XXSYS TECHNOLOGIES INC /CA, 10KSB/A, 1996-07-15

XXSYS TECHNOLOGIES INC /CA
10KSB/A, 1996-07-15
COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-KSB/A

(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED) FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1995

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT
OF 1934 (NO FEE REQUIRED)

Commission File Number: 0-20376

XXSYS TECHNOLOGIES, INC.
(Name of small business issuer in its charter)

California 33-0161808
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

4619 Viewridge Avenue, San Diego, California 92123
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (619) 974-8200

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

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

Common Stock, no par value
(Title of Class)

Indicate by check mark whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities 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

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

Issuer's revenues for its fiscal year ended September 30, 1995: $408,867.

The market value of voting stock held by non-affiliates of the registrant as of
December 22, 1995 was approximately $22,827,000.

Shares of Common Stock outstanding at December 22, 1995: 6,067,082.

DOCUMENTS INCORPORATED BY REFERENCE

Exhibits 10.28, 10.29, 10.30, 10.31 and 10.32 are incorporated by reference
into the Index, Item 13(a) of this Form 10-KSB/A.
<PAGE> 2
PART I

ITEM 1. DESCRIPTION OF BUSINESS

XXsys Technologies, Inc. (the "Company") was organized under the laws
of the State of California on November 19, 1985, to develop and commercialize
non-destructive testing and measurement techniques for advanced materials. In
response to the defense cutbacks of the early 1990s and their impact on the
developing markets for advanced materials, in 1993 the Company initiated efforts
to develop commercial applications of its technologies and know-how. The initial
results of those efforts is the Company's Robo-Wrapper(TM) machine and
application process, a proprietary technology that produces carbon-based
composite jackets designed to protect structurally deficient highway bridge
columns from collapse during seismic activity. The Company anticipates that its
primary source of revenues during the next five years will be as a specialty
subcontractor, using its machinery and processes to wrap bridge columns with
composite materials in upgrading bridges, highways and privately owned
structures.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENT

The Company's business consists of one business segment, the operations
of which are described below. For detailed financial information with respect to
the revenues, operating loss and assets and liabilities of the Company's
operations, see the consolidated financial statements and notes thereto included
elsewhere in this report.

GENERAL

The Company's technology involves a proprietary column wrapping machine
and process, the Robo-Wrapper(TM), which wraps deficient highway bridge columns
with a precise amount of continuous carbon fiber composite jacket that has no
seams, joints or weak spots. The carbon fiber composite jacketing process, which
is an approved alternative to the current method of using welded steel jackets,
has received support of both federal and state research and development (R&D)
funds totaling $5.2 million, including $1.2 million in grants to the Company.
Carbon composite jackets match or exceed the performance of steel jackets at a
fraction of the weight, and can be installed in less time. The Company's carbon
jacketing process has been demonstrated to work by structural testing of
4/10ths-scale columns under simulated seismic loads at the Powell Structural
Systems Research Laboratories at the University of California, San Diego
("UCSD").

Since its inception in 1985, the Company has been engaged principally
in R&D activities and revenue from retrofit operations to date have been
insignificant. In mid-March 1996, construction of the second-generation
production equipment, Robo-Wrapper II(TM), was completed. The new machine was
used in a demonstration project for local Caltrans design engineers to wrap a
six-foot diameter column underneath the I-8/I-5 Interchange in San Diego. On
April 10, 1996, the Company was notified by the California Department of
Transportation ("Caltrans") that Caltrans had issued a procurement specification
approving the use of the Company's Robo-Wrapper(TM) technology as an alternate
method of retrofitting publicly-owned highway bridge columns in the State of
California that meet certain criteria in a composite specification. In June 1996
the Company began bidding on retrofit contracts to be awarded by Caltrans,
however, none has been awarded to the Company as of the date of this
publication. There are approximately 20,000 publicly-owned bridge columns in
California to be retrofitted over the next five years, of which approximately
50% are believed by the Company to be presently eligible for retrofitting
pursuant to the composite specification. Notwithstanding the issuance of the
composite specification, there can otherwise be no assurance that the Company
will achieve significant revenues from the retrofitting of publicly-owned
bridges in California or any other state.

The Company's strategy and plan of operations over the next five years
is to market its Robo-Wrapper(TM) technology primarily to those construction
firms engaging in the retrofitting of publicly-owned highway bridges in the
State of California and other seismic states. The company estimates that the
State of California will spend approximately $2 billion on seismic retrofit if
its highway structures, including $200 to $400 million over the next five years
on the retrofitting of bridge columns alone. Prior to the issuance of the
Composite Specification, the only Caltrans-approved method of retrofitting
publicly-owned bridge columns in the State of California required the use of
steel jackets. Management of the Company believes, and independent testing of
the University of California at San Diego using simulated seismic loads
confirms, that the Company's Robo-Wrapper(TM) technology is as effective as
steel jackets and, in addition, can be applied in less time and with less cost.

