,502
5,366
Jun
30
2,702
1,300
1,402
40%
411
769
1,582
(0.25)
45
512
14,502
8,328
6,174
Mar
31
2,298
1,348
950
45%
934
1,190
2,057
(0.39)
87
2,166
16,022
8,390
7,632
2007
Dec
31
1,568
1,363
205
16%
956
886
2,390
(0.45)
154
2,827
10,141
8,144
1,997
Sep
30
880
709
171
(15%)
1,025
772
2,989
(0.57)
15
2,947
11,054
8,955
2,099
Jun
30
3,616
3,333
283
34%
1,424
1,233
2,559
(0.49)
37
2,264
7,136
6,660
476
Mar
31
873
858
15
(157%)
1,348
903
4,644
(0.89)
99
1,210
7,513
7,078
435
2006
Dec
31
1,643
1,423
220
17%
1,003
760
2,225
(0.42)
261
4,105
5,819
5,697
122
Our operating results have fluctuated from quarter to quarter and this trend is expected to continue for the
foreseeable future.
Revenues and gross margins fluctuate quarter to quarter based on the mix of recognized revenue from gas
purification equipment and engineering service contracts, which in turn is impacted by the length of the
sales cycle required to close a customer order, and by contractual terms related to the timing of delivery
and acceptance of products and services by customers. In the quarters ended March 31, 2007 and
September 30, 2007 we recognized losses on the prototype plant, contributing to the quarterly fluctuation
in percentage gross margins.
Net R&D expenses have declined over the most recent four quarters as the company shifts its focus to
commercial activities. G&A expenses have varied quarter by quarter, largely as a result of quarterly
Page 17 of 63
variations in legal, regulatory and investor relations costs, and specific to the quarters ended June 30,
2007; March 31, 2008; and September 30, 2008 severance and termination benefits associated with the
restructuring of our operations and termination of employees.
Cash usage has declined in recent quarters, reflecting lower operating expenses as a result of restructuring
activities noted above.
Review of the Fourth Quarter ended September 30, 2008
Revenues for the quarter ended September 30, 2008 were the highest in the Company’s history, totaling
$4,864,321, with revenues from both gas purification sales and engineering service contracts increasing
compared to the same period last year. Sales order backlog was $10,867,888 at September 30, 2008, a
decrease of 25% from $14,502,466 at June 30, 2008, reflecting the increased amount of revenue
recognized in the fourth quarter. Cash used in operations and capital expenditures for the quarter ended
September 30, 2008 was $1,582,070, a decrease of 46% from $2,947,643 in the same period in 2007,
driven by higher gross profit in the current quarter. The net loss for the quarter ended September 30,
2008 was $1,612,807, a decrease of 46% from $2,989,025 in the same period in 2007.
Cash Flows, Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents were $9,265,249 at September 30, 2008, an increase of $3,539,004 from
$5,726,245 at September 30, 2007. This increase in cash and cash equivalents during the year was driven
by cash inflows from financing activities, partially offset by cash outflows from operating activities.
Cash used by operations for fiscal 2008 decreased 33% to $6,744,157 compared to $10,113,209 for the
prior year. The decrease in cash used by operations for the year was driven by the decreased loss for the
year, partially offset by a decrease in cash inflows from deferred revenue compared to the prior year.
Cash provided by investing activities declined to $2,715,270 in fiscal 2008, compared to $4,842,856 in
the prior year. Fewer short-term investments matured and less restricted cash was released during the year
compared to the prior year.
Cash provided by financing activities was $7,567,891 in fiscal 2008, reflecting net cash proceeds from an
equity offering that was completed in June 2008. No similar financing occurred in the prior year.
Cash used by operations and capital requirements decreased 33% in fiscal 2008 to $7,087,083, compared
to $10,525,458 for the prior year. The decrease in cash usage reflects the lower net loss for the year
compared to fiscal 2007.
The calculation of this measure of cash usage and a reconciliation of this financial measure to the
statement of cash flows is as follows:
Cash used in Operating Activities
Add: Purchase of property, plant and equipment (“PP&E”)
Add: Government grants and funding related to PP&E
Add: Proceeds from sale of PP&E
Cash used in Operations and Capital Requirements
For the years ended September 30,
2007
(10,113,209)
(426,729)
5,434
9,046
(10,525,458)
2008
(6,744,157)
(364,768)
-
21,842
(7,087,083)
Page 18 of 63
Reconciliation to GAAP Statements of Cash Flow:
Add: Short term investments
Add: Restricted cash
Add: Cash from financing activities
Increase (decrease) in Cash and Cash Equivalents
2,998,399
59,797
7,567,891
3,539,004
4,339,553
915,552
(22,202)
(5,292,555)
Liquidity and Capital Resources
Since incorporation, we have financed our operations through cash generated from revenue, the issuance
of equity and funding received from government and strategic partners. At September 30, 2008 cash and
short-term investments were $9,327,297, compared to $8,786,692 at September 30, 2007. Not included in
cash and short term investments at September 30, 2008 was $281,005 of restricted cash to secure letters
of credit with customers compared to $340,802 at September 30, 2007. At the forecast cash burn rate, we
have sufficient financial resources to fund our operations for more than 12 months.
During the fiscal year we raised gross proceeds of $9,000,000 through the offering of 60,000,000
subscription receipts and the completion of the exchange of each subscription receipt into one unit
consisting of one common share and one common share purchase warrant. Net proceeds from the
offering were $7,918,882 after share issuance costs of $1,264,718, including $183,600 of non-cash
expenses.
Our cash resources will be used to promote sales and fulfill orders for our commercial products, as well as
to advance the development and commercialization of products under development. Our capital
requirements may vary depending on a number of factors, including contributions from the sale of our
systems and engineering service contracts, the progress of our current development programs and any
decisions to enter into additional programs or partnerships. In addition, we review investment and
acquisition opportunities for technologies and products that would complement our business or assist us
in our commercialization plans. An investment opportunity would increase our capital requirements.
Our working capital requirements are met through our current cash reserves, current accounts and future
progress payments not yet invoiced rela ted to orders in backlog. Our standard contract terms for
equipment sales require customers to pay progress payments for eighty percent of the total value of the
order prior to shipment of the goods; this serves to fund our working capital for inventory purchases, and
also reduces our credit risk.
Historically, our accounts receivable collection has been very strong, with zero bad debt expense in the
prior five fiscal years. However, the recent liquidity crisis and economic downturn has created financia l
difficulties for a small number of our customers in the past few months. As a result, in the fourth quarter
of fiscal 2008, we recorded a provision for doubtful accounts for the first time in more than five years as
well as a small bad debt expense. Importantly, the majority of our receivables are with creditworthy, high-
quality customers, which mitigates our credit risk. Nevertheless, we will continue to monitor the
Company’s credit risk closely.
Credit Facilities
During fiscal 2005, we signed a credit facilities agreement with Comerica Bank. This agreement is
amended and restated each year as part of the annual renewal of these facilities, most recently in June
2008. The amended credit facilities include a US$1 million accounts receivable line of credit and a US$1
million term loan, in addition to amounts outstanding under the prior term loan agreements. Both
facilities are secured by the assets of the Company with certain exceptions. As at September 30, 2008,
we had drawn $671,607 against the term loans net of repayments, which includes $190,924 drawn under
Page 19 of 63
the amended term loan. We expect to use the equipment line to fund capital expenditures, and we may use
the accounts receivable line to fund working capital requirements from time to time. At September 30,
2008 we are in compliance with all of our bank covenants.
Contractual Obligations
The following table lists our contractual obligations at September 30, 2008. We expect to fund these
expenditures out of our cash reserves, current accounts receivables and future progress payments not yet
invoiced related to orders in backlog:
(Unaudited)
Bank debt
Capital leases
Operating leases
Purchase obligations3
Total contractual obligations
Total
671,607
105,479
1,029,184
1,025,773
2,832,043
In the next
year
443,345
105,479
350,814
1,025,773
1,925,411
2-3 years
228,262
-
678,370
-
906,632
After
4 years
-
-
-
-
-
If our debt facilities with Comerica Bank were terminated or not renewed, amounts currently classified as
long-term would become due and payable within the current year. Termination of our debt facilities
without replacing them with a new facility would also result in reduced cash on hand, reduced interest
expenses, and decreased borrowing capacity. Termination of our debt facilities is not anticipated.
Termination of our leases may require us to continue to pay the full amounts shown in the above table,
unless, in the case of operating leases, we are able to sublet the premises under lease.
Our purchase obligations relate primarily to work in progress, therefore, termination of these obligations
may impact our ability to fill customer orders in backlog. In many cases, termination of our purchase
obligations would not result in reduced financial obligations, although in certain circumstances reduced
payments may be possible.
Contingent Off-Balance Sheet Financing Arrangements
We have received funding contributions from various programs of the Canadian Government to support
the development and commercialization of our gas purification technology:
Technology Partnerships Canada
At September 30, 2008, we had received $8,139,937 under a conditionally repayable loan under the TPC
funding program, through an agreement administered by Industry Canada. These funds are repayable in
the form of annual royalties under certain conditions. During the year we finalized negotiations with TPC
to amend this agreement to, among other things, eliminate certain development milestones, extend the
program completion date for certain other milestones, and reduce the contribution amount and the
associated royalties. Details of the amendment are contained in note 14 of the Company’s audited
financial statements for fiscal 2008. Amounts drawn under this contribution agreement are subject to final
audit by Industry Canada.
3 Purchase obligation is defined as an agreement to purchase goods or services that is enforceable or legally binding on the
Company that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable
price provisions; and the approximate timing of the transaction.
Page 20 of 63
We entered into a similar funding arrangement with TPC in 1999 and received a total of $4,762,503 in
funding from March 1999 to July 2002. The funding is also repayable under certain conditions. The
repayment obligations and total royalty repayments made to date for these funding programs are listed
below:
Funding
Award Date
June 6, 2003
Description
Royalties
Term
Fast Cycle
Pressure
Swing
Adsorption
Annual
royalties of
1.165% of
gross business
revenues
Royalty Payments to
Date
Total cumulative
payments: $169,744
Accrued for future
payment: $754,834
Total cumulative
payments: $56,347
Accrued for future
payment: $389
The royalty period began on
October 1, 2005 and will end
on the earlier of September 30,
2022 or until a cumulative
royalty ceiling of $18.8
million is reached. In addition,
a one-time unconditional
royalty payment of $495,037
is payable before November
28, 2008.
Royalty period extends to the
later of the date of payment of
all amounts due to the
Minister and 2015. The
maximum cumulative
repayment is $8.75 million.
March 31, 1999
Pulsar
Pressure
Swing
Adsorption
Program
Annual
royalties of
1.8% of gross
project
revenues and
fuel cell
related
products
Department of Natural Resources Efficiency and Alternative Energy Program
In 2005, we were awarded a grant for $225,000 from the Government of Canada under the Department of
Natural Resources Efficiency and Alternative Energy Program. In 2004, we received a similar funding
award of $193,944 under the same funding program. Both funding awards are repayable under certain
conditions. The repayment obligations and total royalty repayments made to date for these funding
programs are listed below:
Funding
Award Date
Description
Royalties
Term
January 4, 2005 Development
of structured
adsorbent for
the production
of high purity
hydrogen
Annual
royalties of
0.12% of gross
project
revenues
January 6, 2004 Development
of a device
that increases
the efficiency
of a high
temperature
fuel cell
system
Annual
royalties of
0.12% of gross
project
revenues
Royalty period starts on date
of first gross project revenues
and extends to March 31,
2015, to a maximum
cumulative repayment of
$225,000, whichever occurs
first.
Royalty period starts on date
of first gross project revenues
and extends to March 31,
2014, to a maximum
cumulative repayment of
$193,944, whichever occurs
first.
