Alternative Fuel Systems (2004) Inc.
TSX VENTURE : AFX

Alternative Fuel Systems (2004) Inc.

August 14, 2007 13:52 ET

AFS Announces Second Quarter 2007 Financial and Operating Results

CALGARY, ALBERTA--(Marketwire - Aug. 14, 2007) - Alternative Fuel Systems (2004) Inc. ("AFS or the Company") (TSX VENTURE:AFX) announced today financial and operating results for the second quarter ended June 30, 2007. President and CEO Jim Perry stated "Revenue for the quarter was slightly down from the same period last year, primarily due to a reduction in sales of engine management systems. While we generated over $0.5 million in revenue in Q2, the level of sales combined with foreign exchange losses and other expenses resulted in a loss for the period."

For the three-month period ended June 30, 2007, the Company recognized revenue of $513,384 including interest on cash balances. In the same period of the prior year, revenue of $543,846 was recorded. In the second quarter of 2007, a net loss of $159,919 was incurred, compared to a net loss of $79,779 in the three months ended June 30, 2006. Mr. Perry added that, "We are continuing to work on promising projects in Southeast Asia. We know that in dealing with large vehicle manufacturers, the time line to get new products introduced into their production can be very long. However, progress has accelerated in the last three months toward bringing these opportunities closer to reality. It should also be noted that the production interruption at our largest customer in Europe has recurred, due to problems unrelated to AFS. This customer remains committed to using our regulator in their vehicle but it is uncertain when they will resume production."



Management's Discussion and Analysis ("MD&A")

Below is Management's discussion and analysis of financial results for the
three and six-month periods ended June 30, 2007 and June 30, 2006.

Operating Results

Sales Revenue

Sales for the second quarter were comprised of the following (amounts in
thousands of Canadian dollars):

----------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
----------------------------------------------------------------------------
2007 2006 2007 2006
----------------------------------------------------------------------------
Pressure regulators $ 403 $ 384 $ 657 $ 770
----------------------------------------------------------------------------
Engine management systems 25 64 107 258
----------------------------------------------------------------------------
Ignition systems and other parts 54 62 122 95
------ ------ ------ ------
----------------------------------------------------------------------------
Subtotal Product Sales $ 482 $ 510 $ 886 $1,123
----------------------------------------------------------------------------
Engineering services 20 21 30 58
------ ------ ------ ------
----------------------------------------------------------------------------
Total $ 502 $ 531 $ 916 $1,181
----------------------------------------------------------------------------


The decrease in revenue in the second quarter of 2007 versus the same period in 2006, and also in the first six months of this year versus last year was primarily due to a decrease in sales of engine management systems. In 2006, significant sales of these systems were made, primarily for use in Southeast Asia. The customer for the majority of these systems chose to order a large number of them at once, to achieve a better price point. Since most of the systems were delivered, the customer has been selling them to end users, but has not yet drawn down his inventory to the point that he might order more units. In addition, in the first six months of 2007, the previously described interruption in vehicle production by a large European customer adversely affected revenue compared to that recognized in the first six months of 2006.

Gross margins

Gross margins realized in the second quarter were $191,558 (2006-$227,408) or 39% (2006- 45%). A significant amount of pressure regulator parts inventory was purchased at a low cost from the predecessor company during the corporate restructuring that occurred in 2004. This low cost inventory has been gradually consumed in production, and as new inventory is purchased at today's cost and used, margins are lowered. In addition, fewer sales of higher margin engine management systems were recorded in the second quarter compared to the same period of 2006. Gross Margins realized for the six months ended June 30, 2007 were $358,779 (2006-$537,144) or 40% (2006- 47%). The margin percentage for the six-month period was lower in 2007 primarily due to the same factors that affected the second quarter.



