SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-K


(Mark
One)


[
      X ]
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the fiscal year ended June 30, 2008[    ]
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934





For the
transition period from ____________ to ____________





Commission
File No. 0-18958





Groen
Brothers Aviation, Inc.


(Name of
registrant as specified in its charter)





Utah
              (State
      or other jurisdiction of incorporation or organization)
            87-0489865
              (I.R.S.
      Employer Identification No.)





2640
W. California Avenue


Salt
Lake City, Utah  84104-4593


(Address
of principal executive offices) (Zip Code)





Registrant’s
telephone number, including area code:(801)
973-0177





Securities
registered pursuant to Section 12(b) of the Act:None





Securities
registered pursuant to Section 12(g) of the Act:





Common
Stock, No Par Value





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. £
Yes  No R





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act. £
Yes  No R





Indicate
by checkmark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Issuer was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.  £
Yes  No R




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). £
Yes  No £




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K. R





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):




Large
      accelerated filer o
            Accelerated
      filer o
            Non-accelerated
      filer o
              (Do
      not check if a smaller reporting company)
            Smaller
      reporting company þ





Indicated
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act  £
Yes  No R





The
aggregate market value of the voting and common equity held by non-affiliates
computed by reference to the average bid and asked price of such common equity,
as of the last business day of the registrant's second fiscal quarter ended
December 31, 2007 was $15,186,000.





The
number of shares outstanding of the registrant’s no par value Common Stock as of
November 5, 2009 was 171,317,499.





Documents
Incorporated by Reference


None










Groen
Brothers Aviation, Inc.


Annual
Report on Form 10-K


Year
Ended June 30, 2008


Table
of Contents








Part
      I
            
            Page
      No.Item
      1.
            Description
      of Business
            1Item
      1A.
            Risk
      Factors
            16Item
      1B.
            Unresolved
      Staff Comments
            21Item
      2.
            Properties
            21Item
      3.
            Legal
      Proceedings
            21Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            21Part
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            22Item
      6.
            Selected
      Financial Data
            24Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            24Item
      7A.
            Quantitative
      and Qualitative Disclosures About Market Risk
            36Item
      8.
            Financial
      Statements and Supplementary Data
            36Item
      9.
            Changes
      in and Disagreements with Accountants on  Accounting and
      Financial Disclosure
            36Item
      9A(T).
            Controls
      and Procedures
            37Item
      9B.
            Other
      Information
            38Part
      IIIItem
      10.
            Directors,
      Executive Officers and Corporate Governance
            38Item
      11.
            Executive
      Compensation
            42Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            45Item
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            46Item
      14.
            Principal
      Accountant Fees and Services
            47Part
      IVItem
      15.
            Exhibits
      and Financial Statement Schedules
            48Signatures
            
            50













CAUTIONARY
STATEMENT REGARDING THE FILING DATE OF THIS REPORT AND THE ANTICIPATED FUTURE
FILINGS OF ADDITIONAL PAST-DUE REPORTS





This
Annual Report on Form 10-K for the fiscal year ended June 30, 2008 is first
being filed in November 2009.  The Company is in the process of
preparing its Annual Report on Form 10-K for the fiscal year ended June 30, 2009
and plans to file such report at the earliest practicable
date.  Shareholders and others are cautioned that the financial
statements included in this report are over one year old and are not necessarily
indicative of the operating results that may be expected for the year ending
June 30, 2009.








PART
I





Item
1.                 Description
of Business




Going
Concern Qualification





The
Report of Independent Registered Public Accounting Firm on our audited
consolidated financial statements addresses an uncertainty about our ability to
continue as a going concern, indicating that our operating losses and lack of
working capital raise substantial doubt about our ability to continue as a going
concern.  At June 30, 2008, we had total current liabilities of
$99,872,000 and current assets of $28,000, resulting in a working capital
deficiency of $99,844,000.  At June 30, 2008, we had a total
stockholders’ deficit of $107,301,000.  There can be no assurance that
management’s efforts to adequately capitalize the Company or attain a successful
level of operations and cash flows will be successful.  In light of
our current financial position and the uncertainty of raising sufficient capital
to achieve our goals, the Company’s viability as a going concern is
uncertain.





Reduced
Level of Operations





As
further discussed in this annual report, following delays in our Heliplane
program for the U.S. Defense Advanced Research Projects Agency (“DARPA”), lower
than anticipated results from sales of our SparrowHawk kits, and negative
conditions in capital markets, we recently affected a substantial reduction in
force and have significantly scaled back the level of our
operations.





We have
experienced a negative gross profit on sales of Sparrow Hawk kits and the number
of SparrowHawk kits sold has fallen below expectations, due in part to lack of
funding to finalize product development and to pay for increased sales and
marketing efforts.  In these circumstances, prospects of reaching a
satisfactory profit level in a deteriorating economic climate were not
promising.  As importantly, we determined that the kit aircraft
business, aimed at customers for their personal use, could not be readily
compatible with the design, manufacture and marketing of more sophisticated
aircraft required by military and commercial customers.  Therefore, in
May 2008, we decided to cease production of the SparrowHawk.  We
intend to sell the program to a buyer with more compatible operating conditions
and strategic interests, thus allowing us to concentrate our limited financial
resources on research and development of more advanced fully assembled
aircraft.





We have
also experienced a negative profit margin on the DARPA contract, which has
reduced cash flows from operations.  Subsequent to June 30, 2008,
DARPA announced the award of the Heliplane prime contractor position to the
Georgia Institute of Technology (GT) for Phases IB and IIA.  Since
then, we have been engaged as a GT subcontractor for rotor systems work of Phase
IB.





1





We
believe our cost-cutting measures will allow us to continue to move forward with
the development of our technology on a reduced scale.  We will
continue our efforts to establish joint ventures or other strategic
relationships that will allow us to fund the development and commercialization
of our technology; however, there can be no assurance that we will be successful
in these efforts.





Although
we are currently operating at a significantly reduced level, we have presented
in this annual report detailed disclosure of the history of the development of
our technology, opportunities for commercialization of our technology in its
various forms, the regulatory environment that we operate in and other
discussions of our business.





Background





Groen Brothers Aviation, Inc. (the
“Company") or (“GBA”) was originally incorporated in the State of Utah on July
28, 1980 as New Wave Energy.  On October 23, 1990, the name of New
Wave Energy was changed to Groen Brothers Aviation, Inc., and under this name,
the Company became a fully reporting public corporation (stock symbol “GNBA”) to
facilitate the raising of capital.  Hereafter, the "Company" refers to
the registrant, Groen Brothers Aviation, Inc. (“GBA”) and its wholly-owned
subsidiaries, Groen Brothers Aviation USA, Inc. (“GBA USA”) and, from December
2002 through November 2004, American Autogyro, Inc.
(“AAI”).  Effective November 1, 2004, we merged AAI into GBA
USA.  Unless otherwise stated, the financial activities described
herein are those of GBA USA, which is the sole operating entity of the
Company.





As
further discussed in this annual report, following delays in our Heliplane
program for the U.S. Defense Advanced Research Projects Agency (“DARPA”), lower
than anticipated results from sales of our SparrowHawk kits, and negative
conditions in capital markets, we recently effected a substantial reduction in
force and have significantly scaled back the level of our
operations.





The initial objective of the Company,
primarily through GBA USA, was to develop and market an easy-to-fly and
cost-efficient gyroplane that could compete effectively in the general aviation
market.  Initially, personal funds of David and Jay Groen were used to
build a proof-of-concept aircraft incorporating a design for the first
collective pitch controlled semi-rigid teetering rotor system for a
gyroplane.  This first prototype aircraft flew successfully in 1987,
and as a result, we were able to obtain the support of private investors to
begin the development of our second prototype gyroplane, the one-seat Hawk
1.  Following the successful flight of the Hawk 1 in 1992 we proceeded
with the design of our third prototype, the two-seat Hawk H2X, which first flew
in February 1997, incorporating a unique airfoil rotor-blade design enabling a
smooth vertical takeoff at a world record-breaking density altitude for
gyroplanes.





At this
point, management recognized that the opportunities for gyroplanes, and for the
Company, extended well beyond the original general aviation market objective,
and had broad potential for commercial, governmental and military
applications.  Our focus was thus reoriented to the design of a larger
four-seat gyroplane, the Hawk 4, intended for Federal Aviation Administration
(“FAA”) certification with a wide range of potential commercial and public use
applications.  The development of the Hawk 4, the smaller two-seat
SparrowHawk and our subsequent entry into the military market are reviewed in
the later section, Company
Products.





2





Gyroplane
and Gyrodyne Technology





Autorotative
flight was developed in 1919 by Spanish aviator, Juan de la Cierva, with the
objective of eliminating the risk of stalling inherent in all fixed wing
aircraft when forward speed drops below a critical speed.  De la
Cierva named and trademarked his invention as the “autogiro,” which means “self
turning” or “autorotation.”  The rotary wing of a gyroplane1, however, powered in
flight only by the onrushing air, much like a windmill, will not
stall.  A reduction in forward speed will not result in a sudden loss
of lift.  As speed decreases, a gyroplane will begin to descend, right
side up and controllable, as its rotating wing continues to provide lift with
the upward flow of air driving the rotor.  This provides the gyroplane
with an important inherent safety advantage over a conventional airplane for
activities requiring low altitude and low speed operations.  In a low
level surveillance role, such as law enforcement, border patrol, traffic
control, etc., proper procedure for all rotorcraft is to circle in a slow orbit,
something we believe the Hawk 4 Gyroplane and SparrowHawk Gyroplane can do
efficiently and safely.





For such
low, slow flying missions, a gyroplane has a similar safety advantage over a
helicopter.  The helicopter obtains its lift from its engine-powered
rotor blades pulling the air downwards, creating an upward force on the rotor,
enabling the helicopter to hover.  This, however, also makes the
aircraft unstable and difficult to fly since a loss of power to a helicopter
rotor will cause an immediate loss of lift.  Only with sufficient
forward speed or altitude will a skilled and practiced pilot have sufficient
time to put a helicopter into autorotation and thus make a controlled landing
while operating as a gyroplane, although without the benefit of rotor blades
optimized for autorotative flight.  A helicopter is also more
mechanically complex than a gyroplane, requiring additional safety-critical
systems, notably a transmission between engine and main rotor, and a tail rotor
with its gearbox, needed to offset the torque in the system created by the
powering of the rotor in flight.  For these reasons, a gyroplane, not
requiring a tail rotor or complex transmission because its rotor is not driven
by its engine, is inherently safer, simpler, quieter, and easier to operate
while much less expensive to maintain than a helicopter.





The one material advantage of a
helicopter over a gyroplane is its ability to hover, which is necessary in some
situations such as sea rescue, sling-load work, or landing in uneven
terrain.  For air surveillance and point-to-point flying, the
inability to hover is not a disadvantage.  Helicopters at low
altitude, out of ground effect, will whenever possible avoid hovering because of
the danger inherent in doing so.  When power fails in a helicopter,
the pilot must convert from powered flight to autorotative flight to keep the
rotor blades turning.  This is an unforgiving process, requiring a
skilled, practiced, accurate, and rapid reaction by the pilot and it requires a
minimum altitude and/or airspeed to be performed safely.  If a power
failure occurs when a helicopter is operating with insufficient altitude or
speed, specifically if operating within the “height-velocity” curve shown on
graphs in the helicopter’s flight manual (informally known as the “dead man’s
curve”), the pilot will not be able to avoid a crash landing.





In summary, gyroplanes in flight, being
in constant autorotation, are much safer in low and slow flight than either
airplanes or helicopters.  Airplanes flying low and slow risk a
stall/spin crash, which cannot happen in a gyroplane, while helicopters losing
power in the same conditions can face an unrecoverable condition as they lose
lift.  If power fails in a gyroplane, however, the autorotation
continues and the aircraft can be guided softly to the ground from virtually any
altitude.





The gyrodyne is a derivative of the
gyroplane that, as the name implies, has a powered rotor that enables the
gyrodyne to hover and to take-off and land vertically.  Gyrodynes
differ from helicopters in that their rotors are powered, not by the main
engine, but by tip-jets which are normally used only for takeoff, landing, and
hovering.  In forward flight the tip-jets are turned off and the
aircraft operates as a gyroplane with the attendant advantages of safety,
reliability, and economy.  Since the rotor is not driven mechanically
by torque from the main engine located in the aircraft fuselage, a gyrodyne,
like a gyroplane, does not require a tail rotor with its complexity and
maintenance requirements.


_____________________


1  Gyroplane
is an official term now designated by the FAA to describe an aircraft that gets
its lift from rotor blades and its thrust from an engine-driven propeller either
in front, the tractor configuration, or at the rear, the pusher
configuration.





3





Interrupted
History of the Gyroplane





In the 1920s and 1930s, following
Spaniard Juan de la Cierva’s successful flights of  his invention, the
autogiro (gyroplane),  Harold Pitcairn and his colleague Walter
Kellett, under license from Cierva, designed and built a series of gyroplanes in
America which eventually made vertical takeoffs and landings.  Their
efforts resulted in the autogiro concept proving commercially successful in many
applications during the 1930s and early 1940s.  An outstanding example
was its use by the U.S. Postal Service for nearly ten years to deliver mail from
the roofs of post offices.  Hundreds of flights carrying mail were
performed by Kellett and Pitcairn gyroplanes flying in Camden, Philadelphia,
Chicago, New Orleans, Washington, D.C., and other cities.





Funding for development of aircraft for
the private market had collapsed in the years of the Great Depression and in the
build up toward World War II, the main source of investment in aviation came
from the U.S. military.  At the time, Igor Sikorsky, who was an
important designer of transport airplanes for the government, recognized the
potential of a helicopter to the military.  After licensing rotor
technology from Pitcairn, he convinced the U.S. military to invest in the
helicopter as the next logical step in the evolution of rotorcraft, promising
more versatility for military purposes than the gyroplane.  This
commitment to the helicopter effectively ended government funding for technical
development of the gyroplane.





After
World War II, there was a brief and modest resurgence as investors enabled three
private companies to develop two-seat commercial gyroplanes that were certified
by the FAA:  the Umbaugh (later the Air & Space 18A), the Avian (a
Canadian design of that same period that reached FAA certification, but was
never produced), and the McCulloch J-2.  In each case, as an expedient
to FAA certification, the designers adapted helicopter rotors and blades and
thus did not fully use the gyroplane technology created by their 1930s
predecessors.  As a result, none of these civilian gyroplanes
performed well and their companies failed.





More
significantly, during the 1950s, Igor Bensen, who had been a principal in
General Electric’s rotary wing program after World War II, developed a
home-built open-frame gyroplane kit for amateurs, which he called the
“gyrocopter.”  Stemming from this initiative, home-built kits, mostly
seating one person, became popular with enthusiasts and more than a dozen small
manufacturers have produced and sold hundreds of kits.





The technical development of the
helicopter necessary to achieve the potential of hovering flight was, however,
much more difficult and took far longer than the military
expected.  Real utility was not fully attained until the middle of the
Vietnam War and then only after billions of dollars had been spent developing
turbine-powered helicopters with sufficient payload to move large numbers of
troops and equipment into and out of the jungle.





4





Company
Products





GBA
Hawk 4 Gyroplane





The first
pre-production piston-engine version of the four-seat Hawk 4 flew in September
1999, followed by the turbine-engine version in July 20002.  This
latter aircraft, powered by a Rolls-Royce Model 250 420shp turboprop engine, was
developed to become our first major production aircraft.  It
incorporates rotor blades optimized for autorotative flight and our patented
rotor head with infinitely variable collective pitch control.  This
enables the pilot to optimize the rotor blade pitch to the existing conditions
and attain a smoothly controlled ultra-short ground roll for both take-off and
landing.  The turbine engine further contributes to the reliability,
maintainability, payload and low operating cost characteristics of the
aircraft.   Based on the superior operating performance of the
aircraft with the gas turbine engine, we proceeded with our FAA certification
program based on that engine for a variety of commercial uses.





We
believed that the safety, reliability, maneuverability and low operating cost of
the Hawk series gyroplanes would permit them to perform competitively with
helicopters (and airplanes) for many missions requiring low, slow flight,
particularly where the absence of a requirement for a runway for take-off or
landing is a critical advantage.  Potential customers include the
following:




1.
            
            Law
      enforcement (police, sheriff, border patrol, customs, and drug
      interdiction).2.
            
            Public
      service agencies (fire patrol, medical transport, wildlife and land
      management).3.
            
            Military
      (courier, armed surveillance, VIP transport, forward artillery control,
      ground attack, unmanned aerial vehicle).4.
            
            Commercial
      (oil, gas, and power line patrol and inspection, land survey, aerial
      photography, crop spraying, herd management, air taxi service, corporate
      transport, and flight training).5.
            
            Private
      (commuting, sport flying,
training).





We flew
the Hawk 4 Gyroplane in several hundred incident-free sorties and hundreds of
hours of flight time in its pre-certification flight-test program in the
following two years.  While substantial progress was made in the
lengthy and expensive certification process, it required significant capital and
we recognized that it would continue to require significant capital to complete
its design, certification, and production potential.  However, the
adverse affects on the venture capital market and the September 11, 2001
terrorist attacks, severely constrained our funding capabilities, necessitating
a substantial cut back in operations in October 2001.





Although
we had been able subsequently to demonstrate the unique capabilities of the Hawk
4 Gyroplane through its participation in the official security arrangements for
the 2002 Winter Olympics, we suspended flight testing of the Hawk 4 during the
first quarter of fiscal 2003 due to lack of financial
resources.  Further development toward commercial certification of the
Hawk 4 was deferred pending the obtaining of the funding necessary to complete
it.





We have
continued to believe that there is a substantial and potentially profitable
market for the Hawk 4 and its derivatives3 for commercial
use in the USA and foreign countries.  We have had conversations with
representatives of several countries with respect to setting up a joint venture
to certificate, manufacture, and sell the Hawk series of
gyroplanes.  To date, this effort has not produced results, but there
continues to be significant interest from foreign entities to bring the Hawk
series into production.  There can be no assurance, however, that we
will ultimately succeed in attracting investment sufficient to enable a foreign
joint venture.


_____________________


2 The
piston-powered Hawk 4, although with space for a pilot and four passengers, was
limited by payload to four occupants.  The more powerful turbine
version can carry a pilot and four passengers.


3As
described later, with design and analysis tools utilized during the Heliplane
program, the Hawk 4 Gyroplane has undergone a redesign study that indicates that
the Company should develop a six place version of the Hawk
series





5





The most
serious interest in this project was coming from Spain with that country
presenting an attractive combination of market potential, available skills and
funding sources, and favorable legal and political environment.  As a
result, we have been diligently seeking to set up a JV in Spain through which
the Hawk series could be certified under FAA and European
regulations.  The objective, in broad terms, is for GBA to provide the
JV with its Hawk Gyroplane technology and oversee and participate in the
certification program (on commercial terms), while the other partners,
governmental and industrial, would provide funding, manufacturing, and other
resources.





As early
as fiscal 2004, after favorable technical recommendations from a Spanish due
diligence team, we believed that such an agreement with a mid-size Spanish
aerospace company as the industrial partner was close at hand.  At a
late stage, however, that company decided that in the very poor economic climate
in the aerospace industry at that time, it would cut back its investing in
aerospace in favor of more profitable non-aerospace activities.





In fiscal
2007, however, we obtained renewed interest from the government of Aragon, an
Autonomous Community within Spain, and entered into a Memorandum of
Understanding with Aragon to set up a JV.  Meetings with
representatives of CDTI4, the investment
arm of the central Spanish government’s Ministry of Industry, Tourism and
Commerce, were favorable and CDTI asked Aragon and other potential partners to
enter into the formal process for funding requests.  Later in 2008,
however, Aragon underwent a change in government leadership and interest in the
Hawk Gyroplane project was lost.




New
interest began when three other Autonomous Communities within Spain showed
considerable promise, until the recession that began in 2008 severely impacted
the Spanish economy, putting the project on hold.   While we can
give no assurance that the JV will be established, or that if established it
will be successful, we believe that at least some potential continues to exist
in Spain.





SparrowHawk
Gyroplane and Derivatives





While
recognizing in fiscal year 2003 the infeasibility of continuing at that time
with FAA certification of the Hawk 4 Gyroplane, we also noted that the general
aviation kit-plane market, which does not require the costly certification
process required for commercial operation of the Hawk 4, still lacked the safe,
economical, easy-to-fly gyroplane that we originally intended to
produce.  In the opinion of management, the kit-plane market could
expand significantly as a result of our entrance into that
market.  Although hundreds of kit-built small gyroplanes have been
produced by a variety of manufacturers over many years, for the most part, we
believed these gyroplanes did not incorporate a full understanding of gyroplane
dynamics and that this contributed to the fact that fatality statistics of kit
gyroplanes did not reflect the inherent safety of the
gyroplane.  Because we recognized our important vested interest in the
reputation for safety of gyroplanes in general, management believed that both to
protect the reputation of the gyroplane and to take full advantage of an
underserved market, we should enter this market.





To take
advantage of these opportunities through utilization of our knowledge of
gyroplane dynamics and aerodynamics built up over the years, we established
American Autogyro, Inc. (“AAI”) in December 2002.   AAI started
with the design and manufacture of a modification kit to enhance flight
stability for another manufacturer’s home-built gyroplane and initiated delivery
of such a kit in April 2003.  We reported our first revenues in the
fiscal year ended June 30, 2003, largely from AAI flight training and the sales
of these modification kits.  However, effective November 1, 2004, to
reduce administrative expense we merged AAI into GBA USA and GBA USA took over
the manufacturing, sales and marketing, and customer support functions of the
SparrowHawk.


_____________________


4Center for
Development of Technology for Industry




6





We began
deliveries of SparrowHawk kits during the third quarter of our fiscal year ended
June 30, 2004, recording initial revenues from this aircraft in the fourth
quarter of fiscal year 2004.  During the years ended June 30, 2008 and
2007, we reported revenues from the sale of SparrowHawk kits and parts of
$720,000 and $562,000.  Additional revenues were also received from
the sale of modification kits, flight training and from contract manufacturing;
however, these revenue sources have not been significant to the
Company.





In
December 2005, we announced the introduction of our improved SparrowHawk model,
the SparrowHawk II.  SparrowHawk II offered added comfort and
robustness and reduced the time and effort needed by the customer to build the
aircraft.  We continued to design improvements for the SparrowHawk
II during fiscal year 2007, and in fiscal year 2008 introduced a new
version called the SparrowHawk III Quick Build.  As the name
implies, the primary objective for the “Quick Build” is a significant further
reduction of time and effort on the part of the purchaser in building the
aircraft while maintaining conformity with FAA regulations.  Careful
attention has been paid to existing customer input and to the needs of potential
customers.  Through a thorough assessment of the build process and
changes in the design manufacture and product delivery, the time to assemble the
kit by a typical purchaser is expected to be in the order of 300 hours, cutting
build time in half.  Deliveries of the Quick Build kit began in
October 2007.





While the
SparrowHawk had become dominant in its category and we had achieved our
objective of creating an understanding within the gyroplane kit industry of the
critical safety factor that had previously led to accidents, the kit program
continued to be a financial drain on the Company.  We have experienced
a negative gross profit on sales of Sparrow Hawk kits and the number of
SparrowHawk kits sold has fallen below expectations, due in part to lack of
funding to finalize product development and to pay for increased sales and
marketing efforts.  In these circumstances, prospects of reaching a
satisfactory profit level in a deteriorating economic climate were not
promising.  As importantly, we determined that the kit aircraft
business, aimed at customers for their personal use could not be readily
compatible with the design, manufacture and marketing of more sophisticated
aircraft required by military and commercial customers.  Therefore, in
May 2008, the Board decided to cease production of the SparrowHawk and to seek
to sell the program to a buyer with more compatible operating conditions and
strategic interests, thus allowing the Company to concentrate its limited
financial resources on research and development of more advanced fully assembled
aircraft.





During fiscal year 2005, the FAA
announced the establishment of a new category of aircraft, called Light Sport
Aircraft (LSA), which permits manufacturers to produce and sell small,
non-complex, fully assembled aircraft without the necessity of fulfilling the
requirements for an FAA “Type-Certificate.”  While helicopters have
been excluded from the LSA category as being too complex, gyroplanes are
included, initially in a sub-category defined as Experimental Light Sport
Aircraft (E-LSA).  We have petitioned the FAA for a “deviation” from
the regulation that would permit us to produce and sell complete aircraft that
meet the LSA standards, with the expectation that the experience gained and
demonstrated will justify full LSA authorization for gyroplanes.  The
Experimental Aircraft Association (EAA) filed with the FAA a “letter in support”
of our petition for deviation, but as of the date of this report,  the
FAA had not taken any action.





7





Management
believes a large market is likely to arise within the United States for fully
assembled LSA gyroplanes if the FAA eventually approves their
operation.  We believe that our technology would be well suited to
this market and be capable of conforming to the anticipated new
regulations.  We have therefore initiated the design of a new light
gyroplane, called the SportHawk for private flying that would meet those LSA
regulations and a sister aircraft called the ShadowHawk as a patrol aircraft,
principally for public agencies.  We believe that the production of
complete aircraft, such as the SportHawk and ShadowHawk rather than the
SparrowHawk in kit form, will enable us to maintain quality control over the
finished product, eliminate the delay between delivery and in-service dates, and
overall enable the product and Company to be more effectively
branded.





As
previously noted, we identified an important untapped potential market for the
Hawk Gyroplane series as a patrol and surveillance aircraft, both in the United
States and overseas.  We also recognized that both the fully assembled
SparrowHawk and the ShadowHawk as smaller professionally designed aircraft with
low purchase and operating costs that can operate “off airport” and are easy to
maintain and fly, would have important applications for patrol
surveillance.  Under so-called “Public Use,” such applications do not
require commercial certification when operated by Federal, state and local
agencies across the nation, particularly Homeland Defense.  This is
particularly the case in parts of the world where skilled helicopter pilots and
maintenance personnel are not readily available.  For this reason, we
believe the SparrowHawk or its derivatives sold as a fully assembled aircraft
could be expected to be popular with law enforcement agencies around the
world.





Our
discussions with the Office of Domestic Preparedness (“ODP”) on gyroplane usage
have emphasized the merits of the SparrowHawk as a readily available, ultra-low
cost air surveillance vehicle.  Similarly, discussions have been held
with the Department of Defense (“DOD”) for the use of gyroplanes for mine and
bomb detection to counter those threats in Iraq and Afghanistan, emphasizing
again its low cost and early availability in relation to other
solutions.





