Auto Underwriters of America (ADWT) 10QSB/A 2007 Q1 Quarterly report (small business) (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-QSB/A

(Amendment No. 2)

(Mark one)
[X]           Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2006
[   ]           Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ___________ to ____________
Commission File Number:  0-11582
AUTO UNDERWRITERS OF AMERICA, INC. (Exact Name of Small Business Issuer as Specified in its Charter)
California (State or Other Jurisdiction of Incorporation or Organization)	94-2915849 (IRS Employer Identification No.)
2670 South White Road Suite 241 San Jose, CA 95148 (Address of Principal Executive Offices)	(408) 270-3587 (Issuer’s Telephone Number)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Check whether the issuer (1) filed all reports required to be filed by section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   No     X   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   No    X   

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:  7,400,575 shares as of April 30, 2008.

Transitional Small Business Disclosure Format (check one):

Yes   No    X   

Explanatory Note:

This Quarterly Report on Form 10-QSB/A (“Form 10-QSB/A”) is being filed as Amendment No. 2 to our Quarterly Report on Form 10-QSB for the quarter ended September 30, 2006, which was originally filed with the Securities and Exchange Commission on November 20, 2006 (“Original Filing”), as amended by Amendment No. 1 filed on November 21, 2006 (“Amendment No. 1”).  We are amending and restating the entire Original Filing and Amendment No. 1.  The financial statements as of and for the three months ended September 30, 2006 have been restated resulting from adjustments made to our interim financial information as a result of the statutorily required review that had not been previously performed by our independent auditors in advance of the Original Filing.  Unless expressly noted otherwise, the disclosures in this Form 10-QSB/A continue to speak as of the date of the Original Filing, and do not reflect events occurring after the filing of the Original Filing unless expressly noted otherwise.  Accordingly, this Form 10-QSB/A should be read in conjunction with our other filings made with the Securities and Exchange Commission subsequent to the filing of the Original Filing, including any amendments to these filings.  The filing of this Form 10-QSB/A shall not be deemed an admission that the Original Filing, when made, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.

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AUTO UNDERWRITERS OF AMERICA, INC.

TABLE OF CONTENTS

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Balance Sheets as of September 30, 2006 and June 30, 2006	3
	Statements of Operations for the Three Months Ended September 30, 2006 and 2005	4
	Statements of Cash Flows for the Three Months Ended September 30, 2006 and 2005	5
	Notes to Financial Statements	6 - 14
Item 2.	Management’s Discussion and Analysis of Financial Condition	15 - 17
Item 3.	Controls and Procedures	17
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	20
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20
Item 3.	Default Upon Senior Securities	21
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 5.	Other Information	22
Item 6.	Exhibits	22

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Part I . Financial Information

Item 1. Financial Statements

Auto Underwriters of America, Inc.

Balance Sheets

(Unaudited)

	(RESTATED)
Assets:	September 30, 2006		June 30, 2006
Cash and cash equivalents	$	34,001	$	4,161
Finance receivables, net of allowance $2,250,031and $2,417,300, respectively		7,405,146		8,430,105
Other receivables		29,280		47,022
Property and equipment, net of accumulated depreciation $69,536 and $59,646, respectively		128,262		138,152
Inventory		861,790		285,135
Prepaid and other assets		35,215		63,502
Deferred financing cost		226,758		261,595
Total assets	$	8,720,452	$	9,229,672

Liabilities and stockholders’ equity (deficit):
Accounts payable and accrued liabilities	$	790,612	$	1,048,670
Drafts payable and floor plan liabilities		216,505		-
Other notes payable		1,761,944		2,590,695
Senior debts - revolving line of credit		8,527,982		9,013,025
Deferred sales tax		736,825		794,990
Advances from related parties		674,995		677,794
Total liabilities		12,708,863		14,125,174
Commitments and contingencies

Stockholders’ equity/(deficit):
Preferred stock: no par value: 10,000,000 authorized 423,020 issued and outstanding		909,492			-
Common stock: no par value: 100,000,000 authorized issued and outstanding: 6,418,570 and    6,018,570 respectively		8,002,498			5,768,364
Retained deficit		(12,900,401	)		(10,663,868	)
Total stockholders’ equity/(deficit)		(3,988,411	)		(4,895,504	)
Total liabilities and stockholders’ equity/(deficit)	$	8,720,452		$	9,229,672

See Notes to Financial Statements.

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Auto Underwriters of America, Inc.

Statements of Operations

For the three months ended September 30, 2006 and 2005

(Unaudited)

	(RESTATED)
	2006			2005
Revenues:
Sales	$	862,990		$	5,490,278
Interest income		390,437			535,949
Other		19,972			185,097
Total revenues		1,273,398			6,211,324
Costs and expenses:
Cost of sales		566,397			3,526,713
Selling, general and administrative		715,337			1,220,188
Provision for credit losses		213,267			1,122,379
Discount on sales of receivables		-			78,455
Depreciation and amortization		103,103			15,804
Interest expense – warrants		561,045			-
Interest expense		387,759			289,950
Total costs and expenses		2,546,908			6,253,489
Loss before income taxes		(1,273,510	)		(42,165	)
Provision for income tax benefit (expense)		-			-
Net loss	$	(1,273,510	)	$	(42,165	)
Preferred deemed dividends		(963,074	)		-
Net loss available to common stockholders	$	(2,236,584	)	$	(42,165	)
Loss per share:
Basic and diluted	$	(0.37	)	$	(0.01	)
Weighted average number of shares outstanding:
Basic and diluted		6,060,328			6,020,053

See Notes to Financial Statements.

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Auto Underwriters of America, Inc.

Statements of Cash Flows

For the three months ended September 30, 2006 and 2005

(Unaudited)

	(RESTATED)
	2006			2005
Operating activities:
Net loss	$	(1,273,510	)	$	(42,165	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		103,103			15,804
Bad debt expense		35,000			-
Imputed interest		10,015			-
Warrant expense		561,045			-
Discount on sale of finance receivables		-			78,455
Change in finance receivables, net:
Finance receivables originations and purchased, net of payments		337,494			(3,300,472	)
Provision for credit losses		213,267			1,122,379
Inventory acquired in repossession		474,198			917,865
Subtotal finance receivables		1,024,959			(1,260,228	)
Changes in operating assets and liabilities:
Deferred financing cost		(52,361	)		(39,375	)
Accounts receivable		17,742			(682,332	)
Inventory		(576,655	)		(588,569	)
Prepaid and other expense		(6,714	)		(20,828	)
Accounts payable and accrued liabilities		(258,008	)		619,994
Drafts payable		216,505			-
Deferred sales taxes		(58,165	)		201,554
Net cash used in operating activities		(257,044	)		(1,717,690	)
Investing activities:
Purchase of property and equipment		-			(3,564	)
Sale (purchase) of finance receivables		-			(170,576	)
Proceeds from sale of finance receivables		-			1,146,174
Net cash provided by investing activities		-			972,034
Financing activities:
Proceeds from (repayments to) related party		(2,799	)		(1,000	)
Proceeds from revolving credit facilities, net		(485,043	)		486,146
Repayments on other notes payable		(134,766	)		(28,252	)
Proceeds from sale of Series A Preferred Stock		909,492			382,500
Net cash provided by financing activities		286,884			839,394
Increase (decrease) in cash		29,840			(93,738	)
Cash at beginning of period		4,161			68,112
Cash at end of period	$	34,001		$	161,850
Cash paid for:
Interest	$	377,744		$	289,950
Income tax		-			-
Non-cash supplemental disclosures:
Preferred deemed dividend	$	963,074			-
Common stock issued to repay debt	$	700,000			-

See Notes to Financial Statements.