Royalty Payments to
Date
Total cumulative
payments: $4,338
Accrued for future
payment: $1,253
Total cumulative
payments: $0
Accrued for future
payment: $0
Page 21 of 63
Outstanding Share Data
Common Shares Outstanding
Our authorized share capital consists of an unlimited number of common shares, of which 11,269,318
common shares were issued and outstanding as of November 30, 2008. We also have an unlimited
number of preferred sha res authorized, none of which are issued.
On May 13, 2008, we completed an offering of subscription receipts, which were automatically converted
into common shares and share purchase warrants following receipt of shareholder approval of the offering
on June 16, 2008. On June 27, 2008, we completed a common share consolidation on a 10 for 1 basis,
reducing the number of common shares outstanding from 112,683,647 to 11,268,318. All share data in
this MD&A and in the associated financial statements for the period ended September 30, 2008 are
reported on a consolidated basis and the basic and diluted earnings per share data have been adjusted
retroactively for all periods presented to reflect the common share consolidation.
The following table provides the weighted average number of common shares outstanding for the relevant
years:
Weighted Average Common Shares Outstanding
For the years ended
September 30,
2007
5,247,331
2008
7,019,409
The average number of common shares outstanding increased for the year ended September 30, 2008
compared to the prior year as a result the issuance of 6,000,000 new common shares as a result of the
equity offering completed during the year.
Stock Options and Warrants Outstanding
As at November 30, 2008 there were 340,758 stock options outstanding with an average exercise price of
$8.30, of which 215,817 were exercisable. As at November 30, 2008 there were 6,180,000 warrants
outstanding compared to 19,231 warrants outstanding at September 30, 2007 which expired unexercised
on June 6, 2008. The outstanding warrants were issued in conjunction with the equity offering and expire
on May 13, 2010. Of the warrants issued and outstanding, 6,000,000 have an exercise price of $2.15 and
180,000 have an exercise price of $1.50.
Related Party Transactions
There were no related party transactions during the year ended September 30, 2008.
Outlook
As we enter fiscal 2009, we are facing a challenging economic environment in certain market segments.
In the biogas market, growth prospects in the European market remain strong. The passing of the
amendment to the EEG Act introduced subsidies for biogas upgrading projects, which is expected to drive
significant growth in the German market in 2009. In the North American biogas market, the fall in natural
gas prices from $10-12/mmBtu range to around $5-6/mmBtu is expected to have some impact on
marginal biogas projects, particularly some single farm projects where the economies of scale are not
strong. However, the longer term macro-economic drivers of the biogas market in North America remain
strong and a growing number of gas utilities and governments in North America are actively supporting
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the development of biogas upgrading projects as a source of renewable natural gas. In addition, the
production of renewable CNG vehicle fuel from biogas represents a significant value-added end use of
biogas that we expect to drive additional growth in the biogas upgrading market.
In the hydrogen market, demand in the oil refining and steel manufacturing sectors is expected to fall as a
result of the current economic climate. However, in some cases this may mean that capital projects are
scaled back, resulting in the purchase of smaller capacity hydrogen plants or purification systems (a
market where QuestAir has a competitive advantage). We will continue to sell our hydrogen PSAs to
existing customers in markets where we have a competitive advantage and focus on industries and
geographies where demand for hydrogen remains strong.
In the refinery hydrogen market, the economic climate has affected our business. Oil prices have declined
over 65% from their peak in July, due to concerns over a slowing global economy. In turn, many oil
refineries have delayed capital projects and reduced capital spending. While we believe that the market
opportunity for the H-6200 refinery hydrogen purifier remains strong, both within ExxonMobil’s own
refinery circuit and with third-party customers, we expect to see some delay in the development of
additional H-6200 projects, and we do not have adequate visibility to forecast an H-6200 sale in fiscal
2009.
Over the past few months, we have seen a small number of prospective orders cancelled or delayed due to
economic uncertainty or the lack of available credit. While uncertainty can be expected to continue for
some time, we are optimistic that government initiatives to increase available credit will help provide the
financing that certain customers require for their capital investments. It should also be noted that many of
our customers have very strong balance sheets, and do not require external financing for their projects.
On a positive note, the recent decline in the Canadian dollar compared to the US dollar has made our
products more competitive in our primary export market. If the current value of the Canadian dollar is
sustained in fiscal 2009, we would expect to win more orders in the United States and we should see our
margins increase on current orders in backlog.
In addition, we have developed our products to be successful in the type of competitive, cost-conscious
environment that we are in today. The advantages of QuestAir’s PSA systems over competing products
includes a more compact, space-efficient and reliable technology that allows for lower installation and
operating costs, and a lower total cost of ownership.
Despite current economic conditions, management is confident that QuestAir is well positioned going
forward from a cash, product and strategy standpoint. Fiscal 2009 will be an important year in terms of
building out our biogas-focused strategy while ensuring that we continue to serve our core customers in
the hydrogen market. In the biogas market, our key areas of focus over the coming year will include:
• Growth of sales of biogas PSAs to key partners and systems integrators including Verdesis and Phase
3;
• Receipt of initial orders for integrated biogas upgrading plants and expansion of our product and
service offerings to include operating and service contracts to support these initial plant sales; and
• Expansion of market channels through additional partnerships with project developers and/or gas
utilities, particularly in the biogas-to-CNG market segment.
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In the hydrogen market, we continue to focus on improving the competitiveness of our hydrogen PSA
product line, through performance improvements and cost reductions. These steps are intended to support
our core hydrogen customers in the hydrogen plant and hydrogen recovery markets. Moreover, the
similarity between our hydrogen and methane PSAs will allow us to utilize these improvements and cost
reductions in the biogas market as well.
In the refinery hydrogen market, we will focus on completing key deliverables in our existing engineering
service contract with ExxonMobil while continuing to support ExxonMobil’s marketing of the H-6200
hydrogen purifier.
Looking at our projected financial performance for fiscal 2009, our strong order backlog as at September
30, 2008 will support our revenues in fiscal 2009, which we forecast to be in the range of $10 million to
$12 million, compared to $11.4 million in fiscal 2008. Our continued focus on prudent cash management
and reducing our investment in self-funded R&D means we will see further reductions in cash burn in
fiscal 2009. We are forecasting cash used in operations and capital expenditures of $4 million to $5
million, down from $7.1 million in fiscal 2008.
Critical Accounting Policies and Estimates
The significant accounting policies that we believe to be most critical in fully understanding and
evaluating our financial results are revenue recognition, stock-based compensation, inventory valuation
and warranty provisions. These accounting principles require us to make certain estimates and
assumptions. We believe that the estimates and assumptions upon which we rely are reasonable based
upon information available at the time that these estimates and assumptions are made. Actual results may
differ from our estimates. Our critical accounting estimates affect our net loss calculation and the balance
sheet value of our assets and liabilities. Our accounting policies are described in note 2 to the audited
financial statements for the financial year ended September 30, 2008.
Revenue Recognition
We earn revenues from the sale of commercial gas purification systems, long-term production type
contracts, and from engineering service contracts. Revenue recognized from long-term production type
contracts and engineering service contracts are determined under the percentage-of-completion method,
whereby revenues are recognized on a pro rata basis in relation to contact costs incurred. There is a risk
that estimated costs to complete a contract might change, which may result in an adjustment to revenues
previously recorded.
During the year ended September 30, 2008 and 2007 there were no material adjustments to long-term
production-type contract and engineering service contract revenue relating to revenue recognized in a
prior period.
Stock-based compensation
We account for stock options using the fair value method calculated using the Black-Scholes option
pricing model. This requires that certain inputs into the model, including the expected life of the options
and expected volatility of the stock, be estimated at the time the options are awarded. We amortize the
fair value over the vesting period of the options, generally a period of four years. Should these estimates
prove to be incorrect, the actual fair value of the options may differ from the estimated fair value of the
options, resulting in a different stock compensation expense calculation.
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Inventory
In establishing whether or not a provision is required for inventory obsolescence, we estimate the
likelihood that inventory carrying values will be affected by changes in market demand for our products
and by changes in technology, which could make inventory on hand obsolete. We perform regular
reviews to assess the impact of changes in technology, sales trends and other changes on the carrying
value of inventory. Where we determine that such changes have occurred and that they will have a
negative impact on the carrying value of inventory on hand, adequate provisions are made.
The majority of our inventory is purchased directly to work in process when a customer order is received,
and only a small portion is held in raw materials. This reduces the exposure to provisions for
obsolescence. For the year ended September 30, 2008, raw materials on hand of $823,006 includes
$47,360 of spare parts inventory available for sale to customers for use on commercial units in the field.
Warranty Provision
A provision for warranty costs is recorded on commercial gas purification systems at the time of
commissioning and customer acceptance. In estimating the accrued warranty liability, past and projected
experience and the nature of the contracts are considered. Should these estimates prove to be incorrect,
we may incur costs different from those provided for in our warranty provision. In each of fiscal 2008
and 2007, actual warranty costs incurred were less than the provision recorded.
Changes in Accounting Policies Including Initial Adoption
Capital Disclosures
The CICA issued Handbook Section 1535, Capital Disclosures, which establishes standards for
disclosing information about an entity’s capital and how it is managed. These changes come into effect
for fiscal years beginning on or after October 1, 2007; accordingly, we have adopted this new standard
effective October 1, 2007. As this standard relates only to disclosure requirements, this section does not
have an impact on our financial results.
Accounting Changes
The CICA has issued Section 1506, Accounting Changes, which establishes criteria for changing
accounting policies, together with the accounting treatment and disclosure of changes in accounting
policies, changes in accounting estimates and correction of errors. As a result, changes in accounting
policies are only permitted when required by a primary source of GAAP or when the change will result in
reliable and more relevant information. These changes come into effect for fiscal years beginning on or
after January 1, 2007; accordingly, we have adopted this new standard effective October 1, 2007. At this
time, we are not aware of any pending accounting changes other than those mandated by the CICA, and
as such we do not anticipate any material effects as a result of this change.
Inventories
The CICA issued Section 3031, Inventories, which supersedes the previously issued standard on
inventory and introduces significant changes to the measurement and disclosure of inventory. The
measurement changes include: the elimination of LIFO and the reversal of previous write-downs to net
realizable value when there is a subsequent increase in the value of inventories. Disclosures of inventor ies
have also been enhanced. Inventory policies, carrying amounts, amounts recognized as an expense, write-
downs and the reversals of write-downs are required to be disclosed. This new standard comes into effect
for fiscal years beginning on or after January 1, 2008; accordingly we will adopt this new standard on
October 1, 2008. We are assessing the impact this standard will have on our financial statements.
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Goodwill & Intangible Assets
The CICA has issued new accounting recommendations for goodwill and intangible assets which
establish standards for the recognition, measurement, presentation and disclosure of goodwill and
intangible assets (including internally developed intangible assets). These recommendations are effective
for the Company beginning October 1, 2008. Goodwill and intangible assets that are not assets as defined
by GAAP will be derecognized and charged to the equity of the Company at that date. We are evaluating
the effect of these recommendations on our financial statements.
Financial Statement Preparation
The CICA has revised section 1400, General Standards of Financial Statement Presentation, which
requires management to make an assessment of, and disclose material uncertainties related to, the ability
of an entity to continue as a going concern. This new standard comes into effect for fiscal years
beginning on or after January 1, 2008; accordingly QuestAir will adopt this new standard in fiscal 2009.
The Company is assessing the impact this standard will have on its financial statements.
International Financial Reporting Standards
On February 13, 2008, the Canadian Accounting Standards Board confirmed that International Financial
Reporting Standards will replace Canada’s current generally accepted accounting principles for publicly
accountable profit-oriented enterprises for interim and annual financial statements effective January 1,
2011. The Company is presently considering the effect these standards will have on its financial
statements.
