Applied Digital Corp. 10-Q

Item 1. Financial Statements. FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY BALANCE SHEETS Unaudited ASSETS AUGUST 31, MAY 31, 2008 2008 Current assets: Cash and cash equivalents $ 414,420 $ 877,899 Contract receivables 71,663 64,396 Investment, at fair value 125,000 125,000 Other current assets 48,068 60,512 659,151 Machinery and equipment, net of accumulated depreciation of $484,179, and $478,149, respectively 267,791 38,821 Other assets: Intangible assets, net of accumulated amortization of $11,820, and $10,662, respectively 157,030 68,188 Other receivables - 30,460 TOTAL ASSETS $ 1,083,972 $ 1,265,276 LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Accounts payable $ 229,144 $ 187,574 Accrued expenses 188,936 289,739 418,080 Stockholders’ equity: Preferred stock, $.001 par value, 5,000,000 shares authorized, none issued and outstanding - - Common stock, $.001 par value, 50,000,000 shares authorized, 8,720,946, and 8,431,510 shares outstanding, respectively 8,721 8,432 Additional paid-in-capital 13,681,388 13,470,027 Treasury stock, 36,300 shares, at cost (62,371) (62,371) Accumulated deficit (12,961,846) (12,628,125) 665,892 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 1,083,972 $ 1,265,276 The accompanying notes are an integral part of these financial statements FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY STATEMENT OF OPERATIONS FOR THE THREE-MONTHS ENDED 3 AUGUST 31, (unaudited) 2008 2007 Contract revenues $ 54,855 $ 46,201 Cost of revenues 25,039 42,751 Gross profit 29,816 3,450 Operating expenses: Selling, general and administrative 338,399 814,927 Depreciation and amortization 7,188 27,250 Research and development 21,082 109,422 Total operating expenses 366,669 851,599 Operating loss (336,853) (948,149) Interest income 3,132 39,980 Loss before provision for income taxes (333,721) (908,169) Provision for income taxes - - NET LOSS $ (333,721) $ (908,169) Net loss per share: Basic $ (.04) $ (.11) Diluted $ (.04) $ (.11) Weighted average number of shares outstanding: Basic 8,407,794 8,250,645 Diluted 8,407,794 8,250,645 The accompanying notes are an integral part of these financial statements 4 FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY STATEMENTS OF CASH FLOW FOR THE THREE-MONTHS ENDED AUGUST 31, (unaudited) 2008 2007 Cash flows from operating activities: Net loss $ (333,721) $ (908,169) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 7,188 27,250 Share-based compensation 11,650 85,385 Changes in operating assets and liabilities: (Increase) decrease in contract receivables (7,267) 58,694 Decrease in other current assets and other Assets 42,904 31,483 Increase (decrease) in accounts payable and accrued expenses (59,233) 145,494 Net cash used in operating activities (338,479) (559,863) Cash flows from investing activities: Purchase of furniture and equipment (35,000) - Proceeds from available for sale securities - 250,000 Payments for patents (90,000) (35,108) Net cash (used in) provided by investing activities (125,000) 214,892 Cash flows from financing activities: Net cash provided by financing activities - - Net increase (decrease) in cash and cash equivalents (463,479) (344,971) Cash and cash equivalents at beginning of period 877,899 2,439,911 Cash and cash equivalents at end of period $ 414,420 $ 2,094,940 Supplemental non-cash disclosures: Issuance of common stock for purchase of furniture and equipment $ 200,000 - The accompanying notes are an integral part of these financial statements 5 FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE THREE-MONTHS ENDED AUGUST 31, (Unaudited) Common Stock Additional Paid-in-Capital Treasury Stock Accumulated Deficit Stockholders’ Equity Shares Amount Balance May 31, 2007 8,331,510 $ 8,332 $ 13,125,455 $ (165,463) $ (9,341,826) $ 3,626,498 Issuance of treasury stock 25,514 51,546 77,060 Share-based compensation 8,325 8,325 Net loss (908,169) (908,169) Balance August 31, 2007 8,331,510 $ 8,332 $ 13,159,294 $ (113,917 $ (10,249,995) $ 2,803,714 Balance May 31, 2008 8,431,510 $ 8,432 $ 13,470,027 $ (62,371) $ (12,628,125) $ 787,963 Share-based compensation 11,650 11,650 Issuance of stock 289,436 289 199,711 200,000 Net loss (333,721) $ (333,721) Balance August 31, 2008 8,720,946 $ 8,721 $ 13,681,388 $ (62,371) $ (12,961,846) $ 665,892 The accompanying notes are an integral part of these financial statements 6 FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 (Unaudited) Note 1. Basis of Presentation The interim consolidated financial statements include the accounts of Flight Safety Technologies, Inc. and it’s newly formed wholly-owned subsidiary Advanced Plasma Products, Inc. On August 7, 2008, the Company executed a letter of intent with the University of Tennessee Research Foundation (UTRF) for the licensing of patent rights related to atmospheric glow plasma technology. The agreement provides for exclusive worldwide rights to commercialize the technology in all but a few fields of use. The letter of intent provides for an initial license fee of $150,000 payable in shares of common stock of the Company and minimum annual royalty payments starting in year two. Additionally, in a related transaction, on August 28, 2008, Advanced Plasma Products, Inc. purchased the assets of Atmospheric Glow Technologies, Inc., the previous licensee of this technology and a company in bankruptcy. These assets included essential instrument prototypes, engineering drawings, test equipment and a variety