ITEM 1.  FINANCIAL STATEMENTS

 

 

Airtrax Inc.

Balance Sheets

March 31,2007 and December 31,2006

(Restated)

 

		March 31, 2007				December 31, 2006
		(Unaudited)				(Audited)
ASSETS
Current assets
Cash		$	1,913,310			$	327,737
Accounts receivable			50,704				50,704
Inventory			1,112,830				1,049,457
Vendor Advances			140,268				103,628
Deferred tax asset			1,001,256				919,889
Total current assets			4,218,368				2,451,415
Fixed assets			604,686				623,136
Less: accumulated depreciation			(339,216	)			339,216
Net fixed assets			265,470				283,920
Other assets:
Deferred financing costs			465,849				133,918
Prepaid interest			487,857				-
Patents – net			143,921				148,151
Total other assets			1,097,627				282,069
TOTAL ASSETS		$	5,581,465			$	3,017,404
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
Current liabilities
Accounts payable		$	826,524			$	1,097,361
Accrued liabilities			307,666				437,139
Current convertible debt, net of discount			1,830,256				1,830,200
Shareholder loans payable			40,713				75,713
Derivative liability-warrants and conversion privileges			3,356,251				236,144
Total current liabilities			6,361,410				3,676,557
Long term convertible debt, net of discount			1,087,290				531,542
TOTAL LIABILITIES			7,448,700				4,208,099
Shareholders’ deficiency:
Preferred stock – authorized; 5,000,000 shares, no par value, 275,000 issued and outstanding			12,950				12,950
Common stock – authorized, 100,000,000 shares; no par value, issued and outstanding –  24,715,235 and 21,939,360, respectively			21,778,529				21,520,559
Paid in capital – options			1,417,660				1,407,299
Paid in capital – warrants			2,315,936				2,315,936
Accumulated deficit			(27,392,310	)			(26,447,439	)
Total shareholders’ deficiency			(1,867,235	)			(1,190,695	)
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIENCY		$	5,581,465			$	3,017,404

 

 

The accompanying notes are an integral part of these financial statements.

 

 

 

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Airtrax Inc.

Statements of Operations

For the Three Month Periods Ended

March 31, 2007 and 2006

(Unaudited and Restated)

 

		2007				2006
Revenues		$	91,385			$	658,976
Cost of sales			134,269				527,678
Gross profit			(42,884	)			131,298
Operating and administrative expenses			764,963				762,535
Operating loss			(807,847	)			(631,237	)
Other income (expense), net
Interest expense			(103,442	)			(48,751	)
Revaluation income			1,618,972				395,222
Amortization of financing costs			(64,969	)			(40,565	)
Amortization of debt discounts			(284,303	)			(132,026	)
Liquidated damages			-				(81,800	)
Settlement expenses			-				(52,840	)
Excess discounts expensed during this period			(1,401,901	)			-
Other income			17,252				-
Total other (expense) income, net			(218,391	)			39,240
Net loss before taxes			(1,026,238	)			(591,997	)
Income tax benefit, (State): Current			81,367				84,484
Net loss attributable to common shareholders			(944,871	)			(507,513	)
Net loss per share - basic and diluted
Loss attributable to common shareholders		$	(944,871	)		$	(507,513	)
Adjustment for preferred stock dividends accumulated		$	(17,188	)		$	(17,188	)
Net loss attributable to common shareholders		$	(962,059	)		$	(524,701	)
Net loss per share - basic and diluted		$	(0.04	)		$	(0.02	)
Weighted average shares outstanding			24,436,655				22,014,543

 

The accompanying notes are an integral part of these financial statements.

 

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 AIRTRAX, INC.

STATEMENTS OF CASH FLOWS

For the Three Month Periods Ended March 31,

		2007				2006
CASH FLOWS FROM OPERATING ACTIVITIES
Net (Loss) Income		$	(944,871	)		$	(507,513	)
Adjustments to reconcile net income to net cash consumed by operating activities:
Charges not requiring the outlay of cash:
Depreciation and amortization			398,135				187,456
Reduction in administrative expenses			-				(68,821	)
Options issued for services			-				42,000
Equity securities issued for services			178,257				250,166
Expense of settling certain liquidated damages			-				52,840
Excess discount expense			1,401,901				-
Increase in accrual of deferred tax benefit			(81,367	)			(84,484	)
Revaluation of liabilities for warrants and conversion privileges			(1,618,972	)			(395,222	)
Interest accrued on shareholder loan			-				1,739
Changes in current assets and liabilities:
Increase in accounts receivable			-				(39,710	)
Increase in vendor advances			(36,640	)			-
Increase (decrease) in accounts payable			(228,336	)			41,947
(Decrease) increase in accrued liabilities			(106231	)			138,471
Decrease (increase) in inventory			(63,373	)			39,709
Net cash consumed by operating activities			(1,101,527	)			(341,422	)
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions of equipment			-				(10,319	)
Net cash consumed by investing activities			-				(10,319	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds of issuance of convertible debt			2,822,100				451,200
Repayment of stockholder loans			(35,000	)			(37,447	)
Repayment of convertible debt			(100,000	)			-
Net cash provided by financing activities			2,687,100				413,753
Net increase in cash			1,585,573				62,012
Balance at beginning of period			327,737				19,288
Balance at end of period		$	1,913,310			$	81,300

 

The accompanying notes are an integral part of these financial statements.

 

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

NOTE 1–BASIS OF PRESENTATION AND BUSINESS

The unaudited  interim amended and restated financial statements of Airtrax, Inc. (“the Company”) as of March 31, 2007,  and for the three and three months ended March 31, 2007 and 2006 (restated),  have been prepared in accordance with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern.  At March 31, 2007, the Company had a working capital deficit of $2,143,042, and a retained deficit of $ 27,392,310.

In prior periods, the Company was a development stage company, as defined in Statement of Financial Accounting Standards (FASB) No. 7. The Company became an operational company in 2005. The Company has incurred losses since its inception. Until the end of 2004, these losses were financed by private placements of equity securities. During 2005 and 2006, the Company obtained financing almost exclusively from the issuance of convertible debentures along with other securities (derivatives). The Company will need to raise additional capital through the issuance of future debt or equity securities to continue to fund its operations.

The Company was formed on April 17, 1997. It has designed a lift truck vehicle using omni-directional technology obtained under a contract with the United States Navy Surface Warfare Center in Panama City, Florida. The right to exploit this technology grew out of a Cooperative Research and Development Agreement with the Navy. Significant resources have been devoted during prior years to the construction of a prototype of this omni-directional forklift vehicle. The Company recognized its first revenues from sales of this product during the year 2005.

In the opinion of management, the information included in this report contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of such periods.  The results of operations for the three month period ended March 31, 2007 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2007.

Certain information and disclosures normally included in the notes to financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission, although the Company believes the disclosure is adequate to make the information presented not misleading.  The accompanying unaudited quarterly financial statements should be read in conjunction with the amended and restated audited financial statements and footnotes thereto included in the Company’s annual report on Form 10-KSB/ A for the year ended December 31, 2006.

 

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NOTE 2– RESTATEMENTS

In conjunction with our independent registered public accounting firm and professional advisors, the Company conducted an analysis of our various financial instruments and agreements involving convertible debt and common stock financings accompanied by warrants, with a particular focus on the accounting treatment of derivative financial instruments under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), the Emerging Issues Task Force issued EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”), and FASB Staff Position No. EITF 00-19-2, “Accounting for Registration Payment Arrangements” (“EITF 00-19-2”) (collectively, the “Derivative Accounting Pronouncements”). Accordingly, certain accounting policies we previously considered to reflect what was deemed to be appropriate at the time when the financings were previously reported, have been modified by recent interpretations, including the Derivative Accounting Pronouncements.

On November 2, 2007, as a result of this analysis, the Company filed a Form 8-K noting that its previously filed financial statements in the annual reports for the years ended December 31, 2004, 2005 and 2006 filed on Form 10-KSB, together with the quarterly reports on Form 10-QSB for the quarters ending March 31, 2005, June 30, 2005, September 30, 2005, March 31, 2006, June 30, 2006, September 30, 2006, March 31, 2007, June 30, 2007 and September 30, 2007(collectively, the “Reports”) could no longer be relied upon.  The Company sent a formal letter request to the Office of the Chief Accountant (OCA) of the Security and Exchange Commission (SEC) dated December 17, 2007,  petitioning the OCA to waive the requirement to file separate amended and restated Reports for the periods  noted above, and instead, file a comprehensive amended and restated  comparative Form 10-KSB for the years ended December 31, 2006 and 2005, along with certain comprehensive financial information and disclosures for 2004 , and comprehensive amended and restated  comparative Forms 10-QSB for the periods ended March 31, 2007, June 30, 2007, and September 30, 2007 along with certain comprehensive financial information and disclosures for 2005 . This waiver was received from the OCA on December 27, 2007.

