<DOCUMENT><TYPE>hyfs1stqtr10qsb2004<SEQUENCE>1<FILENAME>hyfs1stqtr10qsb2004<DESCRIPTION>10QSB33104<TEXT>

 

United StatesSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

*(**MarkOne)*

[XX] QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

> 
For the quarterly period ended  March 31, 2004

*or*

[   ] TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

> 
For the transition period from  _______ to________

Commission File Number:  **333-33134**

**HYBRID FUEL SYSTEMS, INC.**(Exact name of registrant asspecified in its charter)

                                **Georgia **                                                                                               **58-2267238**(State or other jurisdiction ofincorporation or organization)                                           (I.R.S. Employer Identification No.)

**12409 Telecom Drive, Tampa, Florida 33637**(Address of principal executiveoffices) (Zip Code)

**(813)-979-9222**(Registrant's telephone number,including area code)

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ___  No   X  

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct). Yes ___   No  X  

APPLICABLE ONLY TO ISSUERS INVOLVEDIN BANKRUPTCYPROCEEDINGS DURING THE PRECEDINGFIVE YEARS:

Indicate by check mark whether theregistrant has filed all documents and reports required to be filed by Sections12, 13 or 15(d) of the Securities Exchange Act of1934 subsequent to the distribution of securities under a plan confirmed by acourt. Yes ___   No ___

APPLICABLE ONLY TO CORPORATEISSUERS:

Indicate the number of sharesoutstanding of each of the issuer's classes of common stock, as of the latestpracticable date.  **At October 29, 2004, the Company had 42,215 Series A Preferred Shares and 195,209 Series B PreferredShares outstanding.  At October 29, 2004, the Company had 48,031,580 of its$0.001 par value common shares outstanding.  **

Item 1 - Financial Statements

> 
Consolidated Balance Sheets for the three-monthperiods ended March 31, 2004 and 2003Statement of Operations for the three month periods ended March 31, 2004 and2003Statement of Changes in Stockholders' Equity for the three month period endedMarch 31, 2004Statement of Cash Flows for the three month periods ended March 31, 2004 and2003Notes to unaudited financial statements

Item 2 - Management's Discussion and Analysis of FinancialCondition and Results of Operations

Item 5 - Other Information

Item 6 -Exhibitsand Reports on Form 8-K

Item 7 - Litigation

Signatures

 

PART I - FINANCIAL INFORMATION

HYBRID FUEL SYSTEMS, INC.Consolidated Balance Sheets

> March 31, 2004 December 31, 2003**(Unaudited)** **(Audited)**
**ASSETS**   **Current Assets**      Cash  $         40,319   $                        6    Accounts Receivable  $         75,299   $                10,953    Inventory  $         12,584   $                12,584    Other Receivables  $           5,394   $                 5,395    ** Total Current Assets**** $        133,596** ** $                29,938**    Property Plant and Equipment Net  $         15,577   $                15,577    ** Total Assets**** $        149,173** ** $                44,515**   
** LIABILITIES AND STOCKHOLDERS' EQUITY**   ** Current Liabilities**      Accounts Payable  $        365,447   $              398,558    Due to Related Parties  $        157,525   $              157,528    Due to related parties - convertible debt  $                -     $              179,746    Notes Payable Related Parties  $         22,289   $                      -      Sales and Payroll Taxes Payable  $        232,866   $              245,245    Debt in Default  $         89,965   $              123,272    Convertible Debt in Default  $        233,200   $              283,200    Current Portion - Long Term Note  $         83,306   $                      -      Other current liabilities  $         46,360  $                68,649** Total Current Liabilities**** $     1,230,958** ** $           1,456,198**    **Long-Term Liabilities**    Notes Payable - White Knight  $        428,800   $                      -    Redeemable Securities  $        530,000   $              530,000    ** Total Long-Term Liabilities**** $        958,800** ** $              530,000**   ** Total Liabilities**** $     2,189,758** ** $           1,986,198**   ** Shareholders' Equity**    Preferred Stock - A ($.01 par value;      42,215 authorized      42,215     issued and outstanding; liquidation preference $8.021)  $              422   $                    422   Preferred Stock - B ($.01 par value; 954,563 shares      authorized    195,209 shares issued and outstanding; liquidation preference     $1,002,291)  $           1,952   $                 1,952    Common Stock ($.001 par value; 20,000,000 shares      authorized    12,163,464 and 11,963,646 issued and outstanding   respectively)  $         12,164   $                12,164    Paid in Capital  $     3,852,714   $           3,852,712  Accumulated Deficit - Developmental Stage  $   (5,907,837)  $          (5,808,933)   ** Total Shareholders' Equity (Deficit)**** $   (2,040,587)** ** $          (1,941,683)**   ** Total Liabilities and Shareholders' Equity**** $        149,173** ** $                44,515**
*(see Notes to unaudited  Financial Statements)*
**HYBRID FUEL SYSTEMS, INC.  Statement of Operations