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Auto Underwriters of America, Inc.

Notes to Financial Statements

(Unaudited)

NOTE 1 - BASIS OF PRESENTATION

The accompanying unaudited interim financial statements of Auto Underwriters of America, Inc. ("Auto Underwriters") have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission ("SEC"), and should be read in conjunction with the audited consolidated financial statements and notes thereto contained in Auto Underwriters' Annual Report filed with the SEC on Form 10-KSB. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosure contained in the audited consolidated financial statements for fiscal 2006 as reported in the 10-KSB have been omitted.

NOTE 2 – RESTATEMENT

The financial statements as of and for the three months ended September 30, 2006 have been restated resulting from adjustments made to our interim financial information as a result of the statutorily required review that had not been previously performed by our independent auditors in advance of the original filing. The following table presents the effects of the restatement adjustment on the accompanying financial statements as of and for the three months ended September 30, 2006:

Balance Sheets	As Previously Reported			Effect of Restatement			As Restated
Assets
Prepaid and other current assets		70,215			(35,000	)		35,215
Total assets		8,755,452			(35,000	)		8,720,452
Liabilities and Stockholders’ Deficit
Liabilities
Accounts payable and accrued liabilities		(767,851	)		(22,761	)		(790,612	)
Deferred sales tax		(681,440	)		(55,385	)		(736,825	)
Total liabilities		(12,630,717	)		(78,146	)		(12,708,863	)
						��
Stockholders’ equity/(deficit)
Common stock		(6,468,364	)		(1,534,134	)		(8,002,498	)
Retained deficit		11,253,121			1,647,280			12,900,401
Total stockholders’ equity/(deficit)		3,875,265			113,146			3,988,411

Statements of Operations	As Previously Reported			Effect of Restatement			As Restated
Selling, general and administrative		602,200			113,146			715,337
Interest expense – warrants		-			561,045			561,045
Interest expense – other		377,744			10,015			387,759
Net loss		(589,313	)		(684,206	)		(1,273,510	)
Preferred deemed dividends		-			(963,074	)		(963,074	)
Net loss available to common stockholders		(589,313	)		(1,647,271	)		(2,236,584	)
Loss per share – basic and diluted		(0.09	)		(0.28	)		(0.37	)

Statements of Cash Flows	As Previously Reported			Effect of Restatement			As Restated
Net cash used in Operating Activities		(1,226,159	)		(969,115	)		(257,044	)
Net cash provided by Financing Activities		1,255,999			969,115			286,884

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NOTE 3 - GOING CONCERN

As shown in the accompanying financial statements, Auto Underwriters has incurred recurring losses from operations in 2006 and 2005 and has an accumulated deficit of $12,900,401 as of September 30, 2006. These conditions raise substantial doubt as to Auto Underwriters’ ability to continue as a going concern. Management believes that it has the ability to borrow additional funds from third parties such as financial institutions or will be successful in a debt or equity financing that will be sufficient to fund its operations for the next twelve months.  Therefore, for at least the next twelve months, the Company can continue to operate as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

NOTE 4 - FINANCE RECEIVABLES

Auto Underwriters originates installment sale contracts from the sale of used vehicles at its dealerships. These installment sale contracts typically include interest rates ranging from approximately 12% to 27% per annum and provide for payments over periods ranging from 18 to 60 months.

The components of finance receivables as of September 30, 2006 and June 30, 2006 are as follows:

	September 30			June 30
Finance receivables	$	9,655,177		$	10,847,405
Less: allowance for credit losses		(2,250,031	)		(2,417,300	)
Finance receivables, net	$	7,405,146		$	8,430,105

Changes in the finance receivables allowance for credit losses for the periods ended September 30, 2006 and June 30, 2006 are as follows:

	2007			2006
Balance at beginning of the period	$	2,417,300		$	2,323,089
Provision for credit losses		213,267			5,056,597
Recoveries		474,198			3,343,683
Net charge-offs		(854,734	)		(8,306,069	)
Balance at end of year	$	2,250,031		$	2,417,300

NOTE 5 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

A summary of accounts payable and accrued liabilities is as follows:

	September 30, 2006		June 30, 2006
Accounts payable	$	327,233	$	289,081
Payroll and related taxes		171,342		372,641
Recourse obligation		175,000		152,440
Other		117,037		234,508
Total liabilities	$	790,612	$	1,048,670

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NOTE 6 – DEBT

Revolving Credit Facilities

Auto Underwriters has a $9,000,000 senior debt revolving line of credit (“LOC”) with Oak Rock Financial, LLC, (“Oak Rock”) bearing interest at the greater of prime + 7% or 15.25%. The LOC is secured by all of Auto Underwriters’ assets and a personal validity guarantee by its President. At September 30, 2006, the balance of LOC was $8,527,982 of which Auto Underwriters had availability of approximately $472,000 under the facility, maturing on March 31, 2007.

Interest on the LOC is payable monthly. Auto Underwriters’ LOC facility contains various reporting and performance covenants including maintenance of certain financial ratios and tests, limitations on borrowings from other sources, restrictions on certain operating activities, and restrictions on the payment of dividends or distributions.  Oak Rock is involved with the day-to-day operations pertaining to collections, cash payments, and repossessions including procedural monitoring of Auto Underwriters’ operations.

A summary of Auto Underwriters’ Revolving Credit Facilities as of September 30, 2006 and June 30, 2006 is as follows:

Lender	Facility Amount	Interest Rate	Maturity	September 30, 2006	June 30, 2006 Balance
Oak Rock Financial, LLC	$ 9,000,000	Prime + 7%	March 31, 2007	$  8,527,982	$  9,013,025

Other Notes Payable

A summary of Other Notes Payable as of September 30, 2006 and June 30, 2006 is as follows:

	September 30, 2006		June 30, 2006
Unsecured Convertible Promissory Notes	$	979,977	$	990,000
Secured Promissory Notes		250,000		1,000,000
Notes Payable – Gunnels Interests, Inc.		505,477		590,243
Notes Payable – Other		26,490		26,490
	$	1,761,944	$	2 ,590,695

All debt is due within the next 12 months.

Unsecured Convertible Promissory Notes

In fiscal 2006, Auto Underwriters issued $990,000 in unsecured convertible promissory notes pursuant to a private placement.  These notes bear interest at 9.25% per annum from the date of issuance and are convertible into common stock at the request of the investor at $1.50 per share. These notes mature on February 28, 2007.  See Note 10.

Secured Promissory Notes

In fiscal 2006, Auto Underwriters issued $1,000,000 in secured promissory notes pursuant to a private placement.  These notes bear interest at 10% per annum from the date of issuance, and are secured with our inventory and cash in our draft payment account. These notes matured on August 31, 2006. In August 2006, notes totaling (i) $700,000 were converted into 400,000 shares of common stock at $1.75 per share with five-year stock purchase warrants exercisable for a total of 140,000 shares of the Company’s Common Stock at an exercise price of $1.75 per share. See Note 7; (iii) $50,000 were extended with a maturity date of August 31, 2007; and (iii) $250,000 were repaid in cash plus accrued interest to the remaining investors that elected to not convert or extend the term of their loans. See Note 10.