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While the Company intends to focus its initial marketing efforts on the
planned retrofitting of publicly-owned bridge columns in the State of
California, the Company intends to also pursue at this time other potential
markets for its Robo-Wrapper(TM) technology. The Company believes that the
Robo-Wrapper(TM) can also be an effective means of remediating seismic safety
problems experienced by buildings and parking structures, particularly schools
and hospitals, in California and elsewhere. While seismic risk is typically
associated with California, there are other areas of the United States,
including the Midwest (New Madrid Fault) and the Northeast, that are potential
subjects of high seismic activity. In addition to seismic remediation, the
Company believes that structural deficiencies caused by corrosion decay
represent an additional market for its technology. The Company believes that the
issuance of the Composite Specification will have a significant positive affect
on its ability to market its Robo-Wrapper(TM) technology to engineers,
contractors and governmental agencies involved in the remediation of seismic
corrosion safety problems within the U.S. and abroad.

SEISMIC RETROFIT OF BRIDGE COLUMNS--THE INFRASTRUCTURE PROBLEM

Currently, approximately $35 billion a year is spent in the United
States to maintain the highway and bridge infrastructure. Conservative estimates
indicate that approximately $53 billion is necessary to maintain the highway and
bridge infrastructure in its current condition. As estimated 187,515 (32%) of
the nation's 576,460 bridges are classified as structurally deficient or
functionally obsolete. The primary concerns are seismic safety and corrosion
decay.

Subsequent to the collapse of numerous bridge structures during the
1971 San Fernando earthquake (magnitude 6.4 on the Richter scale) there has been
an increased awareness of the vulnerability of highway bridge support columns to
damage from earthquakes. This vulnerability was again demonstrated by the 1989
San Francisco earthquake with the collapse of the Cypress Viaduct of the Nimitz
Freeway, I-880 in Oakland, and the 1994 Los Angeles earthquake with the collapse
of numerous highways, including portions of the Santa Monica Freeway.
Particularly vulnerable are bridge structures designed and/or built prior to
1971, before the San Fernando earthquake prompted drastic revisions in the
seismic design code (which is still in use today).

While seismic risk is typically associated with California, it is of
concern throughout most of the United States. In 1990 the American Association
of State Highway and Transportation Officials adopted seismic design guide
specifications for the entire United States, recognizing the vulnerability of
the nation's bridge infrastructure to potential seismic activity not only along
the West Coast, but also in the Midwest (New Madrid fault) and the Northeast.
The seismic risk to bridge structures differs from region to region due to
different probable earthquake magnitudes and recurrence periods as well as
geological conditions, but the unpredictable nature of seismic events and the
vulnerability of the majority of existing bridges necessitates the development
and implementation of innovative, fast, effective and economical retrofitting
technologies to ensure the safe and continued use of the nation's bridge
infrastructure.

THE XXSYS TECHNOLOGY

The Company's product is applied by a three-man crew using a
proprietary Robo-Wrapper(TM) machine (patent pending) and application process
(patent pending) to wrap prepreg tow (carbon fiber which has been
pre-impregnated with resin) around the bridge column. Columns are first
inspected from a manlift and any defects such as holes or sharp protrusions are
repaired. The columns are then cleaned in preparation for wrapping. The Company
estimates that the preparation will take one person approximately one to two
hours per column.

Prepreg tow in spool form is placed on the Robo-Wrapper(TM) machine. A
controlled tension is applied to each spool. The machine rotates around the
column in a precise, programmed motion applying the tow in a continuous pattern
around the column to form a jacket that conforms to the shape of the column. The
thickness of the jacket varies based on the type of retrofit (flexural or shear)
and is dictated by the design specified by the structural engineer. The Company
estimates that one Robo-Wrapper(TM) machine and a three-man crew will be able to
wrap approximately three to four 22-foot columns per day, including setup, wrap,
and tear down of equipment.

Upon completion of the wrapping process, a heat source is used to cure
the resin in a controlled environment. During the heating process, the liquid
resin undergoes a chemical reaction in which molecules crosslink, forming a
solid which gives the product its ultimate mechanical properties. Heat can be
applied using several methods including electric heat blankets, forced hot air,
or radiant energy. All of these methods have been successfully demonstrated. The
radiant energy curing system is the method the Company intents to use
commercially since it is the most versatile system for the wide range of column
sizes expected to be encountered in the field. Curing a 22-foot column with the
planned curing

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system is projected to take two to three consecutive cures of eight foot
sections estimated at about eight hours per column, including setup and tear
down, with minimal monitoring during the period. Once the curing is complete,
the column will be painted with a chemical and UV resistant coating to complete
the process.