We have
held meetings with several agencies in China in relation to the use of the
SparrowHawk in China, and subsequent to the end of fiscal year 2008, entered
into a non-binding Memorandum of Understanding (MOU) with a Chinese Company with
the objective of setting up a joint venture (“JV”) in China to produce
fully-assembled Light Gyroplanes, focused on production of SparrowHawks,
initially for power line patrol.  We have had subsequent negotiations
related to this MOU and have agreed on non-binding “Terms and Conditions” for
the setting up of the JV.  Preparations are continuing at the date of
this report for the finalization of the JV agreement.  We can give no
assurance that the parties will reach a final agreement to establish the
JV.





While
offering our SparrowHawk gyroplane kits, we built a dealer network in the United
States and internationally.  In the event that we successfully
establish a JV for the production of fully assembled SparrowHawks that met the
anticipated FAA LSA regulations, this dealer network may become the means of
marketing and selling LSA SparrowHawks.





Unmanned
Gyroplane Contract





The
relative mechanical simplicity and aerodynamic stability of the gyroplane and
gyrodyne in comparison to a helicopter or other vertical lift aircraft allows
both aircraft to be potential candidates for unmanned as well as manned
applications.  We have been approached separately by two aerospace
companies with proposals to assist them in the design of unmanned gyroplanes for
two different US military applications.





8





We have
been engaged as a subcontractor to one of these companies for a project called
PAS (Precision Airdrop System) that is projected to produce an unmanned
gyroplane rotorcraft for military supply missions, missions now served with much
less accuracy by parachutes.  We have been engaged by this major
aerospace company to design, and ultimately manufacture, the rotor system and
fuselage using their guidance system.  A large-scale model designed
and built by us was successfully flown on a military test range in July of 2007,
demonstrating the effectiveness of this technology.  It is hoped that
the project will eventually proceed to full-scale demonstrator
development.  If successful, it is possible that we could receive a
significant order for full-scale production for these aircraft, though no
guarantees can be given that such will happen.





The
DARPA “Heliplane” Gyrodyne Contract





We also
believed that the knowledge and experience that we had gained from our work with
the Hawk 4 had made us an authority on gyroplane technology and that in the post
9/11 defense environment this technology had substantial military
potential.  It could serve in a wide variety of roles ranging from
gyroplanes as unmanned air vehicles (“UAV”s) and to gyrodynes as heavy lift
Vertical Take-off and Landing (“VTOL”) transports and as high speed
rotorcraft.  Additionally, the technology could be further developed
to enable the design of runway independent commercial aircraft.





Our
technology is fully scalable and readily adaptable to the gyroplane’s derivative
form, the gyrodyne.  As detailed earlier, the gyrodyne is a rotary
wing aircraft that uses rotor blade “tip-jets” for short duration power
permitting pure vertical takeoff and landing, and providing the capability to
hover like a helicopter.  During the en-route portion of the flight
the tip-jets are turned off and the gyrodyne flies as a gyroplane in
autorotation.  Such an aircraft is capable of both lifting substantial
payloads in gyrodyne mode and covering substantial range as a
gyroplane.  The British Fairey Rotodyne aircraft demonstrated the
technical validity of this concept in the 1960's.  With the
application of modern technology developed by us, the concept is ready to be
turned into a highly utilitarian aircraft platform, with many diverse
applications.





In recognition of these capabilities,
we have been assessing military applications of our gyrodyne technology to
conceptual designs for a vertical takeoff aircraft with payload and range
capabilities that no aerospace manufacturer has been able to offer and that
would contribute to the military and security needs of the United States
Government.  As a consequence, we have been able to respond to
requests for proposals from government agencies and military
commands.  These submissions have ranged from small UAV gyroplanes to
large vertical takeoff and landing (“VTOL”) freighters.  Applications
have also been made in partnership with either a major aerospace company or an
academic institution with preeminent aerospace credentials.





Starting
in fiscal 2003, we made presentations of our views on the potential of our
technology, to DARPA and to other military agencies and also to public aerospace
companies.  DARPA is the central research and development organization
for the US Department of Defense (DoD).  It manages and directs select
basic and applied research for DoD, emphasizing technology development projects
where payoff is high and where success may provide dramatic advances in the
capabilities of this country’s combat forces.





Emerging
from these efforts, on November 7, 2005, we announced that DARPA had selected a
Company-led team to design a proof of concept high-speed, long range, VTOL
aircraft.  This modern rotorcraft, named the “Heliplane” by DARPA, is
intended as a demonstrator aircraft for potential use in combat search and
rescue roles and is designed to fly at a forward speed of 400 mph which is a
speed twice as fast as is typical for helicopters, with a 1,150 mile range,
essentially offering the VTOL capability of a helicopter with the fast forward
flight capability of an airplane with the safety, simplicity and reliability of
a GBA gyroplane and is designed to exploit our gyrodyne technology.





9





Phase One
of this potential multi-year $55 million four-phase Heliplane program began with
a 15-month $6.4 million award to develop the preliminary design and perform key
technology demonstrations.  On September 19, 2007, the DARPA contract
was modified, increasing the contract award from $6.4 million to $10.4 million,
and extending the term of Phase One from 15 to 23 months.  Substantial
portions of Phase One payments are paid by us to subcontractors and consultants
hired by us.  Payments under this contract are conditional upon our
attaining several milestone objectives during the course of Phase One of the
contract.





We
completed Phase One of the four phase program with a preliminary design review
(PDR) in November of 2007.  In January of 2009, DARPA funded a six
month Heliplane Phase 1B effort to design and evaluate a modification to the
Heliplane’s rotor-blade tip-jets to reduce its sound signature.  For
Phase 1B, DARPA chose, at our recommendation, Georgia Tech to lead the program
as prime contractor with the Company as the primary subcontractor for the
critical rotor system.  We made this recommendation because of our
inability to fund the cash flow shortfall while waiting to be paid for work
completed.  Phase 1B had been completed as of the date of this report,
and we do not know whether Phase 2 will be awarded.





During
the fiscal years ended June 30, 2008 and 2007, we reported revenues from the
DARPA contract of $5,070,000 and $2,440,000, respectively.





Future
Company Gyrodyne Aircraft





The Heliplane gyrodyne represents the
possible model for the next generation rotor wing aircraft, meeting economy and
performance goals not considered achievable by any other type of VTOL
aircraft.  As our gyrodyne technology is scalable to much larger
aircraft, it has potential applications for both heavy lift, high speed VTOL
military aircraft and for runway independent commercial airliners.  We
have been actively engaged in discussions with government agencies and potential
aerospace strategic partners in this country with respect to military and
commercial gyrodyne and gyroplane applications, and in Europe, India, and China
with respect to commercial gyroplane applications.





The
gyrodyne technology developed for the Heliplane also has direct application to
the design of short-range vertical take-off and landing (“VTOL”) commercial
airliners that are runway independent.  Growth in the economy can
produce heavy demand for aircraft that do not require the use of increasingly
congested runways and are not limited by air traffic control constraints, and we
anticipate an opportunity to develop such an aircraft.  By using the
airframe of an existing type-certificated production airplane and adding our
rotor system, gyrodyne airliners can be delivered for substantially less
investment and in less time than would normally be required to bring a new
airliner to market.  Our longer-range plans have identified
opportunities for large (18-60 seat) gyrodynes to provide commercial passenger
service in short and medium-range markets.





We believe the proposals that we have
presented, or participated in presenting, have been well received and helped
generate credibility for the value of our technology among key segments of the
aerospace industry.  We will continue to seek opportunities to obtain
government research and development contracts for use of our technology in both
military and civilian agency fields where we believe that it can offer
meaningful advantages in performance or cost over competing
technologies.  Management believes that it is in the national interest
that our unique gyroplane technology is developed.





10





Distribution
and Marketing





It had
been our plan to market the Hawk 4 through a dealer network, both in the United
States and the rest of the world.  A GBA Authorized Dealer network
with 14 United States dealers, 3 International dealers and over 60 national
sales representatives was established and these dealers placed firm orders with
deposits for 145 Hawk 4 gyroplanes.  As of June 30, 2008, dealer
deposits totaled $2,105,000, which amount has been reported as a long-term
liability in the accompanying consolidated financial statements.  The
deposit provides a delivery sequence number and represents a percentage of the
total estimated purchase price.  We have also issued common stock to
dealers as partial consideration for the delay in the certification of the Hawk
4 Gyroplane.  These costs have been charged to interest expense as
incurred.  The dealers have been given the opportunity to convert a
portion of their deposits into shares of the Company’s restricted common
stock.  As stockholders of the Company, the dealers are considered
related parties.  In the event of a successful establishment of a
joint venture for the Hawk 4, the distribution rights of the dealers for
commercial sales may be transferred from GBA to the JV.  Public use
and military sales of the Hawk 4 will be made directly by us or by our
prospective JV.





In recognition that many of the
opportunities for use of our gyroplane products lay in Asia, in fiscal 2005 we
hired Mr. Jason Chen, as Vice President of Business Development in Asia, who now
acts as a consultant leading our efforts in that continent.  As a
result of the hiring of Mr. Chen, executive officers and employees of the
Company met in China with government officials and aerospace executives on
several occasions.  In these meetings, Company representatives made
presentations covering the application of our gyroplane and gyrodyne
technologies to China’s commercial needs.  The presentations were well
received and resulted in us being invited back to China to discuss specific
proposals for joint ventures or cooperation.  Mr. Chen introduced us
to a potential Light Gyroplane JV partner and continues to actively participate
in progressing that objective.





We believe that Asia represents a
potentially very large market for our products, from the SparrowHawk size
gyroplanes, to the Hawk 4 gyroplane and its variants, to the varying sizes of
tip-jet powered gyrodynes in commuter airline and transport category
aircraft.  In addition, we believe that these types of safe,
economical, high performance Ultra-Short and Vertical Takeoff and Landing (USTOL
and VTOL) aircraft can be very important in helping solve the transportation
needs of the burgeoning economies of China, India, Korea and other Asian
nations.





All our
government marketing and therefore our responses to requests for proposals to
participate in research and development programs suited to our technology have
been directed exclusively to the United States Government.





Government
Regulation





The
nature of aviation products has resulted in their manufacture being regulated by
governments for public safety, national defense, and economic and/or political
purposes.  Such regulations vary widely by country, by product type
and by usage.  Our products and intended products are principally
impacted by United States laws and regulations, but also by requirements in our
export markets.  As our products can be used for private, commercial,
public agency or military purposes, their sale and operation are governed by
regulations appropriate to each category.  Developmental flight
testing of our aircraft is carried out under exemption rules covering
experimental aircraft.  The following section reviews the principal
regulations applicable to each category of our activities in the United
States.





11





GBA
Hawk 4 Series Gyroplanes





Commercial
or Private Use:  FAA certification is the process by which the
United States government ensures that aircraft sold into the US civil market
meet appropriate standards for all civil users.  FAA certification is
not required by military aircraft and by many aircraft in “Public Use,” roles
operated by Federal, State or local agencies.  Civil aircraft operated
outside the United States are regulated by the authorities of those countries
and may be required to obtain additional certification.  The analysis
and testing leading to a US certificate is, however, currently acceptable in
most foreign countries as the basis for granting certification in those
countries.





FAA
certification has two related components.  The first, Aircraft Type
Certification assesses the integrity of the design and associated
engineering through analysis and testing of components and complete aircraft to
insure that the aircraft can achieve its performance standards
safely.  The second, Aircraft Production
Certification, assesses the manufacturing organization to insure that its
processes and procedures will result in the production of aircraft that fully
conform to the standards of the aircraft type certificate.





The
regulations pertaining to aircraft certification are contained in Title 14 of
the United States Code, the “Federal Aviation Regulations”
(FAR).  Aircraft in the category of the Company’s Hawk 4 aircraft, to
be operated commercially or privately, must receive a Type Certificate under
Part 27 (normal category rotorcraft weighing less than 6,000 lbs) of the FAR,
while the Production Certificate must be obtained under Part 21 of the
FAR.





Public
Use: The
Company’s efforts to sell its Hawk 4 to government agencies in the United States
is based on the specific exemption for operation of aircraft used by government
agencies as authorized by Federal Public Law 103-411, which defines what is a
“public aircraft operation.”  This law permits training and flights in
“public aircraft” for performance of the following governmental
functions:




Flights
in response to fire fighting;


Flights
in response to search and rescue;


Flights
in response to law enforcement activities; and


Flights
in support of aeronautical research or biological or geological resource
management.





In this
context, ''public aircraft'' means an aircraft:





(i) used
only for the United States Government;


(ii)
owned by the United States Government and operated by any person for purposes
related to crew training, equipment development, or demonstration;
or


(iii)
owned and operated (except for commercial purposes), or exclusively leased for
at least 90 continuous days, by a government (except the United States
Government), including a State, the District of Columbia, or a territory or
possession of the United States, or political subdivision of that
government;





12





It does
not include a government-owned aircraft:





(i)
transporting property for commercial purposes; or


(ii)
transporting passengers other than –





(I)
            transporting
      (for other than commercial purposes) crewmembers or other persons aboard
      the aircraft whose presence is required to perform, or is associated with
      the performance of, a governmental function such as firefighting, search
      and rescue, law enforcement, aeronautical research, or biological or
      geological resource management; or


(II)
            transporting
      (for other than commercial purposes) persons aboard the aircraft if the
      aircraft is operated by the Armed Forces or an intelligence agency of the
      United States.





An
aircraft described in the preceding sentence shall, notwithstanding any
limitation relating to use of the aircraft for commercial purposes, be
considered to be a public aircraft for the purposes of this part without regard
to whether the aircraft is operated by a unit of government on behalf of another
unit of government, pursuant to a cost reimbursement agreement between such
units of government, if the unit of government on whose behalf the operation is
conducted certifies to the Administrator of the Federal Aviation Administration
that the operation was necessary to respond to a significant and imminent threat
to life or property (including natural resources) and that no service by a
private operator was reasonably available to meet the threat.





Military
Use:
Aircraft sold to the US military are not required to meet FAA regulations, but
must conform to military specifications that serve a similar
purpose.  The Company has not attempted to sell its Hawk 4 to the
United States Armed Forces and is thus not familiar with the detailed
requirements that would have to be met.  It believes, however, that
should a military application for the Hawk 4 be needed by the US Armed Forces, a
version of the Hawk 4 could be designed to meet military
specifications.





GBA
SparrowHawk Gyroplanes





Homebuilt
Kit Aircraft:  While it might be possible to design and
manufacture a gyroplane in the size and performance class of the SparrowHawk to
meet the FAA FAR Parts 21 and 27 regulations that the Hawk 4 is designed to
meet, we have not chosen to do this.  Our entry to the SparrowHawk
market has been through the alternative path of producing homebuilt aircraft
kits for which there is an established market.  Homebuilt aircraft
kits are permitted by the FAA under its FAR Part 21 regulations governing the
certification and operation of amateur-built aircraft.  Such kits,
however, require that the majority portion of the kit be built by an amateur
(the “51% rule”), limiting the manufacturer’s portion to 49%.





Light
Sport Aircraft:  The FAA
issued new regulations in 2004 defining a new classification of aircraft called
Light Sport Aircraft (“LSA”) and regulated in two categories, namely Special
Light Sport Aircraft (“SLSA”) and Experimental Light Sport Aircraft
(“E-LSA”).  These regulations define an LSA by specific detailed
limits upon size, weight, speed, and complexity.  The LSA regulations
specifically exclude helicopters and other aircraft types considered to be
overly complex for the LSA classification.  Such aircraft are not
limited by the 51% rule, with the manufacturer permitted to fully build the
aircraft.





13





Aircraft
conforming to the SLSA category, must in addition to the basic LSA limitations,
be designed and manufactured to certain defined standards that include
requirements such as, for example, the need for engines that are either
FAA-certified or have parts traceability.





Unlike
helicopters, gyroplanes are not specifically excluded from the LSA
classification, but in view of the FAA’s relative unfamiliarity with the type,
are eligible for a subcategory defined as Experimental or
E-LSA.  E-LSA aircraft must meet the LSA size, weight and other limits
and can be sold as fully assembled aircraft, but are not required to meet the
SLSA manufacturing standards.  Manufacture of E-LSA aircraft is,
however, limited to the period ending January 31, 2008.





Public
Use Aircraft: We plan to offer SparrowHawk aircraft fully built to US
government agencies for Public Use, for which the regulations and limitations
are covered by the same regulation, Public Law 103-411, that governs Public use
for the Hawk 4, as described above.





Research
and Development Aircraft Flown under Government Contract





Any aircraft developed and flown under
government contracts that we may be granted, such as the DARPA Heliplane
contract, will be tested and flown under FAA regulations governing experimental
aircraft.





Competition





To our knowledge, no other gyroplane is
being prepared for commercial FAA certification, nor are any certified
commercial gyroplanes currently being manufactured.  The sole company
known to be developing modern gyroplane technology is CarterCopter, LLC
(“Carter”).  Carter, like the Company, has identified the potential
for a safe and efficient gyroplane that can operate without the need for a
runway.  Carter has, however, approached the market from a very
different perspective than the Company.  Carter has stated that its
business strategy is to be a technology development company, not a manufacturer,
and therefore, for these reasons we do not believe the CarterCopter represents
any direct competition to the derivatives of the Hawk 4.





Competition
for the Hawk 4 lies largely in the helicopter segment, although the aircraft is
competitive with airplanes for certain missions and is expected to obtain part
of its market from fixed–wing markets.  Its principal competitors are
therefore comparably-sized turbine-powered helicopters, with similar speed,
payload and range capabilities, notably the Schweizer 333, the Enstrom 480, the
Bell 206BIII and the MD 500E.  We believe that the much lower
maintenance cost, greater daily utilization capability and inherent safety will
enable the Hawk 4 derivatives to compete effectively against these aircraft as
well as the lower cost, but lower-performing piston-powered Robinson
R44.





With our
exit from the kit-built market, we no longer regard kit manufacturers as
competitors.   Two new fully-built gyroplanes have recently
entered the E-LSA market, the Xenon from France and the Sportcopter from Oregon
and will be future competition for our SportHawk when it enters the
market.





As our
gyrodyne technology is principally directed towards missions that require either
VTOL or near VTOL capability, our most significant competition comes from
helicopters or hybrid aircraft that combine both helicopter and airplane
characteristics.  For high speed and heavy lift applications, both
civil and military, these include tiltrotors in both two and four rotor
configurations, proposed by Bell and Boeing, compound tandem helicopters with
augmented lift from small wings and augmented thrust from external jet engines,
proposed by Boeing and coaxial twin rotor helicopters proposed by
Sikorsky.  We believe that inherent advantages in its technology allow
us to compete effectively with these approaches.





14





Patents





We presently own several patents that
relate to collective pitch and flight controls.  We believe the
important element of these patents is collective pitch control on a semi-rigid,
teetering rotor head for gyroplanes.  We believe this application is
differentiated from similar sounding claims for helicopters, as this concept has
never before been applied to gyroplanes.  The patent claims are
written very broadly, which we believe makes it difficult to design around
them.  Our patent opportunity existed because of a fifty-year hiatus
in development in gyroplane technology.





Royalty
Commitments





Royalty
payments of 1% of the gross sales price of gyroplanes are to be paid in total to
the Company’s founders, David Groen and the estate of the late Jay
Groen.  Through June 30, 2008, royalties payable totaled $16,000 to
each of these parties.





We have royalty agreements with two
holders of notes payable totaling $300,000 which entitle the note holders to
receive royalties on the sales by the Company of certain gyroplanes other than
the SparrowHawk gyroplane.  The royalties are calculated on each
aircraft sold, and are limited to a combined maximum total of $1.3
million.





We have a royalty agreement with an
investor entitling the investor to receive royalties equal to $2,500 for each
Hawk 4 Gyroplane sold, limited to a maximum total of $125,000.





Research
and Development Expenditures





Total research and development
expenditures incurred by us for the years ended June 30, 2008 and June 30, 2007
were $1,500,000 and $1,555,000, respectively.





Employees





We currently have 7 full time
employees, and utilize part-time employees and outside consultants on an as
needed basis.  Our employees are not represented by any labor union,
and we believe our relations with employees are good.





15





Item
1A.              Risk
Factors





Our
future operating results are highly uncertain.  Before deciding to
invest in Groen Brothers Aviation Corporation or to maintain or increase your
investment, you should carefully consider the risks described below, in addition
to the other information contained in this annual report on Form
10-K.  If any of these risks actually occur, our business, financial
condition or results of operations could be seriously harmed.  In that
event, the market price for our common stock could decline and you may lose all
or part of your investment.  Although the Company has attempted to
list the factors of which it is currently aware that may have an impact on its
operations, there may be other factors of which the Company is currently unaware
or to which it does not assign sufficient significance, and the following list
should not be considered comprehensive.





The
Report of Independent Registered Public Accounting Firm on our consolidated
financial statements addresses an uncertainty about our ability to continue as a
going concern.





The
Report of Independent Registered Public Accounting Firm on our audited
consolidated financial statements addresses an uncertainty about our ability to
continue as a going concern, indicating that our operating losses and lack of
working capital raise substantial doubt about our ability to continue as a going
concern.  At June 30, 2008, we had total current liabilities of
$99,872,000 and current assets of $28,000, resulting in a working capital
deficiency of $99,844,000.  At June 30, 2008, we had a total
stockholders’ deficit of $107,301,000.  There can be no assurance that
management’s efforts to adequately capitalize the Company or attain a successful
level of operations and cash flows will be successful.  In light of
our current financial position and the uncertainty of raising sufficient capital
to achieve our goals, the Company’s viability as a going concern is
uncertain.





We
have a history of operating losses and there can be no assurance that we will be
able to operate at a profit in the future.





We have
incurred operating losses from our inception, and had an accumulated deficit of
$141,761,000 at June 30, 2008.  We incurred a net loss of $19,837,000
for the year ended June 30, 2008 and a net loss of $25,417,000 for the year
ended June 30, 2007.  We recently ceased production of the
SparrowHawk, and our level of involvement in the DARPA contract has been
reduced.  There can be no assurance that we will be able to operate at
a profit in the future.  If we cannot generate sufficient revenues to
operate profitably and to meet our debt obligations, we may suspend or cease
operations.





We will require additional funds to
continue our business plan.





At June
30, 2008, we had a working capital deficiency of $99,844,000 and a stockholders’
deficit of $107,301,000.  We incurred a net loss of $19,837,000 and
used cash of $3,066,000 in our operations during the year ended June 30,
2008.  We do not currently have adequate funds to meet our obligations
for the next twelve months and we are dependent on the receipt of additional
debt or equity capital to fund our operations until such time as our revenues
exceed our expenses and we begin to operate at a profit, if ever.  We
currently have an agreement of the Series B Holders to provide us with monthly
funding to meet minimum operating needs through November 9,
2009.  However, we will need additional debt or equity funding to meet
our other obligations, many of which are past due.  There can be no
assurance that the Series B Holders will further extend the funding agreement
beyond the current November 9, 2009 due date.  We anticipate that we
will have difficulty in obtaining other financing given the current economic
climate and, if we are able to obtain equity financing, it will likely result in
significant additional dilution to the interests of our current
stockholders.





16




We
have a significant amount of debt that is past due.





Current liabilities at June 30, 2008
included $17,483,000 notes payable to related parties, including $6,733,000 that
is in default.  In addition, we are delinquent in making payments of
accrued interest payable of $2,282,000 on this related party debt at June 30,
2008.  Most of these related party notes payable are held by long-time
shareholders and lenders of the Company and are payable on demand or are
short-term in nature.  There is no assurance that these related party
lenders will not demand payment of this short-term indebtedness in the near
future.





Also included in current liabilities at
June 30, 2008 are notes payable to unrelated parties of $564,000, substantially
all of which is in default.  In addition, we are delinquent in making
payments of accrued interest payable of $509,000 on this debt at June 30,
2008.  We continue to make some payments on this indebtedness and
continue discussions with many of these vendors and lenders, and have, in most
instances, been granted grace periods and extensions without receipt of formal
notices of default or threat of legal action.  There is no assurance
that these vendors and lenders will continue to forebear from collection or
legal action.





Substantially
all of our assets, including our intellectual property, have been pledged as
collateral for our debt.





With the
extension of the due dates of the remaining Series B Preferred Stock and the
Note Purchase Agreement, substantially all of our assets, including our
intellectual property, have been pledged as collateral for our
debt.





Our
business is subject to significant government regulation that will increase our
operating costs.





The
nature of aviation products has resulted in their manufacture being regulated by
governments for public safety, national defense, and economic and/or political
purposes.  Such regulations vary widely by country, by product type
and by usage.  Our products and intended products are principally
impacted by United States laws and regulations, but also by requirements in our
export markets.  As our products can be used for private, commercial,
public agency or military purposes, their sale and operation are governed by
regulations appropriate to each category.  Developmental flight
testing of our aircraft is carried out under exemption rules covering
experimental aircraft.  The failure to comply with government
regulation could adversely affect our operations.





Difficulties or
delays in the development, production, testing and marketing of products could
have a materially adverse effect on our business.





Difficulties
or delays in the development, production, testing and marketing of products,
could have a materially adverse effect. Our business is subject, in part, to
regulatory procedures and administration enacted by and/or administered by the
FAA.  Accordingly, our business may be adversely affected in the event
we are unable to comply with such regulations relative to our current products
and/or if any new products and/or services to be offered by us can or may not be
formally approved by such agency.





17





Our potential
international sales may be subject to local government laws, regulations and
procurement policies and practices which may differ from U.S. Government
regulations.





Our
potential international sales may be subject to local government laws,
regulations and procurement policies and practices which may differ from U.S.
Government regulation, including regulations related to products being installed
on aircraft, exchange controls, as well to varying currency, geo-political and
economic risks.  We also are exposed to risks associated with any
relationships with foreign representatives, consultants, partners and suppliers
for international sales and operations.





As
a contractor to the U.S. government, we are subject to extensive government
regulation, and our failure to comply with applicable regulations could subject
us to penalties that may restrict our ability to conduct our
business.





