SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2004
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[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from: to
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Commission file number 1-9263
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DEFENSE TECHNOLOGY SYSTEMS, INC.
(Name of small business issuer in its charter)
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Delaware 11-2816128
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
275K Marcus Boulevard, Hauppauge, New York 11788
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (631) 951-4000
Registrant's former name, former address and former fiscal year, if changed
since last report: DataWorld Solutions, Inc.
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Class
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Common Stock, $.001 par value
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 X No
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Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.
Yes X No
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State issuer's revenues for its most recent fiscal year: $ 695,389
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The aggregate market value of the voting stock held by non-affiliates of the
registrant as of October 8, 2004 was approximately $4,090,302, based on the
closing price on that date.
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court.
Yes No X
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On October 4, 2004, 37,770,854 shares of common stock, $.001 par value were
outstanding.
Transitional Small Business Disclosure Format: Yes No X
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DEFENSE TECHNOLOGY SYSTEMS, INC.
TABLE OF CONTENTS
PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Common Equity and Related Stockholder Matters
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 7. Financial Statements
Item 8. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 8A Controls and Procedures
PART III
Item 9. Directors and Executive Officers of the Company
Item 10. Executive Compensation
Item 11. Security Ownership of Certain Beneficial Owners and Management
Item 12. Certain Relationships and Related Transactions .
Item 13. Exhibits and Reports on Form 8-K
Item 14 Principal Accountant Fees and Services
SIGNATURES
Exhibit 31 Section 302 Certification
Exhibit 32 Section 906 Certification
PART I
FORWARD LOOKING STATEMENTS
This annual report on Form 10-KSB (the "Report"), the other reports, statements,
and information that the Company has previously filed or that it may
subsequently file with the Securities and Exchange Commission and public
announcements that the Company has previously made or may subsequently make
include, may include, incorporate by reference or may incorporate by reference
certain statements that may be deemed to be "forward-looking statements". These
forward-looking statements relate to such matters as, among other things, the
Company's anticipated financial performance, business prospects, technological
developments, new products, future distribution or license rights, international
expansion, possible strategic alternatives, new business concepts, capital
expenditures, consumer trends and similar matters.
Forward looking statements necessarily involve known and unknown risks,
uncertainties and other factors that may cause the actual results, levels of
activity, performance, or achievements to be materially different from any
future results, levels of activity, performance, or achievement expressed or
implied by such forward-looking statements. Readers are cautioned to review
carefully the discussion concerning these and other risks which can materially
affect the Company's business, operations, financial condition and future
prospects.
In some cases, you can identify forward-looking statements by terminology such
as "may," "will," "should," "could," "intend," "expect," "anticipate," "assume",
"hope", "plan," "believe," "seek," "estimate," "predict," "approximate,"
"potential," "continue", or the negative of such terms. Statements including
these words and variations of such words, and other similar expressions, are
forward-looking statements. Although the Company believes that the expectations
reflected in the forward-looking statements are reasonable based upon its
knowledge of its business, the Company cannot absolutely predict or guarantee
its future results, levels of activity, performance, or achievements. Moreover,
neither the Company nor any other person assumes responsibility for the accuracy
and completeness of such statements.
The Company notes that a variety of factors could cause its actual results
and experience to differ materially from the anticipated results or other
expectations expressed in its forward-looking statements. The risks and
uncertainties that may affect the operations, performance, development and
results of its business include, but are not limited to, the following: changes
in spending patterns; changes in overall economic conditions; the impact of
competition and pricing; the financial condition of the suppliers and
manufacturers from whom the Company sources its merchandise; changes in tax
laws; the Company's ability to hire, train and retain a consistent supply of
reliable and effective participants in its marketing operations; general
economic, business and social conditions in the United States; the costs of
complying with changes in applicable labor laws or requirements, including
without limitation with respect to health care; changes in the costs of interest
rates, insurance, shipping and postage, energy, fuel and other business
utilities; the risk of non-payment by, and/or insolvency or bankruptcy of,
customers and others owing indebtedness to the Company; actions that may be
taken by creditors with respect to the Company's obligations that are subject to
default proceedings; threats or acts of terrorism or war; and strikes, work
stoppages or slow downs by unions affecting businesses which have an impact on
the Company's ability to conduct its own business operations.
Forward-looking statements that the Company makes, or that are made by others on
its behalf with its knowledge and express permission, are based on a knowledge
of the Company's business and the environment in which it operates, but because
of the factors listed above, actual results may differ from those in the
forward-looking statements. Consequently, these cautionary statements qualify
all of the forward looking statements made herein. The Company cannot assure the
reader that the results or developments anticipated by it will be realized or,
even if substantially realized, that those results or developments will result
in the expected consequences for it or affect it, its business or operations in
the way the Company expects. Readers are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of their dates, or on
any subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf, which are expressly qualified in their
entirety by these cautionary statements. The Company does not undertake any
obligation to release publicly any revisions to such forward-looking statements
to reflect events or circumstances after the date hereof or thereof or to
reflect the occurrence of unanticipated events, other than as required to comply
with the disclosure requirements of the federal securities laws.
ITEM 1 - BUSINESS
THE COMPANY
DEFENSE TECHNOLOGY SYSTEMS, INC. (the "Company") was incorporated in Delaware on
January 7, 1998 as DataWorld Solutions, Inc. and commenced operations on March
7, 1998. The Company became publicly traded as a result of a reverse merger with
Vertex Computer Cable & Products, Inc. ("Vertex") in December 1998. Previously
in January 1998, Vertex secured certain financing that made effective Vertex's
second amended plan of organization under Chapter 11 of the U.S. Bankruptcy Act.
In June 2004, the Company changed its name to Defense Technology Systems. The
Company consists of two operating divisions: DWS Manufacturing is a specialty
assembler of electronic cable assemblies used in data systems and is also a
distributor of cabling systems, components and cable management solutions; DWS
Defense Systems is a distributor, installer and integrator of specialized
security products. Both divisions operate in one business segment as
contemplated by generally accepted accounting principles.
The Company seeks to add value to its products by providing connectivity
solutions which may include distributed sales of passive components (electronic
connectors, electronic wire and cable, cabinets and racks, and patch panels),
and active components (hubs, bridges, routers, gateways and modems). The Company
provides quality products at competitive prices for interconnection requirements
including Fiber Optics, CAT 5, Telco, V.35, Wire Harnesses, Ethernet, Fast
Ethernet, Token Ring, Flat Ribbon and Coax cables. The Company is one of only
five exclusive domestic distributors of Corning Cable Systems Premise Wiring.
Management believes that the Company's technical ability for providing
connectivity solutions between the data system capabilities of many
manufacturers and the specific connectivity needs of its customers, along with
its reputation for providing manufactured, custom-made electronic cable
assemblies that are subject to quality control testing, will be the principal
factors on which the Company will base its future growth. The Company expects
internal growth to be enhanced by what the Company perceives to be two
continuing trends: (i) the increasing demand for data communications to provide
timely information in the office environment and factory floor that requires
connectivity solutions; and (ii) the growing number of alternatives available to
organizations of all sizes in all types of industries to increase productivity
through improved or upgraded computer data communications.
Driven by the need for added safety and security in this era of increased
terrorist activity, in October 2003, the Company formed a new division, DWS
Defense Systems, Inc., wholly owned subsidiary, which was created to distribute
and install specialty products and equipment for the safety and security needs
of the domestic and international business community.
The Company's executive offices are located at 275K Marcus Boulevard, Hauppauge,
New York 11788 and its telephone number is (631) 951-4000. The Company's address
on the World Wide Web is www.DataWorldDirect.com. Unless the context requires
otherwise, all references herein to the Company and DTS mean Defense Technology
Systems, Inc.
RECENT SIGNIFICANT DEVELOPMENTS
In August 2003, the Company entered into an 8% convertible note agreement
with Augustine Capital Management ("Augustine"). Under the terms of the
agreement with Augustine, the Company may borrow up to $500,000, with interest
paid quarterly in arrears. All outstanding notes are due August 28, 2005. The
agreement provides that the Company's indebtedness to Augustine (inclusive of
accrued interest) may be converted into the Company's common stock at a price
equal to 75% of the lowest bid price for the five trading days immediately
preceding the conversion. The Company is required to reserve shares of common
stock sufficient to satisfy the conversion of any outstanding advances. In
December 2003, the then outstanding balance of $174,000 plus accrued interest
was converted to common stock.
In October 2003, the Company formed a new wholly owned subsidiary, DWS Defense
Systems, Inc. This subsidiary was created to address the growing safety and
security concerns expressed by customers of Defense Technology Systems, Inc. In
November 2003, DWS Defense Systems, Inc. formed an Advisory Board to assist
management in the development and execution of the subsidiary's business plan.
The board consisted of several recognized business and industry leaders who were
chosen to provide guidance, access to prospective customers, and build industry
awareness for the subsidiary's products and services. In September 2004, the
Company dissolved the Advisory Board and announced its intention to add
additional members to the Company's Board of Directors in order to more directly
channel the expertise of certain individuals for the Company's benefit.
In April 2004, Daniel McPhee, the President and Chief Executive Officer of the
Company, contributed for no consideration six million shares of common stock
personally owned and held by him, to the Company's treasury. Mr. McPhee elected
to return the shares for their use in acquisitions and other corporate purposes
without the Company incurring additional dilution.
In June 2004, the Company entered into a settlement agreement with Rosenthal &
Rosenthal ("R&R"), its asset-based lender. The agreement called for the
conversion of the outstanding balance of $1,790,327, including accrued interest,
into one million shares of common stock and a $250,000 note payable. The note
has a term of three years and accrues interest at the current prime rate plus
two percent.
In June 2004, the Company entered into a settlement agreement with two note
holders, TW Cable LLC, and Edward Goodstein, which called for the conversion of
the outstanding balance of $432,865, including accrued interest, into 110,000
shares of common stock.
In July 2004, the Company entered into an agreement with Georal International,
Ltd. ("Georal") to acquire the patent for the GIL 2001 Security Doors (U.S.
Patent No. 6,472,982). The agreement calls for the Company to issue Georal one
million shares of common stock in exchange for the assignment of the patent.
BUSINESS STRATEGY
As described in Part II - Item 6, the Company has suffered losses from
operations and has net working capital and stockholders' equity deficiencies.
Management's plan to address this issue is discussed therein and includes
restructuring its liabilities and raising additional capital. The execution of
the Company's overall business strategy as described below has been hampered by
its financial condition.
The business strategy of the Company's Data Division is to develop a value-added
distribution network through internal growth with a focus on connectivity
solutions for data and telecommunications. Management believes it will continue
to (i) introduce new connectivity solutions, (ii) improve operating efficiencies
through a more efficient organizational structure, (iii) derive the benefits of
critical mass through the opportunity to develop stronger relationships with,
and obtain improved terms from key suppliers, and (iv) derive the benefits of
critical mass through the ability to distribute to and service large national
and international customers. In its relationship with its customers, the Company
focuses on providing connectivity solutions. Such solutions include advising
customers on the options available to meet their specific needs, and
manufacturing custom-made electronic cable assemblies for the customers. In
addition, the Company continues to service the customers with components and
assemblies as the customer's system grows. Management believes that
manufacturers of products generally choose to build relationships with
distributorships capable of offering advisory services, technical support, and
other services such as manufacturing custom-made electronic cable assemblies.