The Company's Robo-Wrapper(TM) technology has been independently
validated under simulated seismic loads by the Powell Structural Research
Laboratory at the University of California, San Diego. The Powell Laboratory
conducted tests of seven 4/10ths scale concrete columns with different
reinforcement and retrofit strategies for shear and flexural failure modes over
a period of 13 months. These tests were conducted at the request, and observed
by, Caltrans and were funded by grants from the U.S. Department of Defense and
Department of Transportation. The data gathered from the testing was analyzed by
the Powell Laboratory and in August 1995 a formal report was submitted to
Caltrans evidencing that the carbon jackets installed by the Robo-Wrapper(TM)
performed as well as and, in some cases, even better than steel jackets, and can
be installed in less time and with less cost.

The testing, marketing and sale of products for civil engineering
applications entails a risk of negligence and other claims by owners and general
contractors of projects, and product liability claims by those persons who
ultimately use or occupy such projects. The Company currently maintains product
liability insurance providing coverage in the approximate amount of $2,000,000
per year, however there can be no assurance that the Company will be able to
maintain insurance coverage at a reasonable cost or that any such insurance will
be sufficient to cover all possible liabilities. In the event of a successful
suit against the Company, lack or insufficiency of insurance coverage could have
a material adverse affect on the Company. Further, owners and general
contractors may require minimum product liability insurance coverage as a
condition precedent to entering into collaborative arrangements with the
Company. Failure to satisfy such insurance requirements could impede the ability
of the Company to achieve broad use and acceptance of its Robo-Wrapper(TM)
technology, which would have a material adverse affect upon the business and
financial condition of the Company.

SENSOR AND NDE TECHNOLOGIES

The Company will utilize its prior expertise in sensor and
non-destructive testing ("NDE") technologies to develop quality assurance and
performance in monitoring technologies to increase user confidence in the carbon
jacketing process, thereby accelerating its commercial acceptance. Quality
assurance technologies include the monitoring of the resin impregnation process
on the carbon fiber line to control resin content of the prepreg tow and ensure
consistency of the product made, and in situ cure monitoring technologies to
ensure the carbon composite jacket reaches the desired cure state during field
installation. Performance monitoring technologies include the measurement of
strain in the composite jacket over its service life, and particularly after
events like an earthquake, such that an informed decision can be made regarding
maintenance and repair of the jacket. These research and development efforts are
partially funded by the Advanced Technology Program (ATP) from the National
Institute of Standards and Technology (NIST) to accelerate the commercialization
of the Robo-Wrapper(TM) technology. If successful, these sensor and NDE
technologies can be utilized for other composite applications. The Company
intends to pursue NDE opportunities as a separate business unit.

MANUFACTURING AND RAW MATERIALS

The Company designed the existing Robo-Wrapper(TM) and its curing
system and intents to contract with original equipment manufacturers for the
manufacture of Robo-Wrapper(TM) and curing systems. To ensure confidentiality of
trade secrets the Company may machine critical parts and perform final assembly,
system integration, and quality assurance at the Company's facilities.

Eight companies currently supply approximately 15 million pounds of
carbon fiber annually to the industrial, aerospace and automotive markets.
Announced plant expansions are expected to soon add approximately 5 million
pounds of annual capacity. The carbon fiber utilized in the Company's test work
was supplied by Hercules Inc., the largest supplier of carbon fiber in the
United States. Amoco, the second largest supplier, is in the process of
qualifying its materials for use in connection with the Robo-Wrapper(TM)
machine. The Company intends to purchase materials from both of these suppliers.

The Company believes that all of the raw materials used in the
installation of the Robo-Wrapper(TM) jackets are generally available in adequate
amounts and at competitive prices from multiple sources. However, since the
majority of the cost involved in installing the Robo-Wrapper(TM) jackets is the
cost of the carbon fiber and resin, any significant increases in the cost of
either material could have a material adverse affect on the composite retrofit
technologies. To

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protect against supply shortages and price increases, the Company intends to
negotiate with carbon fiber and resin suppliers for long term supply agreements.

MARKETING

The Company intends to market its Robo-Wrapper(TM) technology primarily
to the engineers and contractors involved in the retrofitting of bridge columns
and other structures and to government agencies responsible for public
structures and the administration of safety standards for privately-owned
structures. As of the date of this publication, the Company is not and does not
intend to become directly engaged in construction activities, therefore the
Company intends to enter into license or joint venture arrangements with
construction firms involved in seismic retrofitting. The contractor will be
responsible for bidding on public or private retrofit projects, and conducting
the actual retrofitting. The Company proposes to provide the Robo-Wrapper(TM)
machine, prepreg material, curing ovens and one or more technical assistants to
the contractor directly conducting the column retrofit, in return for which the
Company will be reimbursed for its expenses and receive a share of the project
profits.

The Company's marketing mission will be to educate those engineers,
contractors and government agencies involved in the retrofit industry on the
strategic benefits of the Company's Robo-Wrapper(TM) technology and to obtain a
high degree of acceptance of its technology among them. Since state and local
government agencies strictly regulate building and construction standards, it
will be necessary for the Company to obtain government approval in other states
for its Robo-Wrapper(TM) technology. Retrofit contractors will also have to
accept the technology and incorporate it into their big proposals, The Company
believes that the issuance of the Caltrans Composite Specification will have a
significant positive affect on its ability to successfully market its
Robo-Wrapper(TM) technologies to the engineers, contractors and governmental
agencies involved in the remediation of structural deficiencies. However, the
failure of the Company to successfully market its technology to either the
relevant government agencies or the retrofit contractors will significantly
impede the Company's efforts to commercially exploit its Robo-Wrapper(TM)
technology.