March 31, 2004 
March 31, 2003**(Unaudited)** **(Unaudited)**
**REVENUES**   Revenue from Product Sales $           80,092   $           48,778 Cost of product sales $           24,110   $           24,689    **Total revenues**** $           55,982** ** $           24,089**   
**EXPENSES**   Shipping $             1,439              $                890 Auto $                922              $             1,903 Rents & leases $             3,810              $           10,094 Utilities $             7,676              $             4,262 Insurance $             1,441              $           31,225 Travel $           10,519              $           10,049 Compensation $           85,298              $           10,635 Legal & accounting $           10,838              $           17,500 Professional fees $             1,520              $             4,440 Other operating expenses $             4,990              `  $             5,570 research and development $           15,933              $             2,887 Interest        -            -   Consulting Fees $           10,500   $           26,000    **Total Expenses**** $         154,886** ** $         125,455**   **Net Ordinary Income**** $                 (98,904)** ** $             (101,366)**   **Basic and diluted loss per share**** $             (0.01)** ** $             (0.01)**   Basic and diluted weighted average number of            common shares outstanding        12,054,742                     11,741,317            
*(see Notes to unaudited        Financial Statements)*
**HYBRID FUEL SYSTEMS,        INC.        Statement of Changes in Stockholders' Equity
 PreferredStock Common Stock  StockTotal** Shares**** Amount**** Shares**** Amount**** **** **** Paid-In****Accumulated****Subscription****Shareholders'****Series A****Series A****Series B****Series B****Shares****Amount****Capital****deficit****receivable****deficit** Balance at     11,313,646 $11,314 $3,412,981 $(4,653,538)     (200,000) $     (1,429,243)  December 31. 2001                     Sale of Preferred A     45,215       422           99,563  99,985 Sale of Preferred B   195,209   1,952        203,018  204,970 Payment of stock               subscription recvbl              200,000200,000 Sale of common          650,000       650      117,350  118,000  stock for cash           Net loss               (741,575) (741,575)           Balance at     45,215 $    422 195,209 $ 1,952 11,963,646 $11,964 $3,832,912 $(5,395,113) $           -   $       (1,547,863))  December 31, 2002                     Stock issued for          100,000       100         9,900  10,000  legal settlement           Issuance of stock              for conversion of note         100,000       100         9,900  10,000 Net loss             (413,820)            (413,820)           Balance at  45,215 $    422 195,209 $ 1,952 12,163,646 $12,164 $3,852,712 $(5,808,933) $           -   $(1,941,683)  December 31, 2003          Net loss       
$(98,904) 
$(98,904) Balance at  45,215 $    422 195,209 $ 1,952 12,163,646 $12,164 $3,852,712 $(5,907,837) $           -   $(2,040,587)  March 31, 2004          
*(see Notes to unaudited        Financial Statements)*
**HYBRID FUEL SYSTEMS, INC.        Statement of Cash Flows
 March 31, 2004March 31, 2003**      (Unaudited)****       (Unaudited)**Cash Flows from operating activities  Net Income(98,903)(101,367)Adjustments to reconcile net  income to net cash provided  by operating activities  Accounts Receivable(64,347)(23,263)Accounts Payable(33,110)8,142Employee Loans0(32,900)Notes and Loan Payable0(21,681)Notes Payable - White Knight249,0520Other current liabilities0(2,591)Federal PR Tax Settlement Pymt(12,377)0Sales Tax Payable(3)94  Net Cash provided by Operations139,216(72,199)  Cash Flows from financing activities  Notes & Loans Payable                                  (9,500)Paid-In Capital                              176,310  Net cash provided by financing activities 166,810  Cash Balance at End of Period40,318(6,884)Cash Balance at Beg of Period(3,377)128  Net Increase <Decrease> in Cash36,941(6,756)
*(see Notes to unaudited        Financial Statements)*
**HYBRID FUEL SYSTEMS, INC.Notes to Unaudited Financial Statements