 

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

The February 2007 convertible debt issuance includes certain variable conversion pricing which results in the actual maximum number of potential shares needed to satisfy the conversion of such debt to be unknown and not quantifiable at the date of issuance.  EITF 00-19-2 specifies that debt issuances with variable conversion pricing for which there is no established “floor” in the conversion pricing, and where the maximum number of shares needed to satisfy the conversion of such debt is not known, should be accounted for as derivative liabilities and revalued at the end of each reporting period. When a derivative classified as a liability is exercised, cancelled, or the maximum number of shares needed to satisfy the conversion of such debt is known, the fair value of the derivative, as determined at that time, is revalued and transferred to equity, and is no longer revalued.  To the extent that the initial fair values of the derivative liabilities exceed the net proceeds received, an immediate charge to the statement of operations is recognized, for the excess. In the first quarter of 2007, the Company recognized in the statement of operations excess costs over debt proceeds of $1,401,901 related to the excess of derivative liabilities over the net proceeds received for the February 2007 debt issuance.  The remainder of the discount from the face value of the convertible debt resulting from allocating part or all of the proceeds to the derivative liabilities is being amortized over the life of the instrument through periodic charges to the statements of operations, using the straight line method, which was the most systematic and rational approach that approximated the interest method of amortization due to the short two year amortization term of the debt. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. The restatement is required to properly reflect the Company’s financial results for certain non-cash, and non-operational related charges or credits to earnings associated with both embedded and freestanding derivative liabilities, and the accounting for certain derivatives under the control of the issuer, and those involving variable conversion pricing, due to the revised interpretation and implementation of the Derivative Accounting Pronouncements.

The Company has made adjustments to its accounting records in the restated amounts to more fully comply with requirements of the Derivative Accounting Pronouncements, and the Securities and Exchange Commission (SEC) dealing with derivatives.  Among these changes were the balances of derivative liabilities, debt discount, paid in capital-warrants, paid in capital-options ,  revaluation income, and common stock.  The adjustments to the common stock were caused by the elimination of credits to common stock that had resulted principally from the erroneous recognition of liabilities for conversion privileges upon issuances of convertible debt.  These credits were erroneously transferred to pay in capital upon debt conversion.  Other partial offsets to these adjustments affected the amounts of amortization expense and paid in capital-warrants.

 

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The effects of these changes on the Company’s previously issued unaudited March 31, 2007 and 2006 financial statements and the related disclosures included elsewhere in the notes to financial statements, are as follows:

 

 

Balance Sheet as of March 31, 2007:
		Previously				Increase								As
		Reported				(decrease)								Restated
Deferred charges		$	501,166			$	(501,166	)			(1	)		$	-
Deferred financing costs			-				465,784				(1	)			465,784
Total assets		$	5,616,847			$	(35,382	)						$	5,581,465
Current portion-convertible debt, net of discounts		$	2,007,297			$	(177,041	)			(1	)		$	1,830,256
Accrued liabilities			364,750				(57,084	)			(5	)			307,666
Options liability			1,417,660				(1,417,660	)			(9	)			-
Derivative liability-warrants and conversion privileges			4,996,793				(1,640,542	)			(2	)			3,356,251
Total current liabilities			9,653,737				(3,292,327	)							6,361,410
Long term-convertible debt, net of discounts			4,291,837				(3,204,547	)			(1	)			1,087,290
Total liabilities			13,945,574				(6,496,874	)							7,448,700
Paid in capital-warrants			1,065,264				1,250,672				(2	)			2,315,936
Common stock, no par			25,319,211				(3,540,682	)			(4	)			21,778,529
Paid in capital-options			-				1,417,660				(9	)			1,417,660
Accumulated deficit			(34,726,152	)			7,333,842				(3	)			(27,392,310	)
Total stockholders' deficiency			(8,328,727	)			6,461,492								(1,867,235	)
Total liabilities and stockholders' deficiency		$	5,616,847			$	(35,382	)						$	5,581,465
Statement of Operations for the three months ended March 31, 2007:
		Previously				Increase								As
		Reported				(Decrease)								Restated
Operating and administrative expenses		$	(797,363	)		$	32,400				(7	)		$	(764,963	)
Operating loss			(840,247	)			32,400								(807,847	)
Conversion expense			(4,937,231	)			4,937,231				(4	)			-
Amortization of financing costs			-				(64,969	)			(1	)			(64,969	)
Amortization of debt discounts							(284,303	)			(1	)			(284,303	)
Excess discount over proceeds of issue			-				(1,401,901	)			(6	)			(1,401,901	)
Revaluation income (expense)			567,474				1,051,498				(8	)			1,618,972
Other income			10,113				7,139								17,252
Net loss attributable to common shareholder		$	(5,221,966	)		$	4,277,095							$	(944,871	)
Statement of Cash Flows for the three months ended March 31, 2007:
		Previously				Increase								As
		Reported				(Decrease)								Restated
Net loss		$	(5,221,966	)		$	4,277,095							$	(944,871	)
Offsetting adjustments:
Depreciation and amortization			79,364				318,771				(1	)			398,135
Conversion expense			4,937,231				(4,937,231	)			(4	)			-
Revaluation (income) expense			(567,474	)			(1,051,498	)			(8	)			(1,618,972	)
Excess discount expense			-				1,401,901				(6	)			1,401,901
Decrease in accrued liabilities			(97,223	)			(9,038	)			(5	)			(106,261	)
Net cash used in operating activities		$	(1,101,527	)		$	-							$	(1,101,527	)

 

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Balance Sheet as of March 31, 2006:
		Previously				Increase								As
		Reported				(decrease)								Restated
Deferred financing fees		$	-			$	297,226				(1	)		$	297,226
Total assets		$	5,746,775			$	297,226							$	6,044,001
Derivative liability-warrants and conversion privileges		$	1,612,623			$	(568,162	)			(2	)		$	1,044,461
Option liability			1,372,949				(1,372,949	)			(9	)			-
Total current liabilities			4,823,303				(1,941,111	)							2,882,192
Long term-convertible debt, net of discounts			2,198,000				(681,334	)			(1	)			1,516,666
Total liabilities			7,021,303				(2,622,445	)							4,398,858
Paid in capital-warrants			1,115,640				1,187,999				(3	)			2,303,639
Common Stock, no par			22,069,399				(3,429,087	)			(4	)			18,640,312
Paid in capital-options							1,372,949				(9	)			1,372,949
Accumulated deficit			(24,472,517	)			3,787,810				(3	)			(20,684,707	)
Total stockholders' deficiency			(1,274,528	)			2,919,671								1,645,143
Total liabilities and stockholders' deficiency		$	5,746,775			$	297,226							$	6,044,001
Statement of Operations for the three month period ended March 31, 2006:
		Previously				Increase								As
		Reported				(decrease)								Restated
Operating expenses		$	(1,021,573	)		$	259,038				(7	)		$	(762,535	)
Operating loss			(890,275	)			259,038								(631,237	)
Other Income and Expenses			-												-
Liquidated damages			-				(81,800	)			(7	)			(81,800	)
Settlement expense			-				(52,840	)			(7	)			(52,840	)
Conversion expense			(581,438	)			581,438				(4	)			-
Amortization of deferred financing costs			-				(40,565	)			(1	)			(40,565	)
Amortization of debt discounts			-				(132,026	)			(1	)			(132,026	)
Revaluation income			1,972,166				(1,576,944	)			(8	)			395,222
Net loss before taxes		$	451,702			$	(1,043,699	)						$	(591,997	)
Statement of Cash Flows for the Three Month Period Ended March 31, 2006
		Previously				Increase								As
		Reported				(Decrease)								Restated
Net loss		$	536,186			$	(1,043,699	)						$	(507,513	)
Depreciation and amortization			14,865				172,591				(1	)			187,456
Conversion expense			581,438				(581,438	)			(5	)			-
Reduction of administrative expense			-				68,821								(68,821	)
Settlement expense			108,417				(55,577	)			(7	)			52,840
Revaluation (income) expense			(1,972,166	)			1,576,944				(9	)			(395,222	)
Net cash used in operating activities		$	(1,101,527	)		$	-							$	(1,101,527	)

 

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

Adjustments were made to record:

 

(1)

Issuance costs of debt obligations have been separately reported on the balance sheet as deferred financing costs.  The value of derivatives and other securities accompanying debt issuances have been subtracted from the issuance proceeds and the remaining amounts reported as convertible debt.  The combined total of the issuance costs and the values of derivatives and other securities accompanying debt issuances are being amortized over the terms of the issues.  Previously, these costs were written off to expense when the debt was issued.  The adoption of this procedure resulted in adjustments to deferred financing costs and the carrying amounts of the debt issuances.  It also resulted in the establishment on the statements of operations of accounts for amortization of these costs and discounts.