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Notes Payable – Gunnels Interests, Inc.

Amounts due to Gunnels Interests, Inc. relates to the purchase of certain assets by AUA from Gunnels Interests, Inc. in March 2004 and vehicle wholesaling and flooring services provided by Gunnels Interests, Inc. to AUA. See Note 9 “Litigation, Claims, and Assessments.”

Notes Payable – Other

Notes Payable – Other represents various immaterial amounts owed during the ordinary course of business.

NOTE 7 – STOCKHOLDERS’ EQUITY

During the quarter ended September 30, 2006, the Company issued 400,000 shares of common stock for the conversion of $700,000 of Secured Notes.  See Note 6.

Issuance of Series A Stock

During the quarter ended September 30, 2006, the Company issued a total of 423,020 shares of Series A convertible preferred stock (“Series A Stock”) at $2.50 per share, for net total proceeds of $909,492 (net of issuance costs totaling $148,058).  See Note 10. For every two shares of Series A Stock issued, investors received a warrant to purchase the Company’s common stock at $2.50 per share.  The warrants are immediately vested and exercisable and expire five years from the date of issuance.  During the year ended June 30, 2006, the Company entered an agreement with a NASD-licensed broker-dealer to act as the placement agent in connection with the Series A Stock.  In connection with the agreement, the Company issued the placement agent a warrant to purchase up to 1,000,000 shares of the Company’s common stock, depending on the total proceeds of the offering.  The warrant was adjusted down to 578,000 shares due to a “clawback provision” in the placement agreement.  The fair value of the warrants was $40,576. No accounting entry was made for the stock issuance costs as the debit and credit are to the same financial statement caption. See further discussion below.

The holders of the Company’s Series A Stock are entitled to the following rights, preferences, restrictions and other matters as follows:

Dividends.  The Preferred Stock accrues dividends at a rate of 8% per annum, payable in cash or in shares of common stock. Subject to certain terms and conditions, the decision whether to pay for dividends in cash or in shares of common stock, shall be at the discretion of the Company’s board of directors.  The dividends are cumulative and in preference to any dividends declared and paid to the holders of common stock.  As of September 30, 2006, the Company has not paid or accrued any dividends. 

Liquidation Preference. Upon any liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, holders of Series A Stock shall be entitled to receive an amount equal to $2.50 per share (adjusted for stock splits, stock dividends and reclassifications) plus any accrued but unpaid dividends.  If assets of the Company are insufficient to pay in full such amounts, then the entire assets to be distributed to the holders of the Series A Stock shall be distributed among such holders ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full.

Conversion Rights. All or any portion of the stated value of the Series A Stock outstanding may be converted into common stock at anytime by the investors. The conversion rate of the preferred stock is on a two-to-one basis, subject to anti-dilution protection adjustments.

Rights of First Refusal.  In the event that the Company decides to offer additional securities, either through a debt or equity offering, holders of Series A Stock have the first right of refusal to participate in that offering.

Automatic Conversion. Each share of Series A Stock shall automatically be converted into shares of common stock, at the conversion price in effect, if and when the following three requirements simultaneously exist: (1) the shares of Common Stock underlying the Series A Preferred Stock have been registered with the SEC, (2) the Common Stock is publicly traded, and (3) the 30 trading-day average closing price reported on the national securities exchange on which the Common Stock is then listed or the closing bid price of the Common Stock in the NASDAQ Reporting System is at least $3.50 per share.  Additionally, each share of Series A Stock will be automatically converted into Common Stock upon the consent of at least two-thirds of the then-outstanding shares of Series A Stock.   If the Series A Stock has not converted into common stock within 720 days after the Series A Stock final closing, each share of Series A Stock will automatically covert into two shares of common stock.

Voting Rights.  Holders of preferred stock shall be entitled to the number of votes equal to the number of shares of common stock into which such shares of preferred stock could be converted.  Fractional shares, on an as-converted basis, shall be rounded to the nearest whole number.

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Deemed Dividend on Preferred Stock.  In accordance with EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios , and EITF Issue No. 00-27,  Application of Issue No. 98-5 to Certain Convertible Instruments , the Series A Stock is considered to have an embedded beneficial conversion feature because the conversion price was less than the fair value of the Company's common stock at the issuance date. This non-cash dividend is to reflect the implied economic value to the preferred stockholder of being able to convert its shares into common stock at a price which was in excess of the fair value of the Series A Stock at the time of issuance. The fair value allocated to the Series A Stock together with the original conversion terms were used to calculate the value of the deemed dividend on the Series A Stock of $963,074 on the date of issuance. The fair value was calculated using the difference between the agreed-upon conversion price of the Series A Stock into shares of common stock of $2.50 per share and the fair market value of the Company's common stock on the date of issuance of the Series A Stock.  This amount has been charged to accumulated deficit with the offsetting credit to additional paid-in-capital. The Company has treated the deemed dividend on preferred stock as a reconciling item on the consolidated statements of operations to adjust its reported net loss, together with any preferred stock dividends recorded during the applicable period, to the loss available to common stockholders line item on the statements of operations.

The terms of the Series A Preferred, including but not limited to its rights and preferences, are set forth in the Certificate of Determination of Preferences of Series A Convertible Preferred Stock attached as Exhibit 3.2 to the Company’s Form 8-K filed under Item 5.03 on September 7, 2006 and are incorporated by reference herein.

Warrants

During August 2006, the Company issued warrants to purchase 150,000 shares of common stock at $1.75 per share to holders of the $700,000 Secured Notes as incentive to convert the Secured Notes into 400,000 shares of the Company’s common stock.  See Note 6. These warrants were recognized at the fair value, as calculated by the Black-Scholes pricing model, on the date of issuance in the amount of $561,045.  The warrants vested immediately resulting in the non-cash interest expense of $561,045 on the date of issuance.  The warrants expire in August 2011.

During the quarter ended September 30, 2006, the Company issued warrants to purchase a total of 211,510 shares of the Company’s common stock, for $5.00 per share, as part of the Series A Stock offering.  The fair value of these warrants, $705,600 as calculated by the Black-Scholes pricing model, was accounted for as a non-cash Series A Stock issuance cost.  The warrants expire five years from the date of issuance.

The Company calculates the initial fair value of all its warrants under the Black-Scholes pricing model with the following assumptions: contractual term of five years, 4.8% risk-free interest rate, expected volatility of 141% and expected dividend yield of 0%.

The following table summarizes warrant activity as of September 30, 2006:

	Number of Common Stock Shares			Weighted Average Exercise Price
Balance at June 30, 2005		0			-
Granted		1,250,000		$	1.10
Balance at June 30, 2006		1,250,000			1.10
Granted		361,510			3.65
Cancelled		(422,000	)		1.00
Balance at September 30, 2006		1,189,510			1.91

The weighted-average remaining contractual life and weighted-average exercise price of all warrants outstanding and of warrants exercisable as of September 30, 2006 were as follows:

Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life (Years)
$1.00	578,000	4.50
1.50	250,000	4.42
1.75	150,000	4.84
5.00	211,510	5.67
	1,189,510

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All warrants were exercisable at September 30, 2006.