As a
contractor to the U.S. government, we are subject to and must comply with
various government regulations that impact our revenue, operating costs, profit
margins and the internal organization and operation of our
business.  Also, we need special security clearances and regulatory
approvals to continue working on certain of our projects with the U.S.
government.  Classified programs generally will require that we comply
with various executive orders, federal laws and regulations and customer
security requirements that may include restrictions on how we develop, store,
protect and share information, and may require our employees to obtain
government security clearances. Our failure to comply with applicable
regulations, rules and approvals or misconduct by any of our employees could
result in the imposition of fines and penalties, the loss of security
clearances, the loss of our government contracts or our suspension or debarment
from contracting with the U.S. government generally, any of which would harm our
business, financial condition and results of operations.





We
depend on our officers and the loss of their services would have an adverse
effect on our business.





We are
dependent on our officers, particularly David Groen, our president and chief
executive officer, to operate our business and the loss of such persons would
have an adverse impact on our operations. We do not have employment agreements
with our officers and we do not carry key man life insurance on their
lives.





We
will be required to establish and maintain acceptable internal controls related
to financial reporting which will be difficult, time consuming and
expensive





As a
public reporting company, our management is responsible for establishing and
maintaining adequate internal control over financial reporting (as defined in
Rule 13a-15(f) and 15d-15(f) under the Exchange Act).  Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with accounting
principles generally accepted in the United States. Such controls will be
reviewed by our independent registered public accounting firm in connection with
the annual audit of our financial statements and in the future such firm may be
required to provide a report with respect to our internal control over financial
reporting. Since we do not currently have full time employees with the requisite
accounting expertise or experience or an internal audit or accounting group, we
will need to rely on consultants and other outside experts to assist us in
establishing and maintaining internal control over financial reporting which is
anticipated to be expensive.  Since we are currently operating at a
loss, there is no assurance that we will be able to pay the costs of
establishing such controls or that we will be able to establish controls that
are free from material weaknesses.





18





We
have only two directors and they are not independent directors, which means our
board of directors may be influenced by the concerns, issues or objectives of
management to a greater extent than would occur with a number of independent
directors.





We have
only two directors and they are not independent directors.  As a
result, our board of directors may be influenced by the concerns, issues or
objectives of management to a greater extent than would occur with independent
board members. In addition, we do not have the benefit of having persons
independent of management review, comment and direct our corporate strategies
and objectives and oversee our reporting processes, our disclosure controls and
procedures and our internal control over financial reporting.





We
do not anticipate paying dividends on our common stock in the foreseeable
future.





We have
never paid dividends on our common stock.  The payment of dividends,
if any, on the common stock in the future is at the discretion of the board of
directors and will depend upon our earnings, if any, capital requirements,
financial condition, existing financing agreements, and other relevant factors.
The board of directors does not intend to declare any dividends on our common
stock in the foreseeable future.





We have the ability to issue
additional shares of common stock and to issue shares of preferred stock without
stockholder approval.





The
Company is authorized to issue up to 500,000,000 shares of common stock. To the
extent of such authorization, the officers of the Company have the ability,
without seeking stockholder approval, to issue additional shares of common stock
in the future for such consideration as they believe to be
sufficient.  The issuance of additional common stock in the future
will reduce the proportionate ownership and voting power of our current
stockholders.  The Company is also authorized to issue up to
50,000,000 shares of preferred stock, the rights and preferences of which may be
designated in series by the board of directors.  To the extent of any
authorizations, such designations may be made without stockholder
approval.  The designation and issuance of a series of preferred stock
in the future could create additional securities which may have voting,
dividend, liquidation preferences or other rights that are superior to those of
the common stock, which could effectively deter any takeover attempt of the
Company.





The
holders of our Series A Convertible Preferred Stock have a significant number of
votes on all matters submitted to our stockholders for a vote.





David
Groen, President and Chief Executive Officer, owns 1,025,000 shares of the
Company’s Series A Convertible Preferred Stock, and Robin Wilson, Executive Vice
President and Chief Operating Officer, Dennis Gauger, former officer and
director, and Margaret Groen, the surviving spouse of the late Jay Groen, each
owns 125,000 shares of the Company’s Series A Convertible Preferred Stock,
combined representing 100% of the outstanding shares of that series of preferred
stock.  Each share of the Series A Convertible Preferred Stock
entitles the holder to cast one hundred (100) votes, or a total of 140,000,000
votes on all matters submitted to the stockholders for a vote, voting together
with the holders of the common stock of the Company as a single
class.  As such, the holders of the Company’s Series A Convertible
Preferred Stock currently hold approximately 59% of the Company’s total voting
power and are able to control the outcome of any matter submitted to the
Company’s stockholders for their consideration.





19





The
market price of our common stock is volatile.





The market price of our common stock
has fluctuated widely, and in the future may be subject to similar fluctuations
in response to ongoing variations in the future prospects of the Company and
other events or factors, some of which are beyond our control.





Our
common stock historically has been thinly traded.





Our common stock historically has been
thinly traded.  Therefore, our shareholders may not be able to sell
their shares freely.  The volume of trading in our common stock
historically has been low and a limited market presently exists for our common
shares.  We cannot be assured that our trading volume will increase,
or that our historically light trading volume or any trading volume whatsoever
will be sustained in the future.  Therefore, we cannot be assured that
our shareholders will be able to sell their shares of our common stock at the
time or at the price that they desire, of at all.





Our
stock is a penny stock and is subject to special regulations which may make it
more difficult for investors to liquidate their investment.




Because
our common stock is deemed a low-priced “Penny” stock, an investment in our
common stock should be considered high risk and subject to marketability
restrictions.  Since our common stock is a penny stock, as defined in
Rule 3a51-1 under the Securities Exchange Act, it will be more difficult for
investors to liquidate their investment in our common stock. Until the trading
price of the common stock rises above $5.00 per share, if ever, trading in the
common stock is subject to the penny stock rules of the Securities Exchange Act
specified in rules 15g-1 through 15g-10. Those rules require broker-dealers,
before effecting transactions in any penny stock, to: (i) deliver to the
customer, and obtain a written receipt for a disclosure document; (ii) disclose
certain price information about the stock; (iii) disclose the amount of
compensation received by the broker-dealer or any associated person of the
broker-dealer; (iv) send monthly statements to customers with market and price
information about the penny stock; and (v) in some circumstances, approve the
purchaser's account under certain standards and deliver written statements to
the customer with information specified in the rules.  As a result,
the penny stock rules may restrict the ability or willingness of broker-dealers
to sell the common stock and may affect the ability of holders to sell their
common stock in the secondary market and the price at which such holders can
sell any such securities. These additional procedures could also limit our
ability to raise additional capital in the future.




We
currently have a significant number of options, warrants and convertible debt
outstanding, the exercise of which may adversely affect our stock price and
dilute our stockholders’ ownership percentage.





Options and warrants to purchase
87,160,372 shares of our common stock at exercise prices ranging from $0.15 to
$1.10 were outstanding at June 30, 2008.  In addition, certain
notes payable, long-term debt and related accrued interest payable were
convertible into a total of 56,270,363 shares of our common stock at June 30,
2008, with conversion prices ranging from $0.20 to $1.25.  The
exercise of these options and warrants or the conversion of the convertible debt
would result in a significant increase in the number of our common shares
outstanding, which may adversely affect our stock price and dilute our
stockholders’ ownership percentage.





Item
1B.              Unresolved
Staff Comments





Not applicable.





20





Item
2.                 Properties





We lease our development/manufacturing
facility located at 2640 W. California Avenue, Salt Lake City, Utah from an
unrelated party for approximately $20,800 per month.  This property
consists of approximately 25,000 square feet, houses our headquarters and our
administrative offices, and within this facility we conduct research and
development and government contract activities.  This lease extends
through September 2010.





Subsequent to the end of the fiscal
year, in July 2008 the Company terminated its lease for its operating hangar at
Buckeye Airport, Arizona, vacating those premises and ceasing operations at the
airport.  We have, however, retained on a month-to-month basis a small
hangar for storage purposes at a monthly rental of approximately $850 per
month.





We
consider the condition of our leased facility to be good and adequate for the
current level of our operations.








Item
3.                 Legal
Proceedings





We are not involved in any legal
proceedings and, to the best of our knowledge, no legal proceedings against the
Company have been threatened.  We are subject to the potential of
various claims and legal actions arising in the ordinary course of business,
including certain matters relating to past due amounts to
creditors.  The past due amounts are recorded as liabilities in our
consolidated financial statements, and management believes that the amount, if
any, that may result from other claims will not have a material adverse effect
on our consolidated financial statements.








Item
4.                 Submission
of Matters to a Vote of Security Holders





There were no matters submitted to a
vote of security holders during the fourth quarter of fiscal year
2008.




21





PART
II








Item
5: Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities





(a)
Market Information.





Our
common stock traded under the symbol GNBA.OB on the OTC Bulletin Board until
approximately October 7, 2008.  Our common stock was removed from the
OTC Bulletin Board effective as of October 7, 2008, due to our failure to timely
file SEC reports, including this report on Form 10-K.  Since October
7, 2008, our common stock has quoted on the National Quotation Bureau’s Pink
Sheets under the symbol “GNBA.PK”   As of November 5, 2009, the
high bid and low asked quotation for our common stock on the Pink Sheets was
$0.0145  bid and $0.015 asked, respectively.





The following table sets forth the high
and low bid quotations for our common stock for the two fiscal years ended June
30, 2008 and 2007 as provided by the OTC Bulletin Board.  The
quotations presented reflect inter-dealer prices, without retail markup,
markdown, or commissions, and may not necessarily represent actual transactions
in the common stock.





Closing PricesFiscal
      Year Ended June 30:
            High
            Low2008
            First
      Quarter
            $0.17
            $0.13Second
      Quarter
            $0.14
            $0.10Third
      Quarter
            $0.13
            $0.06Fourth
      Quarter
            $0.09
            $0.042007
            First
      Quarter
            $0.18
            $0.14Second
      Quarter
            $0.24
            $0.14Third
      Quarter
            $0.26
            $0.16Fourth
      Quarter
            $0.18
            $0.14




As reflected by the high and low prices
on the foregoing table, the trading price of the common stock of the Company can
be volatile with dramatic changes over short periods.  The trading
price may reflect imbalances in the supply and demand for our shares, market
reaction to perceived changes in the industry in which we sell products and
services, general economic conditions, and other factors.  Investors
are cautioned that the trading price of the common stock can change dramatically
based on changing market perceptions that may be unrelated to us and our
activities.





(b) Number of
equity security holders.





The
number of record holders of our common stock as of November 5, 2009 was
approximately 1,600.  This number counts each broker dealer and
clearing corporation who holds shares for its customers as a single
holder.





(c) Dividends.





We did not declare or pay any cash
dividends on our common stock during the past two fiscal years and we do not
intend to declare any dividends in the foreseeable future.





22





(d) Securities authorized for issuance
under equity compensation plans.





The Company’s Amended and Restated 2000
Stock Option Plan (the “Plan”) has been approved by our
shareholders.  Under the Plan, a maximum of 60,000,000 common shares
are available for granting of options to purchase common stock.  We
may issue both non-qualifying stock options and qualifying incentive stock
options.  We have also issued stock options and warrants outside the
Plan which have been approved by our Board of Directors and which have been
issued under no specific plan approved by our shareholders.  The
following table presents information concerning outstanding stock options and
warrants issued by us as of June 30, 2008.





Plan
      Category
            Number
      of Securities
              to
      be Issued Upon Exercise
              of
      Outstanding Options
              and
      Warrants
            Weighted-Average
              Exercise
      Price of
              Outstanding
      Options
              and
      Warrants
            Number
      of Securities
              Remaining
      Available for
              Future
      Issuance Under
              Equity
      Compensation Plans
              (Excluding
      Securities Reflected
              in
      Column (a))(a)
            (b)
            (c)Equity
      compensation plans
              approved by securityholders
            46,674,340
            $0.31
            13,325,660Equity
      compensation plans
              not approved by securityholders
            27,210,932
            $0.21
            n/aTotal
            73,885,272
            
            13,325,660




See also the Notes to Consolidated
Financial Statements for further information regarding the Plan and stock
options and warrants issued by the Company.





(e) Recent sales of unregistered
securities.





During the three months ended June 30,
2008, we issued a total of 9,283,413 shares of our restricted common stock, at a
prices ranging from $0.04 to $0.10 per share, through private placement
offerings in reliance upon the exemption from registration contained in Section
4(2) of the Securities Act of 1933, as amended.  The prices per share
recorded in these equity transactions approximated the quoted market price of
our common stock.  The shares were issued for the following
consideration: 1,359,375 shares for cash of $127,000; 1,030,697 shares in
payment of interest expense of $97,000; 2,072,560 shares in payment of accrued
expenses of $135,000; 5,402,271 shares in payment of debt of $364,000; and
3,059,760 shares in payment of our matching contribution to our 401(k) plan of
$306,000.  We did not use underwriters in the sale or placement of
these unregistered shares of common stock.





During
the three months ended June 30, 2008, we also issued a total of 5,696,226 stock
options not covered by our Registration Statement on Form S-8, to investors in
connection with the sale of our common stock or lending activities with an
exercise prices ranging from $0.07 to $0.20 per share exercisable for periods of
1 to 2 years in reliance upon exemptions from the registration requirements of
the Securities Act of 1933, as amended.





23




(f) Purchases of equity securities by
the registrant and affiliated purchasers.





We have not adopted a stock repurchase
plan and we did not purchase any shares of our equity securities during the last
three months of the year ended June 30, 2008.








Item
6.                 Selected
Financial Data





Because the Company is a Smaller
Reporting Company, it is not required to respond to this Item.








Item
7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations





Background





We are
engaged in the business of designing and developing new technology gyroplane and
gyrodyne rotor-wing aircraft for military and commercial
uses.  Following the delays in our Heliplane program for DARPA, lower
than anticipated results from sales of SparrowHawk kits, and negative conditions
in capital markets, we recently undertook cost-cutting measures that we hope
will allow us to continue to develop our technology on a reduced
scale.  We recently affected a substantial reduction in force and have
reduced other operating expenditures as well.





Going
Concern Uncertainty





The accompanying consolidated financial
statements have been prepared assuming that the Company will continue as a going
concern.  Because of recurring operating losses, the excess of current
liabilities over current assets, the stockholders’ deficit, and negative cash
flows from operations, there is substantial doubt about our ability to continue
as a going concern.





At June
30, 2008, we had total current liabilities of $99,872,000 and current assets of
$28,000, resulting in a working capital deficiency of $99,844,000.  At
June 30, 2008, we had a total stockholders’ deficit of
$107,301,000.





We have
experienced a negative gross profit on sales of Sparrow Hawk kits and the number
of SparrowHawk kits sold has fallen below expectations, due in part to lack of
funding to finalize product development and to pay for increased sales and
marketing efforts.  In these circumstances, prospects of reaching a
satisfactory profit level in a deteriorating economic climate were not
promising.  As importantly, we determined that the kit aircraft
business, aimed at customers for their personal use, could not be readily
compatible with the design, manufacture and marketing of more sophisticated
aircraft required by military and commercial customers.  Therefore, in
May 2008, we decided to cease production of the SparrowHawk and to seek to sell
the program to a buyer with more compatible operating conditions and strategic
interests.





We have
also experienced a negative profit margin on the DARPA contract, which has
reduced cash flows from operations.  Subsequent to June 30, 2008,
DARPA announced the award of the Heliplane prime contractor position to the
Georgia Institute of Technology (GT) for Phase IB.  Since then, we
have been engaged as a GT subcontractor for rotor systems work of Phase
IB.





24





The
Company’s continuation as a going concern is dependent on attaining profitable
operations, obtaining additional outside financing and/or restructuring its debt
obligations, including its Series B Preferred Stock.  We have funded
losses from operations primarily from the issuance of debt to related parties
(current shareholders and lenders of the Company), the increase in accounts
payable and accrued expenses, and the sale of our restricted common stock in
private placement transactions, and will require additional funding from these
sources to sustain our future operations.





In order
to repay our debt obligations in full or in part when due, we will be required
to raise significant capital from other sources.  Alternatively, we
will be required to negotiate further extensions of the Series B Preferred Stock
maturity date and our notes payable, as we have accomplished in the
past.  There is no assurance, however, that we will be successful in
these efforts.





Included
in current liabilities and the working capital deficiency at June 30, 2008 is a
$68,095,000 Series B Preferred Stock obligation.  On May 10, 2007, we
received the approval of the Series B Holders to extend the redemption date of
the Series B Preferred Stock from May 1, 2007 to June 16, 2007, or such later
date as agreed to in writing by at least 80% of the Series B
Holders.  Subsequently, the Series B Holders agreed in writing to an
extension of the redemption date from June 16, 2007, to June 30,
2008.





Subsequent
to June 30, 2008, as part of a Note Purchase Agreement between the Company and
the Series B Holders, the Company redeemed approximately half of the outstanding
Series B Stock in exchange for interest bearing notes, and the Series B Holders
agreed to an extension of the redemption date of the remaining Series B Stock
from June 30, 2008 to April 9, 2009.  Subsequently, the redemption
date was extended from April 9, 2009 to June 9, 2009, from June 9, 2009 to
August 9, 2009, and from August 9, 2009 to November 9, 2009, or such later date
as agreed to in writing by the holders of at least 80% of the outstanding shares
of Series B Preferred Stock.  In addition, the Series B Holders agreed
to provide the Company with monthly funding to cover its minimum cash needs in
excess of funding provided by payments from Georgia Tech for the Company’s work
on the DARPA contract.





There can be no guarantee or assurance
that we will be successful in our ability to generate income from operations or
from the DARPA contract, or to raise capital at favorable rates or at
all.  The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.




25





Results
of Operations





Revenues





The Company’s consolidated revenues are
comprised of the following:





Year
      Ended June 30,2008
            
            
            2007Government
      contract
            
            $
            5,070,000
            
            
            $
            2,440,000Commercial
      subcontract
            
            
            26,000
            
            
            
            110,000SparrowHawk
      kits and parts
            
            
            720,000
            
            
            
            562,000Flight
      training
            
            
            46,000
            
            
            
            36,000Other
      operating
            
            
            60,000
            
            
            
            255,000Total
            
            $
            5,922,000
            
            
            $
            3,403,000





Total revenues increased $2,519,000 to
$5,922,000 in the year ended June 30, 2008 from $3,403,000 in the year ended
June 30, 2007.  The increase in revenues in the current fiscal year
was primarily attributed to additional revenues from Phase I of the DARPA
contract, and, to a lesser extent, an increase in the sales of SparrowHawk kits
and parts.  These increases in revenues were partially offset by a
decrease in the current year in the commercial subcontract and other operating
revenues.





We
recognize revenue on the DARPA contract as each defined milestone is completed
and the requisite meetings are held and technical data submitted and accepted by
DARPA.  At that time, DARPA instructs us to submit an invoice for
payment for the respective milestone at the amount specified in the
contract.





Revenues
from the sale of SparrowHawk kits and parts increased to $720,000 in the year
ended June 30, 2008 from $562,000 in the year ended June 30,
2007.  The increase in these revenues resulted from us selling more
SparrowHawk kits during the current fiscal year compared to the year ended June
30, 2007 as well as an overall increase in the sales price per
kit.  We also experienced an increase in the sales of SparrowHawk
parts in the current fiscal year.





In
December 2005, we announced the introduction of our improved SparrowHawk model,
the SparrowHawk II.  SparrowHawk II offered added comfort and
robustness, and made some reduction in the time and effort, needed by the
customer to build the aircraft.  We continued to design improvements
for the SparrowHawk II during fiscal year 2008, including the introduction
of a new version called the SparrowHawk III QB (for Quick Build).  As
the name implies, the primary objective for the ‘Quick Build’ is a significant
further reduction of time and effort on the part of the purchaser in building
the aircraft, while maintaining conformity with FAA
regulations.  Careful attention has been paid to existing customer
input and to the needs of potential customers.  Many of the latter
have the financial resources to purchase an aircraft, but have limited time to
complete the build process.  Through a thorough assessment of the
build process, changes in the design manufacture and product delivery, the time
to assemble the kit by a typical purchaser is expected to be in the order of 300
hours, cutting build time in half.  Deliveries of the Quick Build kit
begin in October 2007.  All future SparrowHawk aircraft will be
manufactured to the Quick Build standard.  The priority of effort on
the development of the much improved Quick Build version resulted in some delay
in delivery of kits manufactured to the SparrowHawk II standard.  The
decrease in revenues from the sale of SparrowHawk kits and parts resulting from
a lower volume of kits sold was partially offset in the current year by an
overall increase in the sales price per kit.





26





As
discussed above, we have experienced a negative gross profit on sales of Sparrow
Hawk kits and the number of SparrowHawk kits sold has fallen below expectations,
due in part to lack of funding to finalize product development and to pay for
increased sales and marketing efforts.  In these circumstances,
prospects of reaching a satisfactory profit level in a deteriorating economic
climate were not promising.  As importantly, we determined that the
kit aircraft business, aimed at customers for their personal use could not be
readily compatible with the design, manufacture and marketing of more
sophisticated aircraft required by military and commercial
customers.  Therefore, in May 2008, we decided to cease production of
the SparrowHawk and to seek to sell the program to a buyer with more compatible
operating conditions and strategic interests.





Although
a slight increase in flight training revenues was reported in the current fiscal
year, we also closed our Arizona flight training facility, and no significant
flight training revenues are expected in the near future.





The other
operating revenue, consisting of dealer fees, sales of research and development
parts and miscellaneous revenues, decreased in the current fiscal
year.  These other revenues vary from year to year, and are not
expected to be material in the near future.





Costs and Expenses





The
Company’s consolidated cost of sales is comprised of the following:





Year
      Ended June 30,2008
            
            
            2007Government
      contract
            
            $
            5,036,000
            
            
            $
            7,030,000Commercial
      subcontract
            
            
            281,000
            
            
            
            307,000SparrowHawk
      kits and parts
            
            
            2,002,000
            
            
            
            2,006,000Flight
      training
            
            
            12,000
            
            
            
            17,000Total
            
            $
            7,331,000
            
            
            $
            9,360,000





Comparing
the year ended June 30, 2008 to the year ended June 30, 2007, cost of sales
decreased to $7,331,000 from $9,360,000.  The decrease is due
primarily to a reduced level of costs and expenses related to Phase I of the
DARPA contract recorded in the current year as Phase I of the contract wound
down.  Because of the negative profit margin on Phase I of the DARPA
contract; all contract-related costs and expense were expensed as incurred
during the years ended June 30, 2008 and 2007, resulting in the reporting of
cost of sales in advance of the revenue billed.





On August
31, 2007, the DARPA contract was modified, increasing the contract award for
Phase One from $6.4 million to $10.4 million, and extending the term of Phase I
from fifteen to twenty-three months.  On March 5, 2008, the DARPA
contract was modified, increasing the contract award for Phase I from $10.4
million to $10.9 million, adding an intermediary Phase IB to the base contract,
and extending the term of the contract from twenty-three to thirty-six
months.  The increase in contract revenue of $4.0 million will
partially offset a portion of the cost overruns incurred by us on Phase I of the
DARPA contract.





27





Subsequent
to June 30, 2008, DARPA announced the award of the Heliplane prime contractor
position to the Georgia Institute of Technology (GT) for Phase
IB.  Since then, we have been engaged as a GT subcontractor for rotor
systems work of Phase IB.  Payments to us by GT are expected to be
paid on a monthly basis, significantly reducing our cash flow risk from the
Heliplane program.





We incurred cost of sales on our
commercial subcontract of $281,000 in the year ended June 30, 2008, compared to
$307,000 in the year ended June 30, 2007.  We also experienced a
negative profit margin on this commercial subcontract and, therefore, all
contract-related costs and expenses were expensed as incurred during the years
ended June 30, 2008 and 2007.





Cost of
sales for SparrowHawk kits and parts remained somewhat constant at $2,002,000 in
the year ended June 30, 2008 compared to $2,006,000 in the year ended June 30,
2007.  As discussed above, we continued to experience a negative gross
profit on the SparrowHawk kits and we ceased production of the SparrowHawk and
are seeking to sell the program to a buyer with more compatible operating
conditions and strategic interests.





Research and development expenses
remained somewhat constant at $1,500,000 in the year ended June 30, 2008
compared to $1,555,000 in the year ended June 30, 2007.  Research and
development activities include the development of opportunities for subcontract
opportunities with industry partners, variations to the SparrowHawk, fully
assembled SparrowHawk gyroplane derivatives, potential applications of our
technology to heavy lift vertical take-off military aircraft, runway independent
short-haul airliners and other aircraft, including government contract
opportunities.





Comparing the year ended June 30, 2008
to the year ended June 30, 2007, general and administrative expenses increased
to $3,028,000 from $2,659,000.  The increase in general and
administrative expenses in the current fiscal year is due primarily to the
addition of personnel to support the increased level of operations related to
the DARPA contract and increases in the level of compensation for existing
employees.





As a
result of our decision to cease production of the SparrowHawk and the
substantial decrease in our operations, we reviewed our long-lived assets as of
June 30, 2008 for impairment, and concluded that the carrying value of certain
assets may not be recoverable.  Accordingly, we reduced the carrying
amount of our property and equipment and reported an impairment loss of $504,000
for the year ended June 30, 2008.  There was no impairment loss
recorded in the year ended June 30, 2007.





Other Income and Expenses





Related party interest income remained
somewhat constant at $4,000 in the year ended June 30, 2008 compared to $5,000
in the year ended June 30, 2007.


Similarly, interest and other income
remained somewhat constant at $14,000 in the year ended June 30, 2008 compared
to $13,000 in the year ended June 30, 2007.





We have
realized gains on the extinguishment of certain debt.  We realized a
gain on extinguishment of debt of $8,000 in the year ended June 30, 2008 and
$26,000 in the year ended June 30, 2007.





28





Interest expense for the year ended
June 30, 2008 compared to the year ended June 30, 2007 increased to $4,098,000
from $2,740,000.  We incurred net additional debt of $2,841,000 during
the current fiscal year.  In addition, additional interest expense was
incurred in the current fiscal year for the value of stock and stock options
issued to lenders in connection with new debt or debt extensions.