Disclosure Controls and Procedures
The Company maintains a set of disclosure controls and procedures designed to ensure that information
required to be disclosed is recorded, processed, summarized and reported within the time periods
specified in the Canadian Securities Administrators rules and forms. The Company evaluated its
disclosure controls and procedures as defined under Multilateral Instrument 52-109 for the year ended
September 30, 2008. This evaluation was performed by the Chief Executive Officer and the Chief
Financial Officer with the assistance of other Company employees to the extent necessary and
appropriate. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of these disclosure controls and procedures were effective.
Internal Controls and Procedures
The Company maintains a set of internal controls over financial reporting which have been designed to
provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements in accordance with Canadian GAAP. The Company evaluated the design of its
internal controls and procedures as defined under Multilateral Instrument 52-109 for the year ended
September 30, 2008. This evaluation was performed by the Chief Executive Officer and the Chief
Financial Officer with the assistance of other Company employees to the extent necessary and
appropriate. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the design of these internal controls and procedures was effective.
There were no changes in the Company’s internal control over financial reporting that occurred during the
fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect the
Company’s internal control over financial reporting.
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Risks
The Company’s ability to generate revenue and profit from operations is subject to a number of risks.
The risks and uncertainties described below are not the only ones QuestAir faces. Additional risks and
uncertainties, including those that the Company is not aware of now or that management may believe are
currently not material, may also adversely affect the ability to generate a viable business. The risk factors
presented below are divided into categories of risks impacting QuestAir’s internal and external
environment. Specific risks within each category are listed in approximate order of seriousness, from
most to least serious.
Risk factors related to QuestAir’s business
The Company has a limited operating history and it may be difficult to assess its business and future
prospects.
The Company commenced operations in 1997 and since that time, the Company has been engaged in the
development, manufacture and supply of PSA systems. The Company has made limited sales of PSA
systems to date and has incurred substantial losses since its founding. These losses are expected to
continue for the foreseeable future. For the year ended September 30, 2008, the Company’s sales totalled
$11.4 million and its accumulated deficit totalled $115.1 million. The Company’s historical operating
data may be of limited value in evaluating QuestAir’s future prospects. The Company cannot predict
when it will operate profitably, if ever.
Potential fluctuations in financial results make financial forecasting difficult.
The Company expects its revenues, expenses, cash flows and other operating results to vary significantly
from quarter to quarter. Sales and margins may be lower than anticipated due to general economic
conditions and market-related factors, product quality, performance and safety issues and competitive
factors. Expenditures and cash receipts may also vary from quarter to quarter due to the timing of such
expenditures and cash collections from customers, government entities and other entities providing
funding to the Company. As a result, quarter-to-quarter comparisons of revenues, expenses, cash flows
and other operating results may not be meaningful. In addition, due to the Company’s early stage of
development, the Company cannot accurately predict its future revenues, cash flows or results of
operations. It is likely that in one or more future quarters, financial results will fall below the
expectations of securities analysts and investors. If this occurs, the trading price of the Company’s shares
may be materially and adversely affected.
The Company depends upon a limited number of customers for potential revenue due to the nature of
its markets.
To date, a small number of customers have accounted for a majority of the Company’s revenues and the
Company expects that they will continue to do so for the foreseeable future. For the year ended September
30, 2008, sales to 2 customers accounted for 63% of the Company’s total revenue. For the year ended
September 30, 2007, sales to 2 customers accounted for 70% of the Company’s total revenue.
The Company sells its products to a limited number of customers, some of which may experience
financial difficulty, which may result in bad debts for the Company
The current financial crisis can be expected to affect the ability of some of the Company’s customers to
pay their invoices in a timely fashion. The Company sells to customers of varying financial strength and
in various geographic locations and markets. Some of these customers, particularly smaller companies
with limited financial resources, may be unable to pay their invoices when they become due. This risk is
amplified by the current liquidity crisis and general decline in global economies, which is calling into
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question the sustainability of some of the Company’s customers. The Company mitigates this risk through
its standard contract terms for equipment sales, which require payment of the majority of the contract
value prior to shipment. Neverthele ss, it is possible that some of the Company’s customers will default on
certain amounts owing.
The Company’s revenue and future prospects depend to a great extent on its relationships with EMRE.
The Company’s business and results of operations would be materially adversely affected if EMRE was
to change or terminate its relationship with the Company. There is no guarantee that the interests of the
Company will be aligned with the interests of EMRE or that the Company’s relationship with EMRE will
continue in its current form. Furthermore, any change in EMRE’s strategy with respect to PSA
technology, whether as a result of market, economic or competitive pressures, could also harm the
Company’s business. Such a change in strategy could include, for example, any decision by EMRE to:
• alter its commitment to PSA systems in favour of other competing technologies;
• delay its introduction of products incorporating PSA systems; or
•
initiate the internal development of PSA systems or to purchase PSA systems from another supplier.
The Company may be unable to raise additional capital to pursue its long term development and
commercialization plans and may be forced to discontinue product development, reduce its sales and
marketing efforts or forego attractive business opportunities.
The Company has not yet realized profitable operations and has relied on non-operational sources of
financing to fund its operations. The Company may need to raise additional funds in order to fund its
operations. It may also require addit ional capital to acquire or invest in complementary businesses or
products or obtain the right to use complementary technologies. The Company may be unable to raise
additional capital or may not be able to do so on acceptable terms to pursue its long-term development
and commercialization plans. Either of these outcomes could adversely affect the ability of the Company
to respond to competitive pressures or prevent the Company from conducting all or a portion of its
planned operations.
The development and commercialization of its products could be delayed or discontinued if the Company
is unable to fund its research and product development activities or the development of its manufacturing
capabilities. In addition, it may be forced to reduce its sales and marketing efforts or forego attractive
business opportunities. If the Company issues additional equity securities in order to raise funds, the
ownership percentage in the Company of each of its existing shareholders who do not participate in the
financing will be reduced.
The Company’s PSA systems may not meet performance expectations, which could negatively affect its
customer relationships and the components of its PSA systems may contain defects or errors that could
negatively affect its customer relationships and increase its manufacturing and warranty costs.
The performance of the Company’s PSA system may encounter problems due to the failure of its
technology, the failure of the technology of others, the failure to combine these technologies properly,
operator error and the failure to maintain and service the systems properly. Many of these potential
problems and delays are beyond the Company’s control. In addition, poor performance may involve
delays in product roll-out and modifications to product design, as well as third party involvement. Any
problem or perceived problem with the Company’s PSA systems, whether originating from its
technology, design, or from third parties, could hurt its reputation and the reputation of its products and
limit its sales. Such failures may negatively affect the Company’s relationships with customers and may
require the Company to extend development longer than anticipated before undertaking commercial sales.
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In addition, the Company may be required to offer customers services, products or compensation if the
failure of a product to perform results in a claim under the warranties offered by the Company.
The Company’s strategy for the sale of its products depends upon developing key relationships with a
number of customers who will incorporate its products into theirs.
Other than with respect to a limited number of specific markets, the success of the Company’s business
depends on its ability to develop relationships with parties who will integrate the Company’s products
into their products. The ability of the Company to sell its products to its target markets depends to a
significant extent upon its partners’ worldwide sales and distribution network and service capabilities, and
there can be no assurance that any future relationships that the Company enters into will not require the
Company to share some of its intellectual property. The Company is mitigating this risk in part by
developing its own integrated biogas upgrading plants, which will reduce its dependence upon other
integrators and project developers.
The Company will need to recruit, train and retain key management and other qualified personnel to
successfully expand its business.
The Company’s future success will depend in large part upon its ability to recruit and retain experienced
research and development, engineering, manufacturing, operating, sales and marketing, customer service
and management personnel. If the Company does not attract and retain such personnel, the Company may
not be able to expand its business. Competition for qualified personnel in its industry is intense. Even if
the Company invests significant resources to recruit, train and retain qualified personnel, the Company
may not be successful in its efforts. The Company’s success also depends upon the continuing
contribution of its key management, research, product development, engineering, marketing and
manufacturing personnel, many of whom would be difficult to replace.
The Company currently faces and will continue to face significant competition from other developers
and manufacturers of PSA systems and face competition for its PSA systems from developers and
manufacturers of other gas purification systems.
The Company competes with a number of companies that manufacture conventional gas purification
equipment and other competing technologies, such as membrane systems. In addition, new developments
in technology may adversely affect the development or sale of some or all of the Company’s products or
make its products uncompetitive or obsolete. Other companies, many of which have substantially greater
resources than the Company does, are currently engaged in the development of products and technologies
that are similar to, and competitive with, many of its products and technologies. The Company’s
competition includes numerous companies located throughout the world, some of which may have
advantages over the Company in terms of government incentives, labour, component costs and
technology. Each of these competitors has the potential to capture market share in the Company’s target
markets, which would harm its position in the industry. New competitors may also emerge and entire
product lines may be threatened by new technologies or market trends which reduce the commercial
viability of the Company’s product lines. In addition, the Company’s customers could potentially become
its competitors if they decide to develop and manufacture their own PSA systems.
As the markets for gas purification systems develop, other large industrial companies may enter these
fields and compete with the Company. These large industrial companies may have research and
development, manufacturing, marketing and sales resources necessary to deliver PSA systems more
quickly and effectively than the Company does. In addition, the Company believes that price will become
a more important competitive factor as competition increases. The Company may not be able to compete
effectively with all of these competitors, which would adversely affect its business, financial condition
and results of operations.
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Rapid technological advances could impair the Company’s ability to deliver its products in a timely
manner, and as a result, its revenues would suffer.
The Company’s success depends in large part on its ability to keep its products current and compatible
with evolving technologies and codes and standards. Unexpected changes in technology could disrupt the
development of its products and prevent the Company from meeting deadlines for the delivery of
products. If it is unable to keep pace with technological advancements and adapt its products in a timely
manner, its products may become uncompetitive or obsolete and its revenues would be adversely affected.
The Company is in the development stage of its second generation PSA systems.
The Company is in the development stage of its second generation PSA systems and is subject to all the
risks and uncertainties inherent in such development. These risks include the successful execution of the
Company’s product development and commercialization plan, the ability to successfully integrate the
modules and components of these systems, and the ability to meet the cost, reliability and performance
standards of a viable commercial product.
The Company depends on its intellectual property and failure to protect that intellectual property could
adversely affect the future growth and success of the Company.
Failure to protect its existing intellectual property rights may reduce the Company’s ability to prevent
others from using its technology. The Company relies on a combination of patent, trade secret, trademark
and copyright laws to protect its intellectual property. Some of its intellectual property is currently not
covered by any patent or patent application. The Company does not have, and is unlikely to obtain,
complete patent protection for its primary products. The Company’s patent protection is subject to
complex factual and legal issues that may give rise to uncertainty as to the validity, scope and
enforceability of a particular patent. Accordingly, the Company cannot be assured that:
• any of the U.S., Canadian or other patents owned by the Company will not be invalidated,
circumvented, challenged, rendered unenforceable, or licensed to others; or
• any of its pending or future patent applications will be issued with the breadth of protection sought by
the Company, if issued at all.
In addition, effective patent, trademark, copyright and trade secret protection may be unavailable, limited,
not applied for or unenforceable in foreign countries. Litigation may be necessary to enforce its patents
and other intellectual property rights. Any such litigation may result in substantial costs and diversion of
resources with no assurance of success. Furthermore, although the Company typically retains sole
ownership of the intellectual property that the Company develops, its relationships with EMRE and others
provide for shared intellectual property rights in certain situations.
The Company also seeks to protect its proprietary intellectual property through contracts, including, when
possible, confidentiality agreements and inventors’ rights agreements with its customers and employees.
The Company cannot be assured that the parties that enter into such agreements with the Company will
not breach them, that the Company will have adequate remedies for any breach or that such persons or
institutions will not assert rights to intellectual property arising out of these relationships. If necessary, the
Company may seek licenses under the patents or other intellectual property rights of others. However, the
Company can give no assurances that the Company will obtain such licenses or that the terms of any
offered licenses will be acceptable to it. The failure to obtain a license from a third party for intellectual
property that the Company uses in the future could cause it to: incur substantial liabilities; suspend the
development, manufacturing and the shipment of products; or suspend its use of processes which exploit
such intellectual property.