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Hybrid Fuel Systems, Inc. (the "Company") licenses the worldwide exclusiverights to a combustion engine fuel delivery system embodied in five US patentsand one patent pending.  The Company's current commercial application ofthe licensed technology is referred to as Fuel 2,  an aftermarket device for the conversion ofmedium and heavy duty diesel engines to non-petroleum based fuels such as natural gas.   *Cash and Cash Equivalents*For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.*Accounts Receivable*Accounts receivable, are stated at estimated net realizable value.  Accounts receivable are comprised of balances due from customers.  In determining collectibility, historical trends are evaluated and specific customer issues are reviewed to arrive at appropriate allowances.*Inventories*Inventories, are stated at the lower of cost or market.  Cost is determined using the first-in, first-out method. Inventories consist of component parts used in the manufacture and assembly of retrofit systems for the conversion of gasoline and diesel engines to non-petroleum based fuels such as compressed natural gas.*Property, Plant and Equipment*Depreciation is provided for using the straight-line method, in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives (asset categories range from three to seven years).  Leasehold improvements are amortized using the straight-line method over the lives of the respective leases or the service lives of the improvements, whichever is shorter.  Leased equipment under capital leases is amortized using the straight-line method over the lives of the respective leases or over the service lives of the assets for those leases that substantially transfer ownership.  Accelerated methods are used for tax depreciation. *Impairment of Assets*The Company's policy is to evaluate whether there has been a permanent impairment in the value of long-lived assets, certain identifiable intangibles and goodwill when certain events have taken place that indicate that the remaining balance may not be recoverable.  When factors indicate that the intangible assets should be evaluated for possible impairment, the Company uses an estimate of related undiscounted cash flows.  A deficiency in these cash flows relative to the carrying amounts is an indication of the need for a write-down due to impairment.  The impairment write-down would be the difference between the carrying amounts and the fair value of these assets.  Losses on impairment are recognized by a charge to earnings.  Factors considered in the valuation include current operating results, trends and anticipated undiscounted future cash flows. *Income Taxes*The Company utilizes the guidance provided by Statement of Financial Accounting Standards No. 109,Accounting for Income Taxes (SFAS 109).  Under the liability method specified by SFAS 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse.  Deferred tax expense is the result of changes in deferred tax assets and liabilities.  Valuation allowances are provided if necessary to reduce deferred tax assets to the amount expected to be realized.*Earnings (Loss) Per Common Share*Earnings (loss) per share are computed using the basic and diluted calculations on the face of the statement of operations.  Basic earnings (loss) per share are calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period.  Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period, adjusted for the dilutive effect of common stock equivalents, using the treasury stock method. The warrants outstanding were determined to be antidilutive and therefore do not affect earnings per share.*Use of Estimates*The preparation of financial statements in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities, as well as the reported amounts of revenues and expenses for theperiod then ended.  The actual outcome of the estimates could differ from the estimates made in the preparation of the financial statements.*Revenue Recognition*Revenues are recognized when the merchandise is shipped to the customer, which is when title and risk of loss has passed to the customer. *Stock Based Compensation*The Company has adopted the disclosure-only provisions of SFAS No. 123,Accounting for Stock Based Compensation, but applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for options issued to employees.  Under Opinion No. 25, the intrinsic method is used to determine compensation expense when the fair market value of the stock exceeds the exercise price on the date of grant.  As ofthe date of this report, no options had been granted under the plan and therefore no compensation expense has been recognized.*Research and Development Costs*The Company charges research and development costs to expense as incurred.*Fair Value of Financial Instruments*The Company, in estimating its fair value disclosures for financial instruments, uses the following methods and assumptions:

*Cash, Accounts Receivable, Accounts Payable and Accrued Expenses:* The carrying amounts reported in the balance sheet for cash, accounts receivable, accounts payable and accrued expenses approximate their fair value due to their relatively short maturity.*Long-Term Obligations*: The fair value of the Company's fixed-rate long-term obligations is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.  At December 31, 2003 and 2002, the Company did not have any long-term obligations.

NOTE 2 - RELATED PARTY TRANSACTIONS*License Agreement*During August, 2004, the Company entered a series of agreements relating to itstechnology with a related party who is a substantial shareholder.  Asummary of each agreement is included in this Form 10QSB under Item 5 - OtherInformation.  