The Company believes it is perceived as a value-added manufacturer by both
suppliers and customers as a result of its technical skills and knowledge of the
marketplace, access to and understanding of the product capabilities, and
technical design and manufacturing capabilities for custom-made electronic cable
assemblies. The Company also plans to focus its efforts on the marketing of its
franchised distributorship with Corning Cable Systems, one of the premier fiber
optic cable manufacturers in the Unites States.
The Company's newly formed Security Division was created to distribute and
install specialty products and equipment for the safety and security needs of
the domestic and international business community. The Company seeks to develop
relationships with key product manufacturers and when possible, create a
competitive edge by securing an exclusive distribution agreement with these
manufacturers.
PRODUCTS AND SERVICES
The products and services of the Data Division consist principally of the design
and sales of custom-made electronic cable assemblies and harnesses used as
solutions for connectivity requirements in data communications. Additionally,
the Company is a franchised distributor for the Corning Cable Systems premise
wiring product line.
The products and services of the Security Division include bullet and blast
resistant door and panels, glass laminate and glass-clad barriers, specialized
data-center safety and security products, secure door systems, and video
surveillance and recording equipment.
PRINCIPAL SUPPLIERS
A single manufacturer is manufacturing substantially all of the Company's Data
Division cable assembly products, on a purchase order basis.
SALES AND MARKETING
The Company's Data Division offers a broad range of custom-made cable assemblies
and harnesses used as connectivity solutions to end-users, professionals who
install and service data communications, and original equipment manufacturers
(OEM's). The Company operates through its location in the Northeast region of
the United States. This location operates as a sales office in addition to
supporting the design and manufacture of custom-made and standard cable assembly
requirements for the entire Company. In order to effectively meet each
customer's needs, the sales force first gains an understanding of the customer's
system connectivity requirements before recommending one or more possible
solutions. The Company generally does not participate in the design of computer
applications but rather participates in the design and implementation of the
connectivity solutions required for data communications.
The field sales force is supported by inside sales personnel, who handle
incoming customer calls, perform sales estimates, provide responses to customer
questions and assist in sales prospecting. Sales leads are typically generated
by ongoing interaction with existing customers, sales calls to companies not
currently customers, and referrals from suppliers. The Company is in the process
of updating its web site in order to generate internet-based business in the
future.
MAJOR CUSTOMERS
The Company's net sales are currently concentrated among three major customers
who accounted for 29%, 26%, and 19% of net sales, respectively, in fiscal 2004.
COMPETITION
All aspects of the Company's business are highly competitive. The Company
competes with several national distributors, which have greater financial and
other resources than the Company. The Company also competes with numerous
distributors on a local or regional basis. The Company believes that its ability
to design and manufacture custom cable assemblies as well as make available
technical support, differentiates the Company's from its primary competitors and
gives the Company a certain competitive advantage. Additionally, where possible
the Company seeks to establish exclusive distribution agreements with
manufacturers of specialized products in order to create a competitive
advantage. There can be no assurance the Company will be able to successfully
exploit such advantage.
INSURANCE
Due to liquidity restrictions, the Company ceased carrying insurance in
September 2001. The Company then relied on the pass-through warranties provided
by its manufacturers. The Company can not assess the significance of its not
maintaining product liability insurance, but to date no claims have been made
and the Company is unaware of any potential product liability claims against it.
In February 2004, the Company purchased general liability and property
insurance.
EMPLOYEES
The Company currently has four full-time employees. Of these, two are sales and
marketing personnel, and two are executives. None of the Company's present
employees are covered by a collective bargaining agreement. The Company
considers its employee relations to be generally satisfactory. The Company
retains consultants and sub-contractors on a continuing and as-needed basis to
handle additional workflow.
ITEM 2 - PROPERTIES
The Company's only facility is located at 275K Marcus Boulevard, Hauppauge, New
York, where it moved at the end of February 2004. This location consists of
1,400 square feet of office space, and 1,400 square feet of warehousing space.
The Company recently signed a four-year lease for this facility, and considers
this space to be adequate for its present needs. The lease is for a period of
four years with an annual rent of $30,800 and a 3% annual increase in each of
the three subsequent years. This charge is inclusive of real-estate taxes and
common area charges, but does not include utilities. Previously the Company
leased space on a month-to-month basis in a nearby location.
ITEM 3 - LEGAL PROCEEDINGS
The Company is a party to legal matters arising in the general conduct of
business. The ultimate outcome of such matters is not expected to have a
material adverse effect on the Company's results of operations or financial
position. During fiscal 2001 and subsequently, the Company decided not to
dispute litigation with suppliers and other creditors for collection of amounts
owed to them. As a result, through September 2004, the Company had outstanding
judgments amounting to $527,051.
In September 2000, the Company began to negotiate a potential merger with
American Access Technologies ("AAT") which resulted in a Merger Agreement being
signed in April 2001. In June 2001, the Company was notified by AAT that they
were unilaterally terminating the agreement claiming that the Company had
suffered material and adverse changes and that such changes entitled AAT to
terminate the agreement. AAT then filed suit against the Company seeking
reimbursement of various incurred costs. The Company has filed a countersuit
against AAT alleging wrongful termination. The matter is currently set for trial
in November 2004.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During June 2004, the Company changed its name from DataWorld Solutions, Inc.,
to Defense Technology Systems, Inc. This change in the Certificate of
Incorporation was approved by a written majority of all of the outstanding
shares of the Company in accordance with applicable Delware law. Notice to
non-consenting shareholders was given thereafter.
PART II
ITEM 5 - MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Current symbol - DFTS.OB
The Company's common stock traded on the National Quotation Bureau's Pink Sheets
from November 2001 through June 2004, and on the NASDAQ Over-The-Counter
Electronic Bulletin Board since then. The following table shows the quarterly
range of the high and low closing bid prices for the Common Stock on the
Over-The- Counter Electronic Bulletin Board and the Pink Sheets since July 1,
2003, for the periods indicated.
Common Stock
Period High Low
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FISCAL 2004
First Quarter ended September 30, 2003 .19 .01
Second Quarter ended December 31, 2003 .87 .14
Third Quarter ended March 31, 2004 .53 .14
Fourth Quarter ended June 30, 2004 .51 .15
FISCAL 2003
First Quarter ended September 30, 2002 .02 .01
Second Quarter ended December 31, 2002 .02 .01
Third Quarter ended March 31, 2003 .01 .01
Fourth Quarter ended June 30, 2003 .02 .01
Recordholders
As of September 30, 2004, there were approximately 175 holders of record of the
Company's common stock.
Dividends
The Company has never paid a cash dividend on its common stock and the Company
does not anticipate paying any dividends on the common stock in the foreseeable
future. The Company anticipates retaining future earnings, if any, to fund
capital development.
Recent Sales of Unregistered Securities
Set forth below is information regarding the issuance and sale of our securities
without registration from April 1, 2004 through June 30, 2004.
Issuance of stock in exchange for outstanding debt:
o In April 2004, the Company issued 39,326 shares of common stock
valued at $10,303, or $0.26 per share pursuant to a settlement
agreement with a vendor.
o In April 2004, the Company issued 12,000 shares of common stock valued
at $3,996, or $0.33 per share pursuant to a settlement agreement with
a note holder.
o In June 2004, the Company issued 1,000,000 shares of common stock to
its asset-based lender valued at $402,000, or $0.40 per share,
pursuant to a settlement agreement.
o In June 2004, the Company entered into an agreement with a note holder
to convert the outstanding principal and accrued interest into 110,000
shares of common stock valued at $432,865, or $0.25 per share.
o In June 2004, the Company entered into an agreement with a vendor to
settle an outstanding debt in exchange for the issuance of 5,000
shares of common stock valued at $2,055, or $0.41 per share.
Issuance of stock in exchange for other consideration:
o In June 2004, an existing shareholder entered into an agreement with
the Company to purchase 35,000 shares of common stock for $10,000, or
$0.29 per share.
The above issuances were exempt from registration under the Securities Act of
1993 in that they did not constitute public offerings.
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following discussion should be read in conjunction with our consolidated
financial statements and accompanying notes, included herein. Certain statements
contained herein may constitute forward-looking statements, as discussed at the
beginning of Part I of this Annual Report on Form 10-KSB. Our actual results
could differ materially from the results anticipated in these statements as a
result of a variety of factors, including those discussed in our filings with
the Securities and Exchange Commission and as discussed in the section under the
heading "Forward Looking Statements" in this Report.
RESULT OF OPERATIONS
Net sales decreased 27% from $950,656 in fiscal year 2003 to $695,389 in 2004.
The decline in data sales due to economic factors and lack of working capital,
was partially offset by $177,000 in sales by the Company's newly formed Security
Division.
Gross profit amounted to $207,766 in fiscal 2004 versus $544,768 in 2003. Gross
profit margin decreased to 30% in 2004 from 57% in 2003. The fiscal year 2004
gross profit margin was more representative of the Company's typical gross
margin as the fiscal 2003 gross margin benefited from a the completion of a
major, non-recurring contract that called for the Company to provide labor only,
which resulted in a significantly higher gross margin. Additionally, the gross
margin on sales of the Company's newly formed Security Division was only 3% as
this represented the Company's first effort in this new market.
Selling, general and administrative expenses increased approximately 376% to
$3,815,393 for the year ended June 30, 2004, from $801,127 for the year ended
June 30, 2003. The increase is primarily related to $2,772,665 of non-cash
charges for consulting expenses and officer's compensation related to the
granting of common stock and options to certain individuals. Additionally, as a
result of the Company's efforts to become current in its public reporting
requirements, professional fees were $308,784 in fiscal 2004 versus $4,319 in
fiscal 2003.
Interest expense amounted to $427,254 in 2004 versus $363,643 in 2003. Interest
expensed increased in 2004 due to the beneficial conversion feature of $83,000
related to a note payable to a related party.
Depreciation and amortization included in selling, general and administrative
expenses, was $5,360 in 2004 and $1,440 in 2003.
The Company had a net loss of $2,200,599 in 2004 compared to a net loss of
$492,495 in 2003.
The net loss applicable to common shareholders was $2,326,072 in 2004 and
$636,627 in 2003 primarily due to the dividends declared on convertible
preferred stock.
LIQUIDITY AND FINANCIAL CONDITION AS OF JUNE 30, 2004
The Company has current assets of $93,165 (including $3,920 in cash) compared
with current liabilities of $4,486,259, resulting in a working capital deficit
of $4,393,094 as of June 30, 2004. This compares with current assets of $185,197
in 2003 and a working capital deficit of $6,366,781. Current liabilities
decreased mainly due to the settlement of the Company's obligation with its
asset-based lender. The Company's working capital is clearly not sufficient to
meet the Company's current liquidity needs. The Company has relied upon cash
flow generated from operations, loans from third party lenders, and private
sales of equity securities to sustain itself during the year.
The Company's cash balance at June 30, 2003 decreased $7,968 from $11,888 to
$3,920 as of June 30, 2004. The decrease was the result of a combination of cash
used for repayment of loans totaling $327,572, investing activities totaling
$28,721 and negative cash flows from operations totaling $489,140, offset by
direct cash proceeds from shareholder loans and advances from the Company's
asset-based lender totaling $477,465; indirect loan proceeds (paid directly to
vendors and creditors) of $115,125 and proceeds from common stock sales totaling
$360,000. Operating activities for the year ended June 30, 2004 exclusive of
changes in current assets and liabilities required $1,080,651, offset by a
decrease in receivables and other current assets of $84,064, and an increase in
accounts payable and accrued liabilities of $507,447.