Important aspects of the Company's marketing strategy will include the
development and dissemination of educational materials for the various target
groups through seminars and short-courses, and the development and
implementation of a comprehensive training program to ensure rapid and
successful technology transfer. It will be important to convince the hundreds of
individual contractors and engineers involved with preparing bid retrofit
packages to either request the Company's product or at least give the bidding
contractors a choice of steel or carbon composite as they bid. The Company has
no retrofit contracts to date and it does not expect to generate significant
revenues from work until late 1996. The Company anticipates it will be primarily
dependent on the Caltrans market for most of its revenue in 1996 and 1997.

COMPETITION

The Company will face competition from the current and future retrofit
procedures. As of the date of this publication, the principal competition to the
Robo-Wrapper(TM) technology is the use of steel jackets. Additionally, other
companies, some of which have substantially greater resources than the Company,
have already been using composites to retrofit private and publicly-owned
structures located in California and other states, including Hexel Fyfe Company,
Hardcore Dupont and Mitsubishi. AS of the date of this publication, only one of
the Company's competitors using composites, Hexel Fyfe Company, has received
approval from Caltrans to wrap structures, If Caltrans allows other companies to
rely upon the Company's testing so as to reduce substantially the testing
needed, the Company could face additional composite-based competition sooner
that expected, Additionally, should the Company's pending patents be rejected,
it could lose any competitive advantage that patent protection affords.

RESEARCH AND DEVELOPMENT

Research and development expenses for the years ended September 30,
1995, 1994, and 1993 were $115,304, $277,789 and $230, 261, respectively. These
amounts represent direct expenditures by the Company and do not include
approximately $4 million of federal and state grant monies paid directly to
third parties, such as UCSD and Hercules, Inc., for purposes of developing and
validating the Robo-Wrapper(TM) technology.

The Company participates in several federally-funded joint research and
development projects. The Company is currently a participant in a bridge
infrastructure renewal program funded by the U.S. Department of Defense,
Advanced Research Projects Agency (ARPA). The Company has received matching
funds grants of $514,000, of which $285,877

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had been earned as of September 30, 1995. The purpose of the ARPA program is to
validate and demonstrate carbon composite jacketing. The Company has applied its
grant money under the ARPA program towards the costs of wrapping seven bridge
columns for the independent testing of those columns by Powell Laboratories of
UCSD.

The Company is also the lead participant of a $2.7 million program
funded by the U.S. Department of Commerce, National Institute of Standards and
Technology (NIST). The purpose of the NIST program is to accelerate the
commercialization of carbon composite jacketing technology. The NIST program
participants include: the Company, which is responsible for developing the
method for installing and testing carbon based jackets and sensor and
non-destructive testing technologies for quality assurance and performance
monitoring; Hercules, Inc., which is responsible for developing a low cost
prepreg tow; and Trans Science Corporation, which is responsible for developing
computer software which will design the length and thickness of the jacked based
on the particular characteristics of the structure to be retrofitted. The
Company's share of the grant funds is $538,000, of which $110,710 has been
earned as of September 30, 1995. The Company was also awarded $250,000 in
matching funds from the State of California's Trade and Commerce Agency for the
NIST program.

The Company is a founding member of the Advanced Composite Technology
Transfer (ACTT) Consortium, a group organized to construct an all-composite
cable-stayed bridge in San Diego, the first such bridge in the country for
vehicular traffic. The Company is responsible for assessing non-destructive
testing technology related to various quality assurance programs during
manufacture and for developing procedures to monitor structural integrity over
the life span of the bridge.

The Company intends to conduct continued research and development in
the area of non-destructive testing and measurement, The Company intends to
pursue research grants and invest a portion of the Company's own research and
development budget in the area of ultrasonic measurement and applications.

INTELLECTUAL PROPERTY

In August 1994 the Company filed for a patent on the mobile robotic
wrapping machine (Robo-Wrapper(TM)) and the application process to be used in
the carbon composite retrofit program. In June 1995 the Patent Office, in an
initial office action, asked the Company to split the patent application into
two pieces--one for the machine and the other for the process. In December 1995
the Company filed a patent application for the method of curing filament wound
columns using a radiant heater. All three patent applications are pending. The
Company holds seven U.S. patents on its Ultrasonic Resin Analyzer technology.

The Company endeavors to maintain the confidentiality of its
proprietary technologies and know-how through confidentiality agreements,
in-house controls over the manufacture of certain parts of the Robo-Wrapper(TM)
machine and restricted access to certain information on a "need to know" basis.