*Employment and ConsultingAgreements*

During August 2004, the Companyentered an employment agreement with its Chief Executive Officer and Chairman ofthe Board and consulting agreements with the technology inventor.  Allthree individuals are substantial shareholders.  A summary of eachagreement is included with this Form 10QSB under Item 5 - Other Information*Leases*The Company currently subleases a building from a related party on a month to month basis on the same terms and amount as the primary lease.  The monthly lease amount is$1,500NOTE 3 - DEBT IN DEFAULTThe Company did not meet the payment terms on the note payable to Peachtree National Bank during thethrough March 31, 2004.  The note is secured by all assets of the Company.  The provisions of the note allow for the note to become immediately and fully payable upon default of payments.Since July, the Company has been in negotiations with the bank wherein WhiteKnight SST would stand in place of Hybrid as the guarantor of the note andPeachtree would accept a payment plan which would liquidate the full amount owedwithin one year.  Prior to December 31, 2003 the Company issued convertible promissory notes to various individuals and to a corporation.Following negotiations, the holders of the notes have collectively agreed toaccept $233,200 as payment in full of all principal and interest and such amountis to be converted into shares of the Company's common stock at rates rangingfrom $.06 to $.10 per share.  NOTE 4 - COMMITMENTS AND CONTINGENCIESThe Company is delinquent in the payment of payroll and state sales taxes.  The Company is currently following payment schedules, developed after negotiations with the taxing authorities.  Amounts in arrears for delinquent taxes, along with estimated penalties and interest assessed by the taxing authorities are as follows, as ofMarch 31, 2004 and 2003
 20042003Payroll and sales taxes$162,739$162,739Penalties and interest82,50667,369Total$245,245$230,108
During June, 2004, the Companyentered a negotiated settlement with the IRS and began making monthly paymentsincluding an initial payment of $15,000 plus $5,000 a month through January,2005.  During January 2005, the Company is obligated to payoff anyremaining balance. *Litigation*    On November 14,2003, Ambac International Corporation (" Ambac.") filed a lawsuitseeking $109,915.60 together with interest at the rate of 15% per annum. Thesuits stems from a contract for delivery of certain parts for use in themanufacturing of our kits. We maintain the parts were delivered substantiallypast the date of anticipated delivery and that the parts when received weredefective. On August 3, 2004, we filed a Motion to Dismiss or, in theAlternative, Motion to Compel Arbitration. During October 2004, the Court issueda Motion to Compel Arbitration and we are awaiting the scheduling of suchrequirement.  We intend to vigorously defend our position and believe wewill ultimately prevail. However, there can be no assurance that we will prevailand in the event we were to not prevail, we could be required to pay the amountof the suit, plus interest and associated fees. We do not believe the loss ofthis litigation will have a material effect on our ability to execute ourbusiness mission. 