Stock Options

General.  On March 20, 2004, Auto Underwriters’ board of directors adopted the 2004 Stock Option Plan (the “2004 Plan”), which was approved by the shareholders at the 2004 annual meeting.  The purpose of the 2004 Plan is to provide a means whereby directors and selected employees, officers, agents, consultants and independent contractors may be granted incentive stock options and/or nonqualified stock options to purchase shares of common stock in order to attract and retain the services or advice of such directors, employees, officers, agents, consultants and independent contractors and to provide an additional incentive for such persons to exert maximum efforts for Auto Underwriters’ and its affiliates’ success by encouraging stock ownership.  The maximum number of shares of common stock with respect to which awards may be presently granted pursuant to the 2004 Plan is 450,000 shares.  Shares issuable under the 2004 Plan may be either treasury shares or authorized but unissued shares.  The number of shares available for issuance will be subject to adjustment to prevent dilution in the event of stock splits, stock dividends or other changes in Auto Underwriters’ capitalization.

Subject to compliance with Rule 16b-3 of the Securities Exchange Act of 1934 (the “Exchange Act”), the 2004 Plan is administered by the board of directors or, in the event the Board shall appoint and/or authorize a committee, such as the compensation committee, of two or more members of the Board to administer the 2004 Plan, by such committee (the “Plan Administrator”).  Except for the terms and conditions explicitly set forth in the 2004 Plan, and subject to applicable provisions of the Internal Revenue Code of 1986, as amended (the “Code”), the Plan Administrator shall have the authority, in its discretion, to determine all matters relating to the options to be granted under the Plan, including, without limitation, selection of whether an option will be an incentive stock option or a nonqualified stock option, selection of the individuals to be granted options, the number of shares to be subject to each option, the exercise price per share, the timing of grants and all other terms and conditions of the options.

Options granted under the 2004 Plan do not have a vesting period, are exercisable for 10 years from the date of grant, do not provide for a “cashless exercise” option, and provide for an exercise price equal to the fair market value of the stock on the date of grant.

Stock Option Activity and Outstanding

At September 30, 2006, the Company had outstanding vested options totaling 50,000 shares with a weighted-average exercise price of $0.50 and a weighted-average exercise life of 8.67 years. As of September 30, 2006, there were 400,000 remaining shares available for issuance under the 2004 Stock Option Plan.

NOTE 8 – RELATED PARTY TRANSACTIONS

Advances from related parties represent unsecured, non-interest bearing funds advanced to Auto Underwriters by Gateway Credit Holdings, Inc. (“Gateway”). The balance of the unsecured, non-interest bearing funds advanced as of September 30, 2006 and June 30, 2006, were $674,995 and $677,794, respectively, and the imputed interest for the quarter ended September 30, 2006 was $10,015 and for the year ended June 30, 2006 was $40,400. Gateway has a common officer and shareholder with Auto Underwriters.

NOTE 9 – COMMITMENTS AND CONTINGENCIES

Litigation, claims and assessments

As a consumer finance company, Auto Underwriters is subject to various consumer claims and litigation seeking damages and statutory penalties, based upon, among other things, usury, disclosure inaccuracies, wrongful repossession, violations of bankruptcy stay provisions, certificate of title disputes, fraud, breach of contract and discriminatory treatment of credit applicants. Some litigation against Auto Underwriters could take the form of class action complaints by consumers. Auto Underwriters believes that they have taken prudent steps to address the litigation risks associated with Auto Underwriters’ business activities.

In the opinion of management, the resolution of these types of current matters will not have a material adverse effect on Auto Underwriters’ financial position or results of operations. However, Auto Underwriters cannot provide assurance damages that result in a material adverse effect on its financial position or results of operations will not be imposed in potential future matters. Auto Underwriters accounts for contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

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 Mid-Atlantic

Mid-Atlantic Finance Company, Inc. filed a lawsuit against us on December 13, 2006 in the 6th Judicial Circuit of Pinellas County, Florida, seeking damages in excess of $450,000 concerning a dispute over certain non-prime installment contracts. Mid-Atlantic alleged that the Company failed to repurchase certain finance contracts that were in default.  We counter clamed and alleged that Mid-Atlantic breached its agreement by not remitting to us certain amounts due in relation to a hold back under the installment contracts.  As a result of this dispute, we charged-off our receivable balance due from this finance company of approximately $1,100,000 during fiscal 2006 and have maintained a payable of approximately $152,000 for future repurchase obligations.  On December 12, 2007, we settled this matter and agreed to make periodic payments totaling $175,000.  The entire amount of $175,000 was accrued as of September 30, 2006, and is included in the balance sheet caption “Accounts payable and accrued liabilities.”  As of the date of issuance of these financial statements, $87,500 has been paid.

Gunnels Interests

On October 18, 2007, AUA was sued in the 190th Judicial Court of Harris County, Texas, by Gunnels Interests, Inc., Advantage Autoplex, Inc., TAB Enterprises, Inc., and Lawrence E. Gunnels in the state court of Harris County, Texas.  Case No. 2007-51824, Gunnels Interests, Inc., Advantage Autoplex, Inc., TAB Enterprises, Inc., and Lawrence E. Gunnels v. Auto Underwriters of America, Inc., f/k/a Advanced Cellular Technology, Inc., d/b/a Affordable Cars and Trucks, Dean P. Antonis, and William J. Kellagher.  The lawsuit relates to the purchase of certain assets by AUA from Gunnels Interests, Inc. in March 2004 and vehicle wholesaling and flooring services provided by Gunnels Interests, Inc. to AUA.  Plaintiffs allege, among other things, fraud and breach of contract, and Plaintiffs seek money damages, including exemplary and mental anguish damages.   The Company is currently defending the lawsuit. As of September 30, 2006, the Company’s books reflect a payable due to Gunnels Interests, Inc. of approximately $505,000. The Plaintiffs have not specified any damages, but the estimated contingent liability ranges from $800,000 to $1,000,000, should they be successful. The Company is vigorously defending its position and believes the case is without merit.  Mr. Gunnels is currently an 8.8% shareholder.

AGM, LLC

Auto Underwriters of America, Inc. and its subsidiaries filed litigation against AGM, LLC on or about December 20, 2007 in the U.S. District Court for the Northern District of Illinois alleging that AGM materially breached the Escrow, Servicing and Consignment Sales Agreement dated July 19, 2007.   Specifically, AGM terminated the Escrow Agreement, but failed and refused to refund down payment funds in the amount of $964,000.  Further, we allege that AGM failed to pay Plaintiffs the amounts due and owing for services rendered under the terms of the Escrow Agreement, totaling approximately $155,000. As a result, Auto Underwriters and its subsidiaries have been damaged cumulatively in an amount totaling approximately $1,119,000, exclusive of prejudgment interest, attorneys’ fees and/or additional costs related to bringing this action. Plaintiffs believe that by its improper actions at the expense of Auto Underwriters and its subsidiaries, AGM has been unjustly enriched with monies rightfully belonging to Auto Underwriters and subsidiaries. Further, AGM’s willful and wanton disregard for the rights of Auto Underwriters and subsidiaries constitute an unlawful conversion of monies to which Auto Underwriters and subsidiaries are entitled to immediate possession.  Finally, by falsely and materially misrepresenting the financial bases and prospects for completing this Escrow Agreement, Defendant AGM fraudulently induced Auto Underwriters and subsidiaries into entering the Escrow Agreement and related agreements thereto.  Auto Underwriters and its subsidiaries hope that the court will grant these monies owed to them along with damages. AGM, LLC filed a counter claim on December 28, 2007 in Circuit Court, Cook County, Illinois to keep the $964,000 cash payment and recover other payments of approximately $3,000,000. Auto Underwriters and its subsidiaries believe they have no liability in this claim.