The Company's capital resources include private stock sales and loans and
advances from principal shareholders. During the year ended June 30, 2004, the
Company borrowed $264,000 under the terms of its convertible loan agreements
with Augustine. In December 2003, Augustine converted $174,000 of loan
principal, including $75,000 borrowed during fiscal 2003, into shares of common
stock. These agreements provide for additional borrowings of $251,000, all of
which may be converted to common stock. Additionally, during the year ended June
30, 2004, the Company borrowed approximately $125,000 from an existing
shareholder, of which approximately $115,000 was paid directly to the Company's
vendors and creditors.
During the fiscal year ended June 30, 2002, the Company decided to self-insure
against its liability risks. There have been no claims against the Company with
respect to any insurable risks. In February 2004, the Company purchased property
and general liability insurance.
The Company is currently implementing a business plan that it believes will
strengthen the balance sheet, increase revenue and return it to profitability.
The plan involves a series of initiatives. The Company is seeking to restructure
its liabilities by negotiating with secured and unsecured creditors and vendors
for forgiveness of certain outstanding debt, or to exchange debt for equity.
Through the end of fiscal 2004, the Company has settled a total of approximately
$2 million in exchange for cash payments of approximately $37,000 and new equity
issuances valued at $472,000, resulting in a gain of approximately $1.5 million.
The Company continues to seek settlements of outstanding debt.
In the fourth quarter of fiscal 2004 the Company was advised by its counsel
that pursuant to applicable commercial law, certain of its trade obligations are
statutorily unenforceable after periods of four or six years, as applicable,
from the date of their incurrence. Accordingly the Company has written off
$230,597 of accounts payable which amount is included in gain on settlement and
write-off of debt for the year ended June 30, 2004.
The Company is actively engaged in raising capital through private investors.
This will provide additional working capital and allow it to increase revenue
and pursue more profitable projects. In order to facilitate this process, in
April 2004 the Company's CEO, a major shareholder, contributed six million
shares of the Company's common stock to its treasury for no consideration.
During fiscal 2004, the Company raised $360,000 through sales of common stock.
The Company has expanded into the security business which it believes will
complement and enhance its current product offerings and greatly expand its
customer base. The Company may also pursue strategic acquisitions that provide
it with growth and vertical integration within this new area. The Company may
benefit from additional liabilities becoming statutorily barred from collection.
If management is not successful in implementing the initiatives discussed in the
preceding paragraphs, it could result in the severe curtailment of the Company's
operations and/or the seizure of its assets and/or its being forced into
bankruptcy. There is no assurance that the Company will be successful in
accomplishing its objectives. The accompanying financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
INFLATION
For the last fiscal year, the Company has not been significantly affected by
inflation.
ITEM 7 - FINANCIAL STATEMENTS
The financial statements listed in the index in Item 13-a are attached as part
of this report commencing on page F-1.
ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 8-A - CONTROLS AND PROCEDURES
Daniel McPhee, Chief Executive Officer and Philip J. Rauch, Chief Financial
Officer of Defense Technology Systems, Inc., have established and are currently
maintaining disclosure controls and procedures for the Company. The disclosure
controls and procedures have been designed to ensure that material information
relating to the Company is made known to them as soon as it is known by others
within the Company.
The Company's Chief Executive Officer and Chief Financial Officer conducted an
update and a review and evaluation of the effectiveness of the Company's
disclosure controls and procedures and have concluded, based on their evaluation
within 90 days of the filing of this Report, that the Company's disclosure
controls and procedures are effective for gathering, analyzing, and disclosing
the information it is required to disclose in its reports filed under the
Securities Exchange Act of 1934. There have been no significant changes in the
Company's internal controls or any other factors that could significantly affect
these controls subsequent to the date of the previously mentioned evaluation.
PART III
ITEM 9 - DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The Director and Executive Officers of the Company and certain information
concerning them as of September 30, 2004, are set forth below:
Name Position With The Company Age
-------------------- ------------------------- ---
Daniel McPhee Chairman of the Board, 40
President, Chief Executive Officer
and Director
Philip J. Rauch Chief Operating and Financial Officer, 44
and Director
Mr. Daniel McPhee has been Chairman of the Board of Directors, President, Chief
Executive and Director since December 17, 1998. He also served as Chief
Financial Officer through January 31, 2004. Prior thereto, and since 1992, Mr.
McPhee was associated with Elcan Technologies Corp. ("ETC") as senior sales
representative and was promoted to Executive Vice President in early 1997. From
1988 to 1992, Mr. McPhee was employed by United Datacom & Cable, Inc. as a
salesman and Vice President. From 1985 to 1988, Mr. McPhee was a project manager
with Forest Electric Corp. In 1985, Mr. McPhee received a bachelor's degree in
Business Administration from Adelphi University. Mr. McPhee is a member of the
Communication Managers Association.
Mr. Philip J. Rauch has been the Chief Operating and Financial Officer since
February 1, 2004, and a Director since June 1, 2004. Prior thereto, and since
1997, Mr. Rauch was associated with AboveNet, Inc. (formerly Metromedia Fiber
Network, Inc.) as Vice President, Carrier Business Operations, and since 2001 as
Controller. From 1993 to 1997, Mr. Rauch was Vice President, Controller of
Columbus Construction, a heavy construction company with several plant
facilities. From 1989 to 1993 he was Vice President and Chief Financial Officer
of F. Garofalo Electric Co., a Local #3 IBEW engineering and construction
company. Mr. Rauch earned a Bachelor of Science in Economics degree from the
University of Pennsylvania Wharton School of Business, with a concentration in
finance and accounting. He also earned a certificate in Construction Management
from the Institute of Design and Construction in New York. Mr. Rauch is a member
of the American Management Association and the Construction Financial Management
Association.
ITEM 10 - EXECUTIVE COMPENSATION
The following table sets forth, for the fiscal year indicated, all compensation
awarded to, earned by or paid to all individuals serving as the Company's Chief
Executive Officer ("CEO") or acting in a similar capacity and all executive
officers of the Company who earned more than $100,000 annually.
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
Other ----------------------
Annual All Other
Compen- Number Compen-
Name and Fiscal Salary Bonus sation of sation
Principal Position Year ($) ($) ($) Options ($)
--------------------- ------ ------ ----- ------- ------- ---------
Daniel McPhee 2004 $134,135 $ - $9,000 - $ -
Chief Executive 2003 $150,000 $ - $18,500 - $ -
Officer (1) 2002 $150,000 $ - $27,900 - $ -
Philip J. Rauch 2004 $25,705 $ - $6,250 - $ 236,500
Chief Operating
and Financial
Officer
(1) See Item 12.
The Company currently has no pension plan for employees.
No options were granted to or exercised by the Executive Officers during
the fiscal year ended June 30, 2004. The Executives held no options at June 30,
2004.
DIRECTORS' COMPENSATION
The Company did not pay any director's fees during the 2004 fiscal year.
ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of September 30, 2004, certain information
regarding beneficial ownership of the Common Stock held by each person known by
the Company to own beneficially more than 5% of the Common Stock, each of the
Company's directors, each of the executive officers named in the Summary
Compensation Table, and all of the Company's executive officers and directors as
a group.
Beneficial Ownership
Name and Address Shares %
-------------------- --------- ------
Daniel McPhee 3,185,000 8.6%
275K Marcus Blvd.
Hauppauge, NY 11788
Philip J. Rauch 500,000 1.4%
275K Marcus Blvd.
Hauppauge, NY 11788
All directors and 3,685,000 10.0%
officers as a group
ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In April 2004, Daniel McPhee, the President and Chief Executive Officer of the
Company, contributed for no consideration six million shares of common stock
personally owned and held by him, to the Company's treasury.
As of June 30, 2004, approximately $234,000 of accrued compensation due the
Company's President and Chief Executive Officer was included in accrued expenses
on the Consolidated Balance Sheet.
ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K
(a) CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Registered Public Accounting Firm F1
Consolidated Balance Sheet as of June 30, 2004 F2
Consolidated Statements of Operations for the years ended
June 30, 2004 and 2003 F3
Consolidated Statements of Changes in Stockholders' Deficit
for the years ended June 30, 2004 and 2003 F4 - F5
Consolidated Statements of Cash Flows for the years ended
June 30, 2004 and 2003 F6 - F7
Notes to Consolidated Financial Statements F8 - F29
(b) EXHIBITS:
The following documents are included or incorporated by reference as exhibits to
this report:
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation, or
Succession.
2.1 Second Amended Joint Plan of Reorganization dated September 24, 1997
(incorporated by reference to Exhibit 2.1 to the registrant's current
report on Form 8-K dated February 5, 1998)
2.2 Second Amended Joint Disclosure Statement dated September 24, 1997
(incorporated by reference to Exhibit 2.2 to the registrant's current
report on Form 8-K dated February 5, 1998)
2.3 Order of United States Bankruptcy Court, Eastern District of New York
dated October 30, 1997(incorporated by reference to Exhibit 2.3 to the
registrant's current report on Form 8-K dated February 5, 1998)
2.4 Certificate of Ownership and Merger dated November 20, 1997
(incorporated by reference to Exhibit 3.1(d) to the registrant's
current report on Form 8-K dated February 5,1998)
2.5 Certificate of Ownership and Merger and change of name dated April 30,
1999 (incorporated by reference to Exhibit 2.5 to the registrant's
annual report on Form 10K-SB for the year ended June 30, 2000)
2.6 Certificate of Correction dated February 18, 2000 to the Certificate
of Ownership and Merger dated April 30, 1999 (incorporated by
reference to Exhibit 2.6 to the registrant's annual report on Form
10K-SB for the year ended June 30, 2000)
2.7 Restated Certificate of Incorporation dated May 24, 2000 (incorporated
by reference to Exhibit 3.1 to the registrant's annual report on Form
10K-SB for the year ended June 30, 2000)
(3) Articles of Incorporation & By-laws
3.1 Restated Certificate of Incorporation dated May 24, 2000 (incorporated
by reference to Exhibit 3.1 to the registrant's annual report on Form
10K-SB for the year ended June 30, 2000)
3.2 By-Laws (incorporated by reference to Exhibit 3(b) of Form S-18
Registration Statement No. 33-7693-NY)
3.3 Certificate of Amendment to the Certificate of Incorporation dated
June 28, 2004
(4) Instruments Defining the Rights of Security Holders
4.1 Certificate of Designation, Preferences and Rights of Senior
Cumulative Convertible Preferred Stock (incorporated by reference to
Exhibit 1.2 to the registrant's report on Form 8- K/A dated December
18, 1998)
4.2 Subordinated Debenture Agreement dated December 16, 1999 between the
Company and a non-affiliate (incorporated by reference to Exhibit 4.2
to the registrant's report on Form 10-KSB for the year ended June 30,
1999)
4.3 Securities Purchase Agreement between the Company and Augustine Fund
LP dated May 26, 2000 (incorporated by reference to Exhibit 4.4 to the
registrant's annual report on Form 10K-SB for the year ended June 30,
2000)
4.4 Certificate of Designation of Series B 8% Convertible Preferred Stock
(incorporated by reference to Exhibit 4.5 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2000)
4.5 Eight-Percent (8%) Convertible Note Agreement between the Company and
Augustine Fund, LP, dated August 28, 2003 (incorporated by reference
to Exhibit 4.5 to the registrant's annual report on Form 10K-SB for
the year ended June 30, 2003)
4.6 Second Modification Agreement between Edward Goodstein, TW Cable LLC,
Daniel McPhee and DataWorld Solutions, Inc., dated June 7, 2004
4.7 Settlement Agreement between Rosenthal & Rosenthal, Inc. and DataWorld
Solutions, Inc., dated June 1, 2004
4.8 Promissory Note between DataWorld Solutions, Inc. and Rosenthal and
Rosenthal, Inc., dated June 1, 2004
(10) Material Contracts
10.1 Agreement by and among Vertex Computer Cable & Products, Inc. and
Daniel McPhee and Christopher Francis and TW Cable LLC and Edward
Goodstein and DataWorld Solutions, Inc. dated December 18, 1998
(incorporated by reference to Exhibit 1.1 to the registrant's report
on Form 8-K dated December 18, 1998)
10.2 Agreement by and among DataWorld Solutions, Inc. and Daniel McPhee and
TW Cable LLC and Edward Goodstein, dated December 4, 2002
(incorporated by reference to Exhibit 10.2 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2003)
10.3 Consulting Agreement - SMG Marketing Group, Inc. dated September 10,
2001 (incorporated by reference to Exhibit 10.3 to the registrant's
annual report on Form 10K-SB for the year ended June 30, 2003)
10.4 Consulting Agreement - Lawrence Dobroff dated June 30, 2001
(incorporated by reference to Exhibit 10.4 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2003)
10.5 Consulting Agreement - Bernard Kerik dated October 29, 2003
(incorporated by reference to Exhibit 10.5 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2003)
10.6 Consulting Agreement - Donald DiRenzo dated November 10, 2003
(incorporated by reference to Exhibit 10.6 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2003)
10.7 Consulting Agreement - Scott Vining dated November 10, 2003
(incorporated by reference to Exhibit 10.7 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2003)
10.8 Consulting Agreement - Robert T. Schanz dated November 10, 2003
(incorporated by reference to Exhibit 10.8 to the registrant's annual
report on Form 10K-SB for the year ended June 30, 2003)
10.9 Acquisition of Patent Agreement between Georal International, Ltd.,
DataWorld Solutions, Inc., DWS Defense Systems, Inc., and Alan J.