Operating and administrative expenses

Operating and administrative expenses for the three and six month periods
ended June 30, 2007 and June 30, 2006 were comprised of the following
(amounts in thousands of Canadian dollars):

----------------------------------------------------------------------------
Three months ended Six months ended
June 30 June 30
----------------------------------------------------------------------------
2007 2006 2007 2006
----------------------------------------------------------------------------

----------------------------------------------------------------------------
Engineering & product development $ 137 $ 139 $ 272 $ 290
----------------------------------------------------------------------------
Administrative & other 177 112 286 214
----------------------------------------------------------------------------
Sales & marketing 43 40 88 84
------ ------ ------ ------
----------------------------------------------------------------------------
Total $ 357 $ 291 $ 646 $ 588
----------------------------------------------------------------------------


Employee wages and benefits accounted for 59% of the $357,000 (2006 - 73% of the $291,000) in total operating and administrative expenses recognized during the second quarter of 2007. The increase in Administrative and other costs in Q2 of 2007 was primarily due to foreign exchange losses of more than $36,500 due to the rapid strengthening of the Canadian dollar during the period. In addition, mailing costs for the annual meeting of Shareholders, and increased professional fees contributed to the change. For the six months ended June 30, 2007, increased total operating and administrative expense over the same period in 2006 was due to the same factors.

The Company currently has 11 full time employees, with consultants, distributors and agents in Europe, India, Iran and the U.S.

Net Loss and Cash Flow

AFS reported a net loss for the quarter ended June 30, 2007 of $159,919 ($0.01 per share on a basic and diluted basis). The net loss in the comparable quarter in 2006 was $79,779 ($0.00 per share). Cash outflow from operations for the second quarter of 2007 was ($4,226) versus a cash outflow of ($6,050) in the second quarter of 2006. The loss in the second quarter of 2007 was offset by increased cash flow from working capital, primarily due to an increase in accounts payable of $136,616 and a decrease in accounts receivable of $87,456.

Accounts Receivable

Accounts receivable has decreased to $205,670 as at June 30, 2007 compared to the December 31, 2006 balance of $270,366. As previously discussed above, this decrease is primarily due to a production interruption at our largest customer in Europe, to deal with problems not involving AFS.

Prepaid Expenses

Prepaid expenses increased to $49,404 as at June 30, 2007 compared to the December 31, 2006 balance of $32,177. The increase is due to the prepayment of insurance premiums for the 2007 fiscal year.

Inventory

Inventory has increased in the second quarter of 2007 to $706,719 compared to the December 31, 2006 balance of $664,611, a change of $42,108. During Q2 inventory buildup for pressure regulator production increased, as the Company's largest customer for this product line resumed production of natural gas fueled vehicles, albeit at a low rate.

Accounts payable and accrued liabilities

The June 30, 2007 accounts payable balance increased to $307,222 from $205,095 at December 31, 2006. The increase of $102,127 was attributed to increased purchases of inventory for both pressure regulators and engine control modules.

Advances from customers

Advances from customers have decreased to $38,396 at June 30, 2007 from a balance of $108,328 at December 31, 2006. The decrease is due to customer deposits being applied to second quarter shipments. In order to mitigate the risk inherent in providing customized engineering and product development work, the Company generally requires that all new large orders be guaranteed by a deposit before work commences.

Capital Stock

During the second quarter ended June 30, 2007, there were no changes in the authorized or issued capital stock as disclosed in the audited December 31, 2006 financial statements.

Contractual obligations

AFS leases 5,800 square feet of warehouse, shop and office space, which currently houses all of the company's operations. A new two-year lease was entered into effective July 1, 2006, with monthly lease payments of $4,688 to June 30, 2008.

Contingent liabilities

During the second quarter ended June 30, 2007, there were no material changes in the contingent liabilities as disclosed in the audited December 31, 2006 financial statements.

Liquidity and Capital Resources

In April 2005 the Company closed a series of equity financings which raised gross proceeds of $1.5 million. As a result of these financings, AFS remains well capitalized to pursue potential business opportunities and increase its sustainability period. Through June 30, 2007 there was a total decrease in cash of $225,090 from the December 31, 2006 balance. Included in this decrease was $69,932 of customer deposits that were applied to items shipped and $20,012 that was invested in capital equipment.