As of March 31,2004, the company is unaware of any claim or threat of litigation relating toHybrid or our officers or directors.   NOTE 5 - STOCK OPTIONSThe Company's Stock Option Plan ("SOP") was adopted in 2001 to provide for the grant to employees up to 2,000,000 incentive stock options within the meaning of Section 422 of the Internal Revenue Code.  The SOP, which is administered by the Company's Board of Directors, is intended to provide incentives to directors, officers, and other key employees and enhance the Company's ability to attract and retain qualified employees.  Stock options are granted for the purchase of common stock at a price not less than the 100% of fair market value of the Company's common stock on the date of the grant (110% for holders of more than 10% of the total combined voting power of all classes of capital stock then outstanding).  As ofMarch 31, 2004 and 2003, no options had been granted under the plan.*Warrants*The Company has issued warrants to purchase shares of common stock to consultants and other non employees.  The company uses the Black Scholes option pricing model to value warrants issued to non employees. Asof October 18, 2004, all Warrants issued by the Company haveexpired.  NOTE 6 - SHAREHOLDERS' EQUITYPreferred Stock Effective February 1, 2002, the Company designated 999,779 shares of previously undesignated preferred stock as Series A Preferred Stock, for which 45,216 shares are authorized and Series B Preferred Stock, for 954,563 shares are authorized.Series A Preferred Stock is convertible, at the option of the holder, at any time, into shares of the Company's common stock as determined by dividing $.19 by a conversion price determined on the date the related certificate is surrendered. The conversion price is subject to periodic adjustment and is initially established at $.01632.  Series A Preferred Stock is automatically convertible into shares of the Company's common stock upon (i) the date specified by vote or written consent or agreement of holders of at least three quarters of the shares of Series A Preferred outstanding, or (ii) upon the closing of the sale of the company's common stock in a firm commitment, underwritten public offering registered under the Securities Act in which the Company receives gross proceeds of no less than $20 million.  Series A Preferred Stock has a liquidation preference of the greater of $.19 per share or the amount that such share would be entitled to upon liquidation or distribution.  The Series A Preferred Stock has voting rights, except as to the election of debtors, equal to the number of shares of common stock into which the Series A Preferred Stock is convertible. The Series A preferred Stockholders have the right to elect one director of the Company.Series B Preferred Stock is convertible, at the option of the holder at any time, into shares of the Company's common stock as determined by dividing the lower of $.09 or the price per share paid by the holder of the Series B Preferred Stock by a conversion price determined on the date the related certificate is surrendered.  The conversion price is subject to periodic adjustment and is initially established at $.00773. Series B Preferred Stock is automatically convertible into shares of the Company's common stock upon (i) the date specified by vote or written consent or agreement of holders of at least three quarters of the shares of Series B Preferred Stock outstanding, or (ii) upon the closing of the sale of Company's common stock in a firm commitment, underwritten public offering registered under the Securities Act in which the Company receives gross proceeds of no less than $20 Million.  Series B Preferred Stock has a liquidation preference of the greater of $.09 per share or the amount that such share would be entitled to upon liquidation or distribution.  The Series B Preferred Stock has voting rights, except as to the election of directors, equal to the number of shares of common stock into which the Series B Preferred Stock is convertible. The Series B Preferred Stockholders have the right to elect one director of the Company.NOTE 7 - SUBSEQUENT EVENTS*Subsequent to March 31, 2004, the Company.*
-  During April 2004 we liquidated    a $15,000 payable to our former auditor.On June 21, 2004 we executed a    Sales and Marketing Agreement with DRV Energy which    holds that: (a) DRV is the exclusive distributor in OK, KS, AL, AZ and WI    and/or vehicles tagged in those states; (b) a Fuel2 kit price of $4,500;    (c) DRV is required to sell at least 40 kits during the first twelve months:    (d) performance by DRV is predicated on CARB verification.  On    June 30, 2004, we entered an agreement with the IRS for the repayment of all    delinquent taxes and interest.  Under the terms of the plan, we are to    remit $15,000 upon plan acceptance and then $5,000 a month beginning in July    2004 through January 2005.  During January 2005, we are obligated to    payoff any remaining balances.  On    June 30, 2004, we entered an agreement with the State of Georgia for the    repayment of all delinquent state sales taxes.  Under the terms of the    agreement, we are to remit $3,500 per month through January 2005.     During January 2005, we are obligated to payoff any remaining    balances.  During    June 2004 we initiated the verification process for our technologies with    Olson-Ecologics Lab in California.  On    July 27, 2004, the Board of Directors authorized the issuance of 7,233,351    shares of our restricted common stock to various members of the Davis    family, employees and consultants.  During    August we settled a shareholder suit filed in 2003 with a settlement amount    of $15,000.  On    August 31, 2004 we entered a new, worldwide exclusive technology license    agreement as well as employment and consulting agreements with the inventor    of the technology and our Chief Executive Officer.  A summary of all    agreements is included this Form 10QSB under Item 5 - Other    Information.  During    October, we negotiated a settlement with all outstanding Note holders    allowing for the conversion of their Notes into shares of our restricted    common stock.  During    October we received the first set of official emission measurements for our    Fuel 2 technology.  We provide a discussion of these results in Item    2 - Management's Discussion and Analysis of Financial Condition and Results    of Operations. 
**Item2 - Management's Discussion and Analysis of Financial Condition and Results ofOperations**
The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the results of our operations and financial condition. The discussion should be read in conjunction with the unaudited consolidated financial statements and notes thereto.*For Quarter Ended March 31, 2003 and 2004*Since 1996, we have sought to commercialize our dual-fuel technology with limited success. For the quarter ended March 31, 2003 we experienced a substantial slow-down in our operational state due principally to under capitalization. We dedicated the majority of our resources during the first quarter 2004 (ending March 31, 2004) on the research, development and reengineering of ourFuel 2 dual-fuel application.  The following compares our performance during these periods. During the first quarter ended March 31, 2003 and 2004, we were in a product development stage and during the first quarter 2004, we placed a heavy emphasis on the research, development and reegineering of ourFuel 2 application.  During the first quarter 2004 our research and development expenses increased approximately 551% growing from $2,778 during the first quarter 2003 to $15,933. For the quarter ended March 31, 2003 and 2004, our revenue from product sales increased by 60.09% from $48,778 to $80,092 while our cost of product sales decreased only 2% from $24,689 to $24,110 respectively. Overall, our total revenues during this period increased 43% from $24,089 at March 31, 2003 to $55,982 at March 31, 2004.Overall during this period, our net loss decreased 2% from ($101,366) at March 31, 2003 to ($98,904) March 31, 2004 which encompasses a 247% decrease in consulting fees, a 551% increase in research and development and an 800% decrease in compensation as well as an 11% decrease in other expenses. We have no off-balance sheet items connected with our Company or our operations. *2004 and certain expectations for 2005*We recently filed our Form 10KSB for the years ended December 2002 and 2003. Since the date of that filing we can report encouraging results from our currenttechnology  verification testing. The positive result of our verification cannot be minimized in importance relative to the success of our technology in the domestic marketplace. During the past several years, federal and state governments have enacted ever increasing mandatesrestricting harmful emission pollutants of diesel engines.  In essence, according to these mandates, new vehicle manufacturers will have to ensure their product meets the minimum quantities for certain emissions.  At the very least, any aftermarket product such as ourFuel 2 dual-fuel technology must meet the statutory minimum emission standards. We can report that in a report provided to our Company by an independent lab titled*Emission and Fuel Consumption Data Obtained in Accordance with CARB Retrofit Verification Protocol for On-Road Heavy-Duty Engine Applications to Verify Particulate and NOx Reductions When Operating with The Hybrid Dual Fuel System Using a 2001 Model E7-350 Mack Diesel Engine*- October 12, 2004  ("Summary Report") exceed the statutory emission standards as contained in the Federal Register for new vehicles.  In addition, the results contained in the Summary Report exceed the statutory emission standards as contained in California Codes.  The following tablesummaries our results as compared with the Federal and State of California new vehicle emission standards:
*Calculations are in grams      per brake horsepower-hour (g/bhp-hr)*Displacement      of Diesel with      Natural GasTotal      Hydrocarbons      (THC)Carbon      Monoxide      (CO)Nitrogen      Oxides      (NOx)Particulates      (PM)     Hybrid's Fuel2 Certified Emissions62%
0.048