of facility related assets. We paid $125,000 in cash and issued 289,436 shares of our common stock valued at $200,000. On September 10, 2008 , we concluded our agreement with UTRF and will issue 260,417 shares of our common stock as payment for the license fee. These interim financial statements for the three-months ended August 31, 2008 and August 31, 2007, included herein, have been prepared, without audit, pursuant to the rules and regulations of the SEC. Results for the periods presented are not necessarily indicative of results for the entire year. In the opinion of management, all adjustments, consisting of normal recurring adjustments, which are necessary for a fair statement of operating results for the interim periods have been made. These financial statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with our financial statements and related footnotes for the years ended May 31, 2008 and 2007 which are included in our annual report on Form 10-KSB filed on August 29, 2008. Certain reclassifications have been made to prior interim period balances in order to conform to the current year’s presentation. Note 2 . Going Concern and Liquidity The report of our independent registered public accountant issued in conjunction with our audited financial statements and notes thereto for the year-ended May 31, 2008 indicated that there is substantial doubt about our ability to continue as a going concern. The Company has had recurring losses from operations that have diminished its financial resources. Our liquidity to date has primarily been provided by revenue from government contracts and proceeds from the sale of our equity securities. We have not been successful in securing any additional government funding and we will have to rely on the sale of our equity securities to generate sufficient working capital in order to successfully commercialize our newly acquired technology and to pay for our ongoing operations. As a result of the lack of government funding for 7 FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 (Unaudited) (Continued) our aviation security technologies, we have suspended all related research and develop work. As of August 31, 2008, our cash and investments were $539,420, which will be insufficient to fund our operations through the current year. The Company is currently exploring various equity transactions in order to raise sufficient working capital to maintain its operations. However, in light of the current financial climate, we believe it is unlikely that we will be able to complete a transaction on a timely basis without further interruptions in our operations. Our inability to successfully conclude an equity transaction would have a material adverse affect upon our financial condition and our ability to maintain our operations. These factors raise substantial doubt about our ability to continue as a going concern. On September 29, 2008, we were delisted from the American Stock Exchange for failure to maintain the required listing standards. We are currently trading on the Over-the-counter market under the symbol “FLTS” Note 3. Summary of Significant Accounting Policies Use of Estimates In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and the reported amounts of revenue and expenses during the reporting period. Material estimates that are particularly susceptible to significant change in the near term relate to the carrying values of investments, inventory, intangible assets, other receivables and the calculation of share-based compensation. Actual results could differ from those estimates. Share-Based Compensation: Effective June 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Share-Based Payments (revised 2004)," (SFAS No. 123R) which requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost is recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period). Under SFAS No. 123R, the Company provides an estimate of forfeitures at initial grant date. The Company elected the modified prospective transition method under SFAS 123R and accordingly has not restated periods prior to adoption. The Company recognized $11,640 and $8,325, as compensation expense related to employee stock options in each of the three-months ended August 31, 2008 and 2007, respectively. The fair value of each option grant is estimated as of the grant date using the Black-Scholes option pricing model. There were no options granted in each of the three months ended August 31, 2008 and 2007, respectively. Loss Per Share: Basic loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. For the interim periods presented the effect of stock options and warrants was anti-dilutive; therefore, they were not included in the computation of diluted loss per share. The number of shares issuable upon the exercise of outstanding stock options and warrants that were excluded from the computation as their effect FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 (Unaudited) (Continued) would be anti-dilutive, were 2,962,200 and 3,963,632 for the three-month periods ended August 31, 2008 and August 31, 2007, respectively. Cash and Cash Equivalents: For purposes of reporting cash flows the Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash and cash equivalents. Revenue and Cost Recognition: Our prior contracts with the United States government and our maritime industry customers are cost-reimbursable contracts that provide for a fixed profit percentage (base fee) applied to our actual costs to complete the