Critical accounting estimates

The Company's June 30, 2007 period end financial statements contain significant accounting estimates made by management, including ongoing valuation of inventory and assessment of its net realizable value, determination of the liability related to product warranty costs, and recoverability of the carrying values of property, plant and equipment and intangible assets. There is no guarantee that such estimates are accurate.

Disclosure Controls and Procedures

The Chief Executive Officer has evaluated the effectiveness of the company's internal control over financial reporting as of June 30, 2007, pursuant to the requirements of Multilateral Instrument 52-109 of the Canadian Securities Administrators.

Internal control over financial reporting

There were no changes in the Company's internal controls over financial reporting that occurred during the three months ended June 30, 2007. A full discussion of the internal controls over financial reporting is included in the Company's MD&A for the year ended December 31, 2006.

Financial Instruments

On January 1, 2007, the Company adopted the new CICA Handbook Sections 3855 - Financial Instruments - Recognition and Measurement, 1530 - Comprehensive Income, and 3865 - Hedges. The financial instruments standard establishes the recognition and measurement criteria of financial assets, financial liabilities and derivatives. All financial instruments are required to be measured at fair value on initial recognition of the instrument, except for certain related party transactions. Measurement in subsequent periods depends on whether the financial instrument has been classified as held-for-trading, available-for-sale, held to maturity, loans and receivables, or other financial liabilities as defined by the standard. Financial assets and financial liabilities held-for-trading are measured at fair value with changes in those fair values recognized in net earnings. Financial assets available-for-sale is measured at fair value, with changes in those fair values recognized in other comprehensive income. The methods used by the Company in determining the fair value of financial instruments are unchanged as a result of implementing the new standard.

The Company has no financial instruments or activities that give rise to other comprehensive income. The Company's cash and cash equivalents are designated as held-for-trading and are measured at carrying value, which approximates fair value due to the short-term nature of these instruments. Accounts receivable and accounts payable and accrued liabilities are measured at cost, which due to the short-term nature of these items is estimated to equal their fair values.

Business Risks

Key Business Risks and Uncertainties

Small Customer Base - AFS has a small number of customers, some of which are major contributors to the Company's revenue stream. If one of these major customers ceases to use AFS products, a significant impact on sales volume would occur.

Foreign Exchange Rate Risk - Almost all of Alternative Fuel Systems invoicing to customers is due and payable in US dollars. AFS is exposed to USD to CDN dollar exchange rate risk. Fluctuations in foreign currency valuations may result in exchange losses or gains that would affect net income.

Major Competitors - AFS has a number of competitors that are much larger in size and have considerably more resources than the Company. Although AFS has been successful in gaining business through quality products and customer service, other players in the market may develop competing technologies.

Fuel Pricing and Infrastructure - Growth in the Company's primary markets is dependent on a number of factors, including having a favorable price differential between conventional fuels and natural gas, and having sufficient fueling stations to make natural gas vehicles attractive to customers. There can be no assurance that either or both of these factors will continue to be present in any particular market.

Dependence Upon Key Personnel - AFS depends on its senior management and its technical staff. If the Company is unable to attract and retain key personnel, it may have a material adverse effect on the business.

Financial Statements

Below are the unaudited interim financial statements for the three and six-month periods ended June 30, 2007 and 2006. These interim financial statements have not been reviewed by the Company's external auditor in accordance with Section 7050, "Auditor Review of Interim Financial Statements" of the Canadian Institute of Chartered Accountants Handbook.