1.258
3.2430.027540 CFR Parts 85 and 86 (Federal standards)No standard
1.3

15.5
40.1California Codes 1956.8 (State standards)No standard
1.3

15.5
40.05
  Of greater importance to our Verification process however is the percentagereduction in NOx and Particulates.  In the case of the Verification programcurrently underway, the granting authorities have published reductions in certain emission in order to qualify as an Emission Control Device.  Principally, this verification process is geared toward reductions in Nitrogen Oxidesor NOx and Particulates or PM.  The following chart includes the target reductions sought by the granting authority followed by the certified results achieved by our  Fuel 2 dual-fuel technology.  We believe these overall results position our Company to engage in meaningful sales during 2005. NOxPMApproving authority required minimum emission reductions 
15% 

25%Hybrid's Fuel2 Certified Emission Reductions
19.3%
73%
We should further note thatcompletion of the Verification process currently underway includes a 1,000durability cycle followed by a 200-hour on road cycle culminating with a second set oflaboratory tests.  If we fail to maintainthe results of our first official tests than we would not receive an emissionsverification of our Fuel 2 application as an Emission Control Device.  Failure to achievesuch verificationwill have a substantial negative impact on our domestic sales.  Should the reductions we've achieved highlighted above remain consistentfollowing the 1,000-hour durability cycle, 200-hours on road cycle and final round of official results, ourFuel 2 technology will be the first dual-fuel technology verified as an Emission Control Device. 
We derived the information for thetwo charts cited above from the following three sources:  
Hybrid's Fuel2Certified Emissions  extracted from an independent engine testing lab Summary Report - *Emission  and Fuel Consumption Data Obtained in Accordance with CARB Retrofit  Verification Protocol for On-Road Heavy-Duty Engine Applications To Verify  Particulate and NOx Reductions When Operating With The Hybrid Dual Fuel System  Using a 2001 Model E7-350 Mack Diesel Engine by the Official EPA Transient  Cycle Heavy-Duty Procedure* dated October 12, 2004.  