Risi, dated July 2, 2004.
Certifications
31 Certification of Chief Executive and Financial Officers pursuant to 18
U.S.C. Section 1850, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of the Chief Executive and Financial Officers Pursuant
to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1850, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(c) REPORTS ON FORM 8-K
The Company's report on Form 8-K dated April 30, 2004
On April 30, 2004, the Registrant filed a Current Report on Form 8-K, announcing
the return by the Company's Chief Executive Officer of six million shares of
common stock to the Company's treasury.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following is a summary of the fees billed to the Company by its independent
accountants, BP Audit Group PLLC, applicable to the fiscal years ended June 30,
2004 and 2003:
Fee category 2004 2003
------------ ---- ----
Audit fees $ 54,649 $ 124,380
Audit-related fees - -
Tax fees - 6,243
All other fees - -
-------- ---------
Total fees $ 54,649 $ 130,623
======== =========
Audit fees: Consists of fees for professional services rendered by our principal
accountants for the audit of the Company's annual financial statements and the
review of financial statements included in the Company's Form 10-QSB or services
that are normally provided by our principal accountants in connection with
statutory and regulatory filings or engagements. Fees in fiscal 2003 relate to
the Company's filing of a cumulative Form 10-KSB for three annual audited
periods.
Audit-related fees: Consists of fees for assurance and related services by our
principal accountants that are reasonably related to the performance of the
audit or review of the Company's financial statements and are not reported under
"Audit fees."
Tax fees: Consists of fees for professional services rendered by our principal
accountants for tax compliance, tax advice and tax planning prior to September,
2003.
All other fees: Consists of fees for products and services provided by our
principal accountants, other than the services reported under "Audit fees,"
"Audit-related fees" and "Tax fees" above.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
DEFENSE TECHNOLOGY SYSTEMS, INC.
By: /s/ Daniel McPhee
---------------------------
Daniel McPhee,
President, Chief Executive
Officer and Chairman
of the Board
/s/ Philip J. Rauch
--------------------------
Philip J. Rauch
Chief Financial Officer
(Principal Accounting Officer)
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/ Daniel McPhee
---------------------------
Daniel McPhee,
President, Chief Executive
Officer and Chairman
of the Board
/s/ Philip J. Rauch
-------------------------
Philip J. Rauch
Chief Financial Officer
(Principal Accounting Officer)
Report of Independent Registered Public Accounting Firm
Board of Directors of
Defense Technology Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Defense
Technology Systems, Inc., (formerly DataWorld Solutions, Inc.) and Subsidiaries
(the "Company") as of June 30, 2004 and the related consolidated statements of
operations, stockholders' deficit and cash flows for each of the years in the
two-year period then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Defense
Technology Systems, Inc. and Subsidiaries as of June 30, 2004 and the results of
their operations and their cash flows for each of the years in the two-year
period then ended, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As described in Note
2 to the consolidated financial statements, the Company has suffered losses from
operations and has net working capital and stockholders' equity deficits that
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are described in Note 2-D. The
accompanying consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ BP Audit Group, PLLC
Farmingdale, NY
September 30, 2004
F1
DEFENSE TECHNOLOGY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET
June 30, 2004
ASSETS
CURRENT ASSETS:
Cash $3,920
Accounts receivable 87,745
Other current assets 1,500
------------
TOTAL CURRENT ASSETS 93,165
PROPERTY, PLANT AND EQUIPMENT, net 15,202
SECURITY DEPOSITS 12,119
------------
TOTAL ASSETS $120,486
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable $2,932,351
Accrued expenses and other 1,008,417
Bankruptcy distributions payable 292,120
Notes payable-related parties, current 160,738
Secured subordinated debentures 92,633
------------
TOTAL CURRENT LIABILITIES 4,486,259
Notes payable-related parties 381,087
Accrued dividends on preferred stock 62,189
------------
TOTAL LIABILITIES 4,929,535
------------
COMMITMENTS AND CONTINGENCIES (Notes 2,6,7,9,10,11 and 12)
STOCKHOLDERS' DEFICIT:
8% Series B Convertible Preferred Stock, $.01 par value,
stated value $1,000 per share; Redeemable at $1,250 per share;
authorized, 3,000 shares; 1,559 shares issued and outstanding 1,559,000
Common stock, par value $.001 per share; 40,000,000 shares
authorized, 34,781,755 shares issued and outstanding 34,782
Additional paid-in capital 8,028,629
Accumulated deficit (14,431,460)
------------
TOTAL STOCKHOLDERS' DEFICIT (4,809,049)
------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT: $120,486
============
The accompanying notes are an integral part of these financial statements.
F2
DEFENSE TECHNOLOGY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended
June 30,
2004 2003
-------------- ---------------
Net sales $695,389 $950,656
Cost of goods sold 487,623 405,888
-------------- ---------------
Gross profit 207,766 544,768
-------------- ---------------
Selling, general and administrative expenses 3,815,393 801,127
Interest expense 427,254 363,643
-------------- ---------------
Total expenses 4,242,647 1,164,770
-------------- ---------------
(4,034,881) (620,002)
-------------- ---------------
Commission income 93,205 127,507
Gain on settlements and write-off of debt 1,741,077 -
-------------- ---------------
1,834,282 127,507
-------------- ---------------
Net loss (2,200,599) (492,495)
Accrued dividends on preferred stock (125,473) (144,132)
-------------- ---------------
Net loss attributable to common shares (2,326,072) (636,627)
============== ===============
Basic and diluted loss per share $ (0.07) $ (0.02)
============== ===============
Weighted average common shares outstanding -
basic and diluted 35,659,992 32,828,357
============== ===============
The accompanying notes are an integral part of these financial statements.
F3
DEFENSE TECHNOLOGY SYSTEMS, INC.
STATEMENT OF CHANGES IN CONSOLIDATED STOCKHOLDERS' DEFICIT
YEARS ENDED JUNE 30, 2004 AND 2003
8% $6.00
Preferred Preferred Common Treasury Add'l
Stock Stock Common Stock Treasury Stock Paid-In Retained Stockholder's
Amount Amount Shares Amount Shares Amount Capital Earnings Deficit
----------------------------------------------------------------------------------------------
Balance July 1, 2002 $1,595,000 $650,000 33,740,313 $33,740 - $- $1,209,297 $(11,468,761) $(7,980,724)
Correction for shares
previously cancelled (1,200,000) (1,200) 1,200
Issuance of common stock
in exchange for debt,
accrued interest,
preferred stock and
accrued dividends (650,000) 500,000 500 1,935,634 1,286,134
Accrued dividends on 8%
preferred stock (127,600) (127,600)
Accrued dividends on $6.00
preferred stock (16,532) (16,532)
Net loss (492,495) (492,495)
---------- -------- ---------- -------- --------- ----- ------------ ------------- -----------
Balance June 30, 2003 $1,595,000 $- 33,040,313 $33,040 - $- $3,146,131 (12,105,388) (7,331,217)
========== ======== ========== ======== ========= ===== ============ ============= ===========
F4
Balance July 1, 2003 $1,595,000 $- 33,040,313 $33,040 - $- $3,146,131 $(12,105,388) $(7,331,217)
Conversion of preferred
stock and accrued
dividends into common
stock (36,000) 3,120,566 3,121 489,599 456,720
Value of beneficial
conversion feature of
convertible loans 83,000 83,000
Return of common shares to
treasury by CEO 6,000,000 (2,256,000) 2,256,000 -
Cancellation of treasury
stock (6,000,000) (6,000)(6,000,000) 2,256,000 (2,250,000) -
Common stock sales 1,335,000 1,335 358,665 360,000
Common stock issued
pursuant to subscription
received 350,000 350 34,650 35,000
Common stock issued to
Company officer 500,000 500 236,000 236,500
Common stock issued in
exchange for consulting
services 700,000 700 417,300 418,000
Conversion of note payable
and accrued interest to
common stock 435,550 436 214,164 214,600
Issuance of stock in
settlement of note
payable and accrued
interest 124,000 124 448,977 449,101
Issuance of common stock
in settlement of
liability to asset-based
lender 1,000,000 1,000 401,000 402,000
Issuance of stock in
settlement of accrued
liabilities 176,326 176 74,978 75,154
Stock options granted for
consulting services 2,118,165 2,118,165
Accrued dividends on 8%
preferred stock (125,473) (125,473)
Net loss (2,200,599) (2,200,599)
---------- -------- ---------- -------- --------- ----- ------------ ------------- -----------
Balance June 30, 2004 $1,559,000 $- 34,781,755 $34,782 - $- $8,028,629 ($14,431,460) ($4,809,049)
========== ======== ========== ======== ========= ===== ============ ============= ===========
The accompanying notes are an integral part of these financial statements.