(2)

The values of warrants accompanying debt and stock issued prior to January 1, 2007 had been recorded as liabilities and were revalued at the end of each reporting period.  Most of these warrants have been reclassified to equity, which caused an increase in paid in capital- warrants and a decrease in the derivative liability for warrants and conversion privileges.

 

(3)	The change in the accumulated deficit of June 30, 2007 is a combination of restatements of prior years ($3,056,747), and changes on the current Statement of Operations ($4,277,095).

 

(4)

Previously, conversion privileges were valued at date of issuance regardless of  whether they qualified as derivatives and the liabilities thus created were transferred to paid in capital upon conversion.  Correction of this accounting has caused a reduction in paid in capital equal to the amounts previously transferred upon conversion.  Correction of this accounting procedure also resulted in the elimination of conversion expense.

 

(5)	Correction of calculation of the accruals.

 

(6)	The initial values of the derivative liabilities stemming from the February 2007   convertible debt issue exceeded the net proceeds received by $1,401,901.  This excess was not previously recorded.

(7)

Operating and administrative expenses has been reduced, reflecting several changes: - A portion of amortization that had been included in operating expense has been reclassified to a separately captioned account.  The amount reclassified affected only the 2007 period; this amount was $32,400. - The 2006 expenses were reduced mainly due to a change in the accounting for conversion privileges. Previously, the value of such privileges was treated as a liability and charged to expense. Many of these privileges are now classified as equity.  This correction reduced operating expenses by $55,571. - Liquidated damages and settlement expenses have been reclassified from operating expenses to separately captioned items in other income (expense). For 2007, there were no settlement expenses.

 

(8)

The changes in revaluation income are the result of a change to a more appropriate Black-Scholes Model for valuing conversion privileges and to more appropriate assumptions for valuing warrants.  The amounts of revaluation income have also been affected by the change in accounting describe in (2) above.

 

(9)	The option liability account has been reclassified to equity.

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

NOTE 3-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited financial statements have been prepared on the accrual basis of accounting in conformity to generally accepted accounting principles in the United States.

Use of Estimates

Preparing the Company’s financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect 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 reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers cash deposits and short term debt securities that can be redeemed on demand and investments that have original maturities of less than three months, when purchased, to be cash equivalents.

Fair Value of Financial Instruments

The Company’s financial instruments are cash and cash equivalents, accounts receivable, accounts payable, and notes payable.  The recorded values of these financial instruments approximate their fair values based on their short-term nature.  The recorded values of notes payable approximate their fair values, as interest approximates market rates.

Concentrations of Credit Risk

Financial instruments subject the Company to concentrations of credit risk.  The Company places its cash and temporary cash investments with credit quality institutions.  At times, such investments may be in excess of applicable government mandated insurance limits.  With respect to accounts receivable, the Company limits credit risk by performing ongoing credit evaluations.  Management does not believe significant risk exists in connection with the Company’s concentrations of credit at March 31, 2007.

Accounts Receivable

The Company provides an allowance for doubtful accounts (when necessary) equal to the estimated uncollectible amounts.  The Company’s estimate is based on historical collection experience and a review of the current status of trade accounts receivable.  It is reasonably possible that the Company’s estimate of the allowance for doubtful accounts will change.  As of March 31, 2007 and 2006 there were no allowances for doubtful accounts.

 

Inventories

Inventory consists principally of component parts and supplies used to assemble lift truck vehicles. Inventories are stated at the lower of cost (determined on a first in-first out basis) or market.

Fixed Assets

Fixed assets, consisting of office furniture and equipment, demo and shop equipment along with castings and tools, are recorded at cost. The cost of developing and constructing the prototype omni-directional helicopter handling vehicle and the omni-directional lift truck vehicle is expensed as incurred. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance, and repairs are charged to expense as incurred.  When property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period.  Depreciation is provided over the estimated useful lives of the related assets ranging from 5 to 7 years using the straight-line method for financial statement purposes.

 

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

Intangibles

The Company incurred costs to acquire certain patent rights. These costs are capitalized and are being amortized over a period of fifteen years on a straight line basis.

In accordance with Statement of Financial Accounting Standards  No. 142, “Goodwill and Other Intangible Assets ,” the Company reviews intangibles for impairment annually, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company's business enterprise below its carrying value. The impairment test requires us to estimate the fair value of the Company's overall business enterprise down to the reporting unit level. The Company performs its annual impairment test in its fiscal fourth quarter. No impairment charges related to goodwill or other intangibles were recorded in the three months ended March 31, 2007 and 2006.

The Company continually evaluates whether events and changes in circumstances warrant revised estimates of useful lives or recognition of an impairment loss of our intangibles, which as of March 31, 2007, consist mainly of patents and licensing agreements.  The conditions that would trigger an impairment assessment of our intangible assets include a significant, sustained negative trend in our operating results or cash flows, a decrease in demand for our products, a change in the competitive environment and other industry and economic factors.

Deferred Financing Costs

Deferred financing costs represent legal, commitment; processing, consulting, and other fees associated with the issuance of the Company’s debt and any unamortized debt discount related to derivative separation from the debt instrument. Deferred financing costs are being amortized over the terms of the related debt.

Impairment of Long-Lived Assets  

Pursuant to Statement of Financial Accounting Standards No.  144, “Accounting for the Impairment or Disposal of Long-lived Assets”, the Company continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. An impairment loss is recognized when expected cash flows are less than the asset's carrying value. Accordingly, when indicators of impairment are present, the Company evaluates the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying assets. The Company’s policy is to record an impairment loss when it is determined that the carrying amount of the asset may not be recoverable. No impairment charges were recorded in the three month periods presented ended March 31, 2007, while impairment reserves of $2,000,000 were recorded for the three months ended March 31, 2006.

Revenue Recognition

Revenue on product sales is recognized when persuasive evidence of an arrangement exists, such as when a purchase order or contract is received from the customer, the price is fixed, title to the goods has changed and there is a reasonable assurance of collection of the sales proceeds. We obtain written purchase authorizations from our customers for a specified amount of product at a specified price and consider delivery to have occurred at the time of shipment. Revenue is recognized at shipment.

 

14

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

Revenue from research and development activities relating to firm fixed-price contracts is generally recognized as billing occurs. Revenue from research and development activities relating to cost-plus-fee contracts include costs incurred plus a portion of estimated fees or profits based on the relationship of costs incurred to total estimated costs. Contract costs include all direct material and labor costs and an allocation of allowable indirect costs as defined by each contract, as periodically adjusted to reflect revised agreed upon rates. These rates are subject to audit by the other party. Amounts can be billed on a bi-monthly basis. Billing is based on subjective cost investment factors.

Advertising Costs

Advertising costs are expensed as incurred.  There were no advertising expenses for either the three month periods ended March 31, 2007 and 2006. .

Accounting for Income Taxes

As part of the process of preparing our financial statements, we are required to estimate our income taxes. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. If there is not persuasive evidence that recovery will occur, we would establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the consolidated statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $8,300,000 as of March 31, 2007, due to uncertainties related to our ability to utilize some of our deferred tax assets, primarily consisting of certain net operating losses carried forward before they expire and certain accrued expenses, which are deferred for income tax purposes until paid. The valuation allowance is based on our estimates of taxable income and the period over which our deferred tax assets will be recoverable. The net deferred tax asset as of March 31, 2007 was $1,061,786, net of the valuation allowance.

Accounting for Derivatives

The Company’s issuances of convertible debt are accompanied by other financial instruments. These financial instruments include warrants to purchase stock, and the right to convert debt to stock at specified rates (“conversion benefits.”). Pursuant to SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as amended, and EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, A Company’s Own Stock, the Company has identified certain embedded and freestanding derivative instruments. Generally, where the ability to physical or “net-share settle” an embedded conversion option or free standing financial instrument is not deemed to be within the control of the Company, the embedded conversion option is required to be bifurcated or separated, and both the freestanding instruments and bifurcated conversion feature are accounted for as derivative liabilities. At each reporting date, the Company estimates the fair values of all derivatives, and changes in the fair value are charged to operations.

Under EITF 00-19, warrants are considered free-standing instruments in that they are legally detachable and separately exercisable. The conversion benefits, which are embedded in these debt issues, derive value from the relationship between the stock price and debt conversion price, and are considered embedded derivatives under the provisions of SFAS 133. The fair values of both the warrants and conversion benefits are calculated using a Black-Schools Model, taking into consideration factors such as the underlying price of the common stock, the exercise price for warrants or the conversion price for the conversion benefit, the stock volatility, and the risk-free interest rates available for comparable time periods.