EMPLOYEES

At May 31, 1996, the Company had 19 employees, of whom eight were in
executive or administrative positions, five were engaged in engineering, one in
marketing, and five in manufacturing. None of the Company's employees is covered
by a collective bargaining agreement. The Company believes that its relations
with its employees are good.

ITEM 2. DESCRIPTION OF PROPERTY.

The Company leases approximately 7,000 square feet of office and
production facilities in San Diego, California. This space is utilized for the
Company's executive offices, research and development, sales and marketing, and
engineering activities, at a monthly rent of $5,000 pursuant to a lease that
extends to October 1998. Should additional facilities be required, the Company
believes that adequate space is currently, and in the near future will continue
to be, available in the San Diego area.

ITEM 3. LEGAL PROCEEDINGS.

There are no pending legal proceeding to which the Company or any of
its officers and directors is a party or to which the property of the Company is
subject, other than routine litigation involving claims of immaterial amounts
arising during the normal course of business.

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

No matters were submitted to the Company's security holders in the
fourth quarter of fiscal 1995.

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The Company's Common Stock has traded on the NASDAQ Small Cap Market
under the symbol XXSYS following the Company's initial public offering on July
31, 1992. The table below sets forth the quarterly high and low sales prices as
reported on NASDAQ for the two years ended September 30, 1995.

<TABLE>
<CAPTION>
HIGH LOW
---- ---

<S> <C> <C>
Year ended September 30, 1995:
------------------------------

First Quarter 2 1/8 7/8
Second Quarter 2 7/8
Third Quarter 1 7/8 15/16
Fourth Quarter 7 1/8 1 9/16

Year ended September 30, 1994:
------------------------------

First Quarter 2 7/8 1 1/2
Second Quarter 2 1/2 1 3/8
Third Quarter 1 3/4 3/4
Fourth Quarter 1 7/8 1/2
</TABLE>

On December 15, 1995, the closing price for the Company's Common Stock
was $5 11/16 per share. As of that date, the Company had 130 stockholders of
record and approximately 2,000 stockholders whose shares are held in brokerage
accounts.

The Company has not paid any dividends on its Common Stock and
currently intends to retain any earnings for use in its business; therefore, the
Company does not anticipate paying cash dividends in the foreseeable future.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

The Company is engaged in developing and commercializing the use of
composite materials in construction and transportation markets and developing
technologies for quantitative nondestructive evaluation of composite materials.
Through September 30, 1995, the Company has generated limited revenues and has
incurred significant losses, due primarily to extensive expenditures in research
and development of various technologies leading to new applications of composite
materials.

RESULTS OF OPERATIONS

Fiscal Year 1995 Compared to Fiscal Year 1994

Revenues for the fiscal year ended September 30, 1995, were $408,867
compared to $266,890 in the prior fiscal year, an increase of $141,977 or 53%.
The increase is primarily attributable to funding received from grants awarded
by the Advanced Research Projects Agency (ARPA) and the National Institute for
Standards and Technology (NIST). The Company continued to depend on federal and
state grant programs for its primary revenue sources in fiscal 1995. Revenues in
fiscal 1995 were derived primarily from work performed under a grant from ARPA,
totaling $208,286 or 51% of revenues, and an additional $117,030 or 29% from
NIST. Other federal programs provided for the balance of revenues. At September
30, 1995, the Company had approximately $800,000 of funding available from
outstanding federal and state contracts.

Total operating expenses increased by $411,085 (24%) in fiscal 1995 to
$2,103,926. The cost of services was $225,202, or 55% of contract revenues. In
comparison, the cost of services in fiscal 1994 was $58,521, or 22% of contract

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revenues. This higher percentage in fiscal 1995 was the result of different
contractual terms and is more indicative of expected cost levels. Selling,
general and administrative expenses were $1,763,420 in fiscal 1995, an increase
of $406,889 or 30% over fiscal 1994. The increase reflects additional staffing
costs in support of expanded contract work, as well as increased expenses for
investor relations and fund raising activities. Research and development costs
decreased substantially in fiscal 1995, to $115,304 from $277,289 in the prior
year, a decrease of 58%, as a greater portion of the Company's R&D efforts was
done under research contracts.

Interest income of $48,098 in fiscal 1995 was 60% higher than in the
prior year, the result of accrued interest on a Long-Term note receivable that
was held for a full year in fiscal 1995. Interest expense increased five-fold to
$106,160 as the Company had a significant increase in its average borrowings.

The net loss in the year ended September 30, 1995, was $1,753,121
compared to $1,412,749 in the prior year, an increase of $340,372 or 24%. The
loss per share decreased, however, because of a higher average number of shares
outstanding. The loss per share in fiscal 1995 was $0.34, an improvement of 6%
compared to the loss per share of $0.36 in fiscal 1994.