work. These contracts are subject to audit and adjustment by our customer, and are subject to cost limitations as provided by the contract and the Federal Acquisition Regulations. The government has audited and accepted our rates through our fiscal year ended May 31, 2006. For these contracts, revenue is recorded at the time services are performed based upon actual project costs incurred including a reimbursement for general, administrative, and overhead costs and the base fee. The general, administrative, and overhead costs are estimated periodically in accordance with government contract accounting regulations and may change based on actual costs incurred subject to approval. Revenue may be adjusted for our estimate of costs that may be categorized as disputed or unallowable as a result of cost overruns or the audit process. Project costs include all direct material, labor and subcontracting costs. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability and final contract settlements may result in revisions to chargeable costs and revenue recorded and are recognized in the period in which the revisions are determined. Revenue related to additional claims under the contract is recorded at the lesser of actual costs incurred or the amount expected to be realized. Machinery and Equipment: Machinery and equipment are stated at original cost or fair value at date acquisition in the case of the bulk purchase of machinery and equipment purchased by Advanced Plasma Products, Inc. (“APP”) less accumulated depreciation. Depreciation is computed using the straight-line method. Cost and accumulated depreciation of assets retired or disposed of are removed from the accounts. Gains and losses are recognized upon disposal of assets. The cost of maintenance and repairs is charged to operations as incurred, whereas significant repairs are capitalized. The assets recently acquired by APP are currently being carried at their acquisition cost. We are in the process of determining their fair value and will make the appropriate adjustments to the financial accounts, once that is completed. Estimated useful lives by asset class are as follows: Machinery & equipment 5 years Furniture & fixtures 5 years Automobiles 5 years Software 3 years FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 9 (Unaudited) (Continued) Intangible Assets: At August 31, 2008, intangible assets consist of patent costs associated with, AWSM, TIICM™ and atmospheric glow technologies. Acquisition costs and costs of outside legal counsel related to obtaining new patents are capitalized. Patent costs are being amortized using the straight-line method over the lesser of seventeen years from the date incurred or the remaining life of the underlying patent. In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144) the Company assesses its patents for impairment whenever events or changes in circumstances indicate their carrying value may not be recoverable. Such circumstances may include a significant adverse change in legal factors or the business climate that could affect the value of the patents. The Company also considers the likelihood of obtaining required research and development funding. In determining recoverability, the Company must determine the asset's fair value, which may require Management to make significant assumptions about the future cash generating ability of the asset. If an asset is determined to be impaired, the difference between the asset's fair value and book value is charged to expense in the period the impairment is identified. After an impairment loss is recognized, the adjusted carrying amount of the intangible asset becomes its new basis. Subsequent reversal of a previously recognized impairment loss is prohibited under SFAS 144. Concentration of Credit Risk: The Company had amounts in excess of $100,000 in a single bank during the year. Amounts over $100,000 are not covered by the Federal Deposit Insurance Corporation. Concentration of credit risk also exists with respect to investment securities and contract receivables. The concentrated risk associated with contract receivables is mitigated by the fact that these receivables are due primarily from the United States Government. The risk for investment securities is mitigated by an Investment Policy which, approved by the Board of Directors, restricts investing in fixed income securities below an "A" rating at the time of purchase and investments in asset backed securities, mortgage backed securities and collateralized mortgage obligations below a "AAA" rating at the time of purchase. Research and Development: Company sponsored research and development costs, including proposal costs and un-reimbursed expenditures for developmental activities, are charged to operations as incurred. Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. A valuation allowance is provided on deferred tax assets when it is more likely than not that some portion of the assets will not be realized. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period of enactment. Fair Values of Financial Instruments: The estimated fair value of financial instruments has been determined based on the available market information and appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, accounts receivable (including other receivables), FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 (Unaudited) (Continued) 10 other current assets, accounts payable and accrued expenses, approximate fair value at August 31, 2008 and May 31, 2008, because of the short maturity of these financial instruments. Retirement Savings Plan: Effective July 1, 2004, the Company established a Retirement Savings Plan (the "Plan") under the provisions of Section 401(k) of the Internal Revenue Code. Employees, as defined in the plan, are eligible to participate on their first day of employment. Under the terms of the Plan, the Company can match up to the employee’s contribution of 5% of gross pay. The Company matching funds immediately vest 100%. The Company match for each of the three-months ended August 31, 2008 and 2007 were $7,456 and $15,651 respectively. Recent Accounting Pronouncements: Fair Values of Assets and Liabilities: The Company adopted Statement of Financial Accounting Standards No. 157 (“SFAS 157”), Fair Value Measurements , which provides a framework for measuring fair value under generally accepted accounting principles. This Statement became effective for the Company on June 1, 2008 and did not have a material impact on the Company’s consolidated financial statements. The Company also adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 . SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company did not elect fair value treatment for any financial assets or liabilities upon adoption. SFAS 159 also became effective for the Company on June 1, 2008 and did not have a material impact on the Company’s consolidated financial statements. In accordance with SFAS 157, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value: Level 1 — Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. For example, Level 2 assets and liabilities may include debt securities with quoted prices that are traded less frequently than exchange-traded instruments or mortgage loans held for sale, for which the fair value is based on what the securitization market is currently offering for mortgage loans with similar characteristics. Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 (Unaudited) (Continued) 11 Assets and liabilities measured at fair value on a recurring basis are summarized below: AUGUST 31, 2008 Level 1 Level 2 Level 3 Assets/Liabilities at Fair Value ASSETS: Securities available for sale - $ 125,000 - $ 125,000 Total assets - $ 125,000 - $ 125,000 Also, the Company may be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The Company had no such assets as of August 31, 2008. At August 31, 2008 and May 31, 2008 the investment consisted of an auction market preferred security. Note 4: Contract Receivables Accounts receivable consisted of the following at: August 31, 2008 May 31, 2008 Contract receivables – billed $ 41,203 $ 64,396 Contract receivables – unbilled 30,460 30,460 $ 71,663 $ 94,856 The amount classified as other receivables and contract receivables unbilled is a retained fee on a recently completed government contract. At August 31, 2008 we expect to receive payment during this year. 12 FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED AUGUST 31, 2008 AND AUGUST 31, 2007 (Unaudited) (End) Note 5: Machinery and Equipment Property and equipment are summarized by major classifications as follows: August 31, May 31, 2008 2008 Machinery and equipment $ 225,163 $ 225,163 Furniture and fixtures 16,177 16,177 Automobiles 122,278 122,278 Software and computers 153,352 153,352 Bulk asset purchase not yet allocated, at cost 235,000 - 751,970 516,970 Less accumulated depreciation (484,179) (478,149) $ 267,791 $ 38,821 Note 6: Intangible Assets Intangible assets currently consist of costs associated with the newly acquired atmospheric glow technology, as well as the company’s existing TIICM and AWSM technologies. As more fully explained in Note 2, above, the company has suspended all further research and development on the TIICM and AWSM technologies. Accordingly, we will be evaluating the carrying value of the TIICM and AWSM technologies to determine if those values have been impaired. The carrying values of TIICM and AWSM at August 31, 2008 were $54,150 and $12,880, respectively. Note 7: Stockholders’ Equity Warrants: As of both August 31, 2008 and May 31, 2008, the Company had 1,919,200 warrants outstanding with exercise prices ranging from $3.30 to $5.40 with an expiration date of January 29, 2009. The weighted average exercise price was $3.49. Stock Options: Under the Company’s 2005 Stock Incentive Plan, there are 1,027,000 shares available for future awards. No awards were made during the three-month period ended August 31, 2008. The weighted average exercise price of the 1,043,000 options outstanding is $3.50. The aggregate intrinsic value of the outstanding options is $0.00. As of August 31, 2008 there was $41,710 of total unrecognized compensation cost related to the non-vested stock options that is expected to be expensed over the next one and one-half years. 