F5
DEFENSE TECHNOLOGY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH
FLOWS
Years Ended
June 30,
2004 2003
------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,200,599) $(492,495)
Adjustments to reconcile net loss to net
cash used by operating activities
Depreciation and amortization 1,400 -
Amortized bond discount 3,960 1,440
Interest component of beneficial conversion feature
of convertible loans 83,000 -
Gain on settlements and write off of debt (1,741,077) -
Stock and options granted for consulting services 2,536,165 62,941
Stock issued for officer compensation 236,500 -
Change in current assets and liabilities:
Decrease/(increase) in accounts receivable 85,564 (28,803)
Increase in prepaid expenses and other assets (1,500) -
Accrued interest on bankruptcy liability 21,788
Accrued interest on payable to asset-based lender 60,679 -
Increase in accounts payable and other
accrued expenses 424,980 324,100
-------- --------
Cash used by operating activities (489,140) (132,817)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Fixed asset acquisitions (16,602) 7,500
Security deposits (12,119)
-------- --------
Cash provided (used) by investing
activities (28,721) 7,500
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings from asset-based lender 203,565 1,067,305
Repayments of amounts due asset-based lender (312,572) (934,972)
Proceeds from notes and loans 273,900 -
Principal repayments on loans (15,000) -
Issuance of common stock 360,000
-------- --------
Cash provided by financing activities: 509,893 132,333
-------- --------
NET INCREASE/(DECREASE) IN CASH (7,968) 7,016
Cash beginning of year 11,888 4,872
-------- --------
Cash at end of year $3,920 $11,888
======== ========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest 0 0
======== ========
Taxes 0 0
======== ========
The accompanying notes are an integral part of these Financial Statements.
F6
DEFENSE TECHNOLOGY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
SUPPLEMENTARY STATEMENT OF NON-CASH
INVESTING AND FINANCING ACTIVITIES
YEARS ENDED JUNE 30,
2004 2003
---- ----
Conversion of notes payable and accrued interest
to common stock $ 214,600
Accrued liabilities paid directly by shareholder $ 115,125 $ --
Issuance of common stock in settlement of
accrued liabilities $ 75,154 $ --
Issuance of common stock in settlement of notes
payable and acccrued interest $ 851,101
Dividends accrued on preferred stock $ 125,473 $ 144,132
Common stock issued pursuant to stock
subscription received $ 35,000 $ --
Conversion of preferred stock and accrued
dividends to common stock $ 456,720 $ --
Issuance of common stock in exchange for debt,
accrued interest, preferred stock and
accrued dividends $ -- $ 1,286,134
The accompanying notes are an integral part of these financial statements.
F7
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003
NOTE 1 - ORGANIZATION AND NATURE OF BUSINESS
A) ORGANIZATION
Defense Technology Systems, Inc. (the "Company") was incorporated as
DataWorld Solutions, Inc. in Delaware in January 1998. The Company
became publicly traded as a result of a reverse merger with Vertex
Computer Cable & Products, Inc. ("Vertex") in December 1998.
Previously in January 1998, Vertex secured certain financing that made
effective Vertex's second amended plan of organization under Chapter
11 of the U.S. Bankruptcy Act. In June 2004, the Company changed its
name to Defense Technology Systems, Inc.
B) NATURE OF BUSINESS
The Company has two operating divisions. The Data Division assembles
and distributes electronic wire, cable and related products used
primarily for data communication and distribution. The Security
Division distributes and installs specialty products and equipment for
the safety and security needs of the international and domestic
business community. The principal market for the Company's products is
the United States with a concentration in the New York metropolitan
area.
Effective May 2003, a single manufacturer is manufacturing
substantially all of the Company's cable assembly products. The
Company is dependent on the continued supply arrangement with this
manufacturer. There are several other manufacturers in the
marketplace; however a change in manufacturer may result in less
favorable terms being offered by other manufacturers.
The Company's two operating divisions complement each other; they do
not constitute separate business segments as contemplated under
Statement of Financial Accounting Standards ("SFAS") 131.
F8
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
NOTE 2 - GOING CONCERN
A) GENERAL
The Company has current assets of $93,165 (including $3,920 in cash)
compared with current liabilities of $4,486,259, resulting in a
working capital deficit of $4,393,094 as of June 30, 2004. In
addition, the Company incurred a net loss of $2,200,599 for the year
ended June 30, 2004 and its operating activities required cash of
$489,140. The Company has incurred significant net losses in each of
the three preceding fiscal years and has a stockholder's deficit of
$4,809,049 at June 30, 2004. Such deficits and recurring losses raise
questions about the Company's ability to continue as a going concern.
Additionally, as discussed below the Company's continuation is also
threatened by the existence of numerous judgments by trade creditors,
defaults on secured indebtedness and delinquencies on certain tax
obligations. These conditions could result in the seizure of Company
assets and/or its being forced into bankruptcy.
B) SALES AND PAYROLL TAX OBLIGATIONS
As of August 2001, the Company failed to remit sales taxes that it
collected from customers in four states. As of June 30, 2004,
approximately $331,000 was due these states (inclusive of estimated
penalties and interest). The Company is presently negotiating a
settlement of its approximately $273,000 liability with the State of
New York. Should negotiations not be successful, the Company could be
forced by the State of New York to cease operations.
As of March 2002, the Company failed to remit federal payroll taxes
that it had collected. In March 2004, the Company settled its federal
payroll tax liability which resulted in a forebearance installment
plan whereby the Company is obligated to make monthly payments of
$3,000 plus a final payment of accrued interest in full settlement of
this liability. As of June 30, 2004, approximately $50,000 remained
outstanding, which due to the nature of the obligation is classified
as a current liability.
C) DEFAULT ON DEBT OBLIGATIONS
The Company is currently in default on payments owed on its bankruptcy
distributions payable. This could result in the Company's creditors
requesting that the Company's Chapter 11 bankruptcy proceedings be
re-opened. (See Note 6-B).
Additionally, the Company has not made payments on its Secured
Subordinated Debentures since January, 2001, and may be declared in
default. This obligation is secured by all of the Company's assets,
but is subordinate to all current and future loan facilities. (See
Note 6-B).
D) MANAGEMENT'S PLAN
The Company is currently implementing a business plan that it
believes will strengthen the balance sheet, increase revenue and
return it to profitability. The plan involves a series of initiatives:
F9
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
-- The Company is seeking to restructure its liabilities by
negotiating with secured and unsecured creditors and vendors
for forgiveness of certain outstanding debt, or to exchange
debt for equity. Through the end of fiscal 2004, the Company
has settled a total of approximately $2 million in exchange
for cash payments of approximately $37,000 and new equity
issuances valued at $472,000, resulting in a gain of
approximately $1.5 million. The Company continues to seek
settlements of outstanding debt. (See Notes 3-E and 12-B).
-- The Company is actively engaged in raising capital through
private investors. This will provide additional working
capital and allow it to increase revenue and pursue more
profitable projects. In order to facilitate this process, in
April 2004 the Company's CEO, a major shareholder, returned
six million shares of the Company's common stock previously
owned by him to the Company's treasury for no consideration.
(See Note 8-B). During fiscal 2004, the Company raised
$360,000 through sales of common stock.
-- The Company has expanded into the security business which it
believes will complement and enhance its current product
offerings and greatly expand its customer base. The Company
may also pursue strategic acquisitions that provide it with
growth and vertical integration within this new area.
If management is not successful in implementing the initiatives
discussed in the preceding paragraphs, the conditions discussed
in Notes 2B and 2C could result in the severe curtailment of the
Company's operations and/or the seizure of its assets and/or its
being forced into bankruptcy. The accompanying financial
statements do not include any adjustments that might result from
the outcome of this uncertainty.
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES
A) BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company's wholly-owned subsidiaries, DWS Manufacturing, Inc. and DWS
Defense Systems, Inc. All inter-company accounts and transactions have
been eliminated.
B) CASH and CASH EQUIVALENTS
Cash and cash equivalents include all cash balances and highly liquid
investments with an original maturity, when purchased, of three months
or less. The Company places any temporary cash investments with major
financial institutions. From time to time, such investments may be in
excess of the FDIC insurance limit of $100,000.
F-10
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
C) CONCENTRATION OF CREDIT RISK
The Company sells its services and products to original equipment
manufacturers and end users in various industries such as
manufacturing and finance, concentrated in the Northern and Eastern
United States. The customer base is comprised of several Fortune 500
companies and other large financial institutions which the Company
believes represent virtually no credit risk. Accordingly, an allowance
for doubtful accounts is not required.
D) PROPERTY AND EQUIPMENT
Property and equipment at June 30, 2004, are stated at cost less
accumulated depreciation and amortization computed on a straight-line
basis over the estimated useful lives of the respective assets, which
range from five to ten years. Leasehold improvements are amortized
over the useful life of the improvement, or the lease term, whichever
is less. Expenditures for maintenance, repairs and betterments, which
do not materially extend the useful lives of the assets, are charged
to operations as incurred. The cost and related accumulated
depreciation of assets retired or sold are removed from the respective
accounts and any gain or loss is recognized in operations.
E) WRITE-OFF OF STATUTORILY BARRED LIABILITIES
In the fourth quarter of fiscal 2004 the Company was advised by its
counsel that pursuant to applicable commercial law, certain of its
trade obligations are statutorily unenforceable after periods of four
or six years, as applicable, from the date of their incurrence.
Accordingly the Company has written off $230,597 of accounts payable
which amount is included in gain on settlement and write-off of debt
for the year ended June 30, 2004. (See Note 13 - Fourth Quarter
Adjustments). For subsequent periods, the Company will record any
additional write-offs during the quarter in which the statutory period
is exceeded.
F) REVENUE RECOGNITION
The Company recognizes revenue on the date the product is shipped and
title passes to the customer. The Company recognizes commissions
earned on distribution of certain products when those products are
shipped.
G) STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation pursuant to SFAS No.
123. This pronouncement allows companies to either expense the
estimated fair value of all stock options or, with respect to options
granted to employees and directors, to continue to follow the
intrinsic value method previously set forth in Accounting Principles
Board Opinion No. 25, but disclose the pro forma effects on net income
(loss) had the fair value of those options been expensed. The Company
has elected to continue to apply the previous standard in accounting
for stock options granted to employees and directors. As of June 30,
2004 there are no employee stock options outstanding nor have any
options been granted, vested, exercised or cancelled during the two
most recent fiscal years. The fair value method is used in accounting
for stock options granted to others.
F-11
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
H) ADVERTISING COSTS
Advertising costs are charged to operations when the advertising first
takes place. During the year ended 2004, the Company incurred
approximately $25,000 in advertising expenses.
J) INCOME TAXES
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and
loss carryforwards for which income tax benefits are expected to be
realized in future years. A valuation allowance is established to
reduce the deferred tax assets to estimated realizable amounts.
K) NET LOSS PER COMMON SHARE
Basic and diluted income and loss per share are calculated by dividing
the net loss, after consideration of the deemed and accrued dividends
on preferred stock, by the weighted average number of shares of common
stock outstanding during each period. In years where the Company
incurs a loss, anti-dilutive options and warrants are excluded.
L) USE OF ESTIMATES
In preparing financial statements in conformity with accounting
principles generally accepted in the United States of America,
management makes estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements, as well as
the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
M) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has estimated the fair value of financial instruments
using available market information and other valuation methodologies
in accordance with SFAS No. 107, "Disclosures about Fair Value of
Financial Instruments." Management of the Company believes that the
fair value of financial instruments, consisting of cash, accounts
receivable, accounts payable, notes payable, long-term debt and
subordinated debentures approximate carrying value for assets and is
undeterminable for liabilities.
F-12
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
N) PREFERRED STOCK
Preferred stock issuances are presented as net proceeds received on
issuance. Par and stated values are disclosed parenthetically on the
face of the accompanying consolidated balance sheet.