Federal Standards extracted from 40 CFR Parts 85 and 86  Emissions Control, Air Pollution From 2004 and Later Model Year Heavy-Duty  Highway Engines and Vehicles; Light-Duty On-Board Diagnostics Requirements,  Revision; Final Rule

State Standards  extracted from California Codes 1956.8. Exhaust Emissions Standards and Test  Procedures -1985 and Subsequent Model Heavy-Duty Engines and Vehicles.

We continue to be encouraged by the market potential for our technology forthree principal reasons.  The price of diesel fuel continues to rise as theprice of oil increases while the price of natural gas appears to be somewhatstable at a lower cost than diesel.  This price differential can represent a substantial economicmotivator for fleet conversion.  Second, the preliminary emission testresults cited above could potentially open the domestic US marketplace, an arenawhere our Fuel 2 kit would be the only dual-fuel verified technology availablefor medium and heavy-duty diesel engines.  Finally, while federal and stateenvironmental regulators have long sought creative means to reduce atmosphericpollutants, during the past two years, there has been a focused effort to cleanup the 400,000+/- diesel-only yellow school buses.  A Fuel 2 penetrationrate of only 1% into the school bus market place would translate intoapproximately $18 million dollars in revenue.  During 2003, our liquidity was limited to small amounts of financing provided on a sporadic basis principally from friends and family. During the first quarter 2004, all our financing was provided by White Knight SST, Inc..  For the quarter ended March 31 2004, White Knight has provided $428,000 and theprincipals of  White Knight have served as our Chief Executive, Chief Financial Officerand Chairman of our Board of Directors since December 2003.  During August 2004, we entered an employment agreement with White Knight to provide forthese positions to remain for an additional two-year period.  We believe that our current and anticipated sales together with financing provided by White Knight will be sufficient to ensure we can continue our operations for the foreseeable future. 
**Item 5 - Other Information**

During August, 2004, the Companyentered a series of agreements relating to its technology and the engagement ofcertain individuals.  The following is a summary of these agreements. A copy of the each agreement is included as an Exhibit to this Form 10QSB.

*Technology License Agreement*

On the 18th of August 2004,Hybrid Fuel Systems, Inc., ("Hybrid" or the "Company")entered a world wide exclusive Technology License Agreement (the "LicenseAgreement") with Engine Control Technologies, LLC ("ECT"). ECT is the sole and exclusive owner of US Patents 5,408,978 *GaseousFuel Entrainment Apparatus and Process* issued April 25, 1995; 5,083,547 *Airand Fuel Mixing Apparatus* issued January 28, 1992; 5,103,795 *Air and FuelMixing Apparatus and Method* issued April 14, 1992; 4,479,466 *Natural Gasand Air Mixing Device* issued October 30, 1984 and 5,370,097 *CombinedDiesel and Natural Gas Engine fuel Control system and Method of Using Such*issued December 6, 1994 as well certain patents pending relating to the samematerial as the above referenced patents (collectively the "Patents"). 

Under the term of the LicenseAgreement; Hybrid has the world-wide exclusive rights to use, manufacture, leaseand/or sell products and/or systems which embody the Patents. To maintain the exclusive nature of the License Agreement, Hybrid mustsell a minimum of 750 Fuel2kits during calendar 2005 and 2,500 Fuel2kits in each subsequent year.  Theterm of the License Agreement is the expiration of the last-expiring Patent orten years. 

In exchange for granting theLicense Agreement, ECT is entitled to a one-time fee of $250,000 payable (a)upon the first anniversary of the License Agreement; (b) receipt of $1millionthrough equity or debt financing; or (c) upon the sale of the 100th Fuel2kit.  In addition, ECT is entitledto a royalty rate of either (a) $250 per Fuel2kit, or (b) 3.5% of net sales but in no event shall a royalty payable be createdwhich is lower than $250 or higher than $1,000. 