Delinquent payroll taxes

The Company is delinquent in the payment of its payroll tax liabilities with the Internal Revenue Service. As of September 30, 2006, unpaid payroll taxes total approximately $134,000. The Company has estimated related penalties and interest at $37,000 computed through September 30, 2006, which are included in current liabilities at September 30, 2006. The Company expects to pay these delinquent payroll tax liabilities as soon as possible. The final amount due will be subject to the statutes of limitations related to such liabilities and to negotiations with the Internal Revenue Service. As of the date of issuance of these financial statements, the entire balance remains payable.

Delinquent sales taxes

The Company had a deferred sales tax balance of $736,825 as of September 30, 2006.  The deferred sales tax becomes due on the 20th day of the following month that a principal payment is collected on an installment contract.  Deferred sales tax also becomes due if the installment sales contract is sold to an unaffiliated third party.   

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Contingent liability

The Series A Preferred Stock includes registration rights that require the Company to file a registration statement with the Securities and Exchange Commission (the "SEC") registering the shares of common stock underlying the preferred stock within 60 days after the final closing (March 31, 2008). For every day the Company is late in filing the Registration Statement beyond 60 days, the Company is obligated to issue to the Investors on a pro rata basis additional Series A Preferred shares in whole share increments equal to 1% of the Series A Preferred shares purchased in this Offering.

The Company accounts for the registrations rights agreement under EITF-00-19-2, Accounting for Registration Payment Arrangements (“EITF-00-19-2”).  Because EITF 00-19-2 specifically states that an entity should recognize and measure a registration payment arrangement as a separate unit of account from the financial instrument(s) subject to that arrangement, the registration rights agreement does not in and of itself cause the host contract (Series A Stock) to be considered a derivative instrument.

In management’s opinion, payment of the registrations rights contingent liability is not probable, and therefore, not reflected in the Company’s financials statements as of September 30, 2006. The Company will continue to evaluate the registration rights contingent liability and the probability of the occurrence of payment under the registration rights at each reporting period to determine if the liability should be reflected in the Company’s financial statements.

NOTE 10 – SUBSEQUENT EVENTS

Debt

·   Unsecured Convertible Promissory Notes – During the fiscal year ended June 30, 2007, notes totaling $933,000 were converted into common stock and the balance of $57,000 was returned to the investors.

·   Secured Promissory Notes – Outstanding notes totaling $250,000 were fully repaid in October/November 2006 and $50,000 was repaid in November 2007.

·   Short-term Bridge Loans – On or about June 8, 2007, Auto Underwriters sold $1,100,000 in Secured Promissory Notes in a private placement to a limited number of accredited investors. The offer and sale was conducted on behalf of the Company by a NASD-licensed broker-dealer who served as managing dealer (the “Managing Dealer”)and received a sales commission of 6%, a due diligence fee of 1% and a non-accountable expense allowance of 3% of the gross proceeds. In addition to the cash payment, we also issued to the Managing Dealer a five year warrant to purchase 110,000 shares of our common stock at an exercise price of $1.50 per share.  The Secured Promissory Notes consist of: (i) Secured Promissory Notes which have in the aggregate a principal amount of $1,100,000 bearing interest at a rate of 10% per annum (issuable in individual notes in $100,000 increments) (the “Note”); (ii) for each $100,000 Note, a five-year warrant to purchase 15,000 shares of common stock of the Company at an exercise price of $2.50 per share with piggyback registration rights and cashless exercise and net issuance provisions (the “Bridge Warrant”); and (iii) possibly, for each $100,000 Note, a five-year warrant with the same terms as the Bridge Warrant to purchase 15,000 shares of the common stock of the Company for every 30 days that the Company fails to repay the Note (the “Liquidated Damages Warrant”) (the Bridge Warrant and the Liquidated Damages Warrant may be referred to collectively as the “Warrants”).  There were 165,000 warrants issued with the Secured Promissory Notes. In November 2007, the Company repaid $302,500 of the notes leaving a balance of $797,500.

Issuance of Series A Stock

From August 2006 through June 2007, the Company issued a total of 2,023,220 shares of Series A Stock at $2.50 per share, for net total proceeds of $4,253,735 (net of issuance costs totaling $804,315).  

Private Placement of Series A Convertible Preferred Stock

During August 2007, Auto Underwriters of America, Inc. (the “Company”) and an NASD-registered broker-dealer (the “Placement Agent”) executed a Financial Representative Agreement.  The Placement Agent has been engaged to conduct a best efforts private placement offering of units consisting of two (2) shares of Series A Convertible Preferred Stock and one warrant (the “Investor Warrant”) to purchase one (1) share of the Company’s common stock exercisable for a period of 5 years at an exercise price of $5.00.

The Agreement details the services to be provided by the Placement Agent and sets forth the compensation to be paid in return.  The Company shall pay the Placement Agent a total cash fee equal to 14.00% of the gross proceeds received by the Company in the private placement.  The Company shall also pay the Placement Agent a cash fee equal to 7.00% of the gross proceeds received by the Company upon exercise of any of the Investor Warrants.  Upon the final closing of the offering, the Company shall also issue the Placement Agent a success warrant to purchase a number of shares of the Company’s common stock equal to 14.00% of the gross proceeds received by the Company in the private placement.  The warrant shall have an exercise price of $2.50 and a term of 5 years.  The Placement Agent sold 403,164 units of the offering which resulted in $1,007,911 being raised. The final closing occurred in March 2008.

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Issuance of Common Stock

During August 2007, the Company and the Placement Agent executed an Investment Banking Agreement.  The Placement Agent has been engaged to provide ongoing investor awareness and business advisory services to the Company for one year in exchange for 360,000 shares of the Company’s common stock.  

Termination of “Escrow, Servicing and Consignment Sales Agreement”

On or about July 20, 2007, the Company entered into the Escrow, Servicing and Consignment Sale Agreement among Auto Underwriters Portfolio Acquisition Company, Inc., as Buyer/Borrower, Auto Underwriters Finance Company, Inc., as Servicer/Guarantor, Auto Underwriters of America, Inc., William Kellagher and Dean Antonis, as Guarantors, and AGM, LLC, as Administrative Agent and Initial Lender.  In the agreement, the Company, as a secured obligor, granted a first priority continuing security interest in and lien on certain consigned automobile inventory, loans and related documents and receivables to AGM, LLC.  The Company’s interest in the foregoing stems from its 100% ownership of its subsidiaries Auto Underwriters Portfolio Acquisition Company, Inc., and Auto Underwriters Finance Company, Inc.