ALTERNATIVE FUEL SYSTEMS (2004) INC.
Balance Sheets
(Unaudited)
(expressed in Canadian dollars)

As at As at
June 30, December 31,
2007 2006
$ $
----------------------------------------------------------------------------
Assets

Current assets
Cash and short-term investments 1,240,148 1,465,238
Accounts receivable 205,670 270,366
Prepaid expenses and deposits 49,404 32,177
Inventory 706,719 664,611
----------------------------------------------------------------------------

2,201,941 2,432,392
----------------------------------------------------------------------------

Property, plant and equipment 204,589 209,015

Intangible assets 45,513 55,305
----------------------------------------------------------------------------

2,452,043 2,696,712
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Liabilities

Current liabilities
Accounts payable and accrued liabilities 307,222 205,095
Advances from customers 38,396 108,328
Deferred revenue 16,556 18,108
----------------------------------------------------------------------------

362,174 331,531
----------------------------------------------------------------------------

Shareholders' Equity

Capital stock 2,442,621 2,442,621
Warrants - 195,450
Settlement warrants 171,000 171,000
Contributed surplus 335,300 129,682
Deficit (859,052) (573,572)
----------------------------------------------------------------------------

2,089,869 2,365,181
----------------------------------------------------------------------------

2,452,043 2,696,712
----------------------------------------------------------------------------
----------------------------------------------------------------------------



ALTERNATIVE FUEL SYSTEMS (2004) INC.
Statement of Operations, Comprehensive (Loss) and Deficit
(Unaudited)
(expressed in Canadian dollars)

For the three months For the six months
ended June 30 ended June 30
2007 2006 2007 2006
$ $ $ $
----------------------------------------------------------------------------

Product revenue 481,298 509,468 885,977 1,123,675

Cost of revenue 289,740 282,060 527,198 586,531
----------------------------------------------------------------------------

Gross Margin 191,558 227,408 358,779 537,144

Engineering revenue 20,463 21,141 30,494 57,785
Interest and Other Income 11,624 13,237 22,412 24,955

----------------------------------------------------------------------------
223,645 261,786 411,685 619,884
----------------------------------------------------------------------------

Expenses
Operating and administration
Engineering and product
development 136,930 139,420 271,756 289,970
Administrative and other 176,862 111,608 286,120 213,654
Sales and marketing 43,251 40,199 88,171 84,180
Repayment of research funding 3,610 3,969 6,720 8,834
Depreciation of property, plant
& equipment 12,451 13,805 24,272 27,387
Amortization of intangible
assets 4,979 27,450 9,958 54,889
Stock-based compensation 5,481 5,114 10,168 6,492
----------------------------------------------------------------------------

383,564 341,565 697,165 685,406
----------------------------------------------------------------------------

Loss and Comprehensive Loss for
the period (159,919) (79,779) (285,480) (65,522)

Deficit - Beginning of period (699,133) (458,922) (573,572) (473,179)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Deficit - End of period (859,052) (538,701) (859,052) (538,701)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Basic and diluted loss per
common share (0.01) (0.00) (0.02) (0.00)
----------------------------------------------------------------------------
----------------------------------------------------------------------------



ALTERNATIVE FUEL SYSTEMS (2004) INC.
Statements of Cash Flows
(Unaudited)
(expressed in Canadian dollars)

For the three months For the six months
ended June 30 ended June 30
2007 2006 2007 2006
$ $ $ $
----------------------------------------------------------------------------

Cash provided by (used in)

Operating activities
Loss for the period (159,919) (79,779) (285,480) (65,522)
Items not involving cash:
Depreciation and amortization 17,430 41,255 34,230 82,276
Stock-based compensation 5,481 5,114 10,168 6,492
----------------------------------------------------------------------------
(137,008) (33,410) (241,082) 23,246

Change in non-cash working
capital items 132,782 27,360 36,004 (283,333)
----------------------------------------------------------------------------

Cash flow from operations (4,226) (6,050) (205,078) (260,087)
----------------------------------------------------------------------------

Financing activities
Proceeds from exercise of
warrants - 15,000 - 15,000
----------------------------------------------------------------------------

Investing activities
Purchase of equipment and
intangible assets (13,958) (9,227) (20,012) (23,638)
----------------------------------------------------------------------------

Decrease in cash & short-term
investments (18,184) (277) (225,090) (268,725)

Cash & short-term investments
- beginning of period 1,258,332 1,386,839 1,465,238 1,655,287
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Cash & short-term investments
- end of period 1,240,148 1,386,562 1,240,148 1,386,562
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Contact Information