 

15

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

Free-standing instruments (warrants), and embedded derivatives (conversion benefits) which are initially bifurcated or separated from the host financial instrument, are recorded as separate liabilities, in cases where the security holder has a right to choose to receive a “net settlement” of cash. The identification of such net settlement provisions for prior convertible debt issuances with warrants resulted in the Company concluding that such warrants should have been identified as “derivatives”, and therefore the warrant liabilities must be recorded as a separate derivative liability on the Company’s restated balance sheet, and marked to market for each subsequent reporting period with any non-cash charges or credits attributed to the revised fair value of the liability being recognized through earnings.

If the decision to settle the outstanding liability remains with the Company, the value of the warrants should be recorded in an equity account. The identification of the settlement provisions being controlled by the Company under certain debt issuances resulted in the Company determining that the warrants should be reflected in the restated Reports as components of equity, as compared to having been previously recorded as liabilities with non-cash charges and/or credits to earnings as a result of being marked to market for each period presented.  As of March 31, 2007 and 2006, the Company recognized and recorded the value of certain warrants as equity of $2,315,935 and $2,303,639 , respectively , in the accompanying financials.

EITF 00-19-2 specifies that the contingent obligations to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with SFAS No. 5, “Accounting for Contingencies.” EITF 00-19-2 also requires additional disclosure regarding the nature of any registration payment arrangements, alternative settlement methods, the maximum potential amount of consideration and the current carrying amount of the liability, if any. The Company previously adopted the provisions of EITF 00-19-2 for the reporting period effective January 1, 2007, and does not estimate that any additional contingency accruals and/or disclosures would be required to be included in the Company’s restated Reports other than those items expected to be reflected in the respective amended and restated Reports.

The Company also previously sold stock units which included warrants along with common stock. In these cases, a portion of the proceeds equal to the value of the warrants is allocated to the warrants (when a net settlement provision exists for cash), with the balance allocated to the stock. In such cases, the value of the warrants are treated as liabilities, and the balance is revalued at the end of each reporting period with any change in value being recognized currently as a non-cash charge and/or credit to earnings. When a warrant classified as a liability is exercised or cancelled, the fair value of the warrant, as determined at the time of exercise or cancellation, is transferred to equity, and is no longer revalued. A similar adjustment is made for a conversion benefit classified as a liability when the debt is converted to stock, or cancelled.

The February 2007 convertible debt issuance includes certain variable conversion pricing which results in the actual maximum number of potential shares needed to satisfy the conversion of such debt to be unknown and not quantifiable at the date of issuance.  EITF 00-19-2 specifies that debt issuances with variable conversion pricing for which there is no established “floor” in the conversion pricing, and where the maximum number of shares needed to satisfy the conversion of such debt is not known, should be accounted for as derivative liabilities and revalued at the end of each reporting period. When a derivative classified as a liability is exercised, cancelled, or the maximum number of shares needed to satisfy the conversion of such debt is known, the fair value of the derivative, as determined at that time, is revalued and transferred to equity, and is no longer revalued.  To the extent that the initial fair values of the derivative liabilities exceed the net proceeds received, an immediate charge to the statement of operations is recognized, for the excess. As of March 31, 2007, the Company recognized in the statement of operations excess costs over debt proceeds of $1,401,901 related to the excess of derivative liabilities over the net proceeds received for the February 2007 debt issuance.  The remainder of the discount from the face value of the convertible debt resulting from allocating part or all of the proceeds to the derivative liabilities is amortized over the life of the instrument through periodic charges to the statements of operations, using the straight line method, which was the most systematic and rational approach that approximated the interest method of amortization due to the short two year amortization term of the debt. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Derivative liabilities are classified in the balance sheet as current or non-current based on the classification previously elected for the host instrument.

 

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

For embedded and free standing derivatives valued as of March 31, 2007 and 2006, the Company has recognized in the statement of operations, revaluation income of $ 1,618,972  and $ 395,222, respectively, for the three months ended March 31, 2007 and 2006. In addition, the Company recognized a derivative liability in the accompanying balance sheet for conversion privileges and warrants of $ 3,356,251 in 2007 and $ 1,044,461 in 2006.

 

The estimated fair values of the derivatives have been calculated based on the Black-Scholes Model, using the following assumptions as of March 31:

 

		2007				2006
Fair Value of Stock		$	.58			$	.1.37
Exercise Price		$	.45 - $1.25			$	1.56- $1.65
Dividend Yield			0	%			0	%
Risk Free Interest Rate			4. 33% - 4. 65	%			4.717
Expected Volatility			88.13	%			89.68	%
Expected Life-Years		1.95- 4.70 years				1.62-3.25 years

 

Stock Based Compensation

Common Stock for Services

Because of the significant liquidity issues the Company has faced since our inception, the Company has issued common stock to third party vendors and others in order to pay for services rendered.  Such issuances are recorded as an expense in the period in which the services are performed. During the three month period ended March 31, 2007 and 2006, the Company issued an aggregate of 330,106 and 144,456, respectively, of common stock to third parties in exchange for services performed.  .

Stock Options

Stock options are awarded to employees as compensation for services. Such awards have been immediately exercisable. The Company adopted SFAS 123R, “Share Based Payment” and SFAS 148, “Accounting for Stock Based Compensation - Transition and Disclosure” on January 1, 2006. No stock options were issued, cancelled or exercised in 2007.  Pursuant to the requirements of SFAS 123R, the weighted average fair value of options granted during the three months ended March 31, 2006 was $.25.

Warrants

The Company has issued warrants both as part of “stock units”, and as an integral part of convertible note issues.  The value of the warrants and conversion options which are classified as liabilities are revalued each reporting period.  These values are determined by a Black-Scholes Model, consistent with 2006.  The Company’s recording of a liability for these Registration Payment Arrangements (RPA’s) follow the guidelines in SFAS 5, “Accounting for Contingencies.”  However, the amendment to the original EITF 00-19 will not affect the recording of derivatives as the “RPA’s” were not the sole determining factor in prior decisions about derivative classification, as is emphasized in the amended EITF. The following is a schedule of changes in warrants outstanding through the first quarter of 2007. .  Each of these warrants is exercisable over five year periods from dates of issuance at prices ranging from $0.45-$1.65 per share.

 

17

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

The following summaries the 2007 Warrant issuance activity:

 

Balance, December 31, 2006			10,383,323
Warrants Issued-February 2007			16,595,732
Warrants Issued-Placement Agent			715,333
Total Warrant Issuances-2007			17,311,065
Balance, March 31, 2007			27,694,388

Basic and Diluted Loss Per   Share

In accordance with Statement of Financial Accounting Standards No.  128, “Earnings Per Share,” and SEC Staff Accounting Bulletin (SAB) No.  98, both basic and diluted loss per share (“EPS”) are presented on the face of the income statement. Basic EPS is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS is computed similarly to basic EPS, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were not anti-dilutive. The Company has excluded all common stock equivalents arising from outstanding options, warrants, convertible preferred stock and convertible debt from the calculation of diluted net loss per share because these securities are anti-dilutive. For the three month periods ended March 31, 2007 and 2006, the weighted average number of shares outstanding was 24,436,655 and 22,014,543, respectively.

 

Segment Reporting

Management treats the operations of the Company as one single segment.

Reclassifications

Certain amounts in the 2006 financial statements have been reclassified to conform   to the 2007 financial statement presentation.

NOTE 4- 2007 CAPITALIZATION TRANSACTIONS

2007 CONVERTIBLE NOTE FINANCING AND STOCK TRANSACTIONS

On February 20, 2007, the Company entered into a Securities Purchase Agreement (the "Purchase Agreement") with certain accredited and/or qualified institutional investors pursuant to which the Company sold an aggregate of $3,734,040 principal amount secured convertible debentures (the "February 2007 Debentures") convertible into shares of common stock, no par value ("Common Stock") at a conversion price equal to $0.45 (the "Conversion Price"). The Debentures were sold at a discount equal to the amounts of interest that will accrue at a simple rate of 8% per annum during the term of the debentures.  The amount realized was $3,219,000; this was further reduced by expenses of the sale of $396,900.  In addition, the Company issued to the investors (i) warrants to purchase 8,297,866 shares of Common Stock (the "Warrants") at an exercise price equal to $0.54 per share, which represents 100% of the number of shares issuable upon conversion of the Debentures; (ii) callable warrants to purchase 4,148,933 shares of Common Stock at an exercise price equal to $0.75 per share, which represents 50% of the number of shares issuable upon conversion of the Debentures; and (iii) callable warrants to purchase 4,148,933 shares of  Common Stock at an exercise price equal to $1.25 per share, which represents 50% of the number of shares issuable upon conversion of the Debentures (collectively, the "Callable Warrants").  In addition to the expenses of the sale, noted above, 715,333 warrants to purchase common stock were issued to the placement agent that arranged the financing.