Contemporaneously with the aforementioned Escrow, Servicing and Consignment Sale Agreement, the Company, as a Guarantor, and Auto Underwriters Portfolio Acquisition Company, Inc., a wholly owned subsidiary of the Company as Borrower, executed the Loan and Security Agreement among Auto Underwriters Portfolios Acquisition Company, Inc. (“AUPAC”), as Borrower, Auto Underwrites of America, Inc., William Kellagher, and Dean Antonis, as Guarantors, and AGM, LLC, as Administrative Agent and Initial Lender.  The Loan and Security Agreement provides for a series of term loans to Auto Underwriters Portfolio Acquisition Company, Inc., totaling an amount equal to $14,719,987.03 to be used to purchase automobile inventory and automobile loans from the seller/lender, AGM, LLC.  Although executed, the documents are being held in escrow contingent upon the issuance by the State of Texas of certain vehicle dealer and vehicle financing licenses and permits to our subsidiary AUPAC. AUPAC received the required licenses from the State of Texas on December 12, 2007 but the agreements were terminated by AGM on or about December 4, 2007.  As more fully described in this quarterly report under “Part II, Item 1. Legal Proceedings,” we are currently involved in litigation against AGM, LLC.

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Item 2 . Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report.

Cautionary Statement Regarding Forward-Looking Information

This Quarterly Report on Form 10-QSB contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 about Auto Underwriters of America, Inc. (the “Company”) that are subject to risks and uncertainties.  Forward-looking statements include information concerning future financial performance, business strategy, projected plans and objectives.  Statements preceded by, followed by or that otherwise include the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “may increase,” “may fluctuate” and similar expressions of future or conditional verbs such as “will,” “should,” “would,” and “could” are generally forward-looking in nature and not historical facts.  Actual results may differ materially from those projected, implied, anticipated or expected in the forward-looking statements.  Readers of this quarterly report should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this report. The statements are representative only as of the date they are made.  The Company (sometimes referred to herein as we, us, or similar phrasing) undertakes no obligation to update any forward-looking statement.

These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates, financial condition, results of operations, future performance and business, including management's expectations and estimates with respect to revenues, expenses, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors, some of which are beyond the control of the Company. The following factors, among others, could cause the Company's results or financial performance to differ materially from its goals, plans, objectives, intentions, expectations and other forward-looking statements:

·   our ability to continue operating as a going concern;

·   resolution and payment of unpaid federal and state taxes;

·   unfavorable outcome with respect to pending litigation;

·   general economic and industry conditions;

·   our capital requirements and dependence on the sale of our equity securities;

·   the liquidity of the Company’s common stock will be affected by the lack of, or limited trading market;

·   intense industry competition;

·   our ability to purchase installment contracts;

·   the creditworthiness of contract obligors;

·   shortages in availability of qualified personnel;

·   legal and financial implications of unexpected catastrophic events;

·   regulatory or legislative changes effecting the automobile finance industry; and

·   reliance on, and the ability to attract, key personnel.

For a discussion of these and other risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in the Company’s Annual Report for the fiscal year ended June 30, 2007 filed on Form 10-KSB/A with the SEC, which is available on the SEC’s website at www.sec.gov.  All forward-looking statements are qualified in their entirety by this cautionary statement, and the Company undertakes no obligation to revise or update this Quarterly Report on Form 10-QSB to reflect events or circumstances after the date hereof.  New factors emerge from time to time, and it is not possible for us to predict which factors, if any, will arise.  In addition, the Company cannot assess the impact of each factor on the Company’s business

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or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Business Overview

Auto Underwriters of America, Inc. began operations in August 1983, under the name Advanced Cellular Technology, Inc. and developed and marketed cellular mobile telephone control units and resold used PBX telecommunications equipment.  On December 31, 1990, we suspended operations and remained inactive until December 2002, when we adopted our current name and began our principal operations as a specialty finance company and specialty retailer of used cars and light trucks.

We use AutoUnderwriter.com credit decision software to finance the sale of used cars by our four car sales lots in Houston, Texas and by selected third-party dealers.  We target a selected customer credit profile.  Such purchasers do not meet the credit standards of traditional lenders, such as banks and credit unions, because of the age of the vehicle being financed or the customer’s credit history.  Our borrowers have short or impaired credit histories.  In making decisions regarding the purchase of a particular contract, we consider the following factors related to the borrower: place and length of residence, current and prior job status, history in making installment payments for automobiles, current income and credit history.  In addition, we examine the value of the automobile in relation to the purchase price and the term of the contract.

Our four car lot operations purchase, recondition, sell and finance used vehicles under the name Affordable Cars & Trucks.  These car lots also use AutoUnderwriter.com, which aids in the analysis of the credit worthiness and develops proper deal structure for each customer contract financed.

We are still developing our financing programs and retail concept. The primary drivers for future earnings growth will be vehicle unit sales growth from geographic expansion, comparable same store sales increases to maximize our maturity levels at each lot, and interest income from growth in our contract portfolio.  During the next two years, we plan to focus our growth primarily on adding stores to new markets in the state of Texas.   We also expect used unit comparable store sales increases, reflecting the ramp up in sales of newly opened stores as they mature and continued market share gains at stores that have reached mature sales levels.

The principal challenges we face in expanding our contract volume growth target include:

·   Our ability to procure suitable lot locations at reasonable costs.

·   Our ability to build our management strength to support the store growth.

·   Our ability to maintain competitive direct retail and direct lending operations.

We staff each newly opened store with an experienced management team, including the general manager, purchasing manager, and business office manager, as well as a number of experienced sales managers and account servicing personnel.

Results of Operations

Three months ended September 30, 2006 compared to the three months ended September 30, 2005

Revenues

Total revenues decreased to $1,273,398 for the three month period ending September 30, 2006 compared to the corresponding period ended September 30, 2005 of $6,211,324 principally as a result of the Company’s inability to operate at full capacity because of insufficient capital.

Cost of Sales

Cost of sales as a percentage of automobile and light truck sales was 65.6% or $566,397 for the three month period ending September 30, 2006. During the corresponding period ended September 30, 2005, cost of sales as a percentage of automobile and light truck sales was 64.2% or $3,526,713.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased by $504,851 for the three month period ending September 30, 2006 compared to the corresponding period ended September 30, 2005. This decrease was primarily attributable to the reduction in expenses related to staffing and general operating expenses as the Company sought to conserve its resources until such time that it was able to obtain the necessary capital to expand operations.

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Interest Expense – Warrants

Interest expense warrants represents the fair value of warrants to purchase 150,000 shares of common stock at $1.75 per share to holders of the $700,000 Secured Notes. The warrants were issued as incentive to convert the Secured Notes into 400,000 shares of the Company’s common stock.  See Note 7 to the financial statements. These warrants were recognized at the fair value, as calculated by the Black-Scholes pricing model, on the date of issuance in the amount of $561,045.  The warrants vested immediately resulting in the non-cash interest expense of $561,045 on the date of issuance.  

Interest Expense

Interest expense increased to $387,759 for the three month period ending September 30, 2006 as compared to $289,950 for the corresponding period ended September 30, 2005. The increase in interest expense was primarily due to the increase in borrowings from a line of credit and increased borrowing costs.

Liquidity and Capital Resources

The following table summarizes our liquidity and capital resources for the three months ended September 30, 2006 and 2005.