The License Agreement may beterminated (i) in the event Hybrid is adjudicated bankrupt or insolvent, entersinto a composition with creditors, makes an assignment of all or substantiallyall of its assets for the benefit of its creditors, or if a receiver isappointed for its assets; (ii) in the even that Hybrid fails to produce,manufacture, sell, market or distribute or cause to be produced manufactured,sold, marketed or distributed the kits; (iii) in the event that any of Hybrid orits affiliates, agents, distributors or sub-licensees of Hybrid is in materialbreach or default of any provision of the License Agreement which default orbreach is not cured within the applicable time period granted herein; (iv) uponthe failure or refusal of Hybrid to pay ECT the royalty when and as it becomesdue and payable; (v) in the event that any Hybrid or its affiliates, agents,distributors or sub-licensees pledge, lien, mortgage, secure or otherwiseencumber the Patents in any manner, whether arising by contract, as a matter oflaw, by judicial process or otherwise; (vi) in the event there is a materialadverse effect in the financial condition, operations, assets, business,properties or prospects of Hybrid.  "Materialadverse effect" means any event, change, violation, inaccuracy,circumstances or effect that is or is reasonably likely to be, individually orin the aggregate, materially adverse to the condition (financial or otherwise),capitalization, operations or business of Hybrid, or; (vii) in the event Hybridfails to maintain its status as a public company. 

In the event of any materialbreach, Hybrid has 30 days from the notice of such breach to cure anyoutstanding default.  
*Consulting Agreement*On August 31, 2004, we entered a Consulting Agreement with Frank Davis, the inventor of our Fuel2 technology.  Under the terms of the Consulting Agreement, Mr. Davis shall provide general advice, guidance and counsel to and consult with senior management of Hybrid with respects to all aspects of our business for a period of five years.  The Consulting Agreement automatically extends for subsequent one year periods if not cancelled.  Mr. Davis is to receive health and dental insurance as well as anautomobile as compensation for the Consulting Agreement.*Consulting Agreement*On August 31, 2004, we entered a Consulting Agreement with Engine Control Technologies, LLC (ECT), the Licensor of our Fuel2 technology.  Under the terms of the five year consultingagreement, ECT shall provide customary consulting services relating to the technology.  Compensation for the ECT Consulting Agreement isinitially $7,000 per month increasing to $12,000 per month upon the sale of the first 100 kits or closing of financing of $1,000,000 in equity, debt or a combination.*Employment Agreement*On August 30, 2004, we entered an employment agreement with Mark Clancy and John Stanton, (collectively "White Knight") to serve in the capacities as Chief Executive Officer and Chairman of the Board of Directors for a period of at least two years.  Compensation for both individuals was fixed at $25,000 per month, payable entirely in restricted shares of our common stock.  According to item 6c of the Employment Agreement, If, for the duration of the Employment Agreement (initial two year period), either Mr. Stanton is not nominated and elected as our Chairman of the Board and Mr. Clancy does not continue as our Chief Executive Officer and a Director, then the Technology License between our Company and Electronic Control Technologies is automaticallycancelled.  This provision may be waived only with the express written consent of Messrs. Stanton and Clancy. **Item6 - Exhibits and Reports on Form 8-K**

On  March 26, 2004, we filed a Form 8-K to report our change of independent  accountants.  

**Item7 - Litigation**

OnNovember 14, 2003, Ambac International Corporation (" Ambac.") filed alawsuit seeking $109,915.60 together with interest at the rate of 15% per annum.The suits stems from a contract for delivery of certain parts for use in themanufacturing of our kits. We maintain the parts were delivered substantiallypast the date of anticipated delivery and that the parts when received weredefective. Subsequently we filed a response on December 22, 2003. Ambacsubsequently made a motion for default judgment because the statutory period tofile a response was 30 days and our response was filed in 35 days. Further, theresponse was submitted by a " non-attorney." which is alleged to be afurther violation of South Carolina civil procedure. Our CFO filed the responseduring 2003 at the direction of our then-Chief Executive Officer.

OnAugust 3, 2004, we filed a Motion to Dismiss or, in the Alternative, Motion toCompel Arbitration. During October 2004, the Court issued an order to CompelArbitration.  We are now awaiting the scheduling of the arbitration.  We intend to vigorously defend our position and believe we will ultimatelyprevail. However, there can be no assurance that we will prevail and in theevent we were to not prevail, we could be required to pay the amount of thesuit, plus interest and associated fees. We do not believe the loss of thislitigation will have a material effect on our ability to execute our businessmission. The full amount of the liability has been recorded as a payable in ourfinancial statements as of December 31, 2003.

Thereis no other pending litigation or other proceedings against the Company. 

**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

HybridFuel Systems, Inc.   registrant

October29, 2004

                                                                                        By:    s/s MARK CLANCY                                                                                                     Mark Clancy                                                                                                     Chief Executive Officer</TEXT></DOCUMENT>

 

 

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