 

18

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

The February 2007 Debentures mature on February 20, 2009.  The Company may,  in its discretion,  redeem the February 2007 Debentures, subject to certain equity conditions being met by the Company as set forth in the Debentures, at a price equal to 150% of the principal balance, accrued interest, and all liquidated damages, if any, thereon that are requested to be redeemed. The Company’s obligations under the Purchase Agreement, the February 2007 Debentures and the additional definitive agreements with respect to this transaction are secured by all of the assets of the Company.

The Conversion Price of the February 2007 Debentures is subject to the following adjustments for any failure by the Company to cause the Securities and Exchange Commission (the "SEC") to declare the initial registration statement covering the shares underlying the Debentures, the Warrants and the Callable Warrants effective:

·

if the initial registration statement is not declared effective on or before February 20, 2008, the Conversion Price applicable to an amount of conversion shares equal to the highest number of shares of Common Stock which can be sold by the holder pursuant to Rule 144, promulgated under the Securities Act of 1933, as amended (the "144 Amount"), shall be adjusted to equal the lesser of (i) the then Conversion Price and (ii) 80% of the average of the 3 lowest closing prices of the Common Stock during the 10 trading days immediately preceding February 20, 2008;

·

if the initial registration statement is not declared effective on or before April 20, 2008, the Conversion Price applicable to an amount of conversion shares equal to the 144 Amount shall be adjusted to equal the lesser of (i) the then Conversion Price and (ii) 80% of the average of the 3 lowest closing prices of the Common Stock during the 10 Trading Days immediately preceding April 20, 2008;

·

if the initial registration statement is not declared effective on or before July 20, 2008, the Conversion Price applicable to an amount of conversion shares equal to the 144 Amount shall be adjusted to equal the lesser of (i) the then Conversion Price and (ii) 80% of the average of the 3 lowest closing prices of the Common Stock during the 10 trading days immediately preceding July 20, 2008;

·

if the initial registration statement is not declared effective on or before October 20, 2008, the Conversion Price applicable to an amount of conversion shares equal to the 144 Amount shall be adjusted to equal the lesser of (i) the then Conversion Price and (ii) 80% of the average of the 3 lowest closing prices of the Common Stock during the 10 trading days immediately preceding October 20, 2008; and

·

if the initial registration statement is not declared effective on or before February 20, 2009, the Conversion Price applicable to an amount of conversion shares equal to the 144 Amount shall be adjusted to equal the lesser of (i) the then Conversion Price and (ii) 80% of the average of the 3 lowest closing prices of the Common Stock during the 10 trading days immediately preceding February 20, 2009.

The Conversion Price of the February 2007 Debentures and the respective exercise prices of the Warrants and the Callable Warrants are subject to adjustment in certain events, including, without limitation, upon the consolidation, merger or sale of all of substantially all of the assets, a reclassification of our Common Stock, or any stock splits, combinations or dividends with respect to the Common Stock.

 

In addition, after such time as the SEC declares the registration statement effective, if (i) the volume weighted average price for each of the 10 consecutive trading days (the "Measurement Period") exceeds $1.50 per share with respect to the $0.75 Callable Warrants and $2.50 with respect to the $1.25 Callable Warrants, (ii) the daily volume for each trading day in such Measurement Period exceeds 250,000 shares of Common Stock per trading day, and (iii) the holder is not in possession of any information that constitutes, or might constitute, material non-public information, then the Company may, within one trading day of the end of such Measurement Period, call for cancellation of all or any portion of the Callable Warrants which have not yet been exercised at a price equal to $.001 per share.

19

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

 

Under the Registration Rights Agreement,  the Company entered into with the investors on February 20, 2007, the Company is obligated to file a registration statement on Form SB-2 to effect the registration of 130% the Common Stock issuable upon conversion of the Debentures and exercise of the Warrants, the Callable Warrants and the selling agent warrants (as described below) on the earlier of (i) 15 calendar days from the filing of the annual report on Form 10-KSB for the fiscal year ended December 31, 2006, or (ii) April 15, 2007 (the "Filing Date").  The Company is obligated to use its best efforts to cause the registration statement to be declared effective no later than 90 days after the Filing Date. If we do not file the registration statement by the Filing Date, or if the registration statement is not declared effective by the SEC within the deadline specified in the preceding sentence, the Company shall pay to the investors, as liquidated damages, an amount equal to 1.25% of the principal amount of the Debentures on a pro rata basis for each 30-day period of such registration default.  On May 4, 2007, the Company filed the registration statement but, because the statement has not yet been declared effective, the Company has an obligation for liquidated damages.

   

Further, the Company paid commissions of $321,900 and issued 715,333 warrants to First Montauk Securities Corp. (the "Selling Agent"), a NASD member firm, which acted as Selling Agent for the transaction, each as consideration for services performed in connection with the purchase and sale of the Debentures, Warrants and Callable Warrants to the investors pursuant to the Purchase Agreement.  The Selling Agent had no obligation to buy any Debentures, Warrants or Callable Warrants from us. In addition, the Company agreed to indemnify the Selling Agent and other persons against specific liabilities under the Securities Act of 1933, as amended.

The Company claimed an exemption from the registration requirements of the Act for the private placement of these securities pursuant to Section 4(2) of the Act and/or Regulation D promulgated there under since, among other things, the transaction did not involve a public offering, the Investors were accredited investors and/or qualified institutional buyers, the Investors had access to information about the Company and their investment, the Investors took the securities for investment and not resale, and  the Company took appropriate measures to restrict the transfer of the securities.

OTHER 2007 CAPITALIZATION TRANSACTIONS

On March 1, 2007, an investor in the convertible debt issue October 2005 converted $22,500 of the 8% Convertible Notes due October 18, 2007.  In exchange, the Company issued 50,000 shares of common stock.  The conversion price was $0.45 per share.

 

Note 5- SUBSEQUENT EVENTS

 

On April 18, 2007, an investor in the October 2005 convertible debt issue converted $45,000 of the 8% Convertible Notes due October 18, 2007.  In exchange, the Company issued 100,000 shares of common stock.  The conversion price was $0.45 per share.

 

On June 1, 2007, an investor in the June 2005 convertible debt issue converted $246,797 of principal and $15,736 of accrued interest of the 8% Convertible Notes due June 2007 in exchange, the Company issued 583,407 shares of common stock.  The conversion price was $0.45 per share.

 

On June 5, 2007, an investor in the October 2005 convertible debt issue converted $22,500 of the 8% Convertible Notes due October 18, 2007.  In exchange, the Company issued 50,000 shares of common stock.  The conversion price was $0.45 per share.

 

On July 1, 2007, the Company issued 15,000 shares of common stock for Directors of the Company.

 

On July 7, 2007, the Company issued 147,059 shares of common stock in lieu of $50,000 in service agreement fees with an investor relations firm.

On August 21, 2007 and September 4, 2007, the Company issued 100,000 and 50,000 shares of common stock, respectively, of the Company upon conversion of an aggregate of $67,500 of convertible notes related to the October 2005 convertible debt issuance. The conversion price was $.45 per share. In addition, the remaining October 2005 convertible notes due October 18, 2007, aggregating $1,325,500 plus accrued interest, was automatically extended to a new maturity date of April 18, 2008 as a result of the terms of the original agreement which states that the maturity date of the convertible notes is automatically extended if the trading value of the Common Stock of the Company is trading at a closing bid of less than $2.00 per share.

On August 26, 2007, 200,000 warrants were issued with a five year life at an exercise price of $1.00.

On September 10, 2007, the Company issued 123,371 shares of its common stock in connection with the terms of the November 2004 equity issuance and the “most favored nations” conversion pricing related to the Februaryruary 2005 convertible note issuance. In connection with the November 2004 issuance, the Company may be obligated to issue up to an additional 1.2 million shares of common stock to shareholder’s of record who received the shares under the original November 2004 issuance, due to the reduction in the conversion price of certain convertible debt issued in Februaryruary 2007.  In November 2007, 817,093 shares of common stock were issued based on the supported claims for certain shareholders.

The October 2005 convertible debt issuance contains a provision that automatically extends the term of the note six months until April 18, 2008 if the Company ’ s common stock is trading at a closing bid price of less than $2.00 on the maturity date.  The maturity date was October 18, 2007 and Company ’ s common stock price on October 18, 2007 was $0.24. As such, the October 2005 Note was extended on October 18, 2007 until April 18, 2008.

