Alternative Fuel Systems (2004) Inc.

Originally incorporated as H2 Fuel Inc. during October 2000, the company was an inactive, wholly-owned subsidiary of Alternative Fuel Systems Inc. (AFS), a developer of natural gas fuel management systems. Effective May 13, 2004, H2 changed its name to Alternative Fuel Systems (2004) Inc. A few weeks later, on June 30, 2004, the parent organization, AFS, completed a corporate restructuring and transferred all of its business assets and liabilities to AFS (2004). As consideration for the purchase of the assets and liabilities, the company issued 6.9 million common shares to AFS. Under the restructuring, AFS later changed its name to AFS Energy Inc. to reflect a planned move into the energy sector. As a result of these transactions, AFS (2004) effectively commenced operations on June 30, 2004, independent from its previous parent, AFS.

Today, the company develops and markets electronic engine management systems and related components that enable internal combustion diesel and gas engines to operate on cleaner-burning natural gas. AFS (2004) has products installed worldwide in new vehicles made by original equipment manufacturers (OEMs), or retrofitted in existing fleets. The company’s products and technologies are designed to retain engine performance and fuel economy while reducing harmful emissions.

Currently, AFS (2004) has 12 full-time employees, with consultants, distributors and agents in Europe, India, Iran and the United States.

Products

Over the last five years a majority of the company’s revenues have been attributed to its two primary products, the Sparrow and the Falcon. In the late 1990s, AFS (2004)’s former parent, AFS, developed Sparrow, an engine management system, which is based on a proprietary microprocessor-controlled system that enables gasoline and re-engineered diesel engines to operate on cleaner burning natural gas. The system significantly reduces engine emissions, lowers fuelling and operating costs and can be customized for a wide-range of engine platforms while maintaining engine performance. The core component of the Sparrow system is the electronic control module (ECM) microprocessor which collects input up to 100 times per second from several key sensors to achieve optimal engine performance as measured by engine power, torque, emissions and fuel efficiency. These sensors provide continuous information on the load, temperature, exhaust temperature and other variables on the system enabling the ECM to properly regulate the fuel injection and timing to the engine. Currently, the Sparrow system is patented in the U.S. and Canada and the company has applied for patents in several other countries. In addition, during 2003, AFS (2004) developed the Sparrow-Custom, or Sparrow-C, for the light duty natural gas vehicle (NGV) market. This segment of the NGV market comprises the majority of all NGVs and requires products to be inexpensive and easy to install while meeting emission standards. During the first quarter of fiscal 2006, the company’s engine management systems accounted for $195,000 of total revenues.

AFS (2004) has also commercialized a natural gas pressure regulator called the Falcon. Compressed natural gas regulators are required to reduce the gas pressurebetween the on-board gas storage cylinder, which contains highly compressed natural gas, and the fuel injection point which typically requires much lower pressures. Accurate fuel delivery pressure can make a substantial difference in engine performance and emissions, and according to management, the Falcon is able to maintain precise gas pressure upon calibration for each customer’s engine platform. These regulators are sold as a stand-alone product or as part of the Sparrow engine management system. The Falcon is sold to OEMs, conversion outfitters and automotive distributors primarily in Europe, Mexico and the U.S. During the three months ended March 31, 2006, the company’s pressure regulators accounted for $386,000 of total revenues.

AFS (2004) also produces the following three products: the Gs Series gaseous fuel injector, which is designed to enhance the durability, reliability and cost effectiveness of gaseous fuelling systems that use compressed natural gas and liquid petroleum gas (propane). This injector is sold as a stand-alone product or as a component of the Sparrow system engine management system; the Raven, which is a computer-controlled, distributorless ignition system designed for diesel engines that have been converted to natural gas; and the Sparrow Lean Burn engine management system, which was designed to help achieve higher thermal efficiencies and reduce emissions.

All of the company’s products go through three distinct stages: product development and prototyping, field trials of developed products, as well as sales of commercial product quantities and long-term supplier relations with customers.

Equity Financing & Improved Sustainability

Prior to the end of fiscal 2003, the company had one large client who accounted for a majority of AFS (2004)’s Falcon regulator sales. When this client ceased placing orders for the product, the company was forced to apply for creditor protection. However, AFS (2004) has since made efforts to increase and sustain its capital. During April 2005, the company closed a series of equity financings which raised gross proceeds of $1.5 million. The financings included the issue of 10 million units at a price of $0.15 per unit. Each unit included one common share and one-half of one share purchase warrant. Each whole warrant entitles the holder to purchase one additional common share at an exercise price of $0.20.

AFS (2004) has since increased its number of major clients and in order to mitigate the risk associated with providing customized engineering and product development work, the company now requires that all new large orders be guaranteed by a deposit before work commences. In addition, AFS (2004) has started larger production runs, which has resulting in significant savings when purchasing electronic parts from its suppliers. Management has also begun to focus on higher margin products for the electronics side of its business. Furthermore, during May 2006, the company announced a substantial contract with its largest customer for pressure regulators, a major European automaker, who is about to commence production of taxis that will be fuelled by natural gas.