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The Company may become subject to lawsuits in which it is alleged that the Company has infringed the
intellectual property rights of others or commence lawsuits against others who the Company believes are
infringing upon its rights. Its involvement in intellectual property litigation could result in significant
expense to the Company, adversely affecting the development of sales of the challenged product or
intellectual property and diverting the efforts of its technical and management personnel, whether or not
such litigation is resolved in its favor. In the event of an adverse outcome as a defendant in any such
litigation, the Company may, among other things, be required to:
• pay substantial damages;
• cease the development, manufacture, use, sale or importation of products that infringe upon other
patented intellectual property;
• expend significant resources to develop or acquire non-infringing technology; or
• obtain licenses to the infringing intellectual property.
The complexity of the technology involved and the uncertainty of intellectual property litigation increase
these risks. The Company may not be able to develop non-infringing technology or obtain royalty or
license agreements on terms acceptable to the Company, or at all. The Company may also be subject to
significant damages or injunctions against development and sale of certain of its products.
The Company has foreign currency risk.
The majority of the Company’s revenues are in US dollars and Euros while most of the operating
expenses are in Canadian dollars. Foreign exchange gains and losses are included in results from
operations. A large decline in the US dollar or the Euro relative to the Canadian dollar could impair
revenues, margins and other financial results. The Company has not entered into foreign exchange
contracts to hedge against gains and losses from foreign currency fluctuations.
The Company is dependent upon third party suppliers for materials and components for its products.
The Company relies upon third party suppliers to provide materials and components for its products. A
supplier’s failure to provide materials or components in a timely manner, or to provide materials and
components that meet the Company’s quality, quantity or cost requirements, or its inability to obtain
substitute materials and components in a timely manner or on terms acceptable to the Company, may
harm the Company’s ability to manufacture its products. To the extent that the Company is unable to
develop and patent its own technology and manufacturing processes, and to the extent that the processes,
which its suppliers use to manufacture materials and components, are proprietary, the Company may be
unable to obtain comparable materials or components from alternative suppliers, and that could adversely
affect its ability to produce commercially viable products.
The Company anticipates undergoing a period of continuing growth in its business, the scope of its
operations and the number of its employees and its failure to manage this growth could cause its
results to fluctuate and harm its business.
The Company anticipates undergoing a period of growth in the scope of its operations and in the number
of its employees. The Company may be unable to manage its growth effectively, and its failure to do so
could have a material adverse effect on its operating results and cause its results to fluctuate. As part of its
growth strategy the Company intends to introduce new products, increase its outsourcing capacity and
develop additional customer and distributor relationships. Its expense levels are based, in part, on
expected future revenues and the Company is limited in its ability to reduce expenses quickly if for any
reason its purchase orders do not meet its expectations in a particular quarter or period. Furthermore,
expansion will likely place a strain on its senior management team, key and technical personnel, its
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business operations and other resources. The Company’s ability to manage growth will depend in part on
its ability to continue to enhance its manufacturing and management information systems. It may be
difficult to increase manufacturing or outsourcing capacity in a timely fashion if customer demands
increase in ways that the Company did not anticipate. Any inability to manage growth could result in
shipment delays and cancellation of customer orders.
Risk factors related to the Company’s target markets
The Company’s markets are exposed to recessionary risk
The current financial crisis and possible global recession may result in lost or delayed sales orders, as
many of the Company’s existing and targeted customers may cut back their proposed capital spending in
the face of economic uncertainty and limited access to project financing. This would impact the ability of
the Company to grow its business, and as a result sales orders may be lower than expected. Any decrease
in sales would negatively impact the Company’s cash burn and other financial results. Different gas
purification markets and different geographies may be impacted to different extents, making it difficult to
forecast the likely impact.
Volatility of Oil and Natural Gas Prices
The Company’s PSA systems represent a significant potential capital cost to the Company’s existing and
target customers and their ability to purchase the Company’s products is dependent upon factors which
affect energy industries
The Company’s existing and target customers’ results of operations and financial condition are dependent
on the prices they receive for oil, natural gas and renewable natural gas. Oil and natural gas prices have
fluctuated widely during recent years and are determined by local and worldwide supply and demand
factors, including actions by the Organization of Petroleum Exporting Countries, weather conditions, the
U.S. dollar exchange rate, transportation, competition, and general economic conditions as well as
conditions in other oil producing regions, which are beyond the Company’s control. Any material decline
in oil or natural gas prices could have a material adverse effect on the Company’s existing and target
customers’ operations, financial condition, and the amount they spend on new capital equipment and the
development of new technology, which could have a material adverse effect on the Company’s existing
and target customers’ ability to purchase the Company’s products. If the shift to heavier crude oils were
reversed due to the uneconomic nature of their extraction, such as oil sands extraction, the target markets
for the Company’s PSA systems could be adversely affected.
In addition, the Company’s prospects would be adversely affected should the cost of natural gas were to
fall to levels where production of renewable natural gas from raw biogas becomes uneconomic.
Changes in government policies and regulations could hurt the market for the Company’s products.
The biogas upgrading industry is subject to different government incentives and regulations in various
jurisdictions around the world. Any significant change in these incentives or regulations, including a
decision to reverse subsidy programs for renewable natural gas production or a decision to subsidize
electricity generation rather than renewable natural gas, would adversely impact the Company’s ability to
sell its PSAs and integrated biogas upgrading plants in those jurisdictions. Furthermore, the inability of its
potential customers to obtain a permit, or the inconvenience often associated with the permit process,
could harm demand for biogas upgrading plants and, therefore, harm the Company’s business.
The expected demand for biogas upgrading plants is driven in part by local pollution regulations and
regulatory pressures to reduce greenhouse gas emissions. The Company’s business may suffer if these
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environmental policies and regulations change and no longer encourage the development and growth of
clean power technologies. There can be no guarantee that these laws and regulations will not change.
Changes in these laws and regulations could result in reduced demand for biogas upgrading systems. In
addition, if current laws and regulations are not kept in force or if further environmental laws and
regulations are not adopted in certain jurisdictions, demand for biogas upgrading equipment may be
limited.
The demand for QuestAir’s refinery related products is driven in part by regulations mandating the
reduction of sulphur levels in transportation fuels such as gasoline and diesel. The Company’s business
may suffer if these environmental policies and regulations change and no longer encourage the production
of ‘clean’ transportation fuels. There can be no guarantee that these laws and regulations will not change.
The Company’s products use flammable fuels that are inherently dangerous substances and could
subject the Company to product liabilities.
The Company’s results of operations could be materially harmed by accidents involving either its
products or those of other manufacturers, either because the Company faces claims for damages or
because demand for its products could suffer and its sales could decline. The Company’s products purify
hydrogen and methane containing gases. While its PSA systems do not use these fuels in a combustion
process, natural gas used to generate hydrogen, biogas and biomethane are flammable fuels that could
leak and then combust if ignited by another source. In addition, certain of the Company’s customers may
experience significant product liability claims. As a supplier of products and systems, the Company faces
an inherent business risk of exposure to product liability claims in the event that its products, or the
equipment into which its products are incorporated, malfunction and result in personal injury, death or
property damage. The Company may be named in product liability claims even if there is no evidence that
its systems or components caused the accidents. Product liability claims could result in significant losses
as a result of expenses incurred in defending claims or the award of damages. Since the Company’s
products have not yet gained widespread market acceptance, any accidents involving its systems, or those
used to produce purified biomethane or hydrogen could materially impede acceptance of its products.
Environmental Risks
All phases of the oil and natural gas business, and of the processing of organic wastes, are subject to
environmental regulation pursuant to a variety of Canadian federal, provincial, state and municipal laws
and regulations, as well as international conventions (collectively, “Environmental Legislation”).
Environmental Legislation imposes, among other things, restrictions, liabilities and obligations
in connection with the generation, handling, storage, transportation, treatment and disposal of
hazardous substances and waste and in connection with spills, releases and emissions of various
substances to the environment. Environmental Legislation also requires that wells, facility sites
and other properties associated with oil and natural gas operations be operated, maintained,
abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition,
certain types of operations, including exploration and development projects and significant
changes to certain existing projects, may require the submission and approval of environmental
impact assessments. Compliance with Environmental Legislation can require significant
expenditures and failure to comply with Environmental Legislation may result in the imposition
of fines, penalties and liability for clean up costs and damages. Changes in Environmental
Legislation may require, among other things, reductions in emissions to the air from the
Company’s existing and
increased capital
expenditures. Future changes in Environmental Legislation could occur and result in stricter
target customers’ operations and result
in
Page 33 of 63
standards and enforcement, larger fines and liability, and increased capital expenditures and
operating costs, which could have a material adverse effect on the Company’s existing and target
customers’ ability to purchase the Company’s products.
Management’s Responsibility for Financial Reporting
The accompanying financial statements of QuestAir Technologies Inc. and all the information in
the Annual Report are the responsibility of management and have been approved by the Board of
Directors.
The financial statements have been prepared by management in accordance with accounting
principles generally accepted in Canada.
When alternative accounting methods exist,
management has chosen those it deems most appropriate in the circumstances. Financial
statements are not precise since they include certain amounts based on estimates and judgment.
Management has determined such amounts on a reasonable basis in order to ensure that the
financial statements are presented fairly in all material respects. Management has prepared the
financial information presented elsewhere in the Annual Report and has ensured that it is
consistent with that in the financial statements. QuestAir Technologies Inc. endeavours to
maintain systems of internal accounting and administrative controls of high quality, consistent
with reasonable cost. Such systems are necessary to provide reasonable assurance that the
financial information is relevant, reliable and accurate and that the Company’s assets are
appropriately accounted for and adequately safeguarded.
The Board of Directors is responsible for ensuring that management fulfills its responsibilities
for financial reporting and is ultimately responsible for reviewing and approving the financial
statements. The Board carries out this responsibility principally through its Audit Committee.
The Audit Committee meets periodically with management, as well as the external auditors, to
discuss internal controls over the financial reporting process, auditing matters and financial
reporting issues, to satisfy itself that each party is properly discharging its responsibilities, and to
review the Annual Report, the financial statements and the external auditors’ report. The
Committee reports its findings to the Board for consideration when approving the financial
statements for issuance to the shareholders. The Committee also considers, for review by the
Board and approval by the shareholders, the engagement or re-appointment of external auditors.
The Company’s financial statements have been audited by PricewaterhouseCoopers LLP, the
external auditors, in accordance with generally accepted auditing standards on behalf of the
shareholders. PricewaterhouseCoopers LLP have full and free access to the Audit Committee.
(signed) Andrew Hall
President and Chief Executive Officer
(signed) Sherry Tryssenaar
Vice President Finance and Administration & Chief Financial Officer
Page 34 of 63
To the Shareholders of
QuestAir Technologies Inc.
We have audited the balance sheets of QuestAir Technologies Inc. as at September 30,
2008 and 2007 and the statements of operations, comprehensive loss and deficit,
shareholders’ equity and cash flows for each of the years in the two-year period ended
September 30, 2008. 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 financial statements present fairly, in all material respects, the
financial position of the company as at September 30, 2008 and 2007 and the results of
its operations and its cash flows for each of the years in the two-year period ended
September 30, 2008 in accordance with Canadian generally accepted accounting
principles.
Chartered Accountants
Vancouver, British Columbia
December 3, 2008
Page 35 of 63
QuestAir Technologies Inc.