On January 25, 2008, the Company issued 50,000 shares of common stock to a holder of the October 2005 debt issuance for $22,500 of principal.  The conversion price was $0.45 per share.

 

On January 28, 2008, the Company issued 100,000 shares of common stock to a Director as payment of prior board fees.

 

On January 31, 2008, the Company issued to the holder of the July 26, 2006 convertible note, 100,000 shares of common stock as consideration for four months interest that was in arrears.

 

On February 8, 2008, the Company issued 160,000 shares of common stock to eight Directors as payment of board fees for 2008.

 

On February 8, 2008, the Company issued 1,021,705 shares of common stock to holders of the October 2005 debt issuance for $395,000 of principal and $64,767 of accrued interest. The conversion price was $0.45 per share.

On February 21, 2008, the Company issued 870,228 shares of common stock to holders of the October 2005 debt issuance for $246,000 of principal and $22,135 of accrued interest. The conversion price was $0.45 per share.

 

20

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

 

NOTE 5- SUPPLEMENTAL CASH FLOWS INFORMATION:

There were no taxes paid during the three month periods ended March 31, 2007 and 2006.

Interest of $ 34,886 and $ 0 was paid during the three month periods ended March 31, 2007 and 2006, respectively.

Shares of common stock were issued for services during both the 2007 and 2006 periods. These totaled 330,106 shares and 144,456 shares, respectively and were valued at $ 178,257 and $250,166.

During the March 31, 2007 period the following additional non-cash financing activity occurred:

-	$ 22,500 of convertible debt was converted into 50,000 shares of common stock.

-	A $ 45,000 accounts payable was settled by the issuance of 94,444 shares of common stock.

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Airtrax, Inc.

Notes to the Financial Statements

March 31, 2007

(Unaudited)

 

NOTE 6- GOING CONCERN

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  As shown in the financial statements, the Company had a working capital deficiency and an accumulated deficit as of March 31, 2007 and has experienced continuing losses.  These factors raise substantial doubt about the ability of the Company to continue as a going concern.  The financial statements do not include adjustments relating to the recoverability of assets and classification of liabilities that might be necessary should the Company be unable to continue in operation.  The Company’s present plans, the realization of which cannot be assured, to overcome these difficulties include, but are not limited to, the continuing effort to raise capital in the public and private markets.

 

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Special Note on Forward-Looking Statements. Certain statements in “Management’s Discussion and Analysis or Plan of Operation” below, and elsewhere in this annual report, are not related to historical results, and are forward-looking statements. Forward-looking statements present our expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements frequently are accompanied by such words such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” or the negative of such terms or other words and terms of similar meaning. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or timeliness of such results. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this annual report. Subsequent written and oral forward looking statements attributable to us or to persons acting in our behalf are expressly qualified in their entirety by the cautionary statements and risk factors set forth below and elsewhere in this annual report, and in other reports filed by us with the SEC.

 

You should read the following description of our financial condition and results of operations in conjunction with the financial statements and accompanying notes included in this report.

 

Overview

 

Since 1995, substantially all of our resources and operations have been directed towards the development of the Omni-Directional wheel, related components, Omni-Directional Lift Trucks and other Omni-Directional Vehicles. Many of the components, including the unique shaped wheels, motors, and frames, have been designed by Airtrax and are specially manufactured for us.

 

Omni-Directional means that vehicles designed and built by us can travel in any direction. Our Omni-directional vehicles are controlled with a joystick. The vehicle will travel in the direction the joystick is pushed. If the operator pushes the joystick sideways, the vehicle will travel sideways. If the operator were to twist the joystick the vehicle will travel in circles. Our omni-directional vehicles have one motor and one motor controller for each wheel. The omni-directional movement is caused by coordinating the speed and direction of each motor with joystick inputs which are routed to a micro-processor, then from the micro-processor to the motor controllers and finally to the motor itself.

 

During the year ended December 31, 2006, we continued development of the COBRA and KING COBRA scissor lifts and the Omni-Directional power chair. We anticipate incurring more costs on these products and plan to begin production of the first COBRA and the KING COBRA models in 2007. The growth and development of our business will require a significant amount of additional working capital. We currently have limited financial resources and based on our current operating plan, we will need to raise additional capital in order to continue operations. However, we are in discussions with lenders to raise capital in order to continue operating. We currently do not have adequate cash to meet our short or long term objectives. In the event additional capital is raised, it may have a dilutive effect on our existing stockholders. There can be no assurance that additional financing will be available at terms that are suitable to us.

We have incurred losses and experienced negative operating cash flow since our inception. For the twelve month period ended December 31, 2006 and 2005, we had net losses attributable to common shareholders of approximately $6.2 million and $11.6 million, respectively. The net loss in both periods includes amortization of debt discounts of $648,000 and $1,757,000, respectively, amortization of financing costs of $251,000 and $774,000, respectively, and, liquidated damages and settlement expenses of $505,000 and $281,000, respectively, offset by revaluation income $1.4 million and $68,000 in 2006 and 2005, respectively, in connection with the repricing of the conversion ratios of convertible debenture issues and of warrant conversion prices.  We also wrote down the advances to Filco of $2 million and $4.7 million in 2006 and 2005, respectively.  We expect to continue to incur significant expenses. Our operating expenses have been and are expected to continue to outpace revenue and result in additional losses in the near term. We may never be able to reduce these losses, which will require us to seek additional debt or equity financing. While we are in discussions with several prospective lenders, we do not currently have commitments for these funds and there can be no assurance that additional financing will be available, or if available, will be on acceptable terms. 

 

 

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Results of Operations for the Three Months ended March 31, 2007 Compared to the Three Months March 31, 2006

Liquidity constraints and limited access to additional capital for production in 2004 and 2005 and the unexpected death of our Chief Executive Officer and President, Peter Amico in August 2006 have limited production and sales of omni-directional technology. Consequently, management believes that the year-to-year comparisons described below are not indicative of future year-to-year comparative results.

In September 2006, Airtrax was awarded a $415,000 contract to design and build a customized MP2 Equipment Handling Unit for the Israeli Air Force. The contract includes an option to build five additional units at $95,000 each upon the acceptance of the first unit. It is estimated that the follow on orders that could result from this contract would be from 29 to 100 units over the next one to three years.  The Critical Design Review was completed in November 2006, the design was approved and initial deliverables were provided.  As a result, we received a first process payment of $170,000 on December 12 2006.  We completed the Acceptance Test Procedure in mid April 2007 and we expect to receive a second payment of $162,000.  We cannot predict whether we will be able to successfully pass all of the acceptance tests and complete the contract, or that if we do so, that any subsequent orders will result.

We believe that the joint cooperation between us and the United States Navy with the MP2 contract, including building the ETU-110 omni-directional engine handler and our contract to design and build a customized MP2 Equipment Handling Unit for the Israeli Air Force, has bolstered the potential use of our technology within the military. We do not intend to incur additional costs with the US Navy unless we incur potential expenses in demonstrating the ETU-110 omni-directional engine handler, or other omni-directional vehicles in connection with the Israeli contract.

On February 20, 2007, we entered into a Securities Purchase Agreement (the "Purchase Agreement") with certain accredited and/or qualified institutional investors pursuant to which the Company sold an aggregate of $3,734,040 principal amount secured convertible debentures (the "Debentures") convertible into shares of the common stock, no par value (the "Common Stock") at a conversion price equal to $0.45 (the "Conversion Price"), for an aggregate purchase price of $3,219,000.  The proceeds of this transaction is being used for working capital and funding of the development of our proprietary products.

 

Revenue

 

    Revenue for the three-month period ended March 31, 2007 was approximately $92,000, representing a decrease of approximately $567,000 from revenue of $659,000 for the three-month period ended March 31, 2006.  This decrease in revenue, is primarily, attributed to the reduction in sales of our SIDEWINDER ATX-3000.

 

Cost of Goods Sold

 

Our cost of goods sold for the three-month period ended March 31, 2007 amounted to approximately $134,000, a decrease of approximately $394,000 from $528,000 for the three-month period ended March 31, 2006. This decrease in cost of goods sold is primarily attributed to the reduction in sales of our SIDEWINDER ATX-3000.

 

Operating and Administrative Expenses.

 

Operating and administrative expenses, which include administrative salaries, depreciation and other expenses for the three-month period ended March 31, 2007 totaled $765,000, which represents an increase of approximately $2,000 from $763,000 incurred in the three-month period ended March 31, 2006.  The increase is primarily due to development costs for the Cobra and King Cobra scissor lift and Omni-Directional Power Chair.