Comparing the year ended June 30, 2008
to the year ended June 30, 2007, Series B Preferred Stock interest expense
decreased to $9,324,000 from $12,550,000.  Through December 31, 2006,
we recorded the accretion of the $10,700,000 redemption value of the 10,700
additional shares of Series B Preferred Stock issued in January 2007, resulting
in a higher amount of Series B Preferred Stock interest expense during the first
six months of fiscal year 2007.  From January 1, 2007 through June 30,
2007, and during the year ended June 30, 2008 no such accretion was recorded,
resulting in an overall reduction in the interest expense.  This
reduction in the Series B Preferred Stock interest expense was partially offset
by increased interest expense due to the increased number of shares of Series B
Preferred Stock outstanding, on which the interest expense is
computed.  Dividends on the Series B Preferred Stock, which are
recorded as interest expense, have been “paid in kind” with additional shares of
Series B Preferred Stock.





Net Loss





For the year ended June 30, 2008, the
loss from operations was $6,441,000 compared to the loss from operations of
$10,171,000 for the year ended June 30, 2007.  As discussed above, the
decrease in the loss from operations in the current fiscal year resulted
primarily from increased revenues and lower cost of sales, partially offset by
an increase in general and administrative expenses and impairment
loss.





The net loss for the year ended June
30, 2008 was $19,837,000 compared to $25,417,000 for the year ended June 30,
2007.  The decrease in the net loss in the current fiscal year
resulted primarily from the decrease in loss from operations and Series B
preferred stock interest expense, partially offset by an increase in interest
expense.





Liquidity
and Capital Resources





Series B Preferred Stock
Obligation





As
previously discussed, at June 30, 2008, we had total current liabilities of
$99,872,000 and current assets of $28,000, resulting in a working capital
deficiency of $99,844,000.  Included in current liabilities and the
working capital deficiency at June 30, 2008 is a $68,095,000 Series B Preferred
Stock obligation.  On May 10, 2007, we received the approval of the
Series B Holders to extend the redemption date of the Series B Preferred Stock
from May 1, 2007 to June 16, 2007, or such later date as agreed to in writing by
at least 80% of the Series B Holders.  Subsequently, the Series B
Holders agreed in writing to an extension of the redemption date from June 16,
2007, to June 30, 2008.





Subsequent
to June 30, 2008, as part of a Note Purchase Agreement between the Company and
the Series B Holders, we redeemed approximately half of the outstanding Series B
Stock in exchange for interest bearing notes, and the Series B Holders agreed to
an extension of the redemption date of the remaining Series B Stock from June
30, 2008 to April 9, 2009.  Subsequently, the redemption date was
extended from April 9, 2009 to June 9, 2009, from June 9, 2009 to August 9,
2009, and from August 9, 2009 to November 9, 2009, or such later date as agreed
to in writing by the holders of at least 80% of the outstanding shares of Series
B Preferred Stock.  In addition, the Series B Holders agreed to
provide us with monthly funding to cover our minimum cash needs in excess of
funding provided by payments from Georgia Tech for our work on the DARPA
contract.





29





With the
extension of the due dates of the remaining Series B Preferred Stock and the
Note Purchase Agreement, substantially all our assets, including our
intellectual property, have been pledged as collateral for our
debt.





In order
to repay these obligations in full or in part when due, we will be required to
raise significant capital from other sources and to meet certain capital
requirements under Utah State law.  Alternatively, we Company will be
required to negotiate another extension of the Series B Preferred Stock maturity
date, as we have accomplished in the past.  There is no assurance,
however, that we will be successful in raising the capital required to repay the
Series B Preferred Stock and related notes payable obligations or in obtaining a
further extension of the Series B Preferred Stock redemption date beyond
November 9, 2009.





Other
Debt Obligations





Current liabilities at June 30, 2008
also included $17,483,000 notes payable to related parties, including $6,205,000
that is in default.  In addition, we are delinquent in making payments
of accrued interest payable of $2,273,000 on this related party debt at June 30,
2008.  Most of these related party notes payable are held by long-time
shareholders and lenders of the Company and are payable on demand or are
short-term in nature.  There is no assurance that these related party
lenders will not demand payment of this short-term indebtedness in the near
future.





Also included in current liabilities at
June 30, 2008 are notes payable to unrelated parties of $564,000, substantially
all of which is in default.  In addition, we are delinquent in making
payments of accrued interest payable of $509,000 on this debt at June 30,
2008.  We continue to make some payments on this indebtedness and
continue discussions with many of these vendors and lenders, and have, in most
instances, been granted grace periods and extensions without receipt of formal
notices of default or threat of legal action.  There is no assurance
that these vendors and lenders will continue to forebear from collection or
legal action.





Operating,
Investing and Financing Activities





Net cash used in operating activities
was $3,066,000 for the year ended June 30, 2008 compared to $5,538,000 for the
year ended June 30, 2007.  We continue to use cash in operations
primarily due to negative gross margins on revenues, particularly on the DARPA
contract, and increases in general and administrative expenses.  As
discussed above, we are required to incur and pay significant costs and expenses
on the DARPA contract in advance of receiving approval and payment of DARPA
contract invoices.  The net cash used in operating activities
decreased in the current fiscal year primarily because of increased revenues and
decreased cost of sales, partially offset by increased general and
administrative expenses.





Net cash used in investing activities
for the year ended June 30, 2008 was $159,000, comprised of the purchase of
property and equipment of $157,000 and the increase in related party accounts
and notes receivable, partially offset by proceeds from incidental sales of
property and equipment of $1,000, and related party notes receivable repayments
received of $4,000.  Net cash used in investing activities for the
year ended June 30, 2007 was $153,000 comprised of the purchase of property and
equipment of $197,000, partially offset by proceeds from incidental sales of
property and equipment of $22000, and related party notes receivable repayments
received of $22,000.





30





We have funded losses from operations
and net cash used in investing activities in the current fiscal year primarily
from the issuance of debt to related parties (current shareholders and lenders
of the Company), the increase in accounts payable and accrued expenses, and to a
lesser extent, the sale of our restricted common stock in private placement
transactions, and will require additional funding from these sources to sustain
our future operations.





Net cash provided by financing
activities was $3,168,000 for the year ended June 30, 2007, comprised of a net
increase in debt of $2,841,000, net proceeds from the issuance of common stock
of $258,000, and the increase in bank overdraft and bank overdraft line of
credit of $69,000.  Net cash provided by financing activities for the
year ended June 30, 2007 was $5,747,000, comprised of a net increase in debt of
$5,188,000 and net proceeds from the issuance of common stock of
$499,000.





We
currently do not have cash to sustain our operations for the next twelve
months.  We anticipate that monthly financing from the Series B
Holders, the revenues from the DARPA contract, the issuance of debt and the sale
of our restricted common stock will continue to fund operating losses in the
short-term, or until revenues grow to the point where they are sufficient to
cover operating costs and expenses.  As discussed above, the Series B
Holders agreed to provide us with monthly funding to cover our minimum cash
needs in excess of funding provided by payments from Georgia Tech for our work
on the DARPA contract.  There is no assurance that this funding from
the Series B Holders will continue beyond the current short-term agreement, and
there is no assurance that we will be successful in either raising sufficient
capital from other sources or improving operations.





Management does not anticipate that
revenues or expenses will be materially affected by inflation during the next
twelve months of operations.





Our operations are not subject to
material seasonal fluctuations.





Off
Balance Sheet Commitments





We lease facilities under
non-cancelable operating leases.  Future minimum rental payments
required under these leases are as follows:





Years Ending June
      30,
            
            Amount2009
            
            $
            258,0002010
            
            
            271,0002011
            
            
            73,000$
            602,000




Critical
Accounting Policies





Our critical accounting policies
include the following:





Impairment of Long-Lived
Assets - We periodically reviews our long-lived assets for impairment
when events or changes in circumstances indicate that the carrying value of an
asset may not be recoverable.  We evaluate, at each balance sheet
date, whether events and circumstances have occurred which indicate possible
impairment. The carrying value of a long-lived asset is considered impaired when
the anticipated cumulative undiscounted cash flows of the related asset or group
of assets is less than the carrying value.  In that event, a loss is
recognized based on the amount by which the carrying value exceeds the estimated
fair market value of the long-lived asset.





31





Research and Development Costs- Research and development costs are expensed as incurred in accordance
with SFAS No. 2, “Accounting for Research and Development Costs.”  The
costs of materials and other costs acquired for research and development
activities are charged to expense as incurred.  Salaries, wages, and
other related costs of personnel, as well as other facility operating costs are
allocated to research and development expense through management’s estimate of
the percentage of time spent by personnel in research and development
activities.





Revenue Recognition
-  We recognize revenues from goods and services when there is a
binding agreement, the product has been completely shipped or service has been
delivered, collection is reasonably assured, and we have no significant
obligations remaining.  Portions of the purchase price of our products
collected from customers in advance of product delivery are recorded as deferred
revenue.  Therefore, revenues from the sale of SparrowHawk gyroplane
kits are not recorded until all kit components and parts are delivered to the
customer and collection of any remaining amounts due is reasonably
assured.





We recognize revenue on our current
government contract as each defined milestone is completed and the requisite
meetings are held and technical data submitted and accepted by
DARPA.  At that time, DARPA instructs us to submit an invoice for
payment for the respective milestone at the amount specified in the
contract.  Contract-related expenses incurred by us for each milestone
of the contract, including its own labor, travel, supplies and other costs, and
the costs of subcontractors and consultants, are deferred as work-in-process
inventory and expensed to cost of sales as the contract revenue for the
milestone is recognized.  When a loss on a contract is projected,
however, all contract-related costs and expenses are expensed as
incurred.





We recognize revenue on commercial and
sub-contractor contracts as each scheduled phase of the contract is completed
and invoices are submitted.  Contract-related expenses incurred by us
for each phase of the contract, including its own labor, travel, supplies and
other costs, and the costs of subcontractors and consultants, are deferred as
work-in-process inventory and expensed to cost of sales as the contract revenue
for the milestone is recognized.  When a loss on a contract is
projected, however, all contract-related costs and expenses are expensed as
incurred.





Stock-Based Compensation –We
have adopted the fair value recognition provisions of SFAS No. 123(R),
Share Based Payments,
which requires us to measure the compensation cost of stock options and other
stock-based awards to employees and directors at fair value at the grant date
and recognize compensation expense over the requisite service period for awards
expected to vest.  The grant-date fair value of stock options and
other stock-based awards is estimated using the Black-Scholes option-pricing
model.  The stock-based compensation expense has been allocated to the
various categories of costs and expenses in a manner similar to the allocation
of payroll expense.  Changes in the assumptions used in the
option-pricing model, including the market price of the Company’s common stock,
risk-free interest rates, estimated forfeitures and life of the options, may
result in fluctuations in the estimated fair value and carrying value of the
consideration recorded for employee stock options.





Non-Employee Stock Options and
Warrants –In accordance with SFAS No. 123, “Accounting for Stock-Based
Compensation”, we estimate the fair value of the consideration recorded for
stock options and warrants issued to non-employees using the Black-Scholes
option-pricing model.  For those stock options and warrants that have
variable characteristics, we will continue to use this methodology to
periodically reassess the fair value of the consideration to determine if the
value of the consideration recorded in the consolidated financial statements
requires adjustment.  Changes in the assumptions used in the
option-pricing model, including the market price of our common stock and
risk-free interest rates, may result in fluctuations in the estimated fair value
and carrying value of the consideration recorded for variable non-employee stock
options and warrants.





32





Financial Instruments with
Characteristics of Both Liabilities and Equity -In May 2003, the FASB
issued SFAS No. 150, “Accounting for Certain Instruments with Characteristics of
Both Liabilities and Equity.”  This statement establishes standards
for how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity.  It requires that an
issuer classify a financial instrument that is within its scope as a liability
(or an asset in some circumstances).  Many of those instruments were
previously classified as equity.  The statement was effective on July
1, 2003 for financial instruments entered into or modified after May 31, 2003,
and otherwise effective for existing financial instruments entered into before
May 31, 2003.  The adoption of SFAS No. 150 resulted in the reporting
of our Series B Preferred Stock and a put option obligation as
liabilities.  The carrying value of the Series B Preferred Stock was
the same before and after adoption of SFAS No. 150, and therefore no cumulative
effect adjustment was required.





Income Taxes - We account for
income taxes according to the asset and liability method.  The asset
and liability method requires the recognition of deferred tax liabilities and
assets for the expected future tax consequences of temporary differences between
tax bases and financial reporting bases of existing assets and
liabilities.  Deferred tax assets and liabilities are measured using
enacted 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 income in the period that includes the
enactment date.





Recently
Issued Accounting Pronouncements





The
Financial Accounting Standards Board (FASB) has issued Financial Interpretation
No. 48, Accounting for
Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109(FIN 48).  FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements in accordance
with FASB Statement No. 109, Accounting for Income
Taxes.FIN 48 also prescribes a recognition threshold and
measurement standard for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return.  In
addition, FIN 48 provides guidance on derecognition, classification, interest
and penalties, accounting in interim periods, disclosure and
transition.  The provisions of FIN 48 are to be applied to all tax
positions upon initial adoption of this standard.  Only tax positions
that meet the more-likely-than-not recognition threshold at the effective date
may be recognized or continue to be recognized upon adoption of FIN
48.  The cumulative effect of applying the provisions of FIN 48 should
be reported as an adjustment to the opening balance of retained earnings (or
other appropriate components of equity) for the fiscal year of
adoption.  We adopted the provisions of FIN 48 on July 1, 2007, with
no impact on our consolidated financial statements.





In March 2008, the FASB issued
Statement of Financial Accounting Standards (SFAS) No. 161, Disclosures about Derivative
Instruments and Hedging Activities.  This statement changes the
disclosure requirements for derivative instruments and hedging
activities.  Entities are required to provide enhanced disclosures
about (a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.  This
statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, or our fiscal year beginning
July 1, 2009, with early application encouraged.  This statement
encourages, but does not require, comparative disclosures for earlier periods at
initial adoption.  We are currently unable to determine what impact
the future application of this pronouncement may have on our consolidated
financial statements.





33





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations.  This statement replaces SFAS No. 141, Business Combinations and
applies to all transactions or other events in which an entity (the acquirer)
obtains control of one or more businesses (the acquiree), including those
sometimes referred to as “true mergers” or “mergers of equals” and combinations
achieved without the transfer of consideration.  This statement
establishes principles and requirements for how the acquirer: a) recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree; b)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase; and c) determines what information to disclose to
enable users of the financial statements to evaluate the nature and financial
effects of the business combination.  This statement will be effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2008, or our fiscal year beginning July 1,
2009.  Earlier adoption is prohibited.  We are currently
unable to determine what impact the future application of this pronouncement may
have on our consolidated financial statements.





In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements.  This statement applies to
all entities that prepare consolidated financial statements, except
not-for-profit organizations, and amends Accounting Research Bulletin (“ARB”) 51
to establish accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary.  It also
amends certain of ARB 51’s consolidation procedures for consistency with the
requirements of SFAS No. 141 (revised 2007).  This statement will be
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008, or our fiscal year beginning July 1,
2009.  Earlier adoption is prohibited.  We are currently
unable to determine what impact the future application of this pronouncement may
have on our consolidated financial statements.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115. This statement permits entities to choose to measure many financial
instruments and certain other items at fair value.  Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option.  However, the amendment to SFAS No. 115 Accounting for Certain Investments
in Debt and Equity Securities applies to all entities with
available-for-sale and trading securities.  SFAS No. 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November
15, 2007, or our fiscal year beginning July 1, 2008.  Early adoption
is permitted as of the beginning of a fiscal year that begins on or before
November 15, 2007, provided the entity also elects to apply the provision of
SFAS No. 157, Fair Value
Measurements.  The adoption of this statement is not expected
to have a material effect on our consolidated financial statements.





In
February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2, which
delays by one year the effective date of SFAS No. 157 for certain types of
non-financial assets and non-financial liabilities.  As a result, SFAS
No. 157 will be effective for financial statements issued for fiscal years
beginning after November 15, 2007, or the Company’s fiscal year beginning July
1, 2008, for financial assets and liabilities carried at fair value on a
recurring basis, and on July 1, 2009, for non-recurring non-financial assets and
liabilities that are recognized or disclosed at fair value.  The
Company adopted SFAS No. 157 on July 1, 2008 for financial assets and
liabilities carried at fair value on a recurring basis, with no material impact
on its consolidated financial statements.  The Company is currently
unable to determine what impact the application of SFAS No. 157 on July 1, 2009
for non-recurring non-financial assets and liabilities that are recognized or
disclosed at fair value will have on its consolidated financial
statements.





34





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements.  SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and requires enhanced disclosures about fair
value measurements.  SFAS No. 157 requires companies to disclose the
fair value of their financial instruments according to a fair value hierarchy as
defined in the standard.  Additionally, companies are required to
provide enhanced disclosure regarding financial instruments in one of the
categories, including a reconciliation of the beginning and ending balances
separately for each major category of assets and liabilities.  SFAS
No. 157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, or our fiscal year beginning July 1, 2008, and interim
periods within those fiscal years.  We believe that the adoption of
SFAS No. 157 will not have a material impact on our consolidated financial
statements.





EITF No.
07-3, Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future
Research and Development Activities,was issued in June
2007.  The EITF reached a consensus that nonrefundable payments for
goods and services that will be used or rendered for future research and
development activities should be deferred and capitalized.  Such
amounts should be recognized as an expense as the related goods are delivered
and the related services are performed.  Entities should continue to
evaluate whether they expect the goods to be delivered or services to be
rendered.  If the entity does not expect the goods to be delivered or
services to be rendered, the capitalized advance payment should be charged to
expense.  This pronouncement is effective for financial statements
issued for fiscal years beginning after December 15, 2007 (our fiscal year
beginning July 1, 2008) and interim periods within those fiscal
years.  Earlier application is not permitted.  Entities are
required to report the effects of applying this pronouncement prospectively for
new contracts entered into on or after the effective date of this
pronouncement.  We currently are not a party to research and
development arrangements that include nonrefundable advance
payments.  To the extent that we enter into research and development
arrangements in the future that include nonrefundable advance payments, the
future application of this pronouncement may have a material effect on our
consolidated financial condition and results of operations.








Forward
Looking Statements





We, from time to time, may publish
forward-looking statements relating to such matters as anticipated financial
performance, business prospects, technological development, new products,
research and development activities and similar matters.  The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements.  In order to comply with the terms of the
safe harbor, we note that a variety of factors could cause our actual results
and experience to differ materially from the anticipated results or other
expectations expressed in any of our forward-looking statements.  The
risks and uncertainties that may affect the operations, performance, development
and results of our business include, but are not limited to, the following: (a)
the failure to obtain additional borrowed and/or equity capital on favorable
terms for acquisitions and expansion; (b) adverse changes in federal and state
laws, or other matters affecting our business; (c) the demand for our products
and services; and (d) other risks detailed in our Securities and Exchange
Commission filings.





35





This Form 10-K contains and
incorporates by reference certain “forward-looking statements” within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act
with respect to our results of operations and businesses.  All
statements, other than statements of historical facts, included in this Form
10-K, including those regarding market trends, our financial position, business
strategy, projected costs, and plans and objectives of management for future
operations, are forward-looking statements.  In general, such
statements are identified by the use of forward-looking words or phrases
including, but not limited to, “intended, will, should, may, expect, anticipate,
estimates, projects” or the negative thereof or variations thereon or similar
terminology.





Forward-looking statements are based on
our current expectations.  Although we believe that the expectations
reflected in such forward-looking statements are reasonable, there can be no
assurance that such expectations will prove to be correct.  Because
forward-looking statements involve risk and uncertainty, our actual results
could differ materially.  Important factors that could cause actual
results to differ materially from our expectations are disclosed hereunder and
elsewhere in this Form 10-K.These
forward-looking statements represent our judgment as of the date of this Form
10-K.  All subsequent written and oral forward-looking statements
attributable to us are expressly qualified in their entirety by the Cautionary
Statements.  We disclaim, however, any intent or obligation to update
our forward-looking statements.








Item
7A.              Quantitative
and Qualitative Disclosures About Market Risk





Because the Company is a Smaller
Reporting Company, it is not required to respond to this Item.








Item
8.                 Financial Statements and
Supplementary Data





The consolidated financial statements
of the Company required by this Item are contained in a separate section of this
report located immediately following the signature page.  See “Index
to Consolidated Financial Statements” on Page F-1 for the consolidated financial
statements of the Company included in this report.








Item
9. Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure


None.





36





Item
9A(T).        Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures





Our management, under the supervision
and with the participation of our chief executive officer and chief financial
officer, evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act) as of June 30, 2008.  Based on that
evaluation, and as further discussed below, our chief executive officer and
chief financial officer concluded that the disclosure controls and procedures
employed at the Company are not effective to ensure that the information
required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.





Management’s
Report on Internal Control Over Financial Reporting





Management is responsible for
establishing and maintaining adequate internal control over financial reporting,
as such term is defined under Exchange Act Rules 13a-15(f).  Our
internal control system is designed to provide reasonable assurance to our
management and board of directors regarding the preparation and fair
presentation of published financial statements.  Under the supervision
and with the participation of our management, including our principal executive
officer and principal financial officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
framework in Internal Control – Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.  Based on our
evaluation under that framework, management concluded that our internal control
over financial reporting was not effective as of June 30, 2008.





As a
result of our decision to cease production of the SparrowHawk, our reduced
involvement in the DARPA contract, and the resulting substantial decrease in our
operations, we eliminated substantially all full time accounting and finance
personnel.  We have not, therefore, timely prepared our consolidated
financial statements and filed our periodic reports with the SEC.  We
currently utilize primarily former employees, working either as part time
employees or outside consultants, to maintain the financial records of the
Company and to prepare the consolidated financial statements and footnote
disclosures of the Company.  This has resulted in less segregation of
accounting duties and less compliance with financial close procedures than had
previously been implemented when a fully staffed accounting and finance
department was in place.  This lack of internal oversight and review
resulted in adjusting journal entries not detected by us that were material to
our consolidated financial statements.





The Audit
Committee of our Board of Directors is currently comprised of two individuals
who are not independent directors.





We
believe these deficiencies in the design and operation of our internal control
over financial reporting may be considered material weaknesses.  A
material weakness is a control deficiency (within the meaning of the Public
Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, such that there is a reasonable possibility
that a material misstatement of the annual or interim financial statements will
not be prevented or detected.  In light of the material weaknesses
described above, we performed additional analyses and other post-closing
procedures and increased the involvement of outside consultants to ensure our
financial statements were prepared in accordance with generally accepted
accounting principles.  Accordingly, we believe that the consolidated
financial statements included in this report fairly present, in all material
respects, our financial condition, results of operations and cash flows for the
periods presented.  We intend to continue the involvement of outside
consultants and further implement additional analyses and financial close
procedures to ensure that our financial statements are timely prepared in
accordance with generally accepted accounting procedures.





37




This annual report does not include an
attestation report of the Company’s registered public accounting firm regarding
internal control over financial reporting.  Management’s report was
not subject to attestation by the Company’s registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only management’s report in this annual
report.





Change
in Internal Control Over Financial Reporting





Other than those matters discussed
above, there was no change in our internal control over financial reporting
during the fourth fiscal quarter of 2008, that materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.








Item
9B. Other
Information





None.








PART
III





Item
10. Directors,
Executive Officers and Corporate Governance





The
following table contains the names and ages of all our Directors and Executive
Officers and offices held by each such person.





Name
            Age
            PositionsDavid
      L. Groen
            58
            Chairman
      of the Board of Directors, President and Chief Executive Officer, Chief
      Financial OfficerRobert
      (Robin) H. H. Wilson
            73
            Director,
      Executive Vice President, and Chief Operating
  Officer





Dennis P. Gauger, former Chief
Financial Officer and member of the Board of Directors, resigned these positions
and terminated employment with the Company in January 2008.





Term
of Office





The appointment of David Groen as a
member of the Board of Directors was ratified and approved by the stockholders
at a meeting for that purpose on May 20, 2000.  Mr. Wilson was
appointed a member of the Board of Directors on October 3, 2006.  The
term of service of each director continues until the next annual meeting of the
stockholders.  With the exception of compliance with the duties of a
director as set forth in the Articles of Incorporation or By-laws of the Company
or in the provisions of the Utah Revised Business Corporation Act, there are no
arrangements or understandings pursuant to which any of the foregoing persons
were selected to serve on the Board of Directors of the Company.  Each
of the foregoing persons consented to serve as a director of the Registrant
prior to their designation or subsequent election as such.





38





Background
on Directors and Executive Officers





David L.
Groen  As a founder of Groen Brothers Aviation, David Groen has
performed in an executive management role for twenty-five years, nearly a decade
and a half of which as its President and Chief Executive
Officer.  David and his late brother Jay grew the Company from just
the two of them in 1986 to more than 130 people by 2001, all the while
developing and re-discovering the science of autorotative
flight.  They weathered the severe economic down turn cause by the
“Tech Sector” crash, made even worse by the events of 9/11, necessitating a
reduction in its work force of more than 100 people, then growing the Company
back to nearly 100 full time and part time employees.  This followed
the receipt of the Company’s award, from DARPA, largely conceived by Mr. Groen,
for its important Heliplane contract.   Following the completion
of Phase I of the Heliplane contract and the onset of the current recession, Mr.
Groen undertook another major reduction in force, while at the same time
arranging funding that would permit the Company to continue research and
development on a smaller scale, while seeking major funding for the full
exploitation of its technology of autorotative flight.





Immediately prior to forming Groen
Brothers Aviation, David Groen was a founding partner and Chief Financial
Officer for Seagull Recycling Company.  Previously, he has held
numerous executive positions in the helicopter industry with Sales and
Marketing, Safety Officer, Branch Manager, and Chief Pilot
responsibilities.





Having extensive military and
commercial experience in helicopters, Mr. Groen has logged over 7,000 hours in
rotor-wing and fixed-wing aircraft.  Mr. Groen received his
Certificate of Graduation in 1970 from the U.S. Army Warrant Officer Flight
Training School, was awarded Army Aviator Wings and promoted to the rank of
Warrant Officer.  As a combat helicopter pilot and Aircraft Commander
in Vietnam, he flew hundreds of combat sorties.  He is qualified as a
pilot in most American and French helicopters, and has attended Aerospatiale
factory schools.





Over the years, Mr. Groen’s numerous
commercial helicopter missions have involved such work as EMS (emergency medical
service hospital air ambulance), power line construction and patrol,
topographical survey, USGS map making, wildlife management, predator control,
herd management, back country tour guides, heli-skiing, forest fire fighting,
long line seismic oil exploration, and wildcat on shore and off shore oil
drilling operations.