O) ACCRUED DIVIDENDS ON PREFERRED STOCK
Accrued dividends on preferred stock are presented as non-current
liabilities when it is unlikely that they will be paid in cash or
other current assets.
P) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
On December 17, 2003, the Staff of the Securities and Exchange
Commission (SEC or the Staff) issued Staff Accounting Bulletin No. 104
(SAB 104), Revenue Recognition, which amends SAB 101, Revenue
Recognition in Financial Statements. SAB 104's primary purpose is to
rescind accounting guidance contained in SAB 101 related to multiple
element revenue arrangements, superseded as a result of the issuance
of EITF 00-21. Additionally, SAB 104 rescinds the SEC's Revenue
Recognition in Financial Statements Frequently Asked Questions and
Answers (the FAQ) issued with SAB 101 that had been codified in SEC
Topic 13, Revenue Recognition. Selected portions of the FAQ have been
incorporated into SAB 104. While the wording of SAB 104 has changed to
reflect the issuance of EITF 00-21, the revenue recognition principles
of SAB 101 remain largely unchanged by the issuance of SAB 104.
Adoption of this standard did not have an impact on the Company's
financial position, results of operations or cash flows.
Effective July 1, 2003, the Company adopted SFAS No. 146, Accounting
for Costs Associated with Exit or Disposal Activities, which rescinds
Emerging Issues Task Force (EITF) Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a
Restructuring). SFAS No. 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred,
rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by this statement include lease termination
costs and certain employee severance costs that are associated with a
restructuring, discontinued operation, plant closing or other exit or
disposal activity. Adoption of this statement did not have a material
impact on the Company's financial position, results of operations or
cash flows.
F-13
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
As of July 1, 2003, the Company adopted the disclosure requirements of
SFAS No. 148, Accounting for Stock-Based Compensation--Transition and
Disclosure. This statement amends SFAS No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition
for a voluntary change to the fair value based-method of accounting
for stock-based employee compensation. In addition, this statement
amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. The Company
does not expect to change to the fair value-based method of accounting
for stock-based employee compensation. The Company continues to
account for employee stock options under APB No. 25, Accounting for
Stock Issued to Employees, under which the Company did not recognize
any compensation expense for 2004 or 2003.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity, which requires certain financial instruments that were
previously presented on the consolidated balance sheets as equity to
be presented as liabilities. Such instruments include mandatory
redeemable financial instruments and certain options and warrants.
SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective for the
Company as of July 1, 2003. Adoption of this standard did not have an
impact on the Company's financial position, results of operations or
cash flows.
Effective July 1, 2003, the Company adopted Emerging Issues Task Force
(EITF) Issue No. 00-21, Accounting For Revenue Arrangements with
Multiple Deliverables, which establishes criteria for whether revenue
on a deliverable can be recognized separately from other deliverables
in a multiple deliverable arrangement. The criteria considers whether
the delivered item has stand-alone value to the customer, whether the
fair value of the delivered item can be reliably determined and the
customer's right of return for the delivered item. Adoption of this
standard did not have an impact on the Company's financial position,
results of operations or cash flows.
In January 2003 and December 2003, the FASB issued Interpretation No.
46, Consolidation of Variable Interest Entities (FIN 46), and its
revision, FIN 46-R, respectively. FIN 46 and FIN 46-R address the
consolidation of entities whose equity holders have either not
provided sufficient equity at risk to allow the entity to finance its
own activities or do not possess certain characteristics of a
controlling financial interest. FIN 46 and FIN 46-R require the
consolidation of these entities, known as variable interest entities
(VIEs), by the primary beneficiary of the entity. The primary
beneficiary is the entity, if any, that is subject to a majority of
the risk of loss from the VIE's activities, entitled to receive a
majority of the VIE's residual returns, or both. FIN 46 and FIN 46-R
are applicable for financial statements of public entities that have
interests in VIEs or potential VIEs referred to as special-purpose
entities for periods ending after December 15, 2003. Application by
public entities for all other types of entities is required in
financial statements for periods ending after March 15, 2004. Adoption
of both of these standards did not have an impact on the Company's
financial position, results of operations or cash flows.
F-14
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
NOTE 4 - PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
Computer equipment $ 6,769
Furniture and fixtures 9,833
--------
16,602
Less accumulated depreciation (1,400)
--------
$ 15,202
========
Depreciation of property, plant and equipment was $1,400 for the year
ended June 30, 2004.
NOTE 5 - ACCRUED EXPENSES AND OTHER
This account consists of the following:
Sales and payroll taxes payable $ 382,649
Accrued interest 291,948
Accrued officers compensation 238,612
Other accrued expenses 95,208
-----------
$ 1,008,417
===========
F-15
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
NOTE 6 - DEBT OBLIGATIONS
A) NOTES PAYABLE
Notes Payable consists of the following:
Current Long-Term Total
------- --------- -----
Shareholder loan $ 125,025 $ - $ 125,025
Rosenthal & Rosenthal 35,713 214,287 250,000
Augustine Capital - 166,800 166,800
--------- --------- ---------
$ 160,738 $ 381,087 $ 541,825
========= ========= =========
The long-term maturities are payable as follows: fiscal 2006 - $238,229; fiscal
2007 - $71,429; fiscal 2008 - $71,429.
Shareholder loan:
In January 2004, the Company entered into a letter agreement with a
stockholder whereby the stockholder agreed to advance up to $200,000 to the
Company on a short-term basis for purposes of settling outstanding judgments and
financing ongoing projects. As of June 30, 2004, the outstanding balance was
$125,025. Interest expense at 8% has been accrued. The amounts advanced included
$85,000 paid directly to a subcontractor on behalf of the Company and $30,125
paid in settlement of outstanding judgments of $196,985 plus accrued interest of
$21,893, which resulted in the Company recognizing a gain of $188,753.
Rosenthal & Rosenthal:
Until October 2003, the Company had a financing agreement ("the Agreement")
with Rosenthal & Rosenthal ("R&R") that, as amended, provided for revolving
loans and letters of credit subject to maximum borrowings of $5,000,000. Total
borrowings were limited to 85% of eligible accounts receivable (constituting
those amounts outstanding 90 days or less), 50% of eligible accounts receivable
outstanding between 91 and 120 days, 40% of regular inventories, 10% of slow
moving inventories and the amount of collateral deposited by TW Cable
LLC.("TW"), an entity owned by a former CEO of the Company. The Company was
required to pay interest at prime plus 2 1/2%, with a minimum interest rate of
8%, and a commitment fee of 1% per annum. Borrowings under the Agreement were
collateralized by all of the assets of the Company. In connection with the
Agreement, TW agreed to deposit approximately $1,268,000 as additional
collateral for borrowings under the Agreement. Under the terms of the Agreement,
R&R had the right to draw down on such collateral beginning January 2000 and
began to do so on June 15, 2000. In October 2001, pursuant to the agreement, R&R
seized the collateral pledged by TW and applied the collateral to the
outstanding loan balance.
In June 2004, R&R entered into a settlement agreement with the Company in which
R&R exchanged the outstanding balance of $1,790,327, including accrued interest,
for 1,000,000 shares of common stock and a $250,000 note payable. The stock was
valued at $402,000 or $0.40 per share, the weighted average closing market price
for the two days before and after the date of the agreement. The note payable
has a term of 42 months, with interest-only payments for the first six months.
The interest rate is the prime rate plus two percent. The note is secured by
certain collateral as specified in the original financing agreement. The
settlement agreement further provided for R&R to release the Company's CEO from
his personal guarantee of this debt in exchange for an additional 100,000 shares
of the Company's common stock transferred directly by such officer to R&R. As a
result of this settlement agreement, the Company recorded a gain of $1,138,327.
F-16
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
Augustine Capital:
In August 2003, the Company entered into an 8% convertible note agreement
with Augustine, an existing stockholder. Under the terms of the agreement, the
Company may borrow up to $500,000, with interest paid quarterly in arrears at
the rate of 8% per annum. Individual advances are evidenced by separate
sub-notes. All outstanding notes are due August 28, 2005. The agreement provides
that the Company's indebtedness to Augustine (inclusive of accrued interest) may
be converted into the Company's common stock at a price equal to 75% of the
lowest bid price for the five trading days immediately preceding the conversion.
The Company is required to reserve shares of common stock sufficient to satisfy
the conversion of any outstanding advances.
For the year ended June 30, 2004, the Company's borrowings from Augustine
required the recognition of approximately $83,000 of additional interest expense
related to the lender's right to convert the outstanding balance of their note
payable into shares of common stock at a 25% discount from market. As of June
30, 2004, the Company's cumulative borrowings totaled $249,000, of which
$174,000 had been converted to common stock in December, 2003; the balance
outstanding on this facility was $75,000 at June 30, 2004. Any future borrowings
under this agreement will result in the recognition of additional interest
expense related to this beneficial conversion feature.
In March 2004, the Company entered into a new convertible note agreement with
Augustine. Under this agreement, the Company received proceeds of $90,000 on a
6% discounted note of $100,800 which also accrues additional interest at 8%
payable quarterly. The effective interest rate on this note is approximately
15%. The entire principal balance on this note is due in March 2006. The
amortized balance on this note was $91,800 as of June 30, 2004. The unamortized
discount at such date was $9,000. The agreement allows for the conversion of
outstanding principal and interest into shares of common stock based on the
average closing price of the stock for the ten trading days immediately
preceding the conversion notice.
B) OBLIGATIONS SUBJECT TO DEFAULT
Secured Subordinated Debentures:
The subordinated debentures of $92,633, held by several unaffiliated
private investors, remain secured by all of the Company's assets and are
subordinated to all current and future institutional loan facilities. These
debentures accrue interest at 8% and had a maturity date of January 2004. The
Company discontinued interest payments in January, 2001. Accrued and unpaid
interest was $25,337 at June 2004. As the Company has discontinued such
payments, the entire amount has been reclassified as a current liability.
Further, the holders may declare the Company to be in default and proceed on
their rights under the agreement. (See Note 2-C).
F-17
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
Bankruptcy Distributions Payable:
On March 24, 2000, the Company agreed with the Official Committee of
Unsecured Creditors ("the Committee") as to the modification of the treatment of
the Class 7 Unsecured Creditors ("the Class 7 Creditors") under the Company's
confirmed Chapter 11 Plan of Reorganization, as previously modified ("the
Plan"). Pursuant to such agreement, in satisfaction of the claims of the Class 7
Creditors, the Company paid the Class 7 Creditors, $400,000 from an escrow
account and $100,000 from the Company on or about April 24, 2000. The balance of
the amount due to the Class 7 Creditors was $291,000. This amount was payable in
30 monthly installments of approximately $11,000 including interest at 8%,
beginning on June 15, 2000. In addition, the Company had the option, until March
31, 2001, to pay the then balance due plus an additional $25,000 to the Class 7
Creditors. In the event the Company did not exercise this option, the Company
was obligated to pay the Class 7 Creditors a percentage of the Company's
cumulative cash flow, as defined, through September 2002 as originally specified
in the Plan. As the Company did not prepay the obligation, the option expired.
The Company discontinued making payments on this obligation in March 2001. The
balance owed to the Class 7 Creditors as of June 30, 2004, was $292,120,
including accrued interest. As the Company is not in compliance with respect to
this obligation, the Creditors may seek to reopen the Chapter 11 proceedings.
(See Note 2-C).