 

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Other Income (Expense)

Other Income (Expense) includes interest expense and interest income along with amortization of financing costs, and income (expenses) for revaluation income related to accounting for derivative financial instruments.  For the three months ended March 31, 2007, total other income (expense) was $(218,000) compared to $39,000 for the three months ended March 31, 2006.  The largest cost increases in the three month period were attributable to excess debt discount of $(1.4) million, interest expense ($103,000) and amortization of financing costs ($65,000) and amortization of debt discounts ($284,000), primarily offset by revaluation income of $1.6 million, in connection with the repricing of certain conversion ratios of convertible debenture issues and of warrant conversion prices.

 

Loss Attributable to Common Shareholders.

 

Loss attributable to common shareholders for the three-month period ended March 31, 2007 was $945,000 compared to a loss of $508,000 for the same period in 2006.  The increased loss is due primarily to the recording of excess debt discounts expensed during the period of $1.4 million and amortization of debt discounts $284,000, also in this period compared to $132,000 in 2005.  Additionally, we recorded revaluation income of $1.6 million in the quarter compared to $395,000 in 2006, in connection with the repricing of certain conversion ratios of convertible debenture issues and of warrant conversion prices.

 

Research and Development

 

We incurred $23,579 and $61,593 in research and development expenses during the three month period ended March 31, 2007 and 2006, respectively.  Research and development activities during fiscal 2007 primarily involved continued testing and evaluation of omni-directional components and preparing these components for production in 2007.  Our wheel design was changed from the "concept" to "production" phase. This was and is an ongoing process between our Company and a vendor’s engineers to insure manufacturability. The motors and controllers were designed and/or changed in design in order to meet ANSI (American National Standards Institute) and UL (Underwriters Laboratories) testing requirements. Danaher and us revised the algorithms used in the motor controllers as well the microprocessor that runs the machines. Research and development activities also included further changes to existing designs and new designs that were patented or for those patents with pending applications.

 

Liquidity and Capital Resources

 

Since our inception, we have financed our operations through the private placement of our common stock and sales of convertible debt. During the twelve months ended December 31, 2006 and 2005, we raised net of offering costs approximately $1.3 million and $5.9 million, respectively, from the private placement of our securities.

 

During 2000, we were approved by the State of New Jersey for our technology tax transfer program pursuant to which we could sell our net operating losses and research and development credits as calculated under state law. In the years 2006 and 2005, we recorded credits of $437,803 and $867,413, respectively, from the sale of our losses and credits.

 

We have consistently demonstrated our ability to meet our cash requirements through private placements of our common stock and convertible notes. We have continued to similarly satisfy those requirements during the twelve months ended December 31, 2006. However, there can be no assurances that we will be successful in raising the required capital to continue our current operating plan.

 

We anticipate that our cash requirements for the foreseeable future will be significant. In particular, management expects substantial expenditures for inventory, product production, and advertising with production of its Omni-Directional lift truck and the start of Cobra and King Cobra (Scissors-Lift) production.

 

We will require additional funds to continue our operations beyond the initial production run. We anticipate that operating capital in the amount of approximately $3 to 5 million will be required during the next 12 months to sufficiently fund operations. We expect to recognize lower per unit manufacturing and part costs in the future due to volume discounts, as well as lower per unit shipping costs as we transition from the initial rate to larger-scale production. While we are in discussions with several prospective lenders, we do not currently have commitments for additional funds and there can be no assurance that additional financing will be available, or if available, will be on acceptable terms. If we are unable to obtain sufficient funds during the next six months we will further reduce the size of our organization and may be forced to reduce and/or curtail our production and operations, all of which could have a material adverse impact on our business prospects.

 

       As of March 31, 2005 our working capital was $1.4 million. Fixed assets, net of accumulated depreciation were $93,000 and total assets $8.9 million. Current liabilities as of June 30, 2005 were $3.5 million . Total liabilities were also $3.5 million.

 

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         As of March 31, 2007, our working capital deficit was $2.1 million.  Fixed assets, net of accumulated depreciation, as of March 31, 2007 and 2006, were $265,471 and $283,920, respectively.  Current liabilities as of March 31, 2007 were $6.4 million compared with $3.7 million as of March 31, 2006. Liabilities in 2007 and 2006 include liabilities for warrants and conversion rights of $3.4 million and $1.0 million, respectively.

 

February 2007 Financing

 

On February 20, 2007, we entered into a Securities Purchase Agreement with certain accredited and/or qualified institutional investors pursuant to which we sold an aggregate of $3,734,040 principal amount secured convertible debentures convertible into shares of our common stock at a conversion price equal to $0.45 for an aggregate purchase price of $3,219,000. In addition, we issued to the investors (i) warrants to purchase 8,297,866 shares of our common stock at an exercise price equal to $0.54 per share, which represents 100% of the number of shares issuable upon conversion of the debentures; (ii) callable warrants to purchase 4,148,933 shares of our common stock at an exercise price equal to $0.75 per share, which represents 50% of the number of shares issuable upon conversion of the debentures; and (iii) callable warrants to purchase 4,148,933 shares of our common stock at an exercise price equal to $1.25 per share, which represents 50% of the number of shares issuable upon conversion of the debentures.

 

The Debentures mature on February 20, 2009. We may in our discretion redeem the debentures, subject to certain equity conditions being met by us as set forth in the debentures, at a price equal to 150% of the principal balance, accrued interest, and all liquidated damages, if any, thereon that are requested to be redeemed. Our obligations under the securities purchase agreement, the debentures and the additional definitive agreements with respect to this transaction are secured by all of our assets.

 

As a result of our liquidity issues, we have experienced delays in the repayment of certain promissory notes upon maturity and payments to vendors and others.  If in the future, the holders of our promissory notes may demand repayment of principal and accrued interest instead of electing to extend the due date and if we are unable to repay our debt when due because of our liquidity issues, we may be forced to refinance these notes on terms less favorable to us than the existing notes, seek protection under the federal bankruptcy laws or be forced into an involuntary bankruptcy filing.

 

 

Off-Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenue, results of operations, liquidity or capital expenditures.

 

 

Liquidated Damages

 

 

      In connection with financings we entered into with various investors in November 2004, October 2005, and February 2007 we provided such investors registration rights. Pursuant to those registration rights, in the event that we did not file a registration statement by a certain date registering for resale shares of common stock issuable upon conversion of their securities or have such registration statement effective by another date, we agreed to pay to such investors liquidated damages. While we have not settled the amount for the November 2004 and October 2005 issuances, we have accrued $189,000 in liquidated damages. We have not recorded any expenses during the quarter in connection with the February 2007 issuance, as we are assuming we will file a registration statement by a certain date.

      

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Critical Accounting Policies

The SEC has issued Financial Reporting Release No. 60, “ Cautionary Advice Regarding Disclosure About Critical Accounting Policies” (“ FRR 60 ” ) suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC defined the most critical accounting policies as the ones that are most important to the portrayal of a Company ’s financial   condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include: revenue recognition, which affects sales, inventory valuation, which affects our cost of sales and gross margin; and allowance for doubtful accounts and stock-based compensation, which affects general and administrative expenses. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our consolidated financial statements .

Use of Estimates

Preparing our financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect 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 reporting period. Actual results could differ from those estimates.

Deferred Financing Costs

Deferred financing costs represent legal, commitment; processing, consulting and other fees associated with the issuance of our debt and are being amortized over the terms of the related debt.

Impairment of Long-Lived Assets  

Pursuant to Statement of Financial Accounting Standards No.  144, “Accounting for the Impairment or Disposal of Long-lived Assets”, we continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. An impairment loss is recognized when expected cash flows are less than the asset's carrying value. Accordingly, when indicators of impairment are present, we evaluates the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying assets. Our policy is to record an impairment loss when it is determined that the carrying amount of the asset may not be recoverable. No impairment charges were recorded in the three month periods presented ended March 31, 2007.

Revenue Recognition

Revenue on product sales is recognized when persuasive evidence of an arrangement exists, such as when a purchase order or contract is received from the customer, the price is fixed, title to the goods has changed and there is a reasonable assurance of collection of the sales proceeds. We obtain written purchase authorizations from our customers for a specified amount of product at a specified price and consider delivery to have occurred at the time of shipment. Revenue is recognized at shipment.

 

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Revenue from research and development activities relating to firm fixed-price contracts is generally recognized as billing occurs. Revenue from research and development activities relating to cost-plus-fee contracts include costs incurred plus a portion of estimated fees or profits based on the relationship of costs incurred to total estimated costs. Contract costs include all direct material and labor costs and an allocation of allowable indirect costs as defined by each contract, as periodically adjusted to reflect revised agreed upon rates. These rates are subject to audit by the other party. Amounts can be billed on a bi-monthly basis. Billing is based on subjective cost investment factors.