13 FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Cautionary Statement Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995: Except for the historical information presented in this document, the matters discussed in this annual report on Form 10-Q for the three month period ended August 31, 2008 or otherwise incorporated by reference into this document, contain "forward-looking statements" (as such term is defined in the Private Securities Litigation Reform Act of 1995). These statements are identified by the use of forward-looking terminology such as "believes", "plans", "intend", "scheduled", "potential", "continue", "estimates", "hopes", "goal", "objective", expects", "may", "will", "should" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. The safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, apply to forward-looking statements made by us. We caution you that no statements contained in this Form 10-Q should be construed as a guarantee or assurance of future performance or results. These forward-looking statements involve risks and uncertainties, which include risks and uncertainties associated with, among other things, availability of capital to fund operations, research and development, the impact of competitive products and pricing, limited visibility into future product demand, generally slower economic growth, difficulties inherent in the development of complex technology, new products sufficiency, fluctuations in operating results, and other risks are discussed in the "Known Trends, Risks and Uncertainties" section of Management's Discussion and Analysis of Financial Conditions and Results of Operations of this Form 10-Q. The actual results that we achieve may differ materially from any forward-looking statements due to such risks and uncertainties. These forward-looking statements are based on current expectations, and, except as required by law, we assume no obligation to update this information whether as a result of new information, future events or otherwise. Readers are urged to carefully review and consider the various disclosures made by us in this Form 10-Q and in our annual report on Form 10-KSB and in our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business. Overview Our Company had four basic technologies, all in the field of aviation security that it was pursuing. These technologies were substantially funded by government contracts. The Company has been unsuccessful in securing additional funding for these projects, and at May 31, 2008 decided to suspend all efforts on them. In an effort to reduce our reliance on our aviation security technologies, we have undertaken an effort to identify potential diversifying, technology-based acquisitions to enhance shareholder value and provide better opportunity for profitable operations. To that end, we have licensed patent rights from the University of Tennessee Research Foundation relating to atmospheric glow plasma technology. In addition, we have acquired the key assets from the previous licensee of that technology, hired some of its key employees, and secured a lease on its former facility. We believe that this technology has been advanced to the stage where several products can be commercialized and released to the market within two years. FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY 14 Atmospheric glow discharge plasma is a technology that produces tailored plasma gas chemistry for a wide range of applications such as air purification, materials processing, decontamination, sterilization and many others. We believe these applications can create market opportunities that cover homeland security, health care, process control, and environmental protection, remediation and control. Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations are based on our financial statements that have been prepared according to accounting principles generally accepted in the United States of America. In preparing these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We evaluate these estimates on an on-going basis. We base these estimates on historical experiences and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Our management has discussed these estimates and assumptions with our finance and audit committee. Subjective judgments may have a material impact on our financial statements, including the valuation of inventory and intangible assets. Federal Acquisitions Regulations require that, among other things, our reimbursable costs are reasonable. We have analyzed our actual overhead rate and general administrative rate for the fiscal year ended May 31, 2008. We believe all component costs have been ordinary and necessary but that government auditors may consider some of our selling, general and administrative expenses for the fiscal year ended May 31, 2008 unreasonable for a company our size. The government has audited and accepted our rates through our fiscal year ended May 31, 2006. Since there is a degree of subjectivity in the judgment of what levels of cost are reasonable, we can make no assurance that the government will not require further adjustments. Results of Operations Revenues : Revenues for the three months ended August 31, 2008 and 2007 of $54,855 and $46,201, respectively, consisted entirely of revenue from our hydrodynamic software development contracts issued by companies in the maritime industry. The level of revenues is dependent upon the hours worked on the tasks required. Cost of revenues: Cost of revenues for the three months ended August 31, 2008 and 2007 were $25,039 and $42,751, respectively. It is comprised of subcontract, consultant and direct labor costs. The decrease in cost of revenues for the August 31, 2008 interim period was primarily the result of not incurring costs for subcontractors and consultants, and to a lesser extent, reduced direct labor hours incurred and billed. Selling, general and administrative expenses: Selling, general and administrative expenses for the three months ended August 31, 2008 and 2007 were $338,399 and $814,927, respectively. The decrease of $476,528 was attributable to (i) lower headcount and related employee