Balance Sheets
As At September 30, 2008 and 2007
(expressed in Canadian dollars)
Assets
Current assets
Cash and cash equivalents
Restricted cash (note 3)
Short-term investments
Accounts receivable - net of allowance for doubtful accounts
of $92,689 (2007 - $nil)
Inventories (note 4)
Prepaid expenses
Long-term assets
Property, plant and equipment (note 5)
Other long-term assets
Liabilities
Current liabilities
Accounts payable and accrued liabilities (note 6)
Deferred revenue
Current portion of bank debt (note 7)
Current portion of obligation under capital lease (note 8)
Derivatives (note 9)
Long -term liabilities
Bank debt (note 7)
Obligation under capital lease (note 8)
Shareholders’ Equity
Share capital (note 10)
Authorized
Unlimited common shares, voting, no par value
Unlimited preferred shares, issuable in series, no par value
Common shares
Contributed surplus (note 10)
Deficit
2008
$
2007
$
9,265,249
281,005
62,048
974,404
5,214,342
199,269
15,996,317
1,329,986
178,930
17,505,233
2,896,307
4,735,258
443,345
105,479
412
8,180,801
228,262
-
8,409,063
5,726,245
340,802
3,060,447
1,412,983
4,376,717
256,378
15,173,572
1,703,872
175,080
17,052,524
2,791,139
4,546,584
564,306
97,822
75,874
8,075,725
356,030
97,822
8,529,577
115,363,615
8,863,225
(115,130,670)
9,096,170
17,505,233
109,383,859
6,626,825
(107,487,737)
8,522,947
17,052,524
Commitments and contingencies (note 14)
Approved by the Board of Directors
(signed) Andrew Hall Director
(signed) Denis Connor Director
Page 36 of 63
QuestAir Technologies Inc.
Statement of Operations, Comprehensive Loss and Deficit
For the years ended September 30, 2008 and 2007
(expressed in Canadian dollars)
Revenues
Cost of goods sold
Gross profit
Operating expenses (note 2)
Research and development – net (note 12)
General and administration
Sales and marketing
Operations
Amortization
Loss before undernoted
Other income (expense)
Interest income
Royalty expense
Other income (expense)
Loss and comprehensive loss for the year
Deficit – Beginning of year
Unrealized foreign exchange loss on derivatives (note 10)
2008
2007
$
$
11,432,256
8,030,894
3,401,362
7,012,166
7,007,989
4,177
3,004,486
3,981,456
1,796,842
1,478,150
734,121
4,800,592
3,667,755
2,117,706
936,951
850,833
10,995,055
12,373,837
(7,593,693)
(12,369,660)
199,493
(632,895)
384,162
(49,240)
(7,642,933)
(107,487,737)
-
522,524
(160,984)
(409,292)
(47,752)
(12,417,412)
(95,045,478)
(24,847)
Deficit – End of year
Basic and diluted loss per share (note 16)
(115,130,670)
(107,487,737)
(1.09)
(2.37)
Page 37 of 63
QuestAir Technologies Inc.
Statements of Shareholders’ Equity
For the years ended September 30, 2008 and 2007
(expressed in Canadian dollars)
Common
shares
$
Contributed
surplus
$
Accumulated
other
comprehensive
income
(loss)
$
Balance - September 30, 2006
109,020,202
6,462,772
Loss and comprehensive loss
Adjustment to opening balance of
unrealized foreign exchange loss on
embedded derivatives
Exercise of share options
Stock-based compensation allocated to
common shares on exercise of share
options
Stock-based compensation on fair value
share options
-
-
69,643
-
-
-
294,014
(294,014)
-
458,067
Balance - September 30, 2007
109,383,859
6,626,825
Loss and comprehensive loss
Issuance of common shares - net of
financing costs of $925,582
Issuance of warrants – net of financing
costs of $339,136
Exercise of share options
Stock-based compensation allocated to
common shares on exercise of share
options
Stock-based compensation on fair value
share options
-
5,661,057
-
-
-
143
2,257,825
-
318,556
(318,556)
-
297,131
Balance - September 30, 2008
115,363,615
8,863,225
-
-
-
-
-
-
-
-
-
-
-
-
-
Total
shareholders’
equity
$
Deficit
$
(95,045,478)
20,437,496
(12,417,412)
(12,417,412)
(24,847)
-
-
-
(24,847)
69,643
-
458,067
(107,487,737)
8,522,947
(7,642,933)
(7,642,933)
-
-
-
-
5,661,057
2,257,825
143
-
297,131
(115,130,670)
9,096,170
Page 38 of 63
QuestAir Technologies Inc.
Statements of Cash Flows
September 30, 2008 and 2007
(expressed in Canadian dollars)
Cash flows from operating activities
Loss for the year
Items not involving cash
Amortization
Gain on sale of property, plant and equipment
Unrealized foreign exchange (gain) loss on derivatives
Non-cash compensation expense
Foreign currency loss (gain)
Changes in non-cash operating working capital
Accounts, grants and funding receivables
Inventories
Prepaid expenses
Accounts payable and accrued liabilities
Deferred revenue
Cash flows from investing activities
Decrease in short-term investments
Increase in short-term investments
Purchase of property, plant and equipment
Government grants and funding related to property, plant and
equipment
Proceeds on sale of property, plant and equipment
Decrease in restricted cash
Cash flows from financing activities
Proceeds from financing
Share issue cost
Issuance of common shares on exercise of stock options
Repayment of obligations under capital lease
Term loan advance
Repayment of bank debt
Increase (Decrease) in cash and cash equivalents
Cash and cash equivalents – Beginning of year
Cash and cash equivalents – End of year
Supplemental cash flow information (note 17)
2008
2007
$
$
(7,642,933)
(12,417,412)
734,121
(17,309)
(75,462)
297,131
12,240
(6,692,212)
850,833
(412)
51,027
458,067
(32,489)
(11,090,386)
438,579
(837,625)
53,259
105,168
188,674
(51,945)
517,638
(866,209)
30,877
(1,304,932)
2,599,803
977,177
(6,744,157)
(10,113,209)
3,060,447
(62,048)
(364,768)
-
21,842
59,797
2,715,270
9,000,000
(1,081,118)
143
(102,405)
344,553
(593,282)
7,567,891
7,400,000
(3,060,447)
(426,729)
5,434
9,046
915,552
4,842,856
-
-
69,642
(127,930)
462,760
(426,674)
(22,202)
3,539,004
(5,292,555)
5,726,245
9,265,249
11,018,800
5,726,245
Page 39 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
1 Nature of operations
QuestAir Technologies Inc. (the “Company”), a federally incorporated Canadian company,
is an emerging developer, manufacturer and supplier of advanced pressure swing adsorption
(“PSA”) gas purification systems. PSA systems are used extensively in the production of
purified gases for a wide variety of industries. The Company’s products, which incorporate
patented, proprietary technology, primarily target hydrogen and methane purification in a
range of existing industrial and energy markets, including oil refinery and biogas processing
applications.
The Company has not yet realized profitable operations and has relied on non-operational
sources of financing to fund its operations. The Company raised additional capital to finance
its operations in fiscal 2008. The Company’s ultimate success and the recoverability of
long-lived assets will depend on its ability to successfully execute its business plan.
2 Significant accounting policies
Basis of presentation
These financial statements have been prepared in accordance with Canadian generally
accepted accounting principles.
The Company prepares an income statement using the functional format, other than
amortization, which is not allocated to the respective functions, and categorizes operating
expenses in the following captions:
a) Research and development: salaries and benefits of research and development
personnel, patent filing costs and other expenses incurred in development
programs.
b) General and administration: salaries and benefits of accounting, human
resources and information technology personnel, audit, legal, investor relations,
share compensation and other general corporate expenses.
c) Sales and marketing: salaries and benefits of sales and marketing personnel,
sales commissions, advertising and sales related travel costs.
d) Operations: salaries and benefits of quality assurance, non-development
engineering and supply chain personnel, value engineering and process
improvement costs.
Use of estimates
The preparation of financial statements in conformity with Canadian generally accepted
accounting principles requires management to make estimates and assumptions, which affect
the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the period. Assessment of the valuation of stock-based compensation,
Page 40 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
accrued warranty, revenue from long-term contracts, revenue from engineering service
contracts and losses related to contracts are significant areas requiring the use of estimates.
Actual results could differ from these estimates.
Cash and cash equivalents
Cash is comprised of unrestricted bank deposits some of which are interest bearing. Cash
equivalents consist of money market accounts and term deposits that are readily convertible
to known amounts of cash and are held to their original maturities within three months from
their date of purchase. They are carried at fair value and are classified as held for trading.
Short-term investments
The Company’s investments consist of term deposits, and are classified as held to maturity
for accounting purposes and are carried on the balance sheets at amortized cost using the
effective interest method. Investments with maturities of greater than ninety days and less
than one year are classified as short-term investments.
Inventories
Inventories are recorded at the lower of cost and replacement cost for raw materials and
supplies and at the lower of cost and net realizable value for work-in-progress and finished
goods. Costs of raw materials are determined on an average cost basis. Work-in-progress and
finished goods include materials, direct labour and production overhead. Inventories are
recorded net of any obsolescence provision.
Property, plant and equipment
Property, plant and equipment are recorded at cost (net of third party funding) less
accumulated amortization. Amortization is computed using the straight-line method over an
asset’s estimated useful life at the following rates:
Test equipment
Computer equipment
Leasehold improvements
Lab and warehouse equipment
Manufacturing equipment
Office equipment
Furniture and fixtures
Impairment of long -lived assets
20%
30%
lease term
20%
33%
20%
20%
Long-lived assets are tested for impairment whenever events or changes in circumstances
indicate that its carrying amount may not be recoverable. The Company tests the
recoverability of long-lived assets based on future undiscounted cash flows expected to
result from the use of the related assets to be realized on sale. An impairment loss is
Page 41 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
measured as the amount by which the carrying amount of a long-lived asset exceeds its fair
value.
Revenue recognition
The Company recognizes revenue on commercial equipment sales when title has transferred,
the customer has accepted the product, there is persuasive evidence of an arrangement,
collection is probable and the price is fixed or determinable. Provisions are established for
estimated product returns and warranty costs at the time revenue is recognized. The
Company records deferred revenue when cash is received in advance of all of these revenue
recognition criteria being met.
Revenues from long term production-type contracts and engineering service contracts are
determined under the percentage-of-completion method whereby revenues are recognized on
a pro rata basis in relation to contract costs incurred. Costs and estimated profit on contracts
in progress in excess of amounts billed are reflected as work-in-progress. Cash received in
advance of revenues being recognized on contracts is classified as deferred revenue.
The Company monitors its contracts with customers on a regular basis to determine if a loss
is likely to occur. If a loss is anticipated on a contract, the entire estimated loss is recorded as
a cost of sales and a reduction in work-in-progress in the period in which the loss becomes
evident and reasonably estimable.
Warranty costs
The Company provides for future warranty costs on products sold based on management’s
best estimates of such costs, taking into account past experience and the nature of the
contracts.
Research and development costs
Research costs are expensed as incurred. Development costs are expensed as incurred unless
they meet certain criteria under Canadian generally accepted accounting principles for
deferral and amortization, which relate primarily to technological feasibility, identified
future markets of the product, and availability of resources to complete the project. The
Company has determined that none of its development costs to date have met these criteria.
Government assistance
Government assistance is recorded when receipt is reasonably assured as either a reduction
of the cost of the applicable assets or a credit to the applicable expenses incurred in the
statement of operations and deficit as determined by the terms and conditions of agreements
under which the assistance is provided to the Company. A liability is recorded when
repayment of the assistance is considered probable and recorded as a royalty expense.
Page 42 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
Foreign currency translation
Transactions denominated in foreign currencies are translated to Canadian dollars at the rate
prevailing at the time of the transactions. Monetary assets and liabilities denominated in a
foreign currency are translated into Canadian dollars at the current rates in effect at the
balance sheet date. The resulting exchange gains and losses are recognized in the statement
of operations, comprehensive loss and deficit.