C) OTHER DEBT SETTLEMENTS
In June 2004, the Company entered into a settlement agreement with Edward
Goodstein and TW Cable LLC, noteholders, whereby the Company issued 110,000
shares of common stock in exchange for the notes and accrued interest valued at
$439,301. As the noteholders were also stockholders who were deemed to be
related parties, no gain was recognized on this settlement.
The settlement agreement also provided for the Company's CEO to be relieved of
his personal guarantee of the noteholders' obligation to the Class 7 Creditors.
(See Note 6-B). In exchange for the release of his obligation, the officer
established an escrow with counsel to the Company for the benefit of the
noteholders, should they be required to satisfy the obligation to the Class 7
Creditors. Such escrow initially consisted of 312,500 shares of the Company's
common stock owned by him and valued at $125,000. The agreement further requires
that the value of such escrow be maintained at not less than $125,000 and if the
market value of the shares in escrow declines below such amount, the officer
must periodically increase the number of escrowed shares in order to maintain
such value, based on the thirty-day average of the Company's stock price. In
accordance with this provision, the officer escrowed approximately 66,000
additional shares in August 2004. In the event that the officer has insufficient
shares for this purpose, the Company is required to provide necessary shares to
fund the escrow. At such time as the liability to the Class 7 Creditors is
satisfied, the escrowed shares will be returned to the officer.
During the fourth quarter of fiscal 2004, the Company settled trade
obligations with two vendors aggregating $30,428 for cash payments of $6,816,
which resulted in a gain of $23,612.
NOTE 7 - 8% SERIES B CONVERTIBLE PREFERRED STOCK
On May 31, 2000, the Company issued 1,600 shares of a newly authorized
3,000 share class of 8% Series B Convertible Preferred Stock ("8% Preferred
Stock"), $.01 par value, with a stated value of $1,000 per share, redemption
value at 125% of the stated value, to accredited investors pursuant to
Regulation D under the Securities Act of 1933 for net cash proceeds of
approximately $1,435,000. (See Note 10-C). The 8% Preferred Stock has no voting
rights and is presently convertible into common stock of the Company at an
effective conversion price of the lower of (i) 75% of the market price or (ii)
$1.13, which represents 110% of the lowest closing bid of the Company's common
stock for the five trading days immediately preceding the closing date, May 31,
2000, as defined in the Certificate of Designation of the 8% Preferred Stock. As
the Company's Registration Statement on Form SB-2 has not been declared
effective, the conversion percentage has decreased from 75% of market to 50% of
market as defined.
F-18
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
Additionally, the Stock agreement called for a mandatory conversion of all
outstanding shares (plus accrued dividends) of the 8% Preferred Stock on May 31,
2003, subject to the investors total holdings not exceeding 5% of the then
outstanding shares of the Company's common stock. In September 2003, this
provision was amended to 9.9% of the outstanding shares of common stock, and the
mandatory conversion date was amended to May 31, 2006.
In June, 2002, as per the terms of the preferred stock agreement, the
holders of the 8% Preferred Stock converted 5 shares of preferred stock with a
stated value of $5,000 into 1,453,408 shares of common stock. In August, 2003
the holders converted 3 shares of preferred stock with a stated value of $3,000
into 1,078,571 shares of common stock. In September, 2003 the holders converted
33 shares of preferred stock with a stated value of $33,000 into 1,594,780
shares of common stock. (See Notes 8-B and 12-A).
Holders of the 8% Preferred Stock are entitled to receive dividends at the
stated dividend rate of 8% on the stated value of $1,000 on each 8% Preferred
Stock share. Dividends are cumulative from the date of issue, whether or not
declared, for any reason. As of June 30, 2004, accrued and unpaid dividends were
$62,189.
NOTE 8 - CAPITAL STOCK TRANSACTIONS
A) SALES OF COMMON STOCK
In November 2003, two existing stockholders entered into agreements with
the Company to purchase a total of 300,000 shares of common stock for $150,000,
or $0.50 per share.
In January 2004, a stockholder/consultant purchased 400,000 shares of
common stock for $100,000, or $0.25 per share, pursuant to a stock purchase
agreement.
F-19
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
In February 2004, the Company issued 500,000 shares of common stock to four
unaffiliated individuals, pursuant to four subscription agreements for total
proceeds of $100,000 or $0.20 per share. Additionally, one of the individuals
received an additional 100,000 shares of stock valued at $20,000, based on the
share price implicit in the transaction, for his assistance in placing the
shares with the other investors, which has been charged directly to equity as a
cost of raising capital.
In June 2004, an existing stockholder purchased 35,000 shares of common
stock for $10,000, or $0.29 per share, pursuant to a stock purchase agreement.
B) CONTRIBUTION OF COMMON SHARES
In April 2004, the Company's CEO, a major shareholder, returned six million
shares of common stock that he had previously owned and held to the Company's
treasury. These shares were valued at $ 2,256,000, or $0.38 per share, the
weighted average closing market price for the two days before and after the date
of the transaction. By resolution of the Board of Directors, these shares were
cancelled and are accordingly equivalent to unissued shares.
C) PREFERRED STOCK CONVERSIONS
In August 2003, as per the terms of the 8% Convertible Preferred Stock
agreement, Augustine converted three shares of preferred stock with a stated
value of $3,000 plus accrued dividends of $775 into 1,078,571 shares of common
stock based on a conversion price of $0.0035 per share.
Additionally, in September 2003, Augustine, converted 33 shares of
preferred stock with a stated value of $33,000 plus accrued dividends of $8,730,
into 1,594,780 shares of common stock based on a conversion price of $0.0262 per
share.
In December 2003, together with a debt conversion, Augustine converted
$447,215 of outstanding dividends on their 8% Series B Convertible Preferred
Stock, into 447,215 shares of common stock based on a conversion price of $1.00
per share.
D) CONVERTIBLE DEBT CONVERSIONS
In December 2003, together with the conversion of dividends on preferred
stock, Augustine converted $185,550 of principal and interest on a note payable
into 185,550 shares of common stock based on a conversion price of $1.00 per
share.
F-20
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
In June 2004, as per the terms of their 8% Convertible Promissory Note
Agreement, J&B Associates converted the outstanding balance of their note,
including accrued interest into 250,000 shares of common stock based on a
conversion price of $0.12 per share.
E) DEBT SETTLEMENTS
In November 2003, a former employee entered into an agreement to convert
the outstanding balance of $44,790 of principal and interest on a note payable
into 14,000 shares of common stock, valued at $9,800 or $0.70 a share. As a
result of this transaction, the Company recorded a gain of $34,990.
In December 2003, the Company settled a $97,248 liability with the issuance
of 60,000 shares of common stock valued at $36,000 or $0.60 a share. As a result
of this transaction, the Company recorded a gain of $61,248.
In February 2004, the Company settled an $86,175 liability with the
issuance of 60,000 shares of common stock. The shares were valued at $22,800, or
$0.63 per share, the weighted average closing market price for the two days
before and after the date of the settlement. As a result of this transaction,
the Company recorded a gain of $63,375.
In April 2004, the Company settled a $3,996 liability with the issuance of
12,000 shares of common stock. The shares were valued at $3,996, or $0.33 per
share, the weighted average closing market price for the two days before and
after the date of the settlement.
In June 2004, the Company settled a $10,303 liability with the issuance of
39,326 shares of common stock. The shares were valued at $10,303, or $0.26 per
share, the weighted average closing market price for the two days before and
after the date of the settlement.
In June 2004, the Company settled a $2,230 liability with the issuance of
5,000 shares of common stock. The shares were valued at $2,055, or $0.41 per
share, the weighted average closing market price for the two days before and
after the date of the settlement. As a result of this transaction, the Company
recorded a gain of $175.
In June 2004, the Company reached a settlement agreement with certain
noteholders in which they agreed to convert the outstanding balance of their
notes payable, including accrued interest, into 110,000 shares of common stock.
(See Note 6-B).
F-21
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
In June 2004, the Company reached a settlement agreement with R&R, its
asset-based lender which resulted in the issuance of 1,000,000 shares of common
stock. (See Note 6-B).
F) COMMON STOCK ISSUED FOR SERVICES
In October 2003, the Company awarded 400,000 shares of common stock valued
at $264,000 or $0.66 per share, the weighted average closing market price for
the two days before and after the date of the agreement, to an individual in
consideration of his acceptance to serve on the Advisory Board of the Company's
subsidiary, DWS Defense Systems, Inc.
In November 2003, the Company awarded 100,000 shares of common stock valued
at $74,000 or $0.74 per share, the weighted average closing market price for the
two days before and after the date of the agreement, to an individual in
consideration of his acceptance to serve on the Advisory Board of the Company's
subsidiary, DWS Defense Systems, Inc.
In January 2004, the Company issued 200,000 shares of common stock pursuant
to a consulting agreement, to a relative of the Company's Chief Executive
Officer. The shares were valued at $80,000, or $0.40 per share, the weighted
average closing market price for the two days before and after the date of the
agreement.
In February 2004, the Company issued 500,000 shares of common stock to the
Company's Chief Operating Officer upon his acceptance of the position. The
shares were valued at $236,500, or $0.47 per share, the weighted average closing
market price for the two days before and after the date of his acceptance.
G) PRIOR SUBSCRIPTION RECEIVED
In June 2004, the Company issued 350,000 shares of common stock to the
estate of a prior subscriber for such common shares.
H) 2003 DEBT/EQUITY EXCHANGE
In December 2002, the Company reached an agreement with TW Cable, LLC, and
Edward Goodstein, its principal, to restructure the Company's debt and preferred
stock held by them. Debt principal of $1,416,879 and accrued interest and
dividends of $126,870, together with 6,500 shares of $6.00 Senior Convertible
Preferred Stock, were exchanged for 500,000 shares of common stock, valued at
$0.01 per share, and two 5% notes payable totaling $420,000. The debt/equity
restructuring resulted in a direct credit to additional paid-in capital of
$1,286,134. The notes were subsequently converted to 110,000 shares of common
stock in June, 2004. (See Notes 6-C and 8-F).
F-22
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
NOTE 9 - STOCK OPTIONS AND WARRANTS
A) STOCK OPTIONS
In October and November 2003, the Company issued 3,000,000 options to
purchase shares of common stock at various exercise prices ranging from $0.50 to
$5.00 per share, to individuals serving on the Advisory Board of DWS Defense
Systems, Inc., a wholly owned subsidiary of the Company (See Note 12-D). The
fair value of these options on their grant dates using the Black-Scholes pricing
model was $2,118,165 and the Company incurred a non-cash charge for this amount
for the year ended June 30, 2004 as a result of the issuance of these options.
(See Note 13-B). This amount is included in selling, general and administrative
expenses on the Consolidated Statement of Operations.
The determination of the fair value of these options was based on the
following elements:
Stock price volatility: 276%-310%
Annual interest rate: 0.95%
Dividends paid on common stock: $0.00
Estimated useful life of options: 5-10 years
B) WARRANTS
The holders of the Company's 8% Series B Convertible Preferred Stock were
granted five-year warrants to purchase 160,000 shares of common stock at a
purchase price of $1.2376 per share, which represents 120% of the lowest of the
closing bid prices for the Company's common stock for the five trading days
prior to May 31, 2000.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
A) LEASES
In February 2004, the Company entered into an agreement to lease
approximately 2,800 square feet of office space in Hauppauge, NY, to serve as
the Company's headquarters. The lease is for a period of four years with an
annual rent of $30,800 and a 3% annual increase in each of the three subsequent
years. This charge is inclusive of real-estate taxes and common area charges,
but does not include utilities. Outlined below is the Company's minimum annual
rental commitment under the terms of this lease:
Years ending June 30 Total:
2005 $ 31,108
2006 32,041
2007 33,003
2008 22,437
----------
$ 118,589
==========
F-23
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
B) LITIGATION MATTERS
The Company is a party to legal matters arising in the general course of
business. During fiscal 2001 and subsequently, the Company decided not to
dispute litigation with suppliers and other creditors for collection of amounts
owed to them. As a result, as of June 30, 2004, the Company had outstanding
judgments amounting to approximately $1,165,000, including estimated accrued
interest. This balance is included in accounts payable and accrued expenses in
the accompanying consolidated financial statements.