The Company had current assets of $628,785 as of September 30, 1995,
representing an increase of $547,946 over 1994. The increase is primarily the
result of raising $1,056,000 through a private placement of Common Stock at
$5.00 per share on September 1, 1995. Of the total private placement, $500,000
in cash was received prior to September 30, 1995. A portion of the private
placement, totaling $380,000 was received in early October and is shown as a
subscription receivable on the balance sheet as of September 30, 1995. The
balance of the private placement, totaling $176,000, is in the form of a
two-year note receivable from the holder of the stock (See Note 6 to the
financial statements). These funds were used to help reduce accounts payable and
make a deposit on construction of a second-generation Robo-Wrapper(TM) machine.

Also in fiscal 1995, the Company took a write-down of its remaining
inventory of prepreg carbon fiber which was left over from prior research
programs. Pre-preg carbon fiber ages slowly despite being in refrigeration. The
batch in inventory had reached its productive life and had no other use or
value.

A large portion of the funds raised by the Company were necessary for
commercialization of Robo-Wrapper(TM) technology and construction of equipment
that will generate revenues in the future. The Company modestly increased its
cash position to $148,562, an increase of $139,840 over the prior year. Net cash
used in operating activities of $1,273,074 and investing activities of $305,886
was funded by $1,718,800 in financing activities. Financing activities included
the issuance of convertible notes of $800,000, which were converted to 1,231,030
shares Common Stock during the year, the issuance of notes payable of $564,500,
and the private placement of $1,056,000, of which $500,000 in cash had been
received by September 30, 1995. A portion of the financing activities were used
for the repayment of $190,700 in notes payable which came due during the period.

Fiscal Year 1994 Compared to Fiscal Year 1993

Revenues for the fiscal year ended September 30, 1994 were $266,890
compared to $49,018 in 1993. Contract revenues represented all of the 1994 total
and $35,000 for 1993. In 1994 the Company's contracts were with the Federal
Highway Program, EPA, and ARPA. An ARPA contract of $433,000, awarded in June
1994, provides partial funding for the testing of the Company's column wrapping
technology at the UCSD Powell Laboratory. Revenues in 1994 were primarily from
work performed under grants from ARPA, totaling $127,966 or 48%, and the
Environmental Protection Agency (EPA), totaling $116,875 or 44% of total
revenues. The 1993 revenues related to a $50,000 contract funded by a grant from
the U. S. Environmental Protection Agency that was completed during the second
quarter. Equipment sales of $14,018 were recorded in 1993 pursuant to a sales
and remarketing agreement.

Total operating expenses for 1994 were $1,692,841, a decrease of
$423,332 or 20% over operating expenses in 1993 of $2,116,173. This decrease
reflects the redirection of the Company toward its seismic retrofit technology.
The cost of equipment sales in 1993 was 90% of the related revenues. The cost of
services was 46% of revenues in 1993, compared to 22% in 1994, because of
different contractual terms. Selling, general and administrative expenses
decreased to $1,356,531 from $1,857,195, a decrease of $500,664 (27%), the
result of reduced staffing and marketing activities as the Company developed the
column wrapping technology. The 1993 amount also includes approximately $124,000
of legal, accounting and related fees related to a proposed acquisition that was
not completed. Research and development

8
<PAGE> 9
costs increased to $277,789 from $230,261 in the respective periods, an increase
of $47,528 or 21%, reflecting further research into advanced materials.

Interest income on invested cash, securities, and a long-term note
receivable was $30,037 in the 1994 period compared to $87,224 in the prior year.
The decline represents the lower amount of cash available for investment.
Interest expense in 1994 was $16,835 and was $603 in 1993, reflecting the use of
borrowed funds for the first time since 1992.

The net loss for the year ended September 30, 1994 was $1,412,749
compared to $1,980,534 in the 1993 fiscal year, a decrease of 29%. The loss per
share decreased by 31% to $0.36 in 1994 from $0.52 in 1993, based on a 4%
increase in the average number of shares outstanding.

Liquidity and Capital Resources

During its 1994 and 1995 fiscal years the Company operated with modest
cash resources. Funding of approximately $675,000 was received pursuant to
grants from several government agencies in support of research and development
activities. As of September 30, 1995, approximately $800,000 remained available
under these grants. However, in order to meet all of its operating expenses, the
Company has relied on the sale of common stock and the issuance of convertible
notes to raise additional funds. Net proceeds from such transactions in fiscal
1995 were approximately $2,100,000. In October 1995 a litigation settlement
resulted in the receipt of cash of $1,300,000 by the Company. These funds have
been used to reduce accounts payable, repay outstanding notes payable and
complete the purchase of a second-generation Robo-Wrapper(TM) machine.