Stock-based compensation plans
The Company accounts for stock options using the fair value method calculated using the
Black-Scholes option pricing model. For options granted to directors, officers and
employees, the compensation cost is measured at fair value at the date of grant and is
expensed to operations over the award’s vesting period. For options granted to non-
employees, the fair value is measured when performance is complete, a performance
commitment is made or the options are fully vested and non-forfeitable, whichever is
earliest, and the expense is recognized over the period in which the goods or services from
the non-employees are received. A corresponding increase in contributed surplus is recorded
when stock options are expensed. When stock options are exercised, capital stock is credited
by the sum of the consideration paid and the related portion previously recorded in
contributed surplus. The effects of forfeitures are accounted for as they occur.
Income taxes
The Company follows the asset and liability method of accounting for income taxes. Under
this method, future income taxes are recognized for the future income tax consequences
attributable to differences between the financial statement carrying values and their
respective income tax bases (temporary differences) and for the benefit of loss carry-
forwards. Future tax assets and liabilities are measured using substantively enacted 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 tax rates is included in income in the period that includes the substantial enactment date.
Future income tax assets are evaluated and if realization is not considered to be more likely
than not, a valuation allowance is provided.
Financial instruments
Recognition and Measurement
The company uses the following classifications for its financial instruments:
a) Short-term liquid investments included in cash and cash equivalents have been classified
as held-for-trading and short-term investments have been classified as held-to-maturity.
b) The Company’s accounts receivable are initially measured at fair value and subsequently
at amortized cost, using the effective interest method less provisions for impairment.
Page 43 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
c) The Company’s accounts payable and accrued liabilities are initially measured fair value
and subsequently at amortized cost, using the effective interest method.
d) The Company’s debt has been classified as other financial liability, and initially
measured at fair value and subsequently at amortized cost using the effective interest
method.
Financial assets and liabilities classified as held-for-trading are measured at fair value at
each reporting period with changes in fair value in subsequent periods included in net
earnings. Held-to-maturity assets are initially measured at fair value and subsequently at
amortized cost using the effective interest method.
The Company classifies derivative financial instruments which have not been designated as
hedges for accounting purposes and embedded derivatives as held-for trading, and values
them at fair value each period with changes recorded in other income. The embedded
derivatives relate to the foreign exchange component of certain sales contracts which the
Company enters into during the regular course of business (note 9 and 10c). The Company
does not designate these derivative financial instruments as hedges.
Disclosures and presentation
CICA Handbook Section 3862 Financial Instruments - Disclosures provides standards for
disclosures about financial instruments, including disclosures about fair value and the credit,
liquidity and market risks associated with the financial instruments. CICA Handbook
Section 3863 Financial Instruments - Presentation establishes standards for presentation of
financial instruments and non-financial derivatives. On September 30, 2007, the Company
early adopted these Sections. The early adoption of Section 3862 required additional
disclosures in the Notes to the financial statements which are contained in note 9.
Capital disclosures
CICA Handbook Section 1535 - Capital Disclosures requires an entity to disclose
information to enable users of its financial statements to evaluate the entity’s objectives,
policies and processes for managing capital. On September 30, 2007, the Company elected
to early adopt 1535 resulting in additional disclosures contained in note 10.
Financing charges
Financing charges, which refle ct the cost to obtain new debt financing, are expensed as
incurred. Financing charges, which reflect the cost to obtain new equity financing, are
deducted from net proceeds as incurred.
Page 44 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
Comparative amounts
Comparative amounts have been reclassified, where necessary, to conform to the
presentation adopted in the current year.
Future accounting changes
The CICA issued Section 3031, Inventories, which supersedes the previously issued
standard on inventory and introduces significant changes to the measurement and
disclosure of inventory. The measurement changes include: the elimination of LIFO,
and the reversal of previous write-downs to net realizable value when there is a
subsequent increase in the value of inventories. Disclosures of inventories have also
been enhanced. Inventory policies, carrying amounts, amounts recognized as an
expense, write-downs and the reversals of write-downs are required to be disclosed.
This new standard comes into effect for fiscal years beginning on or after January 1,
2008; accordingly the Company will adopt this new standard in fiscal 2009. The
Company is assessing the impact this standard will have on its financial statements.
The CICA issued Section 3064, Goodwill and Intangible Assets, which establish
standards for the recognition, measurement, presentation and disclosure of goodwill
and intangible assets (including internally developed intangible assets). These
recommendations are effective for the Company beginning October 1, 2008;
accordingly the Company will adopt this new standard in fiscal 2009. Goodwill and
intangible assets that are not assets as defined by GAAP will be derecognized and
charged to the equity of the Company at that date. The Company is assessing the
impact this standard will have on its financial statements.
The CICA revised section 1400, General Standards of Financial Statement
Presentation, which requires management to make an assessment of, and disclose
material uncertainties related to, the ability of an entity to continue as a going
concern. This new standard comes into effect for fiscal years beginning on or after
January 1, 2008; accordingly QuestAir will adopt this new standard in fiscal 2009.
The Company is assessing the impact this standard will have on its financial
statements.
On February 13, 2008, the Canadian Accounting Standards Board confirmed that
International Financial Reporting Standards will replace Canada’s current generally
accepted accounting principles for publicly accountable profit-oriented enterprises
for interim and annual financial statements effective January 1, 2011. The Company
is presently considering the effect these standards will have on its financial
statements.
Page 45 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
3 Restricted cash
During 2008, the Company was required to deposit cash with Comerica Bank as collateral in
order to secure its obligations under irrevocable standby and documentary letters of credit.
Restricted cash is released as the letters of credit are drawn upon or expire. Expiry dates of
the letters of credit vary and extend to July 20, 2009. Restric ted cash at September 30, 2008
of $281,005 (2007 - $340,802) relates to letters of credit of $281,005 (2007 - $340,802).
4
Inventories
Raw materials and supplies
Work-in-progress
Finished goods
5 Property, plant and equipment
Lab and warehouse equipment
Manufacturing equipment
Leasehold improvements
Computer equipment
Test equipment
Office equipment
Furniture and fixtures
2008
$
2007
$
823,006
1,577,912
2,813,424
895,988
2,317,754
1,162,975
5,214,342
4,376,717
Cost
$
Accumulated
amortization
$
2,526,138
1,934,880
1,727,241
1,403,317
1,273,457
263,434
165,979
2,243,341
1,920,557
1,241,311
1,139,308
1,003,762
257,213
158,968
2008
Net
$
282,797
14,323
485,930
264,009
269,695
6,221
7,011
9,294,446
7,964,460
1,329,986
Page 46 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
Lab and warehouse equipment
Manufacturing equipment
Leasehold improvements
Computer equipment
Test equipment
Office equipment
Furniture and fixtures
Cost
$
Accumulated
amortization
$
2,468,956
1,920,074
2,369,348
2,262,737
3,159,623
266,434
207,805
2,033,946
1,896,995
1,856,096
1,848,571
2,856,693
257,573
201,231
2007
Net
$
435,010
23,079
513,252
414,166
302,930
8,861
6,574
12,654,977
10,951,105
1,703,872
As at September 30, 2008, assets under capital lease with a cost of $357,878 (2007 -
$356,065) and accumulated amortization of $178,576 (2007 - $57,860) are included in
property, plant and equipment. Amortization expense for assets under capital lease recorded
in the statement of operations, comprehensive loss and deficit for the year ended September
30, 2008 was $120,716 (2007 - $57,860).
6 Accounts payable and accrued liabilities
Trades payable
Wages and benefits
Royalty payable
Warranty provision
Accounting and legal costs
Taxes payable (GST, PST)
7 Bank debt
2008
$
585,805
971,825
756,476
432,626
107,352
42,223
2007
$
1,256,234
723,322
218,307
473,475
119,000
801
2,896,307
2,791,139
In April 2005, the Company signed a credit facilities agreement with Comerica Bank. This
agreement was amended and restated in June 2008 as part of the annual renewal of these
facilities (Tranche 4). The amended credit facilities include a US$1 million accounts
receivable line of credit and a US$1 million term loan to finance equipment purchases, in
addition to amounts outstanding under prior term loan agreements. Both facilities are
secured by the assets of the Company, with certain exceptions. Under the terms of the
agreement, the Company must comply with financial covenants and certain other business
terms.
Page 47 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
The line of credit is limited to 80% of eligible accounts receivable, subject to certain
restrictions. This credit facility is payable upon demand. The variable interest rate for the
line of credit is 1.75% above the Prime Rate. Interest is payable monthly, and the line of
credit is renewable annually. As at September 30, 2008, no amounts were drawn against this
facility.
The variable interest rate of the Tranche 4 term loan is 1.75% above the Prime Rate
compared to 0.75% above the Prime Rate on the prior term loans. Interest on Tranche 1 is
initially payable monthly with 36 equal payments of principal plus interest payable
beginning October 22, 2005. Interest on Tranche 2, 3 and 4 is initially payable monthly with
30 equal payments of principal plus interest payable beginning February 1, 2007, 2008 and
2009 respectively. As at September 30, 2008, the Company had drawn $671,607 (2007 -
$920,336) on the term loans net of repayments.
Current portion of bank debt
Long-term portion of bank debt
2008
$
443,345
228,262
671,607
2007
$
564,306
356,030
920,336
Accrued interest payable as at September 30, 2008 was $1,939 (2007 - $1,979) and is
included in accounts payable and accrued liabilities. The effective interest rate of the term
loans was 6.25% (2007 – 7.05%) for the year ended September 30, 2008. Total interest
expense was $55,370 (2007 - $58,599) for the year ended September 30, 2008. Draws can
be made against the Tranche 4 term loan, to a maximum of US$1 million, prior to June 19,
2009. As at September 30, 2008, $190,924 had been drawn against the Tranche 4 term loan.
8 Obligations under capital lease
In April 2007, the Company entered into a computer software license under a capital lease
which expires in 2009 and bears an implied annual interest rate of 8.1%. Interest paid during
2008 related to obligations under capital lease was $11,526 (2007 - $nil) and $5,813 (2007 -
$5,753) was accrued in 2008. At September 30, 2008, future minimum lease payments
under capital leases are $105,479 (2007 - $195,644).
9 Financial instruments
On October 1, 2006, the Company adopted section 3855, giving rise to the initial recognition
of unrealized losses on embedded derivatives. These amounts have been calculated and
labeled as transitional balances and have been recognized in the opening retained earnings of
the Company.
Page 48 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
The Company marks to market all financial derivative instruments outstanding at the end of
the reporting period, with the unrealized gain/loss charged to other expense with a
corresponding offset amount recorded in the balance sheet. Included in the loss for the year
ended September 30, 2008 is a $75,462 (2007 – $51,027 loss) unrealized foreign exchange
gain on such embedded derivatives. This gain was determined based on future billing under
the sales contract, exchange rates prevailing at the time the contract was entered into, and
exchange rates prevailing at September 30, 2008.
The following table summarizes the carrying value of the Company’s financial instruments:
2008
$
2007
$
Held for trading (cash and cash equivalents and restricted cash) 9,546,254
62,048
Held to maturity (short term investments)
974,404
Loans and receivables
3,673,393
Other financial liabilities
6,067,047
3,060,447
1,412,983
3,907,119
The carrying amount of short-term financial instruments, less provisions for impairment if
applicable, is used to estimate the fair value of such instruments. The Company’s debt bears
a variable interest rate, and therefore its carrying value approximates its fair value.
Interest income and other gains and losses from “held for trading” and “held to maturity”
financial assets are recognized in interest income. Interest income, expense and gains and
losses from loans, receivables and other financial liabilities are recognized in other income
(expense). The following table summarizes interest income and expense under the effective
interest method for the year ended September 30, 2008:
Interest income from held for trading financial assets
Interest income from held to maturity financial assets
Interest expense from other financial liabilities
Risks
2008
$
159,877
15,925
66,895
2007
$
337,102
184,044
64,352
The Company’s activities expose it to various risks, including credit risk, market risks such
as foreign exchange risk and interest rate risk, and liquidity risk. The Company’s risk
management activities are designed to mitigating possible adverse effects on the Company’s
performance, having regard for the size and scope of the Company’s operations, with a
primary focus on preservation of capital. Risk management activities are managed by the
finance and accounting department.