These years of commercial flying, added
to his tenure serving in management positions within the rotor-wing industry,
gave Mr. Groen a wealth of management and leadership experience in a variety of
related fields.  David Groen is co-author, along with his brother Jay,
of a best selling novel entitled Huey.





Robert (Robin) H.H. Wilson has
had a long and prominent career in aviation.  A U.S. citizen, he is a
native of Ireland, but began his career with Rolls-Royce Aero-Engines in
England, where he worked as an engineer for eight years, obtaining his
Engineering degree from Cambridge University.  During this period he
was a section leader on the development of the Tyne engine intended among other
applications as the powerplant for the Fairey Rotodyne, a large commercial
gyrodyne.





Mr.
Wilson left Rolls-Royce to attend graduate school, obtaining an MBA with High
Distinction from Harvard University.  From Harvard he joined TWA as a
Financial Analyst, where over the following seventeen years he held several Vice
President positions across many functional areas, including Planning, Marketing,
Maintenance and Engineering and finally Senior Vice President,
Operations.  He left TWA to become President of the Long Island
RailRoad, the nation’s oldest and largest passenger carrying
railroad.  His 31⁄2 years in this position were marked by significant
improvement in the railroad with a commendation by the U.S. Senate and New York
State legislature for outstanding performance.





39





Mr. Wilson returned to aviation as
President of Western Airlines, where he participated in the build up of its Salt
Lake City hub as part of the team that managed the major turnaround of that
carrier and merger with Delta.  Later, he was appointed President of
Burlington Air Express, before returning to Ireland, as Chief Technical Officer
of Guinness Peat Aviation, then the world’s largest aircraft leasing
company.





Following TWA’s Chapter 11 filing in
1992, Mr. Wilson was asked to return to TWA as Co-Chief Executive to take the
company out of bankruptcy.  When this was accomplished, he remained as
Vice Chairman until new management was recruited.  He then became a
partner in the international aviation consultancy, SH&E, advising
Governments, Banks, Airlines and other parties on aviation matters over a
five-year period.





In August
2001 he joined Groen Brothers Aviation as Chief Financial Officer and Head of
Business Development.  Late in 2003, he took on added responsibility
for GBA and AAI Marketing and Sales, while relinquishing his CFO role to Mr.
Gauger when he joined the Company.  Subsequently, he was appointed
Executive Vice President and Chief Operating Officer and joined the Board
following the death of Jay Groen..





Communications
Between Shareholders and the Board of Directors





Our Board of Directors has not adopted
a formal procedure that shareholders must follow to send communications directly
to it.  The Board of Directors does receive communication from
shareholders, from time to time, and addresses those communications as
appropriate.  Shareholders can send communication to the Board of
Directors in one of the following ways:





·
            In
      writing, to Groen Brothers Aviation, Inc., 2640 West California Avenue,
      Suite A, Salt Lake City, Utah 84104, Attention of Board of
      Directors





·
            By
      Email, at directors@groenbros.com.





We did
not hold an annual meeting of shareholders during the fiscal year ended June 30,
2008.





Section
16(a) Beneficial Ownership Reporting Compliance





Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our directors
and executive officers, and persons who own more than 10% of a registered class
of the Company’s equity securities, to file initial reports of ownership and
reports of changes in ownership with the SEC.  Such persons are
required by SEC regulations to furnish us with copies of all Section 16(a) forms
they file.





Based
solely on the review of the copies of such forms received by us or written
representations from certain reporting persons, that no other reports were
required, management of the Company believes that all filing requirements
applicable to its officers, directors, and greater than 10% beneficial owners
were complied with during the year ended June 30, 2008.





40





Committees
of the Board of Directors





The two members of the Company’s Board
of Directors, none of whom is deemed independent pursuant to Rule 4200 of the
National Association of Securities Dealers' listing standards, currently serve
as the Audit Committee and Compensation Committee of the Board.  The
Company does not have a standing nominating committee and the Company’s entire
Board of Directors performs the functions that would customarily be performed by
a nominating committee.  The Board of Directors does not believe a
separate nominating committee is required at this time due to the limited size
of the Company’s business operations and the limited resources of the Company
which do not permit it to compensate its directors.  The Board of
Directors has not established policies with regard to the consideration of
director candidates recommended by security holders or the minimum
qualifications of such candidates.





Audit Committee





The Audit Committee of the Board of
Directors makes recommendations regarding the retention of the independent
registered public accounting firm, reviews the scope of the annual audit
undertaken by our independent registered public accounting firm and the progress
and results of their work, reviews the financial statements of the Company, and
oversees the internal controls over financial reporting and corporate programs
to ensure compliance with applicable laws. The Audit Committee reviews the
services performed by the independent registered public accounting firm and
determines whether they are compatible with maintaining the registered public
accounting firm’s independence. The Audit Committee currently does not have a
charter, and the two members of the Audit Committee are not independent
directors.  Our Board of Directors has determined that Robin Wilson is
an “audit committee financial expert,” as that term is defined by the rules and
regulations of the Securities and Exchange Commission.





In fulfilling its oversight
responsibilities, the Audit Committee has reviewed and discussed the audited
financial statements and discussed with the independent auditors the matters
required to be discussed by SAS 61.  Management is responsible for the
financial statements and the reporting process, including the system of internal
controls.  The independent auditors are responsible for expressing an
opinion on the conformity of those audited financial statements with generally
accepted accounting principles.





The Audit Committee discussed with the
independent auditors the auditors' independence from the management of the
Company and received written disclosures and the letter from the independent
accountants required by Independence Standards Board Standard No.
1.





After review and discussions, the Audit
Committee approved the audited financial statements included in the Company's
Annual Report on Form 10-K for the year ended June 30, 2008.  The
Audit Committee also selected HJ & Associates, LLC as the Company’s
independent registered public accounting firm for the fiscal year ending June
30, 2008.





Compensation
Committee





The Compensation Committee of the Board
of Directors reviews and approves executive compensation policies and practices,
reviews salaries and bonuses for our officers, administers our stock option
plans and other benefit plans, and considers other matters as
required.  The Company’s President and Chief Executive Officer and its
Chief Operating Officer are members of the Compensation Committee and such
persons participate in determining the amount and form of executive and director
compensation.  To date, the Company has not engaged independent
compensation consultants to determine or recommend the amount or form of
executive or director compensation.





The Board
of Directors held one formal meeting during the 2008 fiscal year, including
meetings held by telephone conference call.  All of the directors
attended all of such meetings.  In addition, the directors met on
numerous occasions during fiscal 2008 for informal discussions and took action
by unanimous written consents in lieu of meetings.





41





Code
of Ethics





We have adopted Standards of Conduct
applicable to all employees and a Statement of Corporate Values, also applicable
to all employees.  Our Standards of Conduct is being filed as an
exhibit to this report and is also available on our web site.








Item
11. Executive
Compensation





The
following table summarizes all compensation earned by or paid to our President,
Chief Executive Officer and Chief Financial Officer and our Executive Vice
President and Chief Operating Officer (the “Named Executive Officers”) for
services rendered in all capacities for the years ended June 30, 2008 and
2007.





Summary
Compensation Table


Name
      and
              Principal
      Position
            Year
            Salary
            Bonus
            Stock
              Awards
            Option
              Awards
              (1)
            Non-Equity
              Incentive
      Plan
              Compensation
            Change
      in
              Pension
      Value
              and
      Non-
              Qualified
              Deferred
              Compensation
              Earnings
              (2)
            All
              Other
              Compensation
            Total(a)
            (b)
            (c)
            (d)
            (e)
            (f)
            (g)
            (h)
            (i)
            (j)David
      Groen (3)
            2008
            $147,692
            $-
            $-
            $  130,314
            $-
            $
      160,000
            $   4,517
            $
      442,523President,
      Chief Executive Officer and Chief Financial Officer
            2007
            $133,827
            $-
            $-
            $  146,758
            $-
            $
      160,000
            $   1,186
            $
      441,771Robin
      Wilson (4)
            2008
            $137,692
            $-
            $-
            $  84,972
            $-
            $
      145,000
            $   13,019
            $
      380,683Executive
      Vice President and Chief Operating Officer
            2007
            $124,038
            $-
            $-
            $139,139
            $-
            $
      145,000
            $   11,154
            $
      419,331


____________





(1)
            The
      amounts in column (f) reflect the dollar amount of stock-based
      compensation expense recognized for financial statement reporting purposes
      for the years ended June 30, 2008 and 2007 in accordance with SFAS
      123(R).


(2)
            The
      amounts in column (h) reflect the additions to deferred compensation
      payable during the years ended June 30, 2008 and 2007.  The
      deferred compensation is payable in part or in whole only by resolution of
      the Company’s Board of Directors and when not precluded by the Company’s
      financing agreements.


(3)
            The
      other compensation paid to Mr. Groen in fiscal years 2008 and 2007
      consists of matching contributions made by the Company pursuant to the
      Company’s Profit Sharing 401(k)
Plan.


(4)
            The
      other compensation paid to Mr. Wilson in fiscal years 2008 and 2007
      consists of matching contributions made by the Company pursuant to the
      Company’s Profit Sharing 401(k)
Plan.





42





Employment
Agreements





Effective
August 12, 2007 annual salaries for David Groen and Robin Wilson were
established at $150,000 and $140,000, respectively, with no additional
compensation for service on the Company’s Board of Directors.  We do
not have written employment agreements with our executive officers.





Deferred
Compensation





In
addition to cash compensation, we have a deferred compensation arrangement for
executive officers and certain of our senior management that accrues additional
salary, with amounts originating from fiscal year 1998 through the current
fiscal year.  The terms of our Series B Preferred Stock preclude us
from making any deferred compensation payments until all outstanding amounts due
relating to the Series B Preferred Stock have been paid in
full.  Absent payment restrictions related to outstanding Series B
Preferred Stock or other restrictions, the deferred compensation is payable in
part or in whole only by resolution of the Company’s Board of
Directors.  Through June 30, 2008, the Board of Directors has not
authorized payment of any of the deferred compensation, and will not authorize
payments until the Board determines such payments are allowed under our
outstanding financing agreements and would be prudent in light of our financial
condition and availability of cash.  Deferred compensation totaling
$4,722,000, related accrued payroll taxes of $171,000 and related accrued
interest payable of $299,000 are classified as long-term liabilities at June 30,
2008.    In fiscal year 2001, we began accruing interest
expense on the deferred compensation at the rate of 8% per annum.  The
accrual of interest was permanently discontinued on July 1, 2004.  At
June 30, 2008, deferred compensation and related interest accrued to the Named
Executive Officers were as follows:





Deferred
              Compensation
            Accrued
              Interest
            TotalDavid
      Groen
            $1,719,354
            $179,711
            $1,899,065Robin
      Wilson
            937,139
            41,158
            928,297




43





Stock
Option Plan





The following table summarizes the
outstanding stock options held by the Named Executive Officers at June 30,
2008.





Outstanding
Equity Awards at Fiscal Year-End





Option
      AwardsName
            Number
      of
              Securities
              Underlying
              Unexercised
              Options
      (#)
              Exercisable
            Number
      of
              Securities
              Underlying
              Unexercised
              Options
      (#)
              Unexercisable
            Equity
      Incentive
              Plan
      Awards:
              Number
      of
              Securities
              Underlying
              Unexercised
              Unearned
      Options
              (#)
            Option
              Exercise
              Price
      ($)
            Option
              Expiration
              Date(a)
            (b)
            (c)
            (d)
            (e)
            (f)David
      Groen
            50,000
            -
            -
            0.25
            12/30/2008David
      Groen
            1,925,000
            -
            -
            0.25
            10/19/2009David
      Groen
            3,000,000
            -
            -
            1.00
            10/19/2009David
      Groen
            562,500
            187,500
            -
            0.25
            6/20/2011David
      Groen
            1,137,500
            1,137,500
            -
            0.25
            8/13/2011David
      Groen
            61,050
            123,950
            -
            0.15
            10/31/2011David
      Groen
            500,000
            1,000,000
            -
            0.18
            11/16/2011David
      Groen
            -
            50,000
            -
            0.17
            9/16/2012David
      Groen
            125,000
            500,000
            -
            0.08
            3/5/2015David
      Groen
            3,076,923
            -
            -
            0.07
            5/14/2010Robin
      Wilson
            50,000
            -
            -
            0.25
            12/30/2008Robin
      Wilson
            1,000,000
            -
            -
            0.25
            4/30/2009Robin
      Wilson
            1,950,000
            -
            -
            0.25
            9/22/2009Robin
      Wilson
            1,000,000
            -
            -
            0.25
            6/23/2010Robin
      Wilson
            1,000,000
            -
            -
            1.00
            6/23/2010Robin
      Wilson
            562,500
            187,500
            -
            0.25
            6/20/2011Robin
      Wilson
            500,000
            500,000
            -
            0.25
            8/13/2011Robin
      Wilson
            36,300
            73,700
            -
            0.15
            10/31/2011Robin
      Wilson
            -
            50,000
            -
            0.17
            9/16/2012Robin
      Wilson
            -
            583,333
            -
            0.08
            3/5/2015





Columns
(g) through (j) have been omitted since we have not granted any stock
awards.





Under our
2000 amended and restated stock option plan (Plan), there are 60 million shares
that are authorized for stock options.  We may issue both
non-qualifying stock options and qualifying incentive stock
options.  All stock options have an exercise price that is not less
than 100 percent of the fair market value on the date of the
grant.  While expiration dates vary on particular grants, no stock
options may be exercised more than ten years after the date of
grant.  Qualifying incentive stock options are granted only to
employees, while non-qualifying options may be granted to employees, directors,
and non-employees.





On May 17, 2002 and June 10, 2005,
we filed Form S-8 Registration Statements (“Registration”) for the Plan under
the Securities Act of 1933.    Options granted under the
Plan  can be exercised for unrestricted and free trading common
stock.  We have determined not to permit the exercise of stock options
granted under the Plan until such time as we are current in the filing of
periodic reports with the SEC.





Our Board of Directors may also
authorize the issuance of other stock options and warrants outside of the
Plan.





44





Compensation
of Directors





We paid
no cash fees or other consideration to our directors for service as directors
during the fiscal year ended June 30, 2008. We have made no agreements regarding
future compensation of directors. All directors are entitled to reimbursement
for reasonable expenses incurred in the performance of their duties as members
of the Board of Directors.








Item
12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.





The
following tabulation shows, as of October 28, 2009, the number of shares of
common stock, no par value, and the number of shares of Series A preferred stock
owned beneficially by: (a) all persons known to be the holders of more than five
percent (5%) of voting securities, (b) Directors, (c) the Named Executive
Officers and (d) all other Senior Officers and Directors as a
group:





Amount
      and Nature of
              Beneficial
      Ownership (1)Name and Address
      of
              Beneficial
      Owner
            Common
      Shares
            Series
      A
              Preferred
      Shares
            
            Total
      Voting
              Shares(6)Shares
            %
            Shares
            %
            
            Shares
            %Principal
      StockholdersDennis
      Gauger
              2640
      W. California Ave.
              Salt
      Lake City, Utah 84104
            4,415,000
            (4)
            2.6
            125,000
            8.9
            
            16,915,000
            5.4Margaret
      Groen
              2640
      W. California Ave.
              Salt
      Lake City, Utah 84104
            6,605,100
            (5)
            3.9
            125,000
            8.9
            
            19,105,100
            6.1Officers
      and DirectorsDavid
      Groen
              2640
      W. California Ave.
              Salt
      Lake City, Utah 84104
            26,255,530
            (2)
            15.3
            1,025,000
            73.2
            
            128,755,530
            41.4Robin
      Wilson
              2640
      W. California Ave.
              Salt
      Lake City, Utah 84104
            6,424,444
            (3)
            3.8
            125,000
            8.9
            
            18,924,444
            6.1All
      officers and directors as a group (2 persons)
            32,679,974
            
            19.1
            1,150,000
            82.1
            
            147,679,974
            47.5




45





(1)
            Unless
      otherwise indicated, each person identified in the table has sole voting
      and investment power with respect to the common stock beneficially owned
      by such person.  The total number of outstanding shares included
      in the computation of percentages is
  171,317,499.


(2)
            Includes
      10,820,607 shares owned by David Groen, 2,453,000 shares beneficially
      owned held by family trusts and 12,981,923 options exercisable by David
      Groen at October 28, 2009 or within 60 days of October 28,
      2009.


(3)
            Includes
      300,000 shares owned by Robin Wilson, 100,000 shares beneficially owned
      held by family trusts and 6,024,444 options exercisable by Robin Wilson at
      October 28, 2009 or within 60 days of October 28,
  2009.


(4)
            Includes
      50,000 shares owned by Dennis Gauger and 4,365,000 options exercisable by
      Dennis Gauger at October 28, 2009 or within 60 days of October 28,
      2009.


(5)
            Includes
      4,055,100 shares beneficially owned by Margaret Groen held by a trust and
      by the estate of Jay Groen, 1,500,000 options exercisable by Margaret
      Groen at October 28 2009 or within 60 days of October 28, 2009, and
      1,050,000 options beneficially owned and exercisable by a trust and by the
      estate of Jay Groen at October 28, 2009 or within 60 days of October 28,
      2009.


(6)
            Each
      share of Series A preferred stock entitles the holder to cast one hundred
      (100) votes on all matters submitted to the stockholders for a vote,
      voting together with the holders of the common stock as a single
      class.





David
Groen, President and Chief Executive Officer, owns 1,025,000 shares of the
Company’s Series A Convertible Preferred Stock, and Robin Wilson, Executive Vice
President and Chief Operating Officer, Dennis Gauger, former officer and
director, and Margaret Groen, the surviving spouse of the late Jay Groen, each
owns 125,000 shares of the Company’s Series A Convertible Preferred Stock,
combined representing 100% of the outstanding shares of that series of preferred
stock.  Each share of the Series A Convertible Preferred Stock
entitles the holder to cast one hundred (100) votes, or a total of 140,000,000
votes on all matters submitted to the stockholders for a vote, voting together
with the holders of the common stock of the Company as a single
class.








Item
13.              Certain
Relationships and Related Transactions, and Director Independence





Related
Party Transactions





At June 30, 2008, we had a note payable
to David Groen of $228,000, plus accrued interest totaling
$25,000.  The note bears interest at 8% and is due on
demand.





At June 30, 2008, we had two notes
payable to Robin Wilson totaling $254,000, plus accrued interest totaling
$79,000.  The notes bear interest at 8% and are due on
demand.





At June
30, 2008, our current liabilities included short-term notes payable to related
parties (including the notes payable to executive officers discussed in the two
preceding paragraphs), primarily stockholders of the Company, totaling
$17,483,000, with accrued interest payable of $6,815,000.  Most of
these notes are unsecured, due on demand, and bear interest at annual rates
ranging from 5% to 50%.  Included in these notes payable at June 30,
2008 are notes payable totaling $6,733,000 that are technically in
default.  In addition, we are delinquent in making payments of accrued
interest payable of $2,782,000 on this related party debt at June 30,
2008.





At June 30, 2008, the Company had an
unsecured long-term note payable to a stockholder of $186,000, with an interest
rate of 12%.  Accrued interest payable on this related party long-term
debt was $76,000 at June 30, 2008.





At June 30, 2008, we had related party
accounts and notes receivable from employees and a former officer of the
Company, resulting primarily from cash advances, totaling $5,000, bearing
interest at 7% to 12%.  We have implemented a procedure to reduce the
note receivable from a former officer each quarter by offsetting amounts due to
the former officer by the Company for accrued compensation and interest
expense.





46





Royalty payments of 1% of the gross
sales price of gyroplanes are to be paid to our founders, David Groen and the
estate of the late Jay Groen.  Through June 30, 2008, royalties
payable totaled $16,000 to each of these parties, which amounts are included in
cost of sales in the accompanying consolidated statement of
operations.





Included in long-term accrued expenses
in the consolidated balance sheet at June 30, 2008 is deferred compensation
payable to twelve management employees or former employees, including officers
and directors of the Company, with amounts originating from fiscal year 1998
through fiscal year 2008.  In addition to cash compensation, we have a
deferred compensation arrangement for executive officers and certain of our
senior management that accrues additional salary.  The terms of our
Series B Preferred Stock preclude the Company from making any deferred
compensation payments until all outstanding amounts due relating to the Series B
Preferred Stock have been paid in full.  Absent payment restrictions
related to outstanding Series B Preferred Stock or other restrictions, the
deferred compensation is payable in part or in whole only by resolution of our
Board of Directors.  Deferred compensation totaling $4,722,000,
related accrued payroll taxes of $171,000 and related accrued interest payable
of $299,000 are classified as long-term liabilities at June 30,
2008.  Through June 30, 2008, the Board of Directors has not
authorized payment of any of the deferred compensation, and will not authorize
payments until the Board determines such payments are allowed under our
outstanding financing agreements and would be prudent in light of our financial
condition and availability of cash.  In fiscal year 2001, we began
accruing interest expense on the deferred compensation at the rate of 8% per
annum.  The accrual of interest was permanently discontinued on July
1, 2004.





Director
Independence





We currently do not have any directors
considered to be independent pursuant to Rule 4200 of the National Association
of Securities Dealers' listing standards.








Item
14.               Principal
Accountant Fees and Services





The
following schedule presents the professional fees incurred to HJ &
Associates, LLC, our independent registered accountants, for the fiscal years
ended June 30, 2008 and 2007.





2008
            
            
            2007Audit
      fees
            
            $
            88,750
            
            
            $
            56,800Audit
      related fees
            
            
            -
            
            
            
            -Tax
      fees
            
            
            5,167
            
            
            
            4,996Other
      fees
            
            
            -
            
            
            
            -Total
            
            $
            93,917
            
            
            $
            61,796





Audit
Feesconsist
offees billed for
professional services rendered by our principal accountant for the audit of our
financial statements, review of financial statements included in our quarterly
reports and other fees that are normally provided by the accountant in
connection with statutory and regulatory filings or engagements. Audit Related
Fees consist of fees billed for assurance and related services by our principal
accountant that are reasonably related to the performance of the audit or review
of our financial statements.Tax fees were for
preparation of federal and state income tax returns and related tax
consultation.





All professional fees paid to our
independent registered accountants are pre-approved by the Board of Directors of
the Company, acting in its capacity as the Audit Committee.





47





PART
IV





Item
15.               Exhibits
and Financial Statement Schedules




(a)
            Exhibits
      (filed with this report unless indicated
below)





3.1
            Amendment
      to Second Restated Articles of Incorporation of Groen Brothers Aviation,
      Inc. {1}





3.2
            Second Amendment to Second
      Restated Articles of Incorporation of Groen Brothers Aviation, Inc.(1)





3.3
            Third
      Restated Articles of Incorporation of Groen Brothers Aviation, Inc. (2)





3.4
            Amendment
      to Third Restated Articles of Incorporation of Groen Brothers Aviation,
      Inc. (3)





3.5
            Second
      Amendment to Third Restated Articles of Incorporation of Groen Brothers
      Aviation, Inc. (4)





3.6
            Amendment
      to Fourth Restated Articles of Incorporation of Groen Brothers Aviation,
      Inc. (5)





3.7
            Second
      Amendment to Fourth Restated Articles of Incorporation of Groen Brothers
      Aviation, Inc. (6)





3.8
            By-laws
      (4)





4.1
            Amended
      and Restated 2000 Option Plan (7)





10.1
            Amendment to the Common Stock
      Purchase Agreement Dated November 7, 2000(2)




10.2
              Form
      of SparrowHawk Dealer Agreement (4)





10.3
            Form
      of Amendment No. 2 to Securities Exchange Agreement (4)




10.4
              Form
      of Stock Option (4)




11
            Statement
      re: computation of per share earnings. (8)





14.1
            Groen Brothers Aviation Corporate
      Values(2)





48





14.2
            Standards of Conduct(2)





21
              Subsidiaries
      of the registrant. (8)


23.1
                Consent
      of Independent Registered Accounting
Firm


31.1
            Section
      302 Certification of Chief Executive and Chief Financial
      Officer




32.1
              Section
      1350 Certification of Chief Executive and Chief Financial
      Officer





(1)             Filed
as an exhibit to the Company’s report on Form 10-QSB for the quarter ended
December 31, 2003 and incorporated herein by reference.


(2)             Filed
as an exhibit to the Company’s report on Form 10-KSB for the year ended June 30,
2004 and incorporated herein by reference.


(3)             Filed
as an exhibit to the Company’s report on Form 10-QSB for the quarter ended
December 31. 2004 and incorporated herein by reference.


(4)             Filed
as an exhibit to the Company’s report on Form 10-KSB for the year ended June 30,
2005 and incorporated herein by reference.


(5)             Filed
as an exhibit to the Company’s Form 10-QSB for the quarter ended December 31,
2006 and incorporated herein by reference.


(6)             Filed
as an exhibit to the Company’s Report on Form 8-K filed May 11, 2007 and
incorporated herein by reference.


(7)             Filed
as an exhibit to the Company’s registration statement on Form S-8 filed June 10,
2005 and incorporated herein by reference.


(8)             Information
included in Notes to Consolidated Financial statements filed with this
report.





49





SIGNATURES








Pursuant to the requirements of Section
13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.








GROEN
      BROTHERS AVIATION, INC./s/ David
      GroenDavid
      Groen, President, Chief Executive Officerand
      Chief Financial Officer(Principal
      Executive and Principal Financial Officer)Date:  November
      10, 2009








Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.





Signatures
            Capacity
      in Which Signed
            Date/s/ David
      Groen
            Director
            November
      10, 2009David
      Groen/s/ Robert
      Wilson
            Director
            November
      10, 2009Robert
      Wilson








50





GROEN
BROTHERS AVIATION, INC.


Index
to Consolidated Financial Statements








Report
      of Independent Registered Public Accounting Firm – HJ & Associates,
      LLC
            F-2Consolidated
      Balance Sheets
            F-3Consolidated
      Statements of Operations
            F-4Consolidated
      Statements of Stockholders’ Deficit
            F-5Consolidated
      Statements of Cash Flows
            F-7Notes
      to Consolidated Financial Statements
            F-8











F-1





REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM








Board of
Directors and Shareholders of


Groen
Brothers Aviation, Inc.


Salt Lake
City, Utah








We have
audited the accompanying consolidated balance sheet of Groen Brothers Aviation,
Inc. as of June 30, 2008 and 2007, and the related consolidated statements of
operations, stockholders' deficit and cash flows for the two years then ended.
These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.