	Three Months ended September 30,
	2006			2005
Operating activities:
Net loss	$	(1,273,510	)	$	(42,165	)
Bad debt expense		35,000			-
Imputed interest		10,015			-
Warrant expense		561,045			-
Depreciation and amortization		103,103			15,804
Discount on sale of loans		-			78,455
Changes in finance receivables, net:		1,024,959			(1,260,228	)
Changes in operating assets and liabilities:		(717,656	)		(509,556	)
Net cash used in operating activities		(257,044	)		(1,717,690	)
Cash provided by investing activities:		-			972,034
Cash provided by financing activities:		286,884			839,394
Increase (decrease) in cash	$	29,840		$	(93,738	)

Our primary use of working capital was the funding of the origination and purchase of contracts and inventory. The contracts were financed substantially through borrowings on the revolving line of credit. The line of credit is secured primarily by contracts, and available borrowings are based on a percentage of qualifying contracts. We have also funded a portion of our working capital needs through the issuance of Series A Convertible Preferred Stock.

We believe that borrowings available under the line of credit as well as cash flow from operations and, if necessary, the issuance of additional subordinated debt, or the sale of additional securities, will be sufficient to meet our short-term funding needs.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires us to make estimates and assumptions in determining 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 reported period. Actual results could differ from our estimates. We believe the most significant estimate made in the preparation of the accompanying consolidated financial statements relates to the determination of our allowance for credit losses. Below is a discussion of our accounting policy concerning such allowance. Other accounting policies are disclosed in the footnotes of our financial statements which are included in our annual report on Form 10-KSB for the year ended June 30, 2006.

We maintain an allowance for credit losses at a level we consider sufficient to cover anticipated losses in the collection of our finance receivables. The allowance for credit losses is determined based upon a review of historical, recent credit losses, and the finance receivable portfolio. The allowance for credit losses is periodically reviewed by management with any changes reflected in current operations. It is at least reasonably possible that actual credit losses may be materially different from the recorded allowance for credit losses.

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Seasonality

Our automobile sales and finance business is seasonal in nature. In such business, the second fiscal quarter (October through December) is historically the slowest period for vehicle sales. The third fiscal quarter (January through March) is historically the busiest time for vehicle sales as many of our customers use income tax refunds as a down payment on the purchase of a vehicle.

Item 3 . Controls and Procedures

Conclusion Regarding Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer (PEO) and principal financial officer (PFO), we conducted an evaluation of 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 Securities Exchange Act of 1934 (the “Exchange Act”). Based on this evaluation, our management, including our PEO and our PFO, concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report, to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our PEO and our PFO, as appropriate, to allow timely decisions regarding required disclosure.

We, along with our independent auditors, have identified several “significant deficiencies” that collectively constituted a "material weakness" in our internal control over financial reporting under standards established by the Public Company Accounting Oversight Board.

A SIGNIFICANT DEFICIENCY is a control deficiency, or combination of control deficiencies, that adversely affects the Company's ability to initiate, authorize, record, process or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the Company's annual or interim financial statements that is more than inconsequential and will not be prevented or detected.

A MATERIAL WEAKNESS is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement or the annual or interim financial statements will not be prevented or detected.

The following conditions were identified:

·   The current organization of the accounting department does not provide the Company with the adequate skills to accurately account for and disclose significant transactions or disclosures within the time periods as specified by SEC rules and forms.

·   Substantive matters are not being addressed appropriately by the Board resulting in inadequate oversight from the Board. 

·   The process that the Company is currently using to monitor the ongoing quality of internal controls performance, identify deficiencies and trigger timely corrective action is not working effectively.

·   There is no adequate means of accurately capturing and recording certain significant and complex business transactions.

Accordingly, the Company's internal controls over financial reporting are not effective.

Based upon the Company's evaluation, which considered the above findings of our independent auditors, the Company’s management, including the PEO and PFO, concluded that, as of September 30, 2006, the Company's internal controls over financial reporting were not effective.

In response to these deficiencies, the Company has interviewed three public accounting firms and narrowed the search down to one such firm who was contracted, beginning March 2008, The firm will be engaged to assist the Company in establishing additional financial and disclosure controls.  They will also help ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules. Lastly, they will assist in a search for a qualified CFO.  Additionally, we are in the process of improving our internal control over financial reporting in an effort to remediate other deficiencies through improved supervision and training of our accounting staff.  This deficiency has been disclosed to our Board of Directors. Additional effort is needed to fully remedy these deficiencies and we are continuing our efforts to improve and strengthen our control processes and procedures.

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Changes In Internal Control Over Financial Reporting

Other than as described above, there were no changes in our internal control over financial reporting during the quarter ended September 30, 2006 that materially affected or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II.  OTHER INFORMATION

ITEM 1 .    LEGAL PROCEEDINGS

Set forth below are the material pending legal proceedings as of the filing of this report.

Mid-Atlantic

Mid-Atlantic Finance Company, Inc. filed a lawsuit against us on December 13, 2006 in the 6th Judicial Circuit of Pinellas County, Florida, seeking damages in excess of $450,000 concerning a dispute over certain non-prime installment contracts. Mid-Atlantic alleged that the Company failed to repurchase certain finance contracts that were in default.  We counter clamed and alleged that Mid-Atlantic breached its agreement by not remitting to us certain amounts due in relation to a hold back under the installment contracts.  As a result of this dispute, we charged-off our receivable balance due from this finance company of approximately $1,100,000 during fiscal 2006 and have maintained a payable of approximately $152,000 for future repurchase obligations.  On December 12, 2007, we settled this matter and agreed to make periodic payments totaling $175,000.

Gunnels Interests

On October 18, 2007, AUA was sued in the 190th Judicial Court of Harris County, Texas, by Gunnels Interests, Inc., Advantage Autoplex, Inc., TAB Enterprises, Inc., and Lawrence E. Gunnels in the state court of Harris County, Texas.  Case No. 2007-51824, Gunnels Interests, Inc., Advantage Autoplex, Inc., TAB Enterprises, Inc., and Lawrence E. Gunnels v. Auto Underwriters of America, Inc., f/k/a Advanced Cellular Technology, Inc., d/b/a Affordable Cars and Trucks, Dean P. Antonis, and William J. Kellagher.  The lawsuit relates to the purchase of certain assets by AUA from Gunnels Interests, Inc. in March 2004 and vehicle wholesaling and flooring services provided by Gunnels Interests, Inc. to AUA.  Plaintiffs allege, among other things, fraud and breach of contract, and Plaintiffs seek money damages, including exemplary and mental anguish damages.   The Company is currently defending the lawsuit. As of September 30, 2006, the Company’s books reflect a payable due to Gunnels Interests, Inc. of approximately $505,000. The Plaintiffs have not specified any damages, but the estimated contingent liability ranges from $800,000 to $1,000,000, should they be successful. The Company is vigorously defending its position and believes the case is without merit.  Mr. Gunnels is currently an 8.8% shareholder.