The following analysis will provide a measurement of risks as at September 30, 2008.
Page 49 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
i)
Credit risk
Credit risk is the risk that the Company will incur a loss due to the failure by its
customers or other parties to meet their contractual obligations. Financial instruments
that potentially subject the Company to significant concentrations of credit risk consist
primarily of cash and cash equivalents, restricted cash and accounts receivable. The
Company limits its exposure to credit risk by placing its cash and cash equivalents,
restricted cash and short-term investments with high credit quality financial institutions.
Given the current economic environment, the Company recently re-assessed the credit
quality of the financial institutions it deals with, and determined that they continue to be
high credit quality institutions.
Credit risk is limited by the structure of the Company’s sales contracts. Typically,
milestone payments valued at 80% of the contract value are collected prior to shipment.
Further, under its standard contract terms, the Company retains title to all equipment
until final payment is received, which provides the Company with further protection in
respect of its accounts receivable. Given the current economic environment, accounts
receivable invoices have been reviewed for each customer at year end for collectability
and an allowance for doubtful accounts has been estimated. At Se ptember 30, 2008, the
allowance for doubtful accounts balance of $92,689 (2007 - $nil) relates to outstanding
invoices from one customer that is experiencing financial difficulties. In addition, we
recorded a bad debt expense of $8,629 during the year ended September 30, 2008.
There had not been any write-offs related to bad debt for the previous 5 fiscal years.
At September 30, 2008, 28.5% (2007 - 9.5%) of trades receivable were outstanding for
more than 90 days, 27.4% (2007 – 56.1%) were outstanding for between 30 and 90 days
and the remaining 44.1% (2007 – 34.4%) were outstanding less than 30 days. Trades
receivables are considered past due based on the contract terms agreed to with a
customer. As noted above, aged receivables that are past due are not considered
impaired unless customer specific information indicates otherwise.
ii)
Foreign exchange risk
Foreign exchange risk is the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in foreign exchange rates. The Company
is exposed to foreign exchange risk on its cash, cash equivalents, restricted cash, short-
term investment and accounts receivable balances, as well as its obligations under
capital leases and accounts payable.
Predominantly all of the Company’s sales are in United States dollars or Euros and are
converted to Canadian dollars at the time of revenue recognition. For the year ended
September 30, 2008, the Canadian value of United States dollar denominated sales was
$9,295,642 (2007 - $6,008,402) and Euro denominated sales was $1,182,479 (2007 -
$763,948). The Company does not hold or issue financial instruments to manage its
exposure to currency rate fluctuations relating to sales; however it does maintain cash
Page 50 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
balances in foreign currencies sufficient to meet obligations to foreign suppliers, in
effect providing a natural hedge. Periodically, excess balances of foreign currency are
converted to local currency to meet Canadian dollar cash requirements.
At September 30, 2008, the Canadian/US foreign exchange rate was 0.9397 (2007-
1.0052) and the Canadian/Euro rate was 0.6676 (2007 - 0.7049). Assuming that all
other variables remain constant, an increase of $0.10 in the Canadian dollar would have
following impact on the ending balances of certain balance sheet items at September 30,
2007 and 2008, with the net foreign exchange gain or loss directly impacting net loss
for fiscal 2007 and 2008.
(expressed in Canadian dollars)
Financial assets
Cash and cash equivalents
Short-term investments
Trade accounts receivable
Financial liabilities
Accounts payable and accrued
liabilities
Obligations under capital lease
Net foreign exchange loss
(expressed in Canadian dollars)
Financial assets
Cash and cash equivalents
Short-term investments
Trade accounts receivable
Financial liabilities
Accounts payable and accrued
liabilities
Obligations under capital lease
Net foreign exchange loss
Net change in
US$ balances
$
Net change in
Euro balances
$
2008
Total net change
in foreign
currency
balances
$
(83,960)
(142,612)
(56,854)
15,346
10,145
(257,935)
(22,829)
-
(30,477)
126
-
(53,180)
(106,789)
(142,612)
(87,331)
15,471
10,145
(311,115)
Net change in
US$ balances
$
Net change in
Euro balances
$
2007
Total net change
in foreign
currency
balances
$
(52,020)
(202,519)
(112,781)
49,997
17,702
(299,622)
(154,296)
-
(3,430)
2,424
-
(155,302)
(206,316)
(202,519)
(116,211)
52,421
17,702
(454,924)
Page 51 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
iii)
Interest risk
Interest rate risk is the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market interest rates.
The Company is exposed to interest risk on its bank debt for which the interest rates
charged fluctuate based on the bank prime rate. Bank debt at September 30, 2008 is
$671,607 (2007 - $920,336). Interest is compounded daily at prime plus 1.75% on the
Tranche 4 term loan, and at prime plus 0.75% on all prior term loans. If the interest rate
on the bank debt had been 50-basis points higher (lower), related to the bank debt
outstanding during fiscal 2008, net loss would have been $471 (2007 - $445) higher
(lower).
iv)
Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its obligations as
they fall due. The following are the contractual maturities of financial liabilities as at
September 30, 2008:
Financial liabilities
Accounts payable and accrued
liabilities
Bank debt
Obligation under capital lease
Contractual
cash flows
$
0 to 12
months
$
12 to 24
months
$
After 24
months
$
2,896,307
671,607
105,479
3,673,393
2,896,307
443,345
105,479
3,445,131
-
156,347
-
156,347
-
71,915
-
71,915
It is the Company’s intention to meet these obligations through the collection of
accounts receivable and the receipt of future progress payments on amounts not yet
invoiced, as well as from current cash, cash equivalents and short-term investment
resources. In addition, the Company has available lines of credit and term loans of
US$1.8 million at September 30, 2008.
10 Shareholder’s equity
a) Common shares – issued and outstanding
During the year ended September 30, 2008, the Company completed an equity
offering
issuing 60,000,000 subscription receipts for gross proceeds of
$9,000,000. Each subscription receipt was exchanged for one common share of
the Company stock and one common share purchase warrant. The Company
subsequently consolidated its issued and outstanding share capital on a 1 new
share for 10 old shares basis. After giving effect to the share consolidation, each
whole warrant will entitle the holder to acquire one additional common share at a
Page 52 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
price of $2.15 per share until May 13, 2010. A fair value of $2,413,361 was
recognized by the Company as the proceeds for the warrants. Total share issuance
costs for the financing was $1,264,718 including non cash costs of $183,600, of
which $925,582 was allocated to common shares and $339,136 was allocated to
warrants.
The fair value of warrants was estimated as at the date the equity offering was priced,
using the Black-Scholes option-pricing model with the following weighted-average
assumptions:
Dividend yield
Expected volatility
Risk-free interest rate
Expected average warrant term (years)
0.0%
65%
2.8%
2.00
After giving effect to the equity offering and share consolidation, authorized share
capital consists of an unlimited number of common shares, of which 11,268,318 (2007
– 5,254,002) common shares were issued and outstanding as of September 30, 2008.
During the year ended September 30, 2008, 14,316 (2007 – 14,742) common shares
were issued on exercise of share options. An unlimited number of preferred shares are
authorized, none of which are issued. The basic and diluted earnings per share have
been adjusted retroactively for all periods presented to reflect the common share
consolidation.
b) Share purchase warrants - issued and outstanding
During the year 6,180,000 (2007 – nil) warrants were issued and remain outstanding at
September 30, 2008. 6,000,000 were issued on exchange of subscription receipts, with
each warrant entitling the holder to acquire one additional common share at a price of
$2.15 per share until May 13, 2010. The remaining 180,000 warrants were issued to
Underwriters and entitle the holder to acquire one common share at a price of $1.50 per
share until May 13, 2010.
19,231 transferable share purchase warrants, issued as part of the agreement with the
Canadian Federal Minister of Industry under the Technology Partnerships Canada
(“TPC”) Program expired unexercised during the year.
c) Contributed surplus
During the year ended September 30, 2008 $297,131 (2007 - $458,067) stock-based
compensation on share options issued to employees under the fair value method was
recorded in contributed surplus. As noted above, a fair value of $2,074,225 was
recognized by the Company as proceeds for the warrants net of financing costs of
Page 53 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
$339,136, which is included in the balance of contributed surplus as at September 30,
2008.
d) Deficit
Effective October 1, 2006, the Company adopted new valuation principles required for
financial instruments. In accordance with CICA Handbook Section 3855 Financial
Instruments – Recognition and Measurement, the difference between the previous
carrying amount and fair value of derivatives other than those that are designated and
effective hedging items are recognized as an adjustment to the balance of retained
earnings at the beginning of the fiscal year in which this section is initially applied. An
adjustment to retained earnings of $24,847 was made to reflect the difference between the
carrying amount (being zero) and the fair value of embedded derivatives in sales
contracts at September 30, 2006. (Also see note 9)
e) Comprehensive loss
Comprehensive loss is the decrease in equity from sources other than owners and is
comprised of net loss and other revenues, expenses, gains, and losses that, pursuant to
Canadian GAAP, are excluded from net loss. The Company had no other comprehensive
gains or losses during the year, therefore the comprehensive loss equals net loss of
$7,642,933 (2007 - $12,417,412) for the year ended September 30, 2008.
f) Capital management
As an emerging developer, manufacturer and supplier of PSA systems, the Company is a
net consumer of cash with limited access to debt financing. The majority of its capital is
generated through the sale of shares. Additional capital resources consist of secured debt.
The Company’s objective when managing capital is to safeguard its ability to continue as
a going concern in order to provide return to shareholders and benefits for other
stakeholders. In order to maintain or adjust its capital structure, the Company may issue
new shares or secure long-term debt facilities. The Company does not pay dividends.
Total capital is calculated as follows:
Unaudited
Bank debt
Equity
2008
$
671,607
9,096,170
9,767,777
2007
$
920,336
8,522,947
9,443,283
The Company does not use financial ratios to manage capital, and it is not subject to any
externally imposed capital requirements.
Page 54 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
11 Share Options
The Company has issued stock options under two different stock-based incentive plans.
The 2004 Stock Option Plan (“2004 Plan”) only allowed for the issuance of stock
options. On February 6, 2007, Shareholders approved the adoption of the 2006 Omnibus
Plan (“2006 Plan”), which allows for the issuance of stock options, stock appreciation
rights, restricted stock, restricted stock units, performance awards and other stock-based
awards. Under the 2006 Plan, common shares approved for issuance under all stock-
based compensation arrangements are limited to the greater of 591,560 and 10% of the
common shares issued and outstanding. After the equity offering was completed in June
2008, the maximum number of common shares available for issuance under all stock-
based compensation arrangements increased to 1,126,831.
Under the terms of the 2006 Plan, stock options are granted with an exercise price not
less than the volume weighted average trading price of the common shares for the five
trading days prior to the date of grant. Stock options generally vest quarterly over four
years and are exercisable for seven years from the date of grant. During the year ended
September 30, 2008 172,110 (2007 -28,156) options were issued. Included were 144,860
options, vesting over two years and exercisable for five years, issued to non-executive
employees. At September 30, 2008 736,839 (2007- 100,256) common shares are
available for issuance pursuant to awards made under the 2006 Plan. No other form of
stock-based awards have been issued under the 2006 Plan as at September 30, 2008.