We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Groen Brothers
Aviation, Inc. as of June 30, 2008 and 2007, and the results of their operations
and their cash flows for the two years then ended in conformity with US
generally accounting principles.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note 2
to the consolidated financial statements, the Company’s operating losses and
lack of working capital raise substantial doubt about its ability to continue as
a going concern.  Management’s plans concerning these matters are also
described in Note 2.  The consolidated financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.





We were
not engaged to examine management’s assessment of the effectiveness of Groen
Brothers Aviation, Inc.’s internal control over financial reporting as of June
30, 2008 and, accordingly, we do not express an opinion thereon.











/s/ HJ
& Associates, LLC


Salt Lake
City, Utah


October
1, 2009




F-2








GROEN
      BROTHERS AVIATION, INC.Consolidated
      Balance Sheets





Assets
            
            June
      30,2008
            
            
            2007Current
      assets:Cash
            
            $
            3,000
            
            
            $
            60,000Accounts
      receivable, net of allowance of $7,000 in 2008
            
            
            14,000
            
            
            
            15,000Related
      party accounts and notes receivable
            
            
            5,000
            
            
            
            57,000Prepaid
      expenses
            
            
            6,000
            
            
            
            31,000Inventories
            
            
            -
            
            
            
            466,000Total
      current assets
            
            
            28,000
            
            
            
            629,000Property
      and equipment, net
            
            
            133,000
            
            
            
            681,000Total
      assets
            
            $
            161,000
            
            
            $
            1,310,000Liabilities and
      Stockholders’ DeficitCurrent
      liabilities:Bank
      overdraft
            
            $
            22,000
            
            
            $
            -Bank
      overdraft line of credit
            
            
            47,000
            
            
            
            -Accounts
      payable
            
            
            4,232,000
            
            
            
            3,534,000Accrued
      expenses
            
            
            9,429,000
            
            
            
            6,489,000Deferred
      revenue
            
            
            -
            
            
            
            634,000Notes
      payable
            
            
            564,000
            
            
            
            558,000Related
      party notes payable
            
            
            17,483,000
            
            
            
            13,443,000Series
      B 15% cumulative redeemable non-voting preferred stock, no par value,
      50,000,000 shares authorized, 68,095 and 58,771 shares issued and
      outstanding, respectively
            
            
            68,095,000
            
            
            
            58,771,000Total
      current liabilities
            
            
            99,872,000
            
            
            
            83,429,000Long-term
      liabilities:Accrued
      expenses
            
            
            5,192,000
            
            
            
            4,664,000Deferred
      revenue
            
            
            25,000
            
            
            
            25,000Long-term
      debt
            
            
            102,000
            
            
            
            109,000Related
      party long-term debt
            
            
            166,000
            
            
            
            931,000Dealer
      deposits
            
            
            2,105,000
            
            
            
            2,145,000Total
      liabilities
            
            
            107,462,000
            
            
            
            91,303,000Stockholders’
      deficit:Series
      A convertible preferred stock, no par value, 50,000,000 shares authorized,
      1,400,000 shares issued and outstanding
            
            
            70,000
            
            
            
            70,000Common
      stock, no par value, 500,000,000 shares authorized, 171,416,289 and
      154,522,431 shares issued and outstanding, respectively
            
            
            34,390,000
            
            
            
            31,861,000Accumulated
      deficit
            
            
            (141,761,000
            )
            
            
            (121,924,000
            )Total
      stockholders’ deficit
            
            
            (107,301,000
            )
            
            
            (89,993,000
            )Total
      liabilities and stockholders’ deficit
            
            $
            161,000
            
            
            $
            1,310,000





See
accompanying notes to consolidated financial statements





F-3





GROEN
      BROTHERS AVIATION, INC.Consolidated
      Statements of OperationsYears
      Ended June 30,2008
            
            
            2007Revenues
            
            $
            5,922,000
            
            
            $
            3,403,000Costs
      and expenses:Cost
      of sales
            
            
            7,331,000
            
            
            
            9,360,000Research
      and development
            
            
            1,500,000
            
            
            
            1,555,000General
      and administrative expenses
            
            
            3,028,000
            
            
            
            2,659,000Impairment
      loss
            
            
            504,000
            
            
            
            -Total
      costs and expenses
            
            
            12,363,000
            
            
            
            13,574,000Loss
      from operations
            
            
            (6,441,000
            )
            
            
            (10,171,000
            )Other
      income (expense):Related
      party interest income
            
            
            4,000
            
            
            
            5,000Interest
      and other income
            
            
            14,000
            
            
            
            13,000Gain
      on extinguishment of debt
            
            
            8,000
            
            
            
            26,000Interest
      expense
            
            
            (4,098,000
            )
            
            
            (2,740,000
            )Series
      B preferred stock interest expense
            
            
            (9,324,000
            )
            
            
            (12,550,000
            )Total
      other income (expense)
            
            
            (13,396,000
            )
            
            
            (15,246,000
            )Loss
      before income taxes
            
            
            (19,837,000
            )
            
            
            (25,417,000
            )Income
      tax benefit
            
            
            -
            
            
            
            -Net
      loss
            
            $
            (19,837,000
            )
            
            $
            (25,417,000
            )Net
      loss per share – basic and diluted
            
            $
            (0.13
            )
            
            $
            (0.17
            )Weighted
      average number of common shares outstanding – basic and
      diluted
            
            
            154,040,000
            
            
            
            147,446,000





See
accompanying notes to consolidated financial statements





F-4





GROEN
BROTHERS AVIATION, INC.


Consolidated
Statements of Stockholders' Deficit


Years
Ended June 30, 2008 and 2007





Series
      A ConvertiblePreferred
      Stock
            
            
            Common
      Stock
            
            
            AccumulatedShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Deficit
            
            
            TotalBalance
      forward, June 30, 2006
            
            
            1,400,000
            
            
            $
            70,000
            
            
            
            149,358,709
            
            
            $
            29,236,000
            
            
            $
            (96,507,000
            )
            
            $
            (67,201,000
            )Issuance
      of common stock for:
              Cash
            
            
            -
            
            
            
            -
            
            
            
            2,891,135
            
            
            
            578,000
            
            
            
            -
            
            
            
            578,000Accrued
      expenses
            
            
            -
            
            
            
            -
            
            
            
            427,495
            
            
            
            82,000
            
            
            
            -
            
            
            
            82,000Interest
      expense
            
            
            -
            
            
            
            -
            
            
            
            2,844,072
            
            
            
            457,000
            
            
            
            -
            
            
            
            457,000Prepaid
      interest to related parties -
              net
      of unamortized prepaidinterest of $86,000
            
            
            -
            
            
            
            -
            
            
            
            801,728
            
            
            
            36,000
            
            
            
            -
            
            
            
            36,000Reduction
      of deferred revenue
            
            
            -
            
            
            
            -
            
            
            
            175,000
            
            
            
            35,000
            
            
            
            -
            
            
            
            35,000Purchase
      of property and equipment
            
            
            -
            
            
            
            -
            
            
            
            300,000
            
            
            
            45,000
            
            
            
            -
            
            
            
            45,000Reduction
      in stock deposit
            
            
            -
            
            
            
            -
            
            
            
            150,000
            
            
            
            30,000
            
            
            
            -
            
            
            
            30,000Employer
      401(k) expense
            
            
            -
            
            
            
            -
            
            
            
            983,142
            
            
            
            187,000
            
            
            
            -
            
            
            
            187,000Services
            
            
            -
            
            
            
            -
            
            
            
            591,150
            
            
            
            114,000
            
            
            
            -
            
            
            
            114,000Finders’
      compensation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (35,000
            )
            
            
            -
            
            
            
            (35,000
            )Cancellation
      of shares
            
            
            -
            
            
            
            -
            
            
            
            (4,000,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      of stock options for:
              Interest
      expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            185,000
            
            
            
            -
            
            
            
            185,000Services
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            128,000
            
            
            
            -
            
            
            
            128,000Stock-based
      compensation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            783,000
            
            
            
            -
            
            
            
            783,000Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (25,417,000
            )
            
            
            (25,417,000
            )Balance,
      June 30, 2007
            
            
            1,400,000
            
            
            $
            70,000
            
            
            
            154,522,431
            
            
            $
            31,861,000
            
            
            $
            (121,924,000
            )
            
            $
            (89,993,000
            )





See
accompanying notes to consolidated financial statements





F-5








GROEN
BROTHERS AVIATION, INC.


Consolidated
Statements of Stockholders' Deficit Continued


Years
Ended June 30, 2008 and 2007





Series
      A ConvertiblePreferred
      Stock
            
            
            Common
      Stock
            
            
            AccumulatedShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Deficit
            
            
            TotalBalance
      forward, June 30, 2007
            
            
            1,400,000
            
            
            $
            70,000
            
            
            
            154,522,431
            
            
            $
            31,861,000
            
            
            $
            (121,924,000
            )
            
            $
            (89,993,000
            )Issuance
      of common stock for:
              Cash
            
            
            -
            
            
            
            -
            
            
            
            2,353,661
            
            
            
            259,000
            
            
            
            -
            
            
            
            259,000Accrued
      expenses
            
            
            -
            
            
            
            -
            
            
            
            2,095,060
            
            
            
            138,000
            
            
            
            -
            
            
            
            138,000Interest
      expense
            
            
            -
            
            
            
            -
            
            
            
            3,884,106
            
            
            
            499,000
            
            
            
            -
            
            
            
            499,000Repayment
      of debt
            
            
            -
            
            
            
            -
            
            
            
            5,402,271
            
            
            
            364,000
            
            
            
            -
            
            
            
            364,000Employer
      401(k) expense
            
            
            -
            
            
            
            -
            
            
            
            3,059,760
            
            
            
            306,000
            
            
            
            -
            
            
            
            306,000Services
            
            
            -
            
            
            
            -
            
            
            
            99,000
            
            
            
            10,000
            
            
            
            -
            
            
            
            10,000Adjustment
      to finders’ compensation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            15,000
            
            
            
            -
            
            
            
            15,000Issuance
      of stock options for:
              Interest
      expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            174,000
            
            
            
            -
            
            
            
            174,000Services
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            8,000
            
            
            
            -
            
            
            
            8,000Stock-based
      compensation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            701,000
            
            
            
            -
            
            
            
            701,000Contributed
      capital for debtextinguishment
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            55,000
            
            
            
            -
            
            
            
            55,000Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (19,837,000
            )
            
            
            (19,837,000
            )Balance,
      June 30, 2008
            
            
            1,400,000
            
            
            $
            70,000
            
            
            
            171,416,289
            
            
            $
            34,390,000
            
            
            $
            (141,761,000
            )
            
            $
            (107,301,000
            )





See
accompanying notes to consolidated financial statements





F-6





GROEN
      BROTHERS AVIATION, INC.Consolidated
      Statements of Cash FlowsYears
      Ended June 30,2008
            
            
            2007Cash
      flows from operating activities:Net
      loss
            
            $
            (19,837,000
            )
            
            $
            (25,417,000
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization expense
            
            
            248,000
            
            
            
            195,000Stock-based
      compensation
            
            
            701,000
            
            
            
            783,000Common
      stock issued for interest expense and prepaid interest
            
            
            499,000
            
            
            
            493,000Common
      stock issued for services
            
            
            10,000
            
            
            
            114,000Common
      stock issued for 401(k) expense
            
            
            306,000
            
            
            
            187,000Loss
      on debt extinguishment
            
            
            55,000
            
            
            
            -Stock
      options and warrants issued for interest expense
            
            
            174,000
            
            
            
            185,000Stock
      options and warrants issued for services
            
            
            8,000
            
            
            
            128,000Interest
      expense accrued on Series B preferred stock
            
            
            9,324,000
            
            
            
            12,550,000Interest
      expense added to debt principal
            
            
            13,000
            
            
            
            24,000Interest
      income added to related party notes receivable
            
            
            (3,000
            )
            
            
            (5,000
            )Gain
      on extinguishment of debt
            
            
            (8,000
            )
            
            
            (26,000
            )Impairment
      loss
            
            
            504,000
            
            
            
            -Loss
      on disposal of property and equipment
            
            
            46,000
            
            
            
            1,000(Increase)
      decrease in:Accounts
      and notes receivable
            
            
            1,000
            
            
            
            1,201,000Prepaid
      expenses
            
            
            25,000
            
            
            
            (29,000
            )Inventories
            
            
            449,000
            
            
            
            (23,000
            )Increase
      (decrease) in:Accounts
      payable
            
            
            626,000
            
            
            
            1,511,000Accrued
      expenses
            
            
            4,207,000
            
            
            
            2,551,000Deferred
      revenue
            
            
            (374,000
            )
            
            
            39,000Dealer
      deposits
            
            
            (40,000
            )
            
            
            -Net
      cash used in operating activities
            
            
            (3,066,000
            )
            
            
            (5,538,000
            )Cash
      flows from investing activities:Purchase
      of property and equipment
            
            
            (157,000
            )
            
            
            (197,000
            )Proceeds
      from the sale of property and equipment
            
            
            1,000
            
            
            
            22,000Increase
      in related party accounts and notes receivable
            
            
            (7,000
            )
            
            
            -Payments
      of related party notes receivable
            
            
            4,000
            
            
            
            22,000Net
      cash used in investing activities
            
            
            (159,000
            )
            
            
            (153,000
            )Cash
      flows from financing activities:Proceeds
      from the issuance of debt
            
            
            8,594,000
            
            
            
            6,778,000Repayment
      of debt
            
            
            (5,753,000
            )
            
            
            (1,590,000
            )Proceeds
      from the issuance of common stock and stock options
            
            
            259,000
            
            
            
            578,000Increase
      in bank overdraft and bank overdraft line of credit
            
            
            69,000
            
            
            
            -Payment
      of finders’ compensation on issuance of common stock
            
            
            (1,000
            )
            
            
            (19,000
            )Net
      cash provided by financing activities
            
            
            3,168,000
            
            
            
            5,747,000Net
      increase (decrease) in cash
            
            
            (57,000
            )
            
            
            56,000Cash,
      beginning of year
            
            
            60,000
            
            
            
            4,000Cash,
      end of year
            
            $
            3,000
            
            
            $
            60,000





See
accompanying notes to consolidated financial statements





F-7





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements








Note
1:   Organization and Summary of Significant Accounting
Policies





Organization and Principles of
Consolidation – The consolidated financial statements include the
accounts of Groen Brothers Aviation, Inc. and its wholly-owned subsidiary, Groen
Brothers Aviation USA, Inc. (“GBA-USA”), (collectively, the
“Company”).  All significant inter-company balances and transactions
have been eliminated.  The primary business purpose of the Company is
to develop, manufacture and market the gyroplane, which activities are
considered one business segment.





Concentration of Credit Risk –
The Company maintains its cash in bank deposit accounts which, at times, may
exceed federally insured limits.  The Company has not experienced any
losses in such accounts.  The Company believes it is not exposed to
any significant credit risk on cash and cash equivalents.





Cash and Cash Equivalents –
For purposes of the consolidated statements of cash flows, the Company considers
all cash and investments with original maturities to the Company of three months
or less to be cash equivalents.  The Company had no cash equivalents
at June 30, 2008 and 2007.





Accounts Receivable – Trade
accounts receivable are carried at original invoice amount less an estimate made
for doubtful accounts.  Management of the Company determines the
allowance for doubtful accounts by identifying potential troubled accounts and
by using historical experience and future expectations applied to an aging of
accounts.  Trade accounts receivable are written off when deemed
uncollectible.  Recoveries of trade accounts receivable previously
written off are recorded as income when received.  Management
determined that an allowance for doubtful accounts of $7,000 was required at
June 30, 2008, and no allowance for doubtful accounts was required at June 30,
2007.





Inventories – Raw materials
and parts inventories are stated at the lower of cost or market, with cost
determined using primarily the first-in-first-out (FIFO) method.  As a
result of the Company’s decision to cease production of the SparrowHawk, all
inventories were written off as of June 30, 2008.  Work-in-process
inventories at June 30, 2007 consisted of SparrowHawk kits which had not been
delivered in a completed status to customers.  The SparrowHawk kits
work-in-process inventories are stated at the lower of cost or market, with cost
determined on estimated average unit costs of the kits.  The cost of
parts inventories manufactured by the Company and work-in-process inventories
include an allocation of overhead costs comprised of labor, operating supplies,
utilities, depreciation, rent and other facility costs.





Contract-related expenses incurred on
by the Company on its long-term government and commercial contracts, including
its own labor, travel, supplies and other costs, and the costs of subcontractors
and consultants, are generally deferred as work-in-process inventories and
expensed to cost of sales as the contract revenue for each milestone of a
particular contract is recognized.  When a loss on a contract is
projected, however, all contract-related costs and expenses are expensed as
incurred.  At June 30, 2008 and 2007, the Company had no
work-in-process inventories related to long-term contracts.





F-8





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Property and Equipment –
Property and equipment are carried at cost, less accumulated depreciation and
amortization.  Depreciation and amortization are computed using
accelerated and straight-line methods based on the estimated useful lives of the
assets or term of the lease.  Depreciation and amortization expense
was $248,000 and $195,000 for the years ended June 30, 2008 and 2007,
respectively.  When assets are retired or otherwise disposed of, the
cost and related accumulated depreciation are removed and any resulting gain or
loss is recognized in operations for the period.  The cost of
maintenance and repairs is charged to operations as
incurred.  Significant renewals and betterments are
capitalized.





Impairment of Long-Lived
Assets – The Company periodically reviews its long-lived assets for
impairment when events or changes in circumstances indicate that the carrying
value of an asset may not be recoverable.  The Company evaluates, at
each balance sheet date, whether events and circumstances have occurred which
indicate possible impairment. The carrying value of a long-lived asset is
considered impaired when the anticipated cumulative undiscounted cash flows of
the related asset or group of assets is less than the carrying
value.  In that event, a loss is recognized based on the amount by
which the carrying value exceeds the estimated fair market value of the
long-lived asset.  As a result of the Company’s decision to cease
production of the SparrowHawk and the substantial decrease in its operations,
the Company recorded an impairment loss of $504,000 during the fourth quarter of
its fiscal year ended June 30, 2008.





Dealer Deposits – Dealer
deposits consist of amounts received from the Company’s authorized dealers on
aircraft in anticipation of full-scale production of the Company’s Hawk 4
gyroplane.  The deposit guarantees a delivery sequence number and
represents a percentage of the total estimated purchase price.  The
Company has also issued common stock to dealers as partial consideration for the
delay in the certification of the Hawk 4 gyroplane.  These costs have
been charged to interest expense as incurred.  The dealers have been
given the opportunity to convert a portion of their deposits into shares of the
Company’s restricted common stock.  Those dealers that have converted
deposits into shares and are now stockholders of the Company are considered
related parties.  The Company continues its efforts to obtain the
funding to complete the certification of the Hawk 4.  Once such
funding is obtained, the Company estimates the certification process will
require two to three years to complete.  Because of the long-term
prospects of obtaining the funding and completing the certification, dealer
deposits have been recorded as long-term liabilities.





Research and Development Costs
– Research and development costs are expensed as incurred in accordance with
SFAS No. 2, “Accounting for Research and Development Costs.”  The
costs of materials and other costs acquired for research and development
activities are charged to expense as incurred.  Salaries, wages, and
other related costs of personnel, as well as other facility operating costs are
allocated to research and development expense through management’s estimate of
the percentage of time spent by personnel in research and development
activities.  Research and development expenses were $1,500,000 and
$1,555,000 for the years ended June 30, 2008 and 2007,
respectively.





Revenue Recognition – The
Company recognizes revenues from goods and services when there is a binding
agreement, the product has been completely shipped or service has been
delivered, collection is reasonably assured, and the Company has no significant
obligations remaining.  Portions of the purchase price of the
Company’s products collected from customers in advance of product delivery are
recorded as deferred revenue.  Therefore, revenues from the sale of
SparrowHawk gyroplane kits are not recorded until all kit components and parts
are delivered to the customer and collection of any remaining amounts due is
reasonably assured.





F-9




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








The Company recognizes revenue on its
current government contract as each defined milestone is completed and the
requisite meetings are held and technical data submitted and accepted by
DARPA.  At that time, DARPA instructs the Company to submit an invoice
for payment for the respective milestone at the amount specified in the
contract.  Contract-related expenses incurred by the Company for each
milestone of the contract, including its own labor, travel, supplies and other
costs, and the costs of subcontractors and consultants, are deferred as
work-in-process inventory and expensed to cost of sales as the contract revenue
for the milestone is recognized.  When a loss on a contract is
projected, however, all contract-related costs and expenses are expensed as
incurred.





The Company recognizes revenue on
commercial and sub-contractor contracts as each scheduled phase of the contract
is completed and invoices are submitted.  Contract-related expenses
incurred by the Company for each phase of the contract, including its own labor,
travel, supplies and other costs, and the costs of subcontractors and
consultants, are deferred as work-in-process inventory and expensed to cost of
sales as the contract revenue for the milestone is recognized.  When a
loss on a contract is projected, however, all contract-related costs and
expenses are expensed as incurred.





Accounting Estimates – The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the 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.





Stock-Based Compensation – The
Company has adopted the fair value recognition provisions of SFAS
No. 123(R), Share Based
Payments, which requires the Company to measure the compensation cost of
stock options and other stock-based awards to employees and directors at fair
value at the grant date and recognize compensation expense over the requisite
service period for awards expected to vest.  The Company recorded
stock-based compensation expense of $701,000 and $783,000 for the years ended
June 30, 2008 and 2007, respectively.  The grant-date fair value of
stock options and other stock-based awards is estimated using the Black-Scholes
option-pricing model.  The stock-based compensation expense has been
allocated to the various categories of costs and expenses in a manner similar to
the allocation of payroll expense.





Non-Employee Stock Options and
Warrants –In accordance with SFAS No. 123, “Accounting for Stock-Based
Compensation”, the Company estimates the fair value of the consideration
recorded for stock options and warrants issued to non-employees using the
Black-Scholes option-pricing model.  For those stock options and
warrants that have variable characteristics, the Company will continue to use
this methodology to periodically reassess the fair value of the consideration to
determine if the value of the consideration recorded in the consolidated
financial statements requires adjustment.  Changes in the assumptions
used in the option-pricing model, including the market price of the Company’s
common stock and risk-free interest rates, may result in fluctuations in the
estimated fair value and carrying value of the consideration recorded for
variable non-employee stock options and warrants.





F-10





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Financial Instruments with
Characteristics of Both Liabilities and Equity – In May 2003, the FASB
issued SFAS No. 150, “Accounting for Certain Instruments with Characteristics of
Both Liabilities and Equity.”  This statement establishes standards
for how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity.  It requires that an
issuer classify a financial instrument that is within its scope as a liability
(or an asset in some circumstances).  The adoption of SFAS No. 150
resulted in the reporting of the Company’s Series B Preferred Stock as a
liability.  The carrying value of the Series B Preferred Stock was the
same before and after adoption of SFAS No. 150, and therefore no cumulative
effect adjustment was required.





Advertising – Advertising
costs are non-direct in nature, and are expensed over the periods in which the
advertising takes place.  Advertising expense totaled $1,000 and
$3,000 for the years ended June 30, 2008 and 2007,
respectively.





Income Taxes – The Company
accounts for income taxes according to the asset and liability
method.  The asset and liability method requires the recognition of
deferred tax liabilities and assets for the expected future tax consequences of
temporary differences between tax bases and financial reporting bases of
existing assets and liabilities.  Deferred tax assets and liabilities
are measured using enacted 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 income in the period that includes the
enactment date.





Loss per Common and Common Equivalent
Share – The computation of basic loss per common share is computed using
the weighted average number of common shares outstanding during each
year.





The computation of diluted loss per
common share is based on the weighted average number of shares outstanding
during the period plus common stock equivalents which would arise primarily from
the exercise of stock options and warrants outstanding using the treasury stock
method and the average market price per share during the
year.  Options and warrants to purchase 73,885,272 shares of common
stock at exercise prices ranging from $0.07 to $1.00 and 87,160,372 shares of
common stock at exercise prices ranging from $0.15 to $1.10 were outstanding at
June 30, 2008 and 2007, respectively.  Certain notes payable,
long-term debt and related accrued interest payable were convertible into a
total of 62,570,324 and 56,270,363 shares of common stock at June 30, 2008 and
2007, respectively, with conversion prices ranging from $0.10 to
$1.25.  Common stock equivalents were not included in the diluted loss
per share calculation because the effect would have been
antidilutive.





Restricted shares of common stock
issued as collateral for notes payable are excluded from the calculation of loss
per common share.





Reclassifications – Certain
amounts in the consolidated financial statements for fiscal year 2007 have been
reclassified to conform to the current year presentation.





Recently Issued Accounting
Pronouncements – The Financial Accounting Standards Board (FASB) has
issued Financial Interpretation No. 48, Accounting for Uncertainty in Income
Taxes – An Interpretation of FASB Statement No. 109(FIN
48).  FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting
for Income Taxes.FIN 48 also prescribes a recognition
threshold and measurement standard for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return.  In addition, FIN 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition.  The provisions of FIN 48 are to be applied
to all tax positions upon initial adoption of this standard.  Only tax
positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized upon adoption of
FIN 48.  The cumulative effect of applying the provisions of FIN 48
should be reported as an adjustment to the opening balance of retained earnings
(or other appropriate components of equity) for the fiscal year of
adoption.  The Company adopted the provisions of FIN 48 on July 1,
2007, with no impact on its consolidated financial statements.





F-11





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








In March
2008, the FASB issued Statement of Financial Accounting Standards (SFAS) No.
161, Disclosures about
Derivative Instruments and Hedging Activities.  This statement
changes the disclosure requirements for derivative instruments and hedging
activities.  Entities are required to provide enhanced disclosures
about (a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.  This
statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, or the Company’s fiscal year
beginning July 1, 2009, with early application encouraged.  This
statement encourages, but does not require, comparative disclosures for earlier
periods at initial adoption.  The Company is currently unable to
determine what impact the future application of this pronouncement may have on
its consolidated financial statements.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations.  This statement replaces SFAS No. 141, Business Combinations and
applies to all transactions or other events in which an entity (the acquirer)
obtains control of one or more businesses (the acquiree), including those
sometimes referred to as “true mergers” or “mergers of equals” and combinations
achieved without the transfer of consideration.  This statement
establishes principles and requirements for how the acquirer: a) recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree; b)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase; and c) determines what information to disclose to
enable users of the financial statements to evaluate the nature and financial
effects of the business combination.  This statement will be effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2008, or the Company’s fiscal year beginning July 1,
2009.  Earlier adoption is prohibited.  The Company is
currently unable to determine what impact the future application of this
pronouncement may have on its consolidated financial statements.