AGM, LLC

Auto Underwriters of America, Inc. and its subsidiaries filed litigation against AGM, LLC on or about December 20, 2007 in the U.S. District Court for the Northern District of Illinois alleging that AGM materially breached the Escrow, Servicing and Consignment Sales Agreement dated July 19, 2007.   Specifically, AGM terminated the Escrow Agreement, but failed and refused to refund down payment funds in the amount of $964,000.  Further, we allege that AGM failed to pay Plaintiffs the amounts due and owing for services rendered under the terms of the Escrow Agreement, totaling approximately $155,000. As a result, Auto Underwriters and its subsidiaries have been damaged cumulatively in an amount totaling approximately $1,119,000, exclusive of prejudgment interest, attorneys’ fees and/or additional costs related to bringing this action. Plaintiffs believe that by its improper actions at the expense of Auto Underwriters and its subsidiaries, AGM has been unjustly enriched with monies rightfully belonging to Auto Underwriters and subsidiaries. Further, AGM’s willful and wanton disregard for the rights of Auto Underwriters and subsidiaries constitute an unlawful conversion of monies to which Auto Underwriters and subsidiaries are entitled to immediate possession.  Finally, by falsely and materially misrepresenting the financial bases and prospects for completing this Escrow Agreement, Defendant AGM fraudulently induced Auto Underwriters and subsidiaries into entering the Escrow Agreement and related agreements thereto.  Auto Underwriters and its subsidiaries hope that the court will grant these monies owed to them along with damages. AGM, LLC filed a counter claim on December 28, 2007 in Circuit Court, Cook County, Illinois to keep the $964,000 cash payment and recover other payments of approximately $3,000,000. Auto Underwriters and its subsidiaries believe they have no liability in this claim.

Other

In the normal course of business we may become involved with various other litigation.  Other than as described above, we know of no pending or threatened legal proceedings to which we are or will be a party which, if successful, might result in a material adverse change in our business, properties or financial condition.

ITEM 2 .    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

Set forth below are the sales of unregistered securities that occurred during the year ended June 30, 2007.  Other than as described below, during the quarter ended September 30, 2006 and through the year ended June 30, 2007, we did not have any sales of securities in transactions that were not registered under the Securities Act of 1933, as amended, that have not been reported in a Form 8-K or Form 10-QSB.

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During the fiscal year ended June 30, 2007, Auto Underwriters sold an aggregate of 1,011,610 units of the Company’s securities (the “Units”) in a private placement to a limited number of accredited investors for gross proceeds of $5,058,049. The Units were sold at a price of $5.00 per unit, with each Unit consisting of two shares of the Company’s Series A Convertible Preferred Stock (the “Series A Preferred”) and one warrant to purchase one share of the Company’s common stock (the “Common Stock”), exercisable for a period of five years, at an exercise price of $5.00 per share (the “Investor Warrants”). The offer and sale was conducted on behalf of the Company by a NASD-licensed broker-dealer who served as managing dealer (the “Managing Dealer”) and received a sales commission of 7%, and investment banking and marketing fee of 4% and a nonaccountable expense allowance of 3% of the gross proceeds of $5,058,049.The Managing Dealer also received a warrant to purchase 578,000 shares of the Company’s Common Stock, exercisable for a period of 5 years at $1.00 per share. These securities were offered and sold without registration under the Securities Act of 1933 in reliance upon the exemption provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

During fiscal 2006, Auto Underwriters borrowed $1,000,000 from several investors.  These loans were secured by the Company’s inventory, bearing interest at 10%, and were due September 1, 2006.  In August 2006, certain investors elected to convert $700,000 of these loans into 400,000 shares of common stock and five-year stock purchase warrants exercisable for a total of 140,000 shares of the Company’s Common Stock at an exercise price of $1.75 per share.  In August 2006, certain investors elected to receive a replacement note with a total balance of $50,000.  These replacement notes bear interest at 10%, have a new maturity date of August 31, 2007, and include a five-year stock purchase warrant exercisable for a total of 10,000 shares of the Company’s Common Stock at an exercise price of $1.75.  The Company paid $250,000 in cash plus accrued interest to the remaining investors that elected to not convert or extend the term of their loans.  The Company paid a NASD-licensed broker dealer a fee of $32,000 for their assistance in completing this transaction.  These securities were offered and sold without registration under the Securities Act of 1933 in reliance upon the exemption provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

On March 30, 2007, Auto Underwriters of America, Inc. converted $933,000 of outstanding principal balance (the “Outstanding Amount”) due on certain 9.25% unsecured convertible promissory notes that matured on February 28, 2007 into 622,005 shares of the Company’s common stock, determined by dividing the Outstanding Amount by $1.50.  Fractional shares were paid in cash.  The shares were issued to a limited number of accredited investors.  The common stock was offered and sold without registration under the Securities Act of 1933, as amended, in reliance upon the exemption provided by Section 4(2) of the Securities Act and by Rule 506 of Regulation D promulgated thereunder.  An NASD-licensed broker dealer served as placement agent in connection with the conversion of the Notes and was paid an investment banking fee of $25,000 in connection with the transaction.

On or about June 8, 2007, Auto Underwriters sold $1,100,000 in Secured Promissory Notes in a private placement to a limited number of accredited investors. The offer and sale was conducted on behalf of the Company by a NASD-licensed broker-dealer who served as managing dealer (the “Managing Dealer”) and received a sales commission of 6%, a due diligence fee of 1% and a non-accountable expense allowance of 3% of the gross proceeds. In addition to the cash payment, we also issued to the Managing Dealer a five year warrant to purchase 110,000 shares of our common stock at an exercise price of $2.50 per share. The Secured Promissory Notes consist of: (i) Secured Promissory Notes which have in the aggregate a principal amount of $1,100,000 bearing interest at a rate of 10% per annum due October 15, 2007 (issuable in individual notes in $100,000 increments) (the “Note”); (ii) for each $100,000 Note, a five-year warrant to purchase 15,000 shares of common stock of the Company at an exercise price of $2.50 per share with piggyback registration rights and cashless exercise and net issuance provisions (the “Bridge Warrant”); and (iii) for each $100,000 Note, a five-year warrant with the same terms as the Bridge Warrant to purchase 15,000 shares of the common stock of the Company for every 30 days that the Company fails to repay the Note (the “Liquidated Damages Warrant”) (the Bridge Warrant and the Liquidated Damages Warrant may be referred to collectively as the “Warrants”).  These securities were offered and sold without registration under the Securities Act of 1933 in reliance upon the exemption provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

ITEM 3 .    DEFAULT UPON SENIOR SECURITIES

As described above, in June 2007, Auto Underwriters issued $1,100,000 worth of secured promissory notes to eight investors.  The principal amount of these notes plus 10% interest thereon, plus $110,000 in loan fees, became due on October 15, 2007.  The Company has re-paid $300,000 out of the total of $1,210,000 due to the note holders thus far.  Auto Underwriters is in default on these notes and any one or more of the note holders could bring a lawsuit against Auto Underwriters for this default and obtain judgments against us and our assets, including imposition of attorneys’ fees and court costs which could increase the amount Auto Underwriters owes to the note holders.

ITEM 4 .    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable

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ITEM 5 .    OTHER INFORMATION

Not Applicable

ITEM 6 .    EXHIBITS

31.1           Principal Executive Officer Certification under Section 302 of the Sarbanes-Oxley Act of 2002

31.2           Principal Financial Officer Certification under Section 302 of the Sarbanes-Oxley Act of 2002

32.1           Principal Executive Officer Certification under Section 906 of the Sarbanes-Oxley Act of 2002

32.2           Principal Financial Officer Certification under Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Auto Underwriters of America, Inc.

By:   /s/ Dean Antonis

Dean Antonis

President and Treasurer (Principal Executive,

Financial and Accounting Officer)

Dated: May 16, 2008

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