The Company calculated the minimum fair value of each share option grant on the date of
grant using the Black-Scholes option valuation model with the following weighted
average assumptions:
Dividend yield
Expected volatility
Risk-free interest rate
Expected life of options
2008
0%
70%
3.33%
3 years
2007
0%
52%
4.27%
5 years
Share option activity since September 30, 2006 is presented below:
Page 55 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
Outstanding – September 30, 2006 (341,360 share
options exercisable)
Granted
Exercised
Forfeited
Outstanding – September 30, 2007 (381,584 share
options exercisable)
Granted
Exercised
Forfeited
Outstanding – September 30, 2008 (222,531 share
options exercisable)
Weighted average
exercise price
$
13.39
10.79
4.72
18.03
13.21
1.52
0.01
14.44
8.13
Options
493,706
28,156
(14,742)
(30,328)
476,792
172,110
(14,316)
(273,652)
360,934
Options outstanding –
September 30,
2008
Options exercisable –
September 30,
2008
Weighted
average
remaining
contractual
life
(years)
0.13
5.93
5.72
2.17
6.75
1.20
4.33
Weighted
average
exercise
price
$
0.01
1.50
6.46
9.75
12.60
17.44
8.13
Number of
stock options
exercisable
1,000
53,110
3,921
59,029
27,675
77,796
222,531
Weighted
average
exercise
price
$
0.01
1.67
6.61
9.82
12.88
17.44
10.82
Exercise
price range
$
0.01
0.73 – 2.40
4.60 – 6.90
9.00 – 11.90
12.00 – 13.90
16.20 – 17.50
Number of
stock options
outstanding
1,000
156,600
9,679
64,011
51,549
78,095
360,934
The Company did not issue share options with an exercise price less than the estimated
fair market value of a common share on the grant date for the years ended September
30, 2008 and 2007. In 2008, the Company issued 172,110 (2007 – 28,156) share options
with an exercise price equal to the fair market value of a common share on the grant
date. These options had a weighted average exercise price of $1.52 (2007 - $10.79) and
a weighted average fair value of $0.70 (2007 - $6.07). During 2008, $297,131 (2007 -
$458,067) of stock compensation expense has been charged to the statement of
operations, comprehensive loss and deficit related to the vesting of stock option awards.
Page 56 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
12 Research and development
Research and development costs
Government grants
13 Income taxes
a) Effective tax rate
2008
$
2007
$
3,004,486
-
5,175,521
(374,929)
3,004,486
4,800,592
Income tax expense (recovery) differs from the amount that would be computed by
applying the combined federal and provincial statutory income tax rates of 31.905%
(2007 – 34.12%) to income before income taxes. The reasons for the differences are as
follows:
Computed tax recovery
Increase (decrease) resulting from
Permanent and other differences
Book to tax adjustments
Stock based compensation
Change in future income tax rates
Change in valuation allowance
b) Future tax assets and liabilities
Non-capital loss carry-forwards
Scientific research and experimental development
expenses
Non-refundable provincial tax credits
Share issuance costs
Reserves
Property, plant and equipment
2008
$
2007
$
(2,438,000)
(4,237,000)
26,000
(58,000)
95,000
3,833,000
(1,458,000)
-
33,000
77,000
156,000
743,000
3,228,000
-
2008
$
2007
$
11,433,000
13,242,000
6,072,000
3,526,000
550,000
1,370,000
1,328,000
6,818,000
3,393,000
684,000
1,531,000
1,381,000
Total future tax assets before valuation allowance
Valuation allowance
Net future tax asset
24,279,000
(24,279,000)
-
27,049,000
(27,049,000)
-
Page 57 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
In assessing the realizability of future tax assets, management considers whether it is
more likely than not that some portion or all of the future tax assets will be realized. The
ultimate realization of future tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. As management believes there is sufficient uncertainty regarding the
realization of future tax assets, a full valuation allowance has been provided.
The Company has non-capital losses carried forward of approximately $43,971,000,
which are available to reduce taxable income of future years, the benefit of which has
not been recorded in the accounts, and which expire as follows:
2009
2010
2014
2015
2026
2027
2028
$
3,965,000
8,379,000
4,897,000
5,885,000
6,898,000
7,229,000
6,718,000
43,971,000
The Company has scientific research and experimental development expenses of
$23,355,000 (2007 - $22,371,000) which are available to be carried forward indefinitely
and deducted against future taxable income otherwise calculated.
c) As of September 30, 2008, the Company also has investment tax credits of
approximately $8,695,000 (2007 - $8,357,000) available to offset future Canadian
federal and provincial income taxes payable. The investment tax credits began to expire
in 2007. The potential benefit of the investment tax credit has not been recognized in
the accounts.
14 Commitments and contingencies
a) Leases
At September 30, 2008, the Company is committed to make the following minimum
operating lease payments related to premises and office equipment:
2009
2010
2011
$
350,814
340,734
337,636
1,029,184
Page 58 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
b) Letters of Credit
During 2008, the Company had banks issue letters of credit on its behalf, to meet its
performance obligations on customer contracts and to secure future payments to a
vendor. At September 30, 2008, $281,005 (2007 - $340,802) of these letters of credit
are outstanding with varying expiry dates extending to July 20, 2009.
c) TPC Programs
Fast Cycle Pressure Swing Adsorption and Gas Management systems
On June 6, 2003, the Company entered into an agreement with the Canadian Federal
Minister of Industry under the TPC Program to receive financial contributions regarding
the development and commercial exploitation of its Fast Cycle Pressure Swing
Adsorption (“FCPSA”) and Gas Management systems (“GMS”).
Pursuant to the agreement, total project costs for the period from October 1, 2002 to
September 30, 2007 were to be shared, subject to certain contribution limits, such that
the Minister’s contribution would not exceed the lesser of 30% of eligible project costs
and $9,600,000.
The agreement further provides that the Minister shall provide the Company with
financial contributions based on the aforementioned limitations in exchange for:
i.
ii.
the issuance of 19,230 transferable warrants convertible into common shares at
a strike price of $38.80, exercisable for a term of five years (which warrants
expired unexercised), and
repayable contributions to the Minister during the royalty period based on
1.165% of gross business revenues.
During the year ended September 30, 2008, the Company entered into an Amendment
Agreement with the Canadian Federal Minister of Industry to amend the TPC
contribution agreement in respect of the Company’s FCPSA and GMS development
programs. The Amendment Agreement:
iii.
iv.
v.
vi.
vii.
deleted certain milestones related to the GMS program
extended certain milestones rela ted to the FCPSA program, such that the work
phase of the program will end on September 30, 2008
reduced the Minister’s contribution limit towards eligible project costs to $8.14
million, being the amount received thus far by the Company
reduced the ceiling on the conditional repayments under the agreement to $18.8
million and extended the date by which the royalty period will end by 12
months to September 30, 2022, and
provided for an unconditional, one-time royalty payment of $0.5 million to be
paid on or before November 28, 2008.
Page 59 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
Cumulative repayments of $169,744 (2007 - $88,052) have been made to September 30,
2008. Any amounts ultimately determined to be repayable are accrued as a liability
when the project revenues are known and reasonably estimable and recorded as royalty
expense. As of September 30, 2008, $259,797 (2007 - $210,468) has been accrued as a
liability (in addition to the one-time royalty payment noted above).
Pulsar Pressure Swing Adsorption project
On March 31, 1999, the Company entered into an agreement with the Canadian Federal
Minister of Industry under the TPC Program to receive financial contributions regarding
the development and commercial exploitation of its Pulsar Pressure Swing Adsorption
project.
Pursuant to the agreement, total project costs for the period from October 1, 1998 to
March 31, 2002 were to be shared, subject to annual contribution limits, such that the
Minister’s contribution would not exceed the lesser of 35% of eligible project costs, and
$4,947,330.
The Company received contributions aggregating $4,762,503. The agreement further
provides that the contributions are repayable solely based on a royalty of 1.8% of gross
project revenues and revenues from fuel cell related products to a maximum cumulative
repayment of $8.75 million. Cumulative repayments of $56,347 (2006 - $47,651) have
been made to September 30, 2008. Any amounts ultimately determined to be repayable
are accrued as a liability when the project revenues are known and reasonably estimable
and recorded as royalty expense. As of September 30, 2008, $389 (2007 - $7,839) has
been accrued as a liability. The agreement terminates on the later of the date of payment
of all amounts due to the Minister and 2015.
d) Natural Resources Canada Agreement
In January 2005, the Company received a grant from the Government of Canada under
the Department of Natural Resources Efficiency and Alternative Energy Program to
support the development of structured adsorbent that will possess enhanced properties
to assist in high purity hydrogen separation. Total funding received by the Company of
$225,000 was recorded as a credit of $85,349 to research and development and a credit
of $139,651 to property, plant and equipment in fiscal 2005. The agreement provides
that the Minister shall provide the Company with financial contributions based on the
aforementioned limitations and such contributions are repayable solely based on 0.12%
of gross project revenues through March 31, 2015, to a maximum cumulative
repayment of $225,000, whichever occurs first. Cumulative repayments of $4,338
(2007 - $nil) have been made to September 30, 2008. Any amounts ultimately
determined to be repayable are accrued as a liability when the project revenues are
Page 60 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
known and reasonably estimable and recorded as royalty expense. As of September 30,
2008, $1,253 (2007 - $nil) has been accrued as a liability.
In January 2004, the Company received a grant from the Government of Canada under
the Department of Natural Resources Efficiency and Alternative Energy Program to
support the development of a device that increases the efficiency of a High Temperature
Fuel Cell system and permits the co-production of hydrogen. Total funding received by
the Company of $193,944 was recorded as a credit of $142,350 to research and
development and a credit of $51,594 to property, plant and equipment in fiscal 2004.
The agreement provides that the Minister shall provide the Company with financial
contributions based on the aforementioned limitations and such contributions are
repayable solely based on 0.12% of gross project revenues through March 31, 2014, to a
maximum cumulative repayment of $193,944, whichever occurs first. Any amounts
ultimately determined to be repayable are accrued as a liability when the project
revenues are known and reasonably estimable and recorded as royalty expense. To date,
no such project revenue has been recorded.
e) Director and officer indemnification
The Company’s directors and officers are covered under a directors’ and officers’
insurance policy. The aggregate limit of liability applicable to those insured directors
and officers under the policy is $10 million. Under this policy, the Company has
reimbursement coverage to the extent that the Company has indemnified a director or
officer in excess of a deductib le of $250,000 for each loss related to securities claims
and $100,000 for other losses. The Company’s by-laws also provide for the
indemnification of the directors and officers from and against liability and costs in
respect of any action or suit against them in connection with the execution of their
duties of office, subject to certain limitations.
f) Severance and termination benefits
The Company incurred severance costs and termination benefits of $955,080 during the
year ended September 30, 2008 related to the termination of employees and the
restructuring of its operations , of which $494,018 has been paid and $461,062 is
payable prior to the end of fiscal 2009. Severance costs and termination benefits are
included in general and administration expenses.
15 Segmented information
The Company’s overall focus is on the development and commercialization of gas
purification systems, being the Company’s only segment. Summarized product sales and
service revenue by geographic area, as determined by the location of the customer, is as
follows:
Page 61 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
Revenue
United States
Europe
South America
Asia
Canada
Summarized revenue by stream is as follows:
Gas purification systems
Engineering service contracts
2008
$
2007
$
8,623,291
1,848,863
610,940
342,762
6,400
4,783,197
1,654,977
-
447,220
126,772
11,432,256
7,012,166
2008
$
2007
$
7,757,981
3,674,275
6,322,595
689,571
11,432,256
7,012,166
All of the Company’s property, plant and equipment are located in Canada.
Major customers, representing 10% or more of total sales, include:
Customer A
Customer B
Customer C
16 Loss per share
2008
$
2007
$
4,228,465
2,978,156
-
2,573,252
-
2,315,727
Loss per share is calculated using the weighted average number of common shares
outstanding for the year of 7,019,409 (2007 – 5,247,331). Outstanding share options and
warrants to purchase common shares were not included in the computation of diluted loss
per share as their impact are anti-dilutive.
Page 62 of 63
QuestAir Technologies Inc.
Notes to Financial Statements
September 30, 2008 and 2007
(expressed in Canadian dollars)
17 Supplemental cash flow information
Supplemental cash flow information
Cash paid for interest
Cash received for interest
2008
$
2007
$
79,057
229,423
60,422
601,312
Non-cash operating, investing and financing activities
Issuance of common shares on exercise of stock options
143
294,014
Page 63 of 63