In September 2000, the Company began to negotiate a potential merger with
American Access Technologies ("AAT") which resulted in a merger agreement being
signed in April 2001. In June 2001, the Company was notified by AAT that they
were unilaterally terminating the agreement claiming that the Company had
suffered material and adverse changes and that such change entitled AAT to
terminate the agreement. AAT then filed suit against the Company seeking
reimbursement of various incurred costs. The Company has filed a countersuit
against AAT alleging wrongful termination. The matter is currently set for trial
in November 2004. The ultimate outcome of this matter is not expected to have a
material adverse effect on the Company's results of operations or financial
position.
C) CONSULTING AGREEMENTS
Consulting and Commission Agreement:
In October 2003, the Company entered into an agreement with a
consultant/advisor in consideration of his acceptance to be on the Advisory
Board of the Company's subsidiary, DWS Defense Systems, Inc. The agreement calls
for the consultant to devote such time and attention to his duties, as he deems
appropriate in order to expand the Company's of business. The agreement has four
components: a commission component, a loan component, a grant component and a
stock option component.
The commission component calls for the consultant/advisor to receive 2% of
gross receipts from all contracts or other sales of the Company or affiliates
that result from his efforts. Through June 30, 2004, no commissions were earned.
F-24
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
The loan component calls for the Company to loan the consultant $150,000
without interest which is required to be repaid with profits earned by the
consultant out of the sale of shares acquired by him pursuant to the stock grant
or stock options provided for in this agreement, by 2013. Due to the Company's
financial condition, the loan was not advanced.
The grant component calls for the consultant to receive 400,000 shares of
the Company's Common Stock upon signing of the agreement. The 400,000 shares
were issued in October 2003 and were valued at $264,000 or $.66 per share, the
weighted average closing market price for the two days before and after the date
of the agreement.
The stock option component calls for the consultant/advisor to be awarded
1,200,000 options that are exercisable immediately and expire October 29, 2013.
The options have exercise prices as follows: $.50 per share for the first
200,000 shares, $1.00 per share for the next 200,000 shares, $2.00 per share for
the next 200,000 shares, $3.00 per share for the next 200,000 shares, $4.00 per
share for the next 200,000 shares and $5.00 per share for the last 200,000
shares.
In addition, as a result of the aforementioned consulting agreement being
executed, the Company paid to another individual a finder's fee of $50,000, and
issued warrants to purchase 900,000 shares of common stock at prices ranging
from $0.50 to $5.00 per share, such warrants to expire in five years.
Other Consulting Agreements:
In November 2003, the Company entered into an agreement with a consultant
in consideration of his acceptance to serve as Chairman of the Advisory Board of
the Company's subsidiary, DWS Defense Systems, Inc. The agreement calls for the
consultant to devote such time and attention to his duties, as he deems
appropriate in order to expand the Company's business. In consideration, the
Company awarded 300,000 options to purchase common stock that are exercisable
immediately and expire in October 2013. The options have exercise prices as
follows: $.75 per share for the first 50,000 shares, $1.00 per share for the
next 100,000 shares, $1.50 per share for the next 50,000 shares, $2.00 per share
for the next 50,000 shares, and $2.50 per share for the last 50,000 shares.
In November 2003, the Company entered into an agreement with a consultant
in consideration of his acceptance to serve on the Advisory Board of the
Company's subsidiary, DWS Defense Systems, Inc. The agreement calls for the
consultant to devote such time and attention to his duties, as he deems
appropriate in order to expand the Company's business. In consideration, the
Company awarded 100,000 shares of common stock, and 300,000 options to purchase
common stock that are exercisable immediately and expire in November 2008. The
options have exercise prices as follows: $.75 per share for the first 50,000
shares, $1.00 per share for the next 100,000 shares, $2.00 per share for the
next 50,000 shares, $3.00 per share for the next 50,000 shares, and $5.00 per
share for the last 50,000 shares. Pursuant to this agreement the 100,000 shares
were issued in November, 2003 and were valued at $74,000, or $.74 per share, the
weighted average closing market price for the two days before and after the date
of the agreement.
F-25
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
In November 2003, the Company entered into an agreement with a consultant
in consideration of his acceptance to serve on to the Advisory Board of the
Company's subsidiary DWS, Defense Systems, Inc. The agreement calls for the
consultant to devote such time and attention to his duties, as he deems
appropriate in order to expand the Company's business. In consideration, the
Company awarded 300,000 options to purchase common stock that are exercisable
immediately and expire in November 2008. The options have exercise prices as
follows: $.75 per share for the first 50,000 shares, $1.00 per share for the
next 100,000 shares, $2.00 per share for the next 50,000 shares, $3.00 per share
for the next 50,000 shares, and $5.00 per share for the last 50,000 shares.
In January, 2004, the Company entered into a consulting agreement with a
relative of the Company's President and Chief Executive Officer. The agreement
calls for the consultant to provide business planning and consulting services.
In consideration, the Company awarded him 200,000 shares of Common Stock valued
at $80,000, or $0.40 per share, the weighted average closing market price for
the two days before and after the date of the agreement.
D) MAJOR CUSTOMERS
During the fiscal year ended June 30, 2004, three customers accounted for
29%, 26% and 19% of net sales, respectively. During the fiscal year ended June
30, 2003, four customers accounted for 19%, 14%, 14% and 13% of net sales,
respectively.
E) INSURANCE
Due to liquidity restrictions, the Company ceased carrying insurance in
September 2001 and relied on the pass-through warranties provided by its
manufacturers. The Company cannot assess the significance of not maintaining
product liability insurance, but to date no claims have been made and the
Company is unaware of any potential product liability claims against it. In
February 2004, the Company purchased general liability and property insurance.
F-26
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
NOTE 11 - INCOME TAXES
As a result of the Company's fiscal 2004 and 2003 losses, the Company was unable
to utilize its tax loss carry-forwards and accordingly recorded no tax benefit
for the years ended June 30, 2004 and 2003 respectively.
The Company anticipates that for the foreseeable future it will continue to
be required to provide a 100% valuation allowance for the tax benefit of its net
operating loss carry-forwards and temporary differences.
As a result of the above, the Company has an effective tax rate of zero for
both years. As of June 30, 2004, the Company's net operating loss carry-forwards
aggregate approximately $18,600,000, which expire during fiscal 2006 through
2023.
NOTE 12 - SUBSEQUENT EVENTS - (UNAUDITED)
A) PREFERRED STOCK CONVERSIONS
In July 2004, as per the terms of the 8% Convertible Preferred Stock
agreement, Augustine, converted 200 shares of preferred stock with a stated
value of $200,000 plus accrued dividends of $8,153 into 1,200,883 shares of
common stock based on a conversion price of $0.173 per share.
In September 2004, as per the terms of the 8% Convertible Preferred Stock
agreement, Augustine, converted 38 shares of preferred stock with a stated value
of $38,000 plus accrued dividends of $2,199 into 788,216 shares of common stock
based on a conversion price of $0.051 per share.
B) GAIN ON SETTLEMENT OF DEBT
In August 2004, the Company entered into a settlement agreement with a
vendor in which the vendor agreed to accept three equal monthly payments of
$19,000 in full settlement of approximately $400,000 in trade obligations. As a
result, the Company recognized a gain of approximately $343,000.
C) ACQUISITION OF PATENT
In July 2004, the Company entered into an agreement to purchase the patent
for a security product in exchange for one million shares of common stock valued
at $393,000 or $0.393 per share, the weighted average closing market price for
the two days before and after the date of the agreement.
D) DISSOLUTION OF ADVISORY BOARD
In September 2004, the Company dissolved the DWS Defense Systems Advisory Board
and announced its intention to add additional members to the Company's Board of
Directors.
F-27
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
NOTE 13 - FOURTH QUARTER ADJUSTMENTS - (UNAUDITED)
A) COMMON SHARES
As disclosed on the Company's annual report on Form 10-KSB for the
year-ended June 30, 2003, the Company recovered 1.2 million shares of common
stock in fiscal 2001 as a result of substantial non-performance by a service
provider. The Company correctly recorded the $306,000 value of such shares as a
gain in fiscal 2001 but did not adjust the number of common shares outstanding.
The correction for these 1.2 million common shares has been reflected on the
accompanying Statement of Changes in Consolidated Stockholders' Deficit at the
beginning of fiscal 2003. There is no effect on previously reported
loss-per-share amounts for any of the quarters in fiscal 2003 as a result of
this reduction in outstanding shares.
B) STOCK OPTIONS GRANTED TO CONSULTANTS
During the fourth quarter of fiscal 2004, the Company discovered an error
in the Black-Scholes formula application used to determine the value of stock
options granted to consultants in the second quarter of fiscal 2004. The prior
calculation reflected stock price volatilities of 151% and 187%. Correction of
the volatilities to 276% and 310% resulted in an increase in the expense of
$153,000. This correction has been reflected in the table following Note 13-C.
There is no effect on the previously reported loss-per-share for the quarter.
C) WRITE-OFF OF STATUTORILY BARRED LIABILITIES
In the fourth quarter of fiscal 2004, the Company recorded a gain of
$230,597 from the write-off of certain statutorily barred liabilities. (See Note
3-E). The amounts of this adjustment applicable to each of the quarterly periods
in fiscal 2004 were $165,998, $13,458, and $14,622, and $36,519, respectively.
The following table shows, for the first three quarterly periods of fiscal
2004, the amount of the applicable adjustments, the net losses as previously
reported and the corrected results as well as the respective losses attributable
to common stockholders and the related per-share amounts. Also presented below
is the corrected number of outstanding common shares after the reduction of 1.2
million common shares discussed in Note 13-A above. As shown, reported
loss-per-share amounts were unchanged except for the first quarter.
F-28
DEFENSE TECHNOLOGY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004 AND 2003
First Second Third
Quarter Quarter Quarter
Gain on write-off of debt $ 165,998 $ 13,458 $ 14,622
Additional stock option expense - (153,000) -
Net loss as
previously reported (146,626) (2,531,356) (483,702)
---------- ------------ ----------
Net income (loss)
as corrected $ 19,372 $ (2,670,898) $ (469,080)
========== ============ ==========
Net loss attributable to common
stockholders as previously reported (178,730) (2,562,536) (514,797)
---------- ------------ ----------
Net loss attributable to common
stockholders as corrected $ (12,732) $ (2,702,078) $ (500,175)
========== ============ ==========
Loss per share as previously reported $ (.01) $ (.07) $ (.01)
---------- ------------ ----------
Loss per share as corrected $ - $ (.07) $ (.01)
========== ============ ==========
Weighted average common shares
outstanding - basic and diluted
as corrected 33,554,646 36,120,911 38,118,011
========== ============ ==========
F-29