As of September 30, 1995, the Company had cash and cash equivalents of
$148,562 and accounts receivable of $46,623 and stock subscriptions receivable
of $380,000. However, the Company's current liabilities as of September 30,
1995, were $1,508,299 and the Company had a working capital deficit of $879,514
as of the same date. Following September 30, 1995, the Company has incurred
additional losses in pursuing the commercialization of its seismic retrofit
process, which have drawn on the Company's resources. In May 1996 the Company's
Chairman and CEO, Dr. Gloria Ma, paid to the Company $309,916 as a partial
reduction of amounts owed to the Company under a promissory note made by her.
Dr. Ma also offset against the amounts owed by her under the note certain
deferred salaries, accrued vacation and unreimbursed travel and entertainment
expenses, the net of which reduced the amounts owing under the note by an
additional $137,012.

The Company estimates that it will require approximately $2.8 million
of additional capital for the purchase of machines and for the working capital
necessary to further advance the commercialization of the Robo-Wrapper(TM)
technology. In order to finance these costs, the Company intends to call its
publicly traded Warrants for redemption. However, there are no commitments or
understandings on the part of any third parties to exercise the Warrants and
there can be no assurance of the amount of proceeds, if any, that the Company
may receive by way of the Warrant redemption. Further, there are no
understandings or arrangements for the Company's receipt of additional capital
from alternative sources. Therefore, there can be no assurance that the Company
will be able to obtain capital from sources other than the Warrant redemption
should the need arise.

During 1996 calendar year the Company may repurchase some of the
restricted common stock that was issued in conversion of debt during the 1994
and 1995 fiscal years. Several of the conversions had repurchase rights in favor
of the Company. The Company plans to repurchase stock where the repurchase price
is advantageous.

Impact of Inflation

Inflation has not had any significant effect on the Company's operating
costs.

9
<PAGE> 10
ITEM 7. FINANCIAL STATEMENTS.

<TABLE>
<CAPTION>
PAGE
----

<S> <C>
Report of Independent Auditors 11

Consolidated Balance Sheets at September 30, 1995 and 1994 12

Consolidated Statements of Operations for the years ended 13
September 30, 1995, 1994 and 1993

Consolidated Statements of Stockholders' Equity for the three 14
years ended September 30, 1995

Consolidated Statements of Cash Flows for the years ended 15
September 30, 1995, 1994 and 1993

Notes to Consolidated Financial Statements 16-23
</TABLE>

10
<PAGE> 11
REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders
XXsys Technologies, Inc.

We have audited the accompanying consolidated balance sheets of XXsys
Technologies, Inc. as of September 30, 1995 and 1994 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years ended September 30, 1995. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. 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 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of XXsys
Technologies, Inc. as of September 30, 1995 and 1994, and the consolidated
results of its operations and cash flows for each of the three years ended
September 30, 1995, in conformity with generally accepted accounting principles.

Feldman Radin & Co., P.C.
Certified Public Accountants

New York, New York
December 22, 1995, except as to
Note 6, Shareholders' Equity,
Preferred Stock, as to which
the date is May 31, 1996.

11
<PAGE> 12
XXSYS TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30,
ASSETS 1995 1994
------------ ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 148,562 $ 8,722
Accounts receivable 46,623 40,400
Stock subscription receivable 380,000 --
Inventory -- 26,045
Prepaid expenses and other 53,600 5,672
------------ ------------
Total current assets 628,785 80,839

Machinery, equipment and furniture, net of
accumulated depreciation of $340,220 and $184,098 439,047 328,753

Long-Term note receivable 446,928 446,928

Deferred acquisition costs 1,102,181 1,117,188

Patents, net of amortization of $86,298 and $66,524 59,796 49,474
------------ ------------
TOTAL ASSETS $ 2,676,737 $ 2,023,182
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable $ 695,552 $ 290,700
Accounts payable 521,699 621,880
Accrued liabilities 98,622 77,988
Related party accrued expenses 192,426 156,659
------------ ------------
Total current liabilities 1,508,299 1,147,227

Commitments and contingencies

Stockholders' equity:
Preferred stock, par value $100, shares authorized--
2,000,000; issued and outstanding -- 4,500
(liquidation preference -- $450,000) 450,000 450,000
Common stock, no par value. 20,000,000 shares
authorized; 6,067,082 shares issued and
outstanding (4,257,989 in 1994) 12,068,535 9,836,305
Accumulated deficit (10,910,399) (9,157,278)
Note receivable for preferred stock (263,698) (218,697)
Note receivable for common stock (176,000) --
Deferred compensation -- (34,375)
------------ ------------
Total stockholders' equity 1,168,438 875,995
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,676,737 $ 2,023,182
============ ============
</TABLE>

See accompanying notes.

12
<PAGE> 13
XXSYS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,

1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Sales $ -- $ -- $ 14,018
Contract revenues 408,867 266,890 35,000
----------- ----------- -----------
Total revenues 408,867 266,890 49,018

Operating expenses:
Cost of equipment sales -- -- 12,617
Cost of services 225,202 58,521 16,100
Selling, general and administrative 1,763,420 1,356,531 1,857,195
Research and development 115,304 277,789 230,261
----------- ----------- -----------
Total operating expenses 2,103,926 1,692,841 2,116,173
----------- ----------- -----------

Operating loss (1,695,059) (1,425,951) (2,067,155)

Interest income 48,098 30,037 87,224
Interest expense (106,160) (16,835) (603)
----------- ----------- -----------

Net loss $(1,753,121) $(1,412,749) $(1,980,534)
----------- ----------- -----------

Net loss per share $ (0.34) $ (0.36) $ (0.52)
----------- ----------- -----------

Weighted average number of shares
outstanding 5,083,000 3,939,000 3,800,000
----------- ----------- -----------
</TABLE>

See accompanying notes.

