AFS announces second quarter 2007 financial and operating results



    CALGARY, Aug. 14 /CNW/ - 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.





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