benefits of $156,000; (ii) reduced legal, professional and lobbying fees of $183,000; (iii) reduced stock-based FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY 15 compensation of $73,000; with the remaining decrease of $65,000 spread over various other categories of expense. All of these reductions were related to an overall contraction in the operations of the business due to liquidity constraints. Depreciation and amortization: Depreciation and amortization expenses for the three months ended August 31, 2008 and 2007 were $7,188 and $27,250, respectively. The reduction of $20,062 resulted from the write-down or disposition of several assets and the completion of depreciation on other assets. Research and development: Research and development expenses for the three months ended August 31, 2008 and 2007 were $21,082 and $109,422, respectively. The reduction of $88,340 resulted from the decision to suspend all develop activities on our aviation related technologies until we are able to raise sufficient working capital for such purposes. Interest income: Interest income for the three months ended August 31, 2008 and 2007 were $3,132 and $39,980, respectively. The reduction of $36,848 was attributable to a reduction in cash available for investment in interest bearing investments and accounts. Liquidity and Capital Resources The report of our independent registered public accountant issued in conjunction with our audited financial statements and notes thereto for the year-ended May 31, 2008 indicated that there is substantial doubt about our ability to continue as a going concern. Our sources of liquidity have been primarily from government contracts and equity financings. We have undertaken several actions to mitigate the liquidity issue. We have suspended all research and development activities on our related aviation technologies, as we no longer believe that we can obtain additional government contracts to continue such development and do not have the funds internally. This lack of funding has had an adverse impact on our ability to develop our current aviation and security related technologies. As a result we have undertaken to diversify our technology base by identifying other technologies to reduce our reliance on our current technologies. As a result of this diversification effort, on September 10, 2008, we finalized our licensing agreement with the University of Tennessee Research Foundation for the licensing of patent rights related to atmospheric glow plasma technology. The agreement provides for exclusive worldwide rights to commercialize the technology in all but a few fields of use. We believe this technology can be applied to produce products used for, among other things, the sterilization or cleaning of a wide variety of objects and substances, such as medical instruments and air. Commercialization of this technology will require final product development and for certain applications may require regulatory approval. Additionally, in a related transaction on August 28, 2008, we purchased the assets of the previous licensee of this technology. These assets included essential instrument prototypes, engineering drawings, test equipment and a variety of facility related assets. The payment for the assets was $125,000 cash and $200,000 paid by the issuance of 289,436 shares of our common stock. We have also hired two senior executives to manage the newly acquired technology and oversee the overall growth plan for the Company, due to their experience in growing early stage companies. The Company’s previous senior management had since resigned. To develop products under the licensed technology and bring products to market, we estimate that we will require approximately $2.5 million of new working capital. We are looking to obtain this FLIGHT SAFETY TECHNOLOGIES, INC. AND SUBSIDIARY 16 working capital with proceeds from one or more private placements of our securities, some type of financial transaction or a combination of both. However, in light of the current economic climate, we believe it is unlikely that we will be able to complete such a transaction on a timely basis without further interruptions in our operations. Without new working capital during our current quarter we will have to either, suspend all operations to provide additional time to try to complete an equity transaction or cease our operations and liquidate our assets. In the event of liquidation we do not expect any proceeds would be available after payment of liabilities for distribution to our shareholders. We can give no guaranty or assurance as to whether or when we will complete one or more private placements, financial transaction or bridge funding on a timely basis or whether this newly licensed technology and its commercialization will be successful. As of August 31, 2008 and May 31, 2008, our cash and investments were $539,000 and $1,003,000, respectively. For the three months ended August 31, 2008: (i) cash used by operating activities was $338,479 primarily the result of net losses for the period of $333,721 and (ii) cash used by investing activities was $125,000 attributable solely to the bulk acquisition of assets relating to the atmospheric glow technology business. Our current revenues come from two contracts relating to hydrodynamic software development for the maritime industry. These contracts generate approximately $15,000 to $20,000 a month in billings. Our current backlog is approximately $150,000. Item 3. Not applicable