In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements.  This statement applies to
all entities that prepare consolidated financial statements, except
not-for-profit organizations, and amends Accounting Research Bulletin (“ARB”) 51
to establish accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary.  It also
amends certain of ARB 51’s consolidation procedures for consistency with the
requirements of SFAS No. 141 (revised 2007).  This statement will be
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008, or the Company’s fiscal year beginning
July 1, 2009.  Earlier adoption is prohibited.  The Company
is currently unable to determine what impact the future application of this
pronouncement may have on its consolidated financial statements.





F-12





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115. This statement permits entities to choose to measure many financial
instruments and certain other items at fair value.  Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option.  However, the amendment to SFAS No. 115 Accounting for Certain Investments
in Debt and Equity Securities applies to all entities with
available-for-sale and trading securities.  SFAS No. 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November
15, 2007, or the Company’s fiscal year beginning July 1, 2008.  Early
adoption is permitted as of the beginning of a fiscal year that begins on or
before November 15, 2007, provided the entity also elects to apply the provision
of SFAS No. 157, Fair Value
Measurements.  The adoption of this statement is not expected
to have a material effect on the Company's financial statements.





In
February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2, which
delays by one year the effective date of SFAS No. 157 for certain types of
non-financial assets and non-financial liabilities.  As a result, SFAS
No. 157 will be effective for financial statements issued for fiscal years
beginning after November 15, 2007, or the Company’s fiscal year beginning July
1, 2008, for financial assets and liabilities carried at fair value on a
recurring basis, and on July 1, 2009, for non-recurring non-financial assets and
liabilities that are recognized or disclosed at fair value.  The
Company adopted SFAS No. 157 on July 1, 2008 for financial assets and
liabilities carried at fair value on a recurring basis, with no material impact
on its consolidated financial statements.  The Company is currently
unable to determine what impact the application of SFAS No. 157 on July 1, 2009
for non-recurring non-financial assets and liabilities that are recognized or
disclosed at fair value will have on its consolidated financial
statements.





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements.  SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and requires enhanced disclosures about fair
value measurements.  SFAS No. 157 requires companies to disclose the
fair value of their financial instruments according to a fair value hierarchy as
defined in the standard.  Additionally, companies are required to
provide enhanced disclosure regarding financial instruments in one of the
categories, including a reconciliation of the beginning and ending balances
separately for each major category of assets and liabilities.  SFAS
No. 157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, or the Company’s fiscal year beginning July 1, 2008,
and interim periods within those fiscal years. The Company believes that the
adoption of SFAS No. 157 will not have a material impact on its consolidated
financial statements.





EITF No.
07-3, Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future
Research and Development Activities,was issued in June
2007.  The EITF reached a consensus that nonrefundable payments for
goods and services that will be used or rendered for future research and
development activities should be deferred and capitalized.  Such
amounts should be recognized as an expense as the related goods are delivered
and the related services are performed.  Entities should continue to
evaluate whether they expect the goods to be delivered or services to be
rendered.  If the entity does not expect the goods to be delivered or
services to be rendered, the capitalized advance payment should be charged to
expense.  This pronouncement is effective for financial statements
issued for fiscal years beginning after December 15, 2007 (the Company’s fiscal
year beginning July 1, 2008) and interim periods within those fiscal
years.  Earlier application is not permitted.  Entities are
required to report the effects of applying this pronouncement prospectively for
new contracts entered into on or after the effective date of this
pronouncement.  The Company currently is not a party to research and
development arrangements that include nonrefundable advance
payments.  To the extent that the Company enters into research and
development arrangements in the future that include nonrefundable advance
payments, the future application of this pronouncement may have a material
effect on its consolidated financial condition and results of
operations.





F-13





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
2:  Going Concern Uncertainty





The accompanying consolidated financial
statements have been prepared assuming that the Company will continue as a going
concern.  Because of recurring operating losses, the excess of current
liabilities over current assets, the stockholders’ deficit, and negative cash
flows from operations, there is substantial doubt about the Company’s ability to
continue as a going concern.





At June
30, 2008, the Company had total current liabilities of $99,872,000 and current
assets of $28,000, resulting in a working capital deficiency of
$99,844,000.  At June 30, 2008, the Company had a total stockholders’
deficit of $107,301,000.





The
Company has experienced a negative gross profit on sales of Sparrow Hawk kits
and the number of SparrowHawk kits sold has fallen below expectations, due in
part to lack of funding to finalize product development and to pay for increased
sales and marketing efforts.  In these circumstances, prospects of
reaching a satisfactory profit level in a deteriorating economic climate were
not promising.  As importantly, the Company determined that the kit
aircraft business, aimed at customers for their personal use could not be
readily compatible with the design, manufacture and marketing of more
sophisticated aircraft required by military and commercial
customers.  Therefore, in May 2008, the Company decided to cease
production of the SparrowHawk and to seek to sell the program to a buyer with
more compatible operating conditions and strategic interests.





The
Company has also experienced a negative profit margin on the DARPA contract,
which has reduced cash flows from operations.  Subsequent to June 30,
2008, DARPA announced the award of the Heliplane prime contractor position to
the Georgia Institute of Technology (GT) for Phase IB.  Since then,
the Company has been engaged as a GT subcontractor for rotor systems work of
Phase IB.





The
Company’s continuation as a going concern is dependent on attaining profitable
operations, obtaining additional outside financing and/or restructuring its debt
obligations, including its Series B Preferred Stock.  The Company has
funded losses from operations primarily from the issuance of debt to related
parties (current shareholders and lenders of the Company), the increase in
accounts payable and accrued expenses, and the sale of the Company’s restricted
common stock in private placement transactions, and will require additional
funding from these sources to sustain its future operations.





In order
to repay its debt obligations in full or in part when due, the Company will be
required to raise significant capital from other
sources.  Alternatively, the Company will be required to negotiate
further extensions of the Series B Preferred Stock maturity date and its notes
payable, as it has accomplished in the past.  There is no assurance,
however, that the Company will be successful in these efforts.





F-14





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Included
in current liabilities and the working capital deficiency at June 30, 2008 is a
$68,095,000 Series B Preferred Stock obligation.  On May 10, 2007, the
Company received the approval of the Series B Holders to extend the redemption
date of the Series B Preferred Stock from May 1, 2007 to June 16, 2007, or such
later date as agreed to in writing by at least 80% of the Series B
Holders.  Subsequently, the Series B Holders agreed in writing to an
extension of the redemption date from June 16, 2007, to June 30,
2008.





Subsequent
to June 30, 2008, as part of a Note Purchase Agreement between the Company and
the Series B Holders, the Company redeemed approximately half of the outstanding
Series B Stock in exchange for interest bearing notes, and the Series B Holders
agreed to an extension of the redemption date of the remaining Series B Stock
from June 30, 2008 to April 9, 2009.  Subsequently, the redemption
date was extended from April 9, 2009 to June 9, 2009, from June 9, 2009 to
August 9, 2009, and from August 9, 2009 to November 9, 2009, or such later date
as agreed to in writing by the holders of at least 80% of the outstanding shares
of Series B Preferred Stock.  In addition, the Series B Holders agreed
to provide the Company with monthly funding to cover its minimum cash needs in
excess of funding provided by payments from Georgia Tech for the Company’s work
on the DARPA contract.





Substantially all assets of the
Company, including its intellectual property, have been pledged as collateral
for the Company’s debt.





There can be no guarantee or assurance
that the Company will be successful in its ability to generate income from
operations or from the DARPA contract, or to raise capital at favorable rates or
at all.  The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.








Note
3:  DARPA Contract





The
Company announced on November 7, 2005 that the US Defense Advanced Research
Projects Agency (“DARPA”) has selected the Company to lead a team to design a
proof of concept high speed, long range, vertical takeoff and landing (“VTOL”)
aircraft.  This modern rotorcraft, named the “Heliplane” by DARPA, is
an intended demonstration vehicle for future gyrodynes to be used in combat
search and rescue roles.





In Phase
I of this potential multi-year $55 million four-phase program, the Company was
awarded a fifteen month $6.4 million contract to develop the preliminary design
and perform key technology demonstrations.   On September 19,
2007, the DARPA contract was modified, increasing the contract award for Phase I
from $6.4 million to $10.4 million, and extending the term of Phase I from
fifteen to twenty-three months.  On March 5, 2008, the DARPA contract
was modified, increasing the contract award for Phase I from $10.4 million to
$10.9 million, adding an intermediary Phase IB to the base contract, and
extending the term of the contract from twenty-three to thirty-six
months.  Phase I and Phase IB of this potential multi-year program
consist of developing the Heliplane through the level of the Preliminary Design
Review (PDR) and performance of key technology demonstrations.





Phase I
ended with a successful PDR in November 2007, except for final reports and some
continued work on completing a test article rotor blade for the
Heliplane.  The “kickoff meeting” for Phase IB took place in February
of 2008; however, the Company could no longer bridge the large financial gap
that this type of program, and the way it pays, created.  Thus, Phase
IB was suspended until a new contractor could be found to replace the Company in
its role as prime contractor for the Heliplane, with the Company to become the
primary “subcontractor” supplying rotor system design and analysis work in
support of Phase IB.





F-15





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Subsequent
to June 30, 2008, DARPA announced the award of the Heliplane prime contractor
position to the Georgia Institute of Technology (GT) for Phase
IB.  Since then, the Company has been engaged as a GT subcontractor
for rotor systems work of Phase IB.  Payments to the Company by GT are
expected to be paid on a monthly basis, significantly reducing the Company’s
cash flow risk from the Heliplane program.





Substantial
portions of Phase I payments are paid by the Company to subcontractors and
consultants hired by the Company.  Payments under this contract are
conditional upon the Company attaining several milestone objectives during the
course of Phase I of the contract.  Contracts for subsequent phases
are conditional on completion of Phase I and successor phases.





The
Company recognizes revenue on this contract as each defined milestone is
completed and the requisite meetings are held and technical data submitted and
accepted by DARPA.  At that time, DARPA will instruct the Company to
submit an invoice for payment for the respective milestone at the amounts
specified in the contract.  Because the Company has experienced a
negative profit margin on Phase I of the DARPA contract, all contract-related
costs and expenses are expensed as incurred.  Through June 30, 2008,
the Company recognized revenues totaling $9,860,000 from the DARPA contract,
$5,070,000 recognized in the fiscal year ended June 30, 2008, $2,440,000
recognized in the fiscal year ended June 30, 2007, and $2,350,000 recognized in
the fiscal year ended June 30, 2006.








Note
4:  Loss Per Common Share





The
computation of basic net loss per common share is computed using the weighted
average number of common shares outstanding during each period.  The
computation of diluted net loss per common share is based on the weighted
average number of shares outstanding during the period plus common stock
equivalents which would arise from the exercise of stock options and warrants
outstanding using the treasury stock method and the average market price per
share during the period, as well as common shares issuable upon the conversion
of debt to common stock.  Common stock equivalents were not included
in the diluted loss per share calculation because the effect would have been
antidilutive.





The calculation of the weighted average
number of common shares outstanding excludes common shares that have been issued
as collateral for certain notes payable to related parties (Note
9).  These collateral shares are restricted and bear a legend
prohibiting the holder from selling or transferring the shares at any
time.  The Company has assigned no value to these shares, and the
terms of the notes payable require the holder of the collateral shares to return
the shares to the Company when the applicable note and accrued interest are paid
in full.  At June 30, 2008, the Company had issued 5,350,000 shares of
common stock as collateral.





Note
5:  Related Party Accounts and Notes Receivable





Related party accounts and notes
receivable at June 30, 2008 and 2007 resulted primarily from cash advances to
employees, and include unsecured notes receivable totaling $5,000 and $37,000
from employees and former employees at June 30, 2008 and 2007, respectively,
which bear interest at 7% to 12% per annum.





F-16





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
6:  Detail of Certain Balance Sheet Accounts





Inventories consist of the following at
June 30:





2008
            
            
            2007Raw
      materials and parts
            
            $
            -
            
            
            $
            255,000Work-in-progress
            
            
            -
            
            
            
            197,000Finished
      goods
            
            
            -
            
            
            
            14,000$
            -
            
            
            $
            466,000





Property and equipment consists of the
following at June 30:





2008
            
            
            2007Equipment
      and tools
            
            $
            783,000
            
            
            $
            855,000Computer
      equipment and software
            
            
            564,000
            
            
            
            574,000Aircraft
            
            
            203,000
            
            
            
            388,000Vehicles
            
            
            71,000
            
            
            
            68,000Leasehold
      improvements
            
            
            46,000
            
            
            
            111,000Furniture
            
            
            57,000
            
            
            
            59,000Construction-in-progress
            
            
            -
            
            
            
            28,0001,724,000
            
            
            
            2,083,000Accumulated
      depreciation and amortization
            
            
            (1,591,000
            )
            
            
            (1,402,000
            )$
            133,000
            
            
            $
            681,000





Substantially all of the property and
equipment has been pledged as collateral for debt.





F-17





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Accounts payable consist of the
following at June 30:





2008
            
            
            2007Trade
      accounts payable
            
            $
            3,720,000
            
            
            $
            3,052,000Related
      party payables
            
            
            512,000
            
            
            
            482,000$
            4,232,000
            
            
            $
            3,534,000





Deferred
revenue consists of the following at June 30:





2008
            
            
            2007Related
      party customer advance payments
            
            $
            -
            
            
            $
            289,000Customer
      advance payments
            
            
            -
            
            
            
            345,000$
            -
            
            
            $
            634,000





Dealer
deposits consist of the following at June 30:





2008
            
            
            2007Related
      party dealer deposits
            
            $
            1,701,000
            
            
            $
            1,741,000Dealer
      deposits
            
            
            404,000
            
            
            
            404,000$
            2,105,000
            
            
            $
            2,145,000





Related parties consist of officers,
directors, employees and shareholders.





Note
7:  Accrued Expenses:





Accrued expenses reported as current
liabilities consist of the following at June 30:





2008
            
            
            2007Compensation
      and related taxes
            
            $
            1,243,000
            
            
            $
            789,000Related
      party interest
            
            
            7,175,000
            
            
            
            4,843,000Interest
            
            
            601,000
            
            
            
            506,000SparrowHawk
      customer deposits
            
            
            260,000
            
            
            
            -Loan
      fees payable
            
            
            -
            
            
            
            164,000Consulting
      fees
            
            
            45,000
            
            
            
            57,000Finders’
      compensation
            
            
            14,000
            
            
            
            33,000Royalties
      to related parties (Note 20)
            
            
            32,000
            
            
            
            25,000Other
            
            
            59,000
            
            
            
            72,000Total
            
            $
            9,429,000
            
            
            $
            6,489,000





Accrued related party interest payable
is comprised of interest expense payable on notes payable to related parties,
consisting primarily of stockholders of the Company.





F-18





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Long-term
accrued expenses consist of the following at June 30:





2008
            
            
            2007Deferred
      compensation
            
            $
            4,722,000
            
            
            $
            4,195,000Accrued
      payroll taxes on deferred compensation
            
            
            171,000
            
            
            
            160,000Accrued
      interest on deferred compensation
            
            
            299,000
            
            
            
            309,000Total
            
            $
            5,192,000
            
            
            $
            4,664,000








The deferred compensation is payable to
certain current and former officers, directors, and senior management executives
of the Company, with amounts originating from fiscal year 1998 through the
current fiscal year.  In addition to cash compensation, the Company
has a deferred compensation arrangement for executive officers and certain of
its senior management that accrues additional salary.  The terms of
the Company’s Series B Preferred Stock preclude the Company from making any
deferred compensation payments until all outstanding amounts due relating to the
Series B Preferred Stock have been paid in full.  Absent payment
restrictions related to outstanding Series B Preferred Stock or other
restrictions, the deferred compensation is payable in part or in whole only by
resolution of the Company’s Board of Directors.  Through June 30,
2008, the Board of Directors has not authorized payment of any of the deferred
compensation, and will not authorize payments until the Board determines such
payments are allowed under the Company’s outstanding financing agreements and
would be prudent in light of the Company’s financial condition and availability
of cash.  In fiscal year 2001, the Company began accruing interest
expense on the deferred compensation at the rate of 8% per annum.  The
accrual of interest was permanently discontinued on July 1, 2004.  The
deferred compensation and related accrued payroll taxes and interest payable are
classified as long-term liabilities at June 30, 2008 as the Company does not
anticipate payment of any of these amounts in the next twelve
months.




F-19





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
8:  Notes Payable





Current notes payable are comprised of
the following at June 30:





2008
            
            
            2007Unsecured
      notes payable to vendors with interest at 20% for the first three months
      and 25% thereafter, in default as of June 2007
            
            $
            251,000
            
            
            $
            269,000Unsecured
      note payable to a vendor with interest at 12%, in default as of June
      2007
            
            
            272,000
            
            
            
            272,000Unsecured
      note payable to an individual, with interest at 5%, due on
      demand
            
            
            24,000
            
            
            
            -Unsecured
      note payable to a company with interest at 10.5%, due on
      demand
            
            
            10,000
            
            
            
            10,000Current
      portion of long-term debt (Note 10)
            
            
            7,000
            
            
            
            7,000$
            564,000
            
            
            $
            558,000





Short-term notes payable include notes
payable to vendors totaling $523,000 and $541,000 that are technically in
default at June 30, 2008 and 2007, respectively.  In addition, the
Company is delinquent in making payments of accrued interest payable of $580,000
and $487,000 on this debt at June 30, 2008 and 2007,
respectively.  The Company continues ongoing negotiations with these
vendors and has, in most instances, been granted grace periods and extensions
without receipt of formal notices of default or threat of legal
action.





Note
9:  Related Party Notes Payable





Related party notes payable are
comprised of the following notes payable either due on demand or within the
twelve months at June 30:





2008
            
            
            2007Unsecured
      notes payable to stockholders with interest at 18%
            
            $
            3,848,000
            
            
            $
            3,755,000Unsecured
      note payable to stockholder with interest at 16%
            
            
            50,000
            
            
            
            50,000Unsecured
      notes payable to stockholders with interest at 12%
            
            
            4,506,000
            
            
            
            5,488,000Unsecured
      notes payable to stockholders with interest at 36%
            
            
            4,400,000
            
            
            
            1,400,000





F-20





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Unsecured
      note payable to stockholders with interest at 50%
            
            
            162,000
            
            
            
            558,000Unsecured
      notes payable to stockholders with interest at 24%
            
            
            1,161,000
            
            
            
            -Unsecured
      note payable to a stockholder with interest at 25%
            
            
            20,000
            
            
            
            20,000Unsecured
      note payable to stockholder with interest at 12.5%
            
            
            100,000
            
            
            
            100,000Unsecured
      note payable to stockholder with interest at 48%
            
            
            165,000
            
            
            
            -Unsecured
      notes payable to stockholders with interest at 8%
            
            
            869,000
            
            
            
            706,000Unsecured
      note payable to stockholder with interest at 5%
            
            
            188,000
            
            
            
            191,000Unsecured
      note payable to an entity owned by certain members of senior management,
      with interest at 12%
            
            
            184,000
            
            
            
            180,000Note
      payable to a stockholder with interest at 12%, secured by
      aircraft
            
            
            40,000
            
            
            
            -Note
      payable to a stockholder with interest at 18%, due on demand, secured by
      research and development parts
            
            
            50,000
            
            
            
            50,000Notes
      payable to stockholders with interest at 12%, secured by shares of the
      Company’s common stock
            
            
            470,000
            
            
            
            437,000Unsecured
      note payable to a stockholders with interest at 12%, convertible into
      shares of the Company’s common stock upon successful completion of
      proposed financing/recapitalization
            
            
            310,000
            
            
            
            310,000Unsecured
      note payable to a stockholder with interest at 18%, due May
      2009
            
            
            745,000
            
            
            
            -Notes
      payable to stockholders with interest at 10%, secured by shares of the
      Company’s common stock
            
            
            215,000
            
            
            
            198,000$
            17,483,000
            
            
            $
            13,443,000





Related
party notes payable at June 30, 2008 and 2007 include notes payable totaling
$6,733,000 and $2,270,000, respectively, which are technically in
default.  In addition, the Company is delinquent in making payments of
accrued interest payable of $2,782,000 and $434,000 on this related party debt
at June 30, 2008 and 2007, respectively.





F-21





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Certain
shareholder related party note holders may choose to convert outstanding
principal and interest balances to common stock of the Company.  The
conversion prices per share range from $0.20 per share to $1.25 per
share.  At June 30, 2008, $15,168,000 of principal and interest
is convertible into 56,081,180 shares of the Company’s common stock (see Note
12).





A total
of 5,350,000 shares of the Company’s common stock have been issued as collateral
for related party notes payable totaling $685,000 and $635,000 at June 30, 2008
and 2007, respectively (see Note 4).








Note
10:  Long-Term Debt





Long-term debt is comprised of the
following at June 30:





2008
            
            
            2007Unsecured
      note payable to a government-sponsored organization, due in monthly
      installments of $200 with final payment of $87,000 due December
      2010
            
            $
            92,000
            
            
            $
            95,000Capital
      lease obligations (Note 11)
            
            
            17,000
            
            
            
            21,000109,000
            
            
            
            116,000Less
      current portion (Note 8)
            
            
            (7,000
            )
            
            
            (7,000
            )Total
            
            $
            102,000
            
            
            $
            109,000








Related party long-term debt is
comprised of the following at June 30:





2008
            
            
            2007Unsecured
      note payable to a stockholder with interest at 12%, due February
      2010
            
            $
            166,000
            
            
            $
            186,000Unsecured
      note payable to a stockholder with interest at 18%, due May
      2009
            
            
            -
            
            
            
            745,000Total
            
            $
            166,000
            
            
            $
            931,000





The stockholders may choose to convert
outstanding principal and interest balances to common stock at $0.20 per
share.  At June 30, 2008, $262,000 of principal and interest is
convertible into 1,309,209 shares of the Company’s common stock (see Note
12).





F-22





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Future maturities of long-term debt are
as follows:





Years Ending June
      30:2009
            
            $
            7,0002010
            
            
            173,0002011
            
            
            92,0002012
            
            
            3,000275,000Less
      current portion
            
            
            (7,000
            )Long-term
      portion
            
            $
            268,000








Note
11:  Capital Lease Obligations





The Company has entered into capital
lease agreements with financial institutions for office
equipment.  Assets held under capital lease included in property and
equipment at June 30, 2008 and 2007 are as follows:





2008
            
            
            2007Office
      equipment
            
            $
            24,000
            
            
            $
            24,000Accumulated
      amortization
            
            
            (7,000
            )
            
            
            (3,000
            )$
            17,000
            
            
            $
            21,000





Amortization expense for assets under
capital lease is included with depreciation expense for all other depreciable
assets.





Future minimum lease payments are as
follows:





Year
      Ending June 30:2009
            
            $
            6,0002010
            
            
            6,0002011
            
            
            5,0002012
            
            
            3,00020,000Less
      amount representing interest
            
            
            (3,000
            )Present
      value of minimum lease payments (Note 10)
            
            $
            17,000




F-23


GROEN
BROTHERS AVIATION, INC.
 Notes
to Consolidated Financial Statements
 (Continued)





Note
12:  Preferred Stock





The
Company has authorized 200,000,000 shares of preferred stock having no par
value.  There are four series of preferred stock with 50,000,000
shares authorized within each series.  The rights, terms and
preferences of preferred stock are set by the Board of Directors.  As
of June 30, 2008, the Board of Directors has set rights, terms and preferences
of Series A and Series B Preferred Stock for issue.





Series
A Convertible Preferred Stock





As of
June 30, 2008 and 2007, 1,400,000 shares of Series A Convertible Preferred Stock
were issued and outstanding, and held by the following: David Groen, President
and member of the Board of Directors, 1,025,000 shares; Robin Wilson, member of
the Board of Directors 125,000 shares; the widow of the late Jay Groen 125,000
shares; and Dennis Gauger, former member of the Board of Directors, 125,000
shares.





The
rights, terms and preferences of the Series A Convertible Preferred Stock, as
amended, are summarized as follows:





·
            Each
      share may cast one hundred (100) votes on all matters submitted to the
      stockholders for a vote, voting together with the holders of the common
      stock of the Company as a single class, effectively giving current voting
      control to the Company's founders.





·
            The
      voting rights expire seven years from the date of
  issue.





·
            Upon,
      and only upon, the Company reaching significant revenue milestones, the
      shares are convertible into common stock of the Company through payment of
      a cash conversion price of $0.50 per share of common stock, convertible on
      a one-for-one hundred (1:100) basis (100 shares of common stock for each
      share of Series A Convertible Preferred Stock).  Conversion is
      allowed at the rate of 25% of the preferred shares for each $30 million in
      defined cumulative gross sales, for a total of $120 million in
      sales.  This convertibility is also only available if these
      significant revenue milestones are met within seven years from the date of
      issue of the Series A Convertible Preferred
  Stock.





·
            The
      shares, including all voting and conversion rights, to the extent not
      converted into common shares, will expire seven years from the date of
      issue, and will be cancelled by the
Company.





·
            Upon
      the death or permanent incapacity of a holder of Series A Convertible
      Preferred Stock, all shares held by such holder will be divided equally
      between the then existing members of the Company’s Board of Directors and
      the holder’s survivor(s) (if more than one person, treated collectively as
      one person).  Upon a temporary mental incapacity of a holder of
      Series A Convertible Preferred Stock, all shares will be voted by the
      remaining holders of the Series A Convertible Preferred Stock until the
      end of the temporary incapacity.





·
            The
      shares are non-transferable, non-assignable, and have no dividend or
      liquidation rights.





F-24





GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Series B Preferred Stock





At June 30, 2008 and 2007, there were
68,095 and 58,771 shares of Series B 15% Cumulative Redeemable Non-Voting
Preferred Stock (the “Series B Preferred Stock”) outstanding,
respectively.  The rights, terms, and preferences of the outstanding
preferred shares, as amended, are as follows:





·
            The
      shares have no voting rights other than those voting rights provided under
      applicable laws.





·
            Each
      share’s original Stated Value, upon which unpaid dividends may accumulate,
      is $1,000.