Accounting for Income Taxes

As part of the process of preparing our financial statements, we are required to estimate our income taxes. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. If there is not persuasive evidence that recovery will occur, we would establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the consolidated statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $8,300,000 as of March 31, 2007, due to uncertainties related to our ability to utilize some of our deferred tax assets, primarily consisting of certain net operating losses carried forward before they expire and certain accrued expenses, which are deferred for income tax purposes until paid. The valuation allowance is based on our estimates of taxable income and the period over which our deferred tax assets will be recoverable. The net deferred tax asset as of March 31, 2007 was $1,212,741, net of the valuation allowance.

Accounting for Derivatives

Our issuances of convertible debt are accompanied by other financial instruments. These financial instruments include warrants to purchase stock, and the right to convert debt to stock at specified rates (“conversion benefits.”). Pursuant to SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as amended, and EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, A Company’s Own Stock, we have identified certain embedded and freestanding derivative instruments. Generally, where the ability to physical or “net-share settle” an embedded conversion option or free standing financial instrument is not deemed to be within our control, the embedded conversion option is required to be bifurcated or separated, and both the freestanding instruments and bifurcated conversion feature are accounted for as derivative liabilities. At each reporting date, we estimate the fair values of all derivatives, and changes in the fair value are charged to operations.

Under EITF 00-19, warrants are considered free-standing instruments in that they are legally detachable and separately exercisable. The conversion benefits, which are embedded in these debt issues, derive value from the relationship between the stock price and debt conversion price, and are considered embedded derivatives under the provisions of SFAS 133. The fair values of both the warrants and conversion benefits are calculated using a Black- Scholes Model, taking into consideration factors such as the underlying price of the common stock, the exercise price for warrants or the conversion price for the conversion benefit, the stock volatility, and the risk-free interest rates available for comparable time periods.

 

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Free-standing instruments (warrants), and embedded derivatives (conversion benefits) which are initially bifurcated or separated from the host financial instrument, are recorded as separate liabilities, in cases where the security holder has a right to choose to receive a “net settlement” of cash. The identification of such net settlement provisions for prior convertible debt issuances with warrants resulted in us concluding that such warrants should have been identified as “derivatives”, and therefore the warrant liabilities must be recorded as a separate derivative liability on our restated balance sheet, and marked to market for each subsequent reporting period with any non-cash charges or credits attributed to the revised fair value of the liability being recognized through earnings.

If the decision to settle the outstanding liability remains with us, the value of the warrants should be recorded in an equity account. The identification of the settlement provisions we control under certain debt issuances resulted in us determining that the warrants should be reflected in the restated Reports as components of equity, as compared to having been previously recorded as liabilities with non-cash charges and/or credits to earnings as a result of being marked to market for each period presented.

EITF 00-19-2 specifies that the contingent obligations to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with SFAS No. 5, “Accounting for Contingencies.”  EITF 00-19-2 also requires additional disclosure regarding the nature of any registration payment arrangements, alternative settlement methods, the maximum potential amount of consideration and the current carrying amount of the liability, if any. We previously adopted the provisions of EITF 00-19-2 for the reporting period beginning January 1, 2007 , and do not estimate that any additional contingency accruals and/or disclosures would be required to be included in our restated Reports other than those items expected to be reflected in the respective amended and restated Reports.

We also previously sold stock units which included warrants along with common stock. In these cases, a portion of the proceeds equal to the value of the warrants is allocated to the warrants (when a net settlement provision exists for cash), with the balance allocated to the stock. In such cases, the value of the warrants are treated as liabilities, and the balance is revalued at the end of each reporting period with any change in value being recognized currently as a non-cash charge and/or credit to earnings. When a warrant classified as a liability is exercised or cancelled, the fair value of the warrant, as determined at the time of exercise or cancellation, is transferred to equity, and is no longer revalued. A similar adjustment is made for a conversion benefit classified as a liability when the debt is converted to stock, or cancelled.

The February 2007 convertible debt issuance includes certain variable conversion pricing which results in the actual maximum number of potential shares needed to satisfy the conversion of such debt to be unknown and not quantifiable at the date of issuance.  EITF 00-19-2 specifies that debt issuances with variable conversion pricing for which there is no established “floor” in the conversion pricing, and where the maximum number of shares needed to satisfy the conversion of such debt is not known, should be accounted for as derivative liabilities and revalued at the end of each reporting period. When a derivative classified as a liability is exercised, cancelled, or the maximum number of shares needed to satisfy the conversion of such debt is known, the fair value of the derivative, as determined at that time, is revalued and transferred to equity, and is no longer revalued.  To the extent that the initial fair values of the derivative liabilities exceed the net proceeds received, an immediate charge to the statement of operations is recognized, for the excess. As of March 31, 2007, we recognized in the statement of operations excess costs over debt proceeds of $1,401,901 related to the excess of derivative liabilities over the net proceeds received for the February 2007 debt issuance .  The remainder of the discount from the face value of the convertible debt resulting from allocating part or all of the proceeds to the derivative liabilities is amortized over the life of the instrument through periodic charges to the statements of operations, using the straight line method, which was the most systematic and rational approach that approximated the interest method of amortization due to the short two year amortization term of the debt. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period.

 

 

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Basic and Diluted Loss Per   Share

In accordance with Statement of Financial Accounting Standards No.  128, “Earnings Per Share,” and SEC Staff Accounting Bulletin (SAB) No. 98, both basic and diluted loss per share (“EPS”) are presented on the face of the income statement. Basic EPS is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS is computed similarly to basic EPS, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were not anti-dilutive. We have excluded all common stock equivalents arising from outstanding options, warrants, convertible preferred stock and convertible debt from the calculation of diluted net loss per share because these securities are anti-dilutive. As of March 31, 2007 and 2006, we had approximately  24,890,142 and 22,694,207 ,  weighted average number of shares, respectively, outstanding and used in both the Basic and Diluted EPS calculation.

 

Reclassifications

Certain amounts in the 2006 consolidated financial statements have been reclassified to conform to the 2007 consolidated financial statement presentation.

 

Recent Accounting Pronouncement

The Financial Accounting Standards Board (FASB) has recently issued FASB Staff Position EITF 00-19-2 which modifies the accounting treatment of derivatives that flow from financings involving embedded derivatives. This Staff Position is effective for financial statements for periods beginning January 1, 2007.  Adoption of this staff position has not caused any change in the quarter or three month period ended March 31, 2007 in the way we account for derivatives.  We have reviewed other accounting pronouncements issued during 2006 and 2007,  and have concluded that they will have no effect on our financial statements.

 

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ITEM 3. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

The Company, under the supervision and with the participation of its management, including the recently appointed principal executive officer and acting principal financial officer, has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Act”) as of the end of the period covered by this report (the “Disclosure Controls”). Based upon the Disclosure Controls evaluation, the recently appointed principal executive officer and acting principal financial officer have concluded that the Company’s disclosure controls and procedures were not effective in connection with preparing this Quarterly Report on Form 10-QSB due to a material weakness in the Company’s internal control over financial reporting, mainly its financial closing, review and analysis process and its ability to maintain adequate records. The Company determined that a restatement of its financial statements was necessary due to the issuance of convertible debentures and warrants (collectively, the “Securities”) in various private placements over the last three years. This restatement is required to properly reflect the Company’s financial results for certain non-cash, and non-operational related charges or credits to earnings associated with both embedded and freestanding derivative liabilities, and the accounting for certain derivatives under the control of the issuer due to the revised interpretation and implementation under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, the Emerging Issues Task Force issued EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and FASB Staff Position No. EITF 00-19-2, “Accounting for Registration Payment Arrangements.”

The Company believes that the issues surrounding the restatement of this report, mainly the internal controls related to the financial closing, review, and analysis process and its ability to maintain adequate records has been addressed and the Company has taken additional steps to avoid the reoccurrence of this condition by adding an additional qualified person with SEC experience in the financial reporting and analysis area. The Company has instituted a policy requiring the controller, at the end of each quarter, to reconcile the accounting records to the securities issuance report prepared and maintained by the corporate secretary to ensure that all issuances have been properly recorded and that appropriate adjustments to previously issued securities are recorded, if necessary. The Company believes that these additional efforts taken by new management since the end of 2006 to strengthen the Company’s internal controls will be effective in future periods.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

The Company’s internal control over financial reporting has been modified during the Company’s most recent fiscal quarter by adding additional resources to address deficiencies in the financial closing, review and analysis process, and improve the Company’s record keeping, which has materially improved the Company’s internal control over financial reporting.

 

(b) Changes in internal control over financial reporting.

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.

We made the changes as specified above in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-QSB that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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