·
            The
      shares have right to dividends at a 15% annual dividend rate, payable in
      cash or in kind at the end of each fiscal quarter.  Accumulated
      but unpaid dividends shall be cumulative and shall be added to the Stated
      Value for purposes of subsequent quarterly dividend
      calculations.





·
            The
      shares shall have superior liquidation priority to any other series of the
      Company’s capital stock, equal to the Stated Value plus all accrued but
      unpaid dividends thereon.





·
            The
      redemption price of the shares must be paid by the Company in
      cash.





·
            The
      Company may incur indebtedness of up to $18.5 million without consent of
      the holders of the shares.





·
            The
      Company is required to give notice to holders of the shares prior to
      making any capital expenditures in excess of
  $300,000.





·
            The
      maturity date of the shares is defined as the first to occur of (a) June
      15, 2007, or such later date as agreed to in writing by at least 80% of
      the holders of the Series B Preferred Stock (“Series B Holders”), (b) the
      occurrence of a defined “liquidation event”, or (c) the date that is six
      months following the receipt by the Company or its affiliates of proceeds
      from one or more financing transactions in excess of $50
      million.





·
            The
      Company is required to make pro rata redemptions of the shares months from
      the date that the Company receives proceeds from certain financing
      transactions that exceed $20 million in the
  aggregate.





On October 11, 2005, the Series B
Holders extended the redemption date of the Series B Preferred Stock from
October 31, 2005 to January 1, 2007.  The extension required the
following consideration to be paid to the Series B Holders:





·
            The
      cancellation on October 11, 2005 of existing warrants issued to the Series
      B Holders to purchase 2.5 million shares of the Company’s common stock at
      an exercise price of $0.30 per
share.





·
            The
      issuance on October 11, 2005 of warrants to purchase 6.85 million shares
      of the Company’s common stock exercisable through January 1, 2009 at an
      exercise price of $0.30 per share.





·
            The
      issuance of additional shares of Series B Preferred Stock with a
      redemption value of $10.7 million face value (10,700 shares) on January 1,
      2007, with reductions in the number of shares to be issued allowed for
      repayments during the extension period of amounts due to the Series B
      Holders in accordance with an agreed-upon
  formula.





F-25




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








On
February 13, 2007, the Series B Holders further extended the redemption date to
May 1, 2007.  On May 10, 2007, the Series B Holders agreed to an
extension of the redemption date of the Series B Preferred Stock to June 16,
2007, or such later date as agreed to in writing by at least 80% of the Series B
Holders.  Subsequently, the Series B Holders agreed in writing to an
extension of the redemption date June 16, 2007, to June 30, 2008.





Subsequent
to June 30, 2008, as part of a Note Purchase Agreement between the Company and
the Series B Holders, the Company redeemed approximately half of the outstanding
Series B Stock in exchange for interest bearing notes, and the Series B Holders
agreed to an extension of the redemption date of the remaining Series B Stock
from June 30, 2008 to April 9, 2009.  Subsequently, the redemption
date was extended from April 9, 2009 to June 9, 2009, from June 9, 2009 to
August 9, 2009, and from August 9, 2009 to November 9, 2009, or such later date
as agreed to in writing by the holders of at least 80% of the outstanding shares
of Series B Preferred Stock.  In addition, the Series B Holders agreed
to provide the Company with monthly funding to cover its minimum cash needs in
excess of funding provided by payments from Georgia Tech for the Company’s work
on the DARPA contract.





The
Company reviewed the requirements of Emerging Issues Task Force (EITF) No. 02-4,
Determining Whether a Debtor’s
Modification or Exchange of Debt Instruments Is Within the Scope of FASB
Statement 15,and determined that the extension of the redemption date of
the original issuance of the Company’s Series B Preferred Stock in October 2003
met the criteria of a troubled debt restructuring outlined in Statement of
Financial Accounting Standards (SFAS) No. 15, Accounting for Debtors and Creditors
for Troubled Debt Restructurings.No gain or loss was recorded on the
October 2003 extension and subsequent extension of the due date in October
2005.  The value of the warrants issued to the Series B Holders in
connection with the extensions of the due dates, estimated by the Black-Scholes
option pricing model, was charged to interest expense.  The Series B
Preferred Stock will be classified through its redemption as a troubled debt
restructuring.





Included
in the periodic interest expense on the Series B Preferred Stock is the
accretion of the $10,700,000 obligation to issue 10,700 shares of additional
Series B Preferred Stock on January 1, 2007, calculated on the interest
method.  The 10,700 additional shares of Series B Preferred Stock were
issued in January 2007.





As a result of amendments to the
features of the Series B Preferred Stock, if the Company is successful in
raising the levels of funding that it requires to bring its debt obligations
current, fund its planned operations, and complete aircraft certification
requirements for its Hawk 4 gyroplane, significant portions of this funding may
be required to make redemption payments on the Series B Preferred Stock in
advance of the maturity date.  At June 30, 2008 and 2007, the recorded
value of the Series B Preferred Stock was $68,095,000 and $58,771,000,
respectively, which was recorded as a current liability.





Statement of Financial Accounting
Standards No. 150 (SFAS 150), “Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity,” establishes standards for how
an issuer classifies and measures in its statement of financial position certain
financial instruments with characteristics of both liabilities and
equity.  SFAS 150 requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) because that financial instrument embodies an obligation of the
issuer.  Many of those instruments were previously classified as
equity.  The Company’s Series B Preferred Stock is classified as a
liability because it embodies an obligation of the Company and falls within the
scope of SFAS 150.  Preferred Stock accretion and dividends are
expensed as interest expense.





F-26




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
13:  Common Stock





During
the year ended June 30, 2008, the Company issued a total of 16,893,858 shares of
its restricted common stock, primarily to accredited investors, in private
placement offerings exempt from registration.  These shares were
issued at prices per share of $0.04 to $0.20, with the prices per share recorded
in these equity transactions approximating the quoted market price of the
Company’s common stock.  The shares were issued for the following
consideration: 2,353,661 shares for cash of $259,000; 2,095,060 shares in
payment of accrued expenses of $138,000; 3,884,106 shares in payment of interest
expense of $499,000; 5,402,271 shares in repayment of debt of $364,000;
3,059,760 shares in payment of the Company’s matching contribution to its 401(k)
plan of $306,000; and 99,000 shares in payment of services of
$10,000.  In addition, common stock was increased by $15,000 to adjust
finders’ compensation on the sale of common stock.  The Company did
not use underwriters in the sale or placement of these unregistered shares of
common stock.





During
the year ended June 30, 2007, the Company issued a total of 9,163,722 shares of
its restricted common stock, primarily to accredited investors, in private
placement offerings exempt from registration.  These shares were
issued at prices per share of $0.14 to $0.25, with the prices per share recorded
in these equity transactions approximating the quoted market price of the
Company’s common stock.  The shares were issued for the following
consideration: 2,891,135 shares for cash of $578,000; 427,495 shares in payment
of accrued expenses of $82,000; 3,645,800 shares in payment of interest expense
and prepaid interest expense of $493,000; 175,000 shares in reduction of
deferred revenue of $35,000; 300,000 shares to purchase property and equipment
of $45,000; 150,000 shares in reduction of stock deposit of $30,000; 983,142
shares in payment of the Company’s matching contribution to its 401(k) plan of
$187,000; and 591,150 shares in payment of services of $114,000.  In
addition, total finders’ compensation on the sale of common stock totaled
$35,000.  The Company did not use underwriters in the sale or
placement of these unregistered shares of common stock.





During
the year ended June 30, 2008, the Company issued options to purchase a total of
40,177,921 shares of common stock:  2,367,075 options to investors in
connection with the sale of common stock of the Company with exercise prices of
$0.07 to $0.20 per share exercisable for periods of 1 to 2
years;  6,293,954 options as loan fees or interest expense to lenders
with exercise prices of $0.07 to $0.20 per share exercisable for a period of 1
to 2 years; and 31,516,892 options to employees with exercise prices of $0.07 to
$0.17 per share exercisable for a period of 5 to 7 years (granted under the
Company’s employee stock option plan for which a Form S-8 registration statement
has been filed).





During
the year ended June 30, 2008, the Company issued warrants to purchase a total of
3,400,000 shares of common stock as loan fees or interest expense to lenders
with exercise prices of $0.16 to $0.27 per share exercisable for a period of
three years.





F-27




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








The
Company estimated the combined value of the 6,293,954 options and the 3,400,000
warrants issued to lenders in the year ended June 30, 2008 at $174,000 using the
Black-Scholes option pricing model, and charged this amount to interest
expense.  This amount has been reduced by $76,000 for the periodic
adjustments to the value of 3,200,000 variable stock options issued during the
year ended June 30, 2006 computed using the Black-Scholes option pricing
model.  The Company also charged a total of $8,000 to general and
administrative expense for the current year vesting of the grant date fair value
of 500,000 options issued to a non-employee consultant.





During
the year ended June 30, 2007, the Company issued options to purchase a total of
23,638,788 shares of common stock:  4,575,385 options to investors in
connection with the sale of common stock of the Company with exercise prices of
$0.20 to $0.25 per share exercisable for periods of 1 to 2
years;  2,868,403 options as loan fees or interest expense to lenders
with exercise prices of $0.16 to $0.25 per share exercisable for a period of 1
to 3 years; 1,500,000 options to an individual for services with an exercise
price of $0.18 per share exercisable for a period of five years; and 14,695,000
options to employees with exercise prices of $0.14 to $0.25 per share
exercisable for a period of 5 to 7 years (granted under the Company’s employee
stock option plan for which a Form S-8 registration statement has been
filed).





During
the year ended June 30, 2007, the Company issued warrants to purchase a total of
420,000 shares of common stock as loan fees or interest expense to lenders with
exercise prices of $0.16 to $0.24 per share exercisable for a period of five
years.





The
Company estimated the combined value of the 2,868,403 options and the 420,000
warrants issued to lenders in the year ended June 30, 2007 at $185,000 using the
Black-Scholes option pricing model, and charged this amount to interest
expense.  This amount has been reduced by $6,000 for the periodic
adjustments to the value of 3,200,000 variable stock options issued during the
year ended June 30, 2006 computed using the Black-Scholes option pricing
model.  The Company estimated the value of the 1,500,000 options
issued to an individual for services at $120,000 using the Black-Scholes option
pricing model, and charged this amount to general and administrative
expense.  The Company also charged a total of $8,000 to general and
administrative expense for the current year vesting of the grant date fair value
of 500,000 options issued to a non-employee consultant.





The Company has issued shares of its
common stock as collateral for certain notes payable to related
parties.  These collateral shares are restricted and bear a legend
prohibiting the holder from selling or transferring the shares at any
time.  The legend will only be removed if the Company is in default on
the applicable loan, at which time, a new certificate will be issued and a value
recorded for the shares to account for the loan and accrued interest
settled.  In addition, the terms of the notes payable require the
holder of the collateral shares to return the shares to the Company when the
applicable loan and accrued interest are paid in full.  To date, the
Company has not defaulted on any loan where common stock has been pledged as
collateral.  Under this assumption, the Company believes it is
appropriate to not assign any value to the collateral shares issued and to not
include these shares in the calculation of loss per share.  At June
30, 2008 and 2007, the Company had issued 5,350,000 shares of common stock as
collateral.





The
Company was a plaintiff in connection with four million shares of the Company’s
common stock issued for the purposes of obtaining a foreign loan in Luxembourg
in 1993.  In that suit, the Company obtained injunctions in Germany
and Luxembourg preventing those shares from being sold or
liquidated.  The Company prevailed in the case at appellate
levels.  The Company obtained a court order from Luxembourg to have
the certificates returned to the Company.  The shares were returned to
the Company and were cancelled in May 2007.





F-28




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








The conversion prices per share of the
convertible notes payable and long-term debt disclosed in Notes 9 and 10 were
based on the cash price per common share paid in private placement transactions
on or near the date the debt agreements were negotiated.  The cash
price per common share and the conversion prices per share approximated the
quoted market price per share of the Company’s common stock on or near the date
the note agreements were negotiated.  The conversion prices per share
have all been set at the market price of the common stock, or above the market
price whenever possible, with market price typically established at the price
per share that the Company was selling restricted common shares for cash at the
time.  Because the conversion price per share was generally “under
water” in substantially all of these transactions, the Company concluded that
the conversion terms did not represent a beneficial conversion
feature.  Therefore, no beneficial conversion features have been
accounted for in the Company’s consolidated financial statements for these
transactions.





Note
14:  Stock Option Plan and Stock Based Compensation





The
Company accounts for stock-based compensation in accordance with SFAS No.
123(R), Share Based
Payments.Under the fair value recognition provisions of this
statement, stock-based compensation cost is measured at the grant date based on
the value of the award granted using the Black-Scholes option pricing model, and
recognized over the period in which the award vests.  The stock-based
compensation expense for the years ended June 30, 2008 and 2007 has been
allocated to the various categories of operating costs and expenses in a manner
similar to the allocation of payroll expense as follows:





Years
      Ended June 30,2008
            
            
            2007Cost
      of sales
            
            $
            176,000
            
            
            $
            119,000Research
      and development
            
            
            386,000
            
            
            
            453,000General
      and administrative
            
            
            139,000
            
            
            
            211,000Total
      stock-based compensation expense realized
              and increase in net loss
            
            $
            701,000
            
            
            $
            783,000





There was
no stock compensation expense capitalized during the years ended June 30, 2008
and 2007.





F-29




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








The
following table summarizes the stock option and warrant activity during the year
ended June 30, 2008:





Options
      and
              Warrants
            Weighted
              Average
              Exercise
      Price
            Weighted
              Average
              Remaining
              Contract
      Term
            Aggregate
              Intrinsic
      ValueOutstanding
      at June 30, 2007
            87,160,000
            $   0.27Granted
            43,578,000
            0.11Exercised
            -
            -Cancelled
            (30,456,000)
            0.15Expired
            (26,397,000)
            0.32Outstanding
      at June 30, 2008
            73,885,000
            0.28
            2.63
            $     0Options
      vested and exercisable at June 30, 2008
            62,106,000
            0.30
            2.15
            $     0





The
aggregate intrinsic value in the preceding table represents the total pretax
intrinsic value, based on the Company’s closing stock price of $0.04 per share
as of June 30, 2008, which would have been received by the holders of
in-the-money options had the option holders exercised their options as of that
date.





As of
June 30, 2008, the total future compensation cost related to non-vested
stock-options not yet recognized in the condensed consolidated statements of
operations was $779,000, and the weighted average period over which these awards
are expected to be recognized was 0.90 years.





The grant
date fair value of the stock options and warrants issued during the year ended
June 30, 2008 was estimated using the Black-Scholes option pricing model with
the following weighted average assumptions:





Expected
      dividend yield
            $    -Expected
      stock price volatility
            50.29%Risk-free
      interest rate
            3.12%Expected
      life of options and warrants
            1 –
      7 years





Under the Company’s 2000 amended and
restated stock option plan (Plan), there are 60 million shares that are
authorized for stock options.  The Company may issue both
non-qualifying stock options and qualifying incentive stock
options.  All stock options have an exercise price that is not less
than 100 percent of the fair market value on the date of the
grant.  While expiration dates vary on particular grants, no stock
options may be exercised more than ten years after the date of
grant.  Qualifying incentive stock options are granted only to
employees, while non-qualifying options may be granted to employees, directors,
and non-employees.





F-30




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








On May 17, 2002 and June 10, 2005, the
Company filed Form S-8 Registration Statements (“Registration”) for the Plan
under the Securities Act of 1933.  Options granted under the Plan
prior to the filing of the 2002 Registration can only be exercised for
restricted common stock as defined under the Securities and Exchange Commission
Rule 144.  Options granted under the Plan after the 2002 Registration
can be exercised for unrestricted and free trading common stock.





The Company’s Board of Directors may
also authorize the issuance of other stock options and warrants outside of the
Plan.








Note
15:  Income Taxes





The benefit for income taxes differs
from the amount computed at the federal statutory rate as follows:





Years
      Ended June 30,2008
            
            
            2007Income
      tax benefit at federal statutory rate
            
            $
            7,736,000
            
            
            $
            9,913,000Series
      B preferred stock interest expense
            
            
            (3,636,000
            )
            
            
            (4,895,000
            )Stock
      and stock options issued for services and interest
            
            
            (543,000
            )
            
            
            (737,000
            )Research
      and development credit
            
            
            152,000
            
            
            
            161,000Other
            
            
            (4,000
            )
            
            
            (4,000
            )Change
      in valuation allowance
            
            
            (3,705,000
            )
            
            
            (4,438,000
            )$
            -
            
            
            $
            -




F-31




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)






Deferred
tax assets (liabilities) as of June 30, 2008 and 2007 are as
follows:




2008
            
            
            2007Net
      operating loss carryforwards
            
            $
            27,108,000
            
            
            $
            25,567,000Research
      and development credit carryforward
            
            
            2,379,000
            
            
            
            2,227,000Accrued
      interest payable
            
            
            2,849,000
            
            
            
            1,889,000Accrued
      payroll and related
            
            
            2,438,000
            
            
            
            1,840,000Deferred
      revenue
            
            
            101,000
            
            
            
            247,000Other
            
            
            15,000
            
            
            
            75,000Depreciation
            
            
            138,000
            
            
            
            (81,000
            )Inventories
            
            
            115,000
            
            
            
            -Valuation
      allowance
            
            
            (35,143,000
            )
            
            
            (31,764,000
            )$
            -
            
            
            $
            -





At June
30, 2008, the Company has net operating loss carryforwards available to offset
future taxable income of approximately $70 million which will begin to expire in
fiscal year 2009.  The utilization of the net operating loss
carryforwards is dependent upon the tax laws in effect at the time the net
operating loss carryforwards can be utilized.  The Tax Reform Act of
1986 limits the annual amount that can be utilized for certain of these
carryforwards as a result of changes in ownership of the Company.  An
ownership change may have occurred which may severely impact the utilization of
the net operating loss carryforwards.





Due to
uncertainties surrounding the realization of all carryforwards and currently
non-deductible accruals, a valuation allowance has been established to offset
the net deferred income tax asset resulting from such deferred tax
items.





The FASB
has issued Financial Interpretation No. 48, Accounting for Uncertainty in Income
Taxes – An Interpretation of FASB Statement No. 109 (FIN
48).  FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting
for Income Taxes.  Fin 48 requires a company to determine
whether it is more likely than not that a tax position will be sustained upon
examination based upon the technical merits of the position.  If the
more-likely-than-not threshold is met, a company must measure the tax position
to determine the amount to recognize in the financial statements.  As
a result of the implementation of FIN 48, the Company performed a review of its
material tax positions in accordance with recognition and measurement standards
established by FIN 48.





At the
adoption date of July 1, 2007, the Company had no unrecognized tax benefit which
would affect the effective tax rate if recognized.  There has been no
significant change in the unrecognized tax benefit during the year ended June
30, 2008.





The
Company classifies interest and penalties arising from the underpayment of
income taxes in the consolidated statements of operations under general and
administrative expenses.  As of June 30, 2008, the Company had no
accrued interest or penalties related to uncertain tax positions.





The
Company files income tax returns in the U.S. federal jurisdiction and certain
state jurisdictions.  All federal net operating loss carry forwards as
of June 30, 2008 are subject to examination.





F-32




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
16:  Supplemental Statement of Cash Flows Information





During the year ended June 30, 2008,
the Company:





·
            Decreased
      related party notes receivable through reduction of accrued expenses
      payable to related parties of
$10,000.





·
            Decreased
      inventory and increased property and equipment by
  $17,000.





·
            Acquired
      property and equipment of $78,000 through the issuance of accounts
      payable.





·
            Issued
      debt to acquire property and equipment of
  $5,000.





·
            Decreased
      property and equipment and debt by
$5,000.





·
            Issued
      2,095,060 shares of common stock in payment of accrued expenses of
      $138,000.





·
            Increased
      common stock and decreased accrued expenses by
  $15,000.





·
            Increased
      debt and decreased accrued expenses by $804,000 for the reclassification
      of interest payable.





·
            Issued
      5,402,271 shares of common stock in repayment of debt of
      $364,000.





·
            Increased
      accrued expenses and decreased deferred revenue by
    $260,000.





·
            Decreased
      related party accounts and notes receivable by $26,000, decreased accrued
      expenses by $6,000, and decreased related party long-term debt by
      $20,000.





·
            Decreased
      related party accounts and notes receivable and accrued expenses by
      $22,000.





During
the year ended June 30, 2007, the Company:





·
            Decreased
      related party notes receivable through reduction of accrued expenses
      payable to related parties of
$10,000.





·
            Decreased
      inventory and increased property and equipment by
  $6,000.





·
            Acquired
      property and equipment of $127,000 through the issuance of accounts
      payable.





·
            Issued
      debt to acquire property and equipment of
  $11,000.





F-33




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








·
            Issued
      300,000 shares of common stock to acquire property and equipment of
      $45,000.





·
            Increased
      related party notes payable and decreased accounts payable by $96,000 for
      the transfer of accounts payable to
debt.





·
            Issued
      427,495 shares of common stock in payment of accrued expenses of
      $82,000.





·
            Issued
      175,000 shares of common stock in repayment of deferred revenue of
      $35,000.





·
            Increased
      accrued expenses and decreased common stock by $35,000 for accrued
      finders’ compensation.





·
            Issued
      150,000 shares of common stock in reduction of stock deposits of
      $30,000.





·
            Increased
      debt and decreased accrued expenses by $490,000 for the reclassification
      of interest payable.





·
            Issued
      10,700 shares of Series B Preferred Stock, resulting in an increase to
      Series B cumulative redeemable non-voting preferred stock and a decrease
      to liability to issue additional shares of Series B preferred stock of
      $10,700,000.





Actual cash paid for interest was
$79,000 and $195,000 in fiscal years 2008 and 2007,
respectively.





No amounts were paid for income taxes
in the fiscal years 2008 and 2007.








17:  Operating
Lease Obligations





The Company leases certain property,
vehicles and facilities under noncancellable operating leases.  Future
minimum rental payments required under these leases are as follows:





Years Ending June
      30,
            
            Amount2009
            
            $
            258,0002010
            
            
            271,0002011
            
            
            73,000$
            602,000





Rental expense for non-cancellable
operating leases was $348,000 and $324,000 for the years ended June 30, 2008 and
2007, respectively.





F-34




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
18:  401(k) Saving Plan





The Company has a 401(k) Plan (the
Plan) to provide retirement and incidental benefits for its
employees.  Employees may contribute from 1% to 25% of their gross pay
to the Plan, limited to a maximum annual amount as set periodically by the
Internal Revenue Service.  The Company may contribute a matching
contribution at a rate set by the Board of Directors.  The Plan
operates on a calendar year basis.  In fiscal years 2008 and 2007, and
based on contributions by employees during calendar years 2007 and 2006, the
Company made matching contributions to the Plan of $306,000 and $187,000,
respectively, in the form of shares of its common stock.  Shares
issued under the Plan are “restricted” as defined under the rules of the
Securities and Exchange Commission.








Note
19:  Commitments and Contingencies





Royalty payments of 1% of the gross
sales price of gyroplanes are to be paid to the Company’s founders, David Groen
and the estate of the late Jay Groen.  As of June 30, 2008 and 2007,
royalties payable totaled $16,000 and $12,500 to each of these parties,
respectively.  The royalty expense is included in cost of sales in the
consolidated statement of operations.





The Company has royalty agreements with
two holders of notes payable totaling $300,000 which entitle the note holders to
receive royalties on the sales by the Company of certain gyroplanes other than
the SparrowHawk gyroplane.  The royalties are calculated on each
aircraft sold, and are limited to a combined maximum total of $1.3
million.





The Company has a royalty agreement
with an investor entitling the investor to receive royalties equal to $2,500 for
each Hawk 4 Gyroplane sold, limited to a maximum total of $125,000.





The Company has various agreements to
compensate individuals and companies with finders’ compensation up to 10% for
securing debt and equity financing for the Company.





The Company is subject to various
claims and legal actions arising in the ordinary course of business, including
certain matters relating to past due amounts due creditors.  The past
due amounts are recorded as liabilities in the consolidated balance sheet, and
management of the Company believes that the amount, if any, that may result from
other claims will not have a material adverse effect on the consolidated
financial statements.








Note
20:  Fair Value of Financial Instruments





The Company’s financial instruments
consist of cash, receivables, payables, and notes payable.  The
carrying amount of cash, receivables and payables approximates fair value
because of the short-term nature of these items.  The aggregate
carrying amount of the notes payable approximates fair value as the individual
borrowings bear interest at market interest rates.




F-35




GROEN
BROTHERS AVIATION, INC.


Notes
to Consolidated Financial Statements


(Continued)








Note
21:  Subsequent Events





DARPA Contract -In January
2009, DARPA awarded the Heliplane prime contractor position to the Georgia
Institute of Technology (GT) for Phase IB of the DARPA
contract.  Since then, the Company has been engaged as a GT
subcontractor for rotor systems work of Phase IB.





Series B Preferred Stock -On
October 9, 2008, as part of a Note Purchase Agreement between the Company and
the Series B Holders, the Company redeemed approximately half of the outstanding
Series B Stock in exchange for interest bearing notes, and the Series B Holders
agreed to an extension of the redemption date of the remaining Series B
Preferred Stock from June 30, 2008 to April 9, 2009.  Subsequently,
the redemption date was extended from April 9, 2009 to June 9, 2009, from June
9, 2009 to August 9, 2009, and from August 9, 2009 to November 9, 2009, or such
later date as agreed to in writing by the holders of at least 80% of the
outstanding shares of Series B Preferred Stock.





Also as
part of the Note Purchase Agreement, the Series B Holders, through the purchase
of the Company’s promissory notes, agreed to provide the Company with monthly
funding to meet minimum operating capital needs for a period up to the end of
January 2009.  Subsequent to the end of January, 2009, the Series B
Holders and the Company have twice amended the October 9, 2008 Note Purchase
Agreement, continuing to provide funding to meet the Company’s monthly minimum
financial needs.  Pursuant to the Note Purchase Agreement, monthly
funding will be provided up through a fixed amount that management of the
Company anticipates will cover its minimum cash needs in excess of the funding
provided by payments from Georgia Tech for the Company’s continued work on the
DARPA Heliplane.





With the extension of the due dates of
the remaining Series B Preferred Stock and the Note Purchase Agreement,
substantially all assets of the Company, including its intellectual property,
have been pledged as collateral for the Company’s debt.






F-36