13
<PAGE> 14
XXSYS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED SEPTEMBER 30, 1995

<TABLE>
<CAPTION>
COMMON STOCK NOTES DEFERRED TOTAL
PREFERRED -------------------- RECEIVABLE ACCUMULATED COMPEN- STOCKHOLDERS'
STOCK SHARES AMOUNT FOR STOCK DEFICIT SATION EQUITY
----- ------ ------ --------- ------- ------ -------------

<S> <C> <C> <C> <C> <C> <C> <C>
Balances at September 30, 1992 $ -- 3,800,000 $ 9,032,366 $ -- $ (5,763,995) $(109,375) $ 3,158,906

Warrants issued for services 17,200 17,200
Amortization of deferred 37,500 37,500
compensation
Net loss (1,980,534) (1,980,534)
-------- --------- ----------- --------- ------------ --------- -----------
Balances at September 30, 1993 -- 3,800,000 9,049,566 -- (7,744,529) (71,875) 1,233,162

Sale of 4,500 shares of preferred
stock 450,000 198,750 (201,822) 446,928
Increase in interest receivable on note (16,875) (16,875)
Stock issued in settlement of debt 387,989 387,989 387,989
Sale of common stock 70,000 50,000 50,000
Warrants issued for services 150,000 150,000
Amortization of deferred
compensation 37,500 37,500
Net loss (1,412,749) (1,412,749)
-------- --------- ----------- --------- ------------ --------- -----------
Balances at September 30, 1994 450,000 4,257,989 9,836,305 (218,697) (9,157,278) (34,375) 875,955

Stock issued in settlement of debt 84,789 84,789 84,789
Increase in interest receivable on note (45,001) (45,001)
Conversion of notes issued in
Regulation S offering 1,231,030 800,000 800,000
Exercise of warrants 200,000 45,000 45,000
Sale of common stock 211,200 1,056,000 (176,000) 800,000
Warrants issued with debt 56,268 56,268
Warrants issued for services 100,000 100,000
Stock issued for services 82,074 90,173 90,173
Amortization of deferred
compensation 34,375 34,375
Net loss (1,753,121) (1,753,121)
-------- --------- ----------- --------- ------------ --------- -----------
Balances at September 30, 1995 $450,000 6,067,082 $12,068,535 $(439,698) $(10,910,399) $ -- $ 1,168,438
-------- --------- ----------- --------- ------------ --------- -----------
</TABLE>

See accompanying notes

14
<PAGE> 15
XXSYS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(1,753,121) $(1,412,749) $(1,980,534)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization 241,538 131,927 72,913
Non-cash compensation 224,548 37,500 37,500
Accrued interest income (45,001) (16,875) --
Changes in assets and liabilities:
Investments -- 1,163,500 (182,521)
Accounts receivable (6,223) (30,842) 3,354
Inventories 26,045 61,125 74,637
Prepaid expenses and other (47,928) 46,864 68,977
Accounts payable (385) 550,706 46,939
Accrued liabilities 51,686 (79,409) 48,486
Related party accrued expenses 35,767 156,659 --
----------- ----------- -----------
Net cash used in operating activities (1,273,074) 608,406 (1,810,249)
Cash flows from investing activities:
Purchase of machinery and equipment (275,790) (277,719) (170,620)
Deferred acquisition costs -- (579,199)
Other assets (30,096) 79,998 (89,298)
----------- ----------- -----------
Net cash used in investing activities (305,886) (776,920) (259,918)

Cash flows from financing activities:
Sale of common stock 500,000 50,000 --
Exercise of warrants 45,000 -- --
Issuance of convertible notes 800,000 -- --
Issuance of other notes payable 564,500 38,800 200,000
Repayment of notes payable (190,700) -- (70,200)
Payments of related party debt -- (284,305) --
----------- ----------- -----------
Net cash from financing activities 1,718,800 (195,505) 129,800

Net increase (decrease) in cash 139,840 (364,019) (1,940,367)
Cash and cash equivalents--beginning of year 8,722 372,741 2,313,108
----------- ----------- -----------

Cash and cash equivalents at end of year $ 148,562 $ 8,722 $ 372,741
----------- ----------- -----------

Supplemental information:
Cash interest paid $ 15,208 $ 16,835 $ 603
Issuance of warrants $ 156,268 $ 150,000 $ 17,200
Stock issued for accounts payable $ 84,789 $ 387,989 $ --
Stock issued for services $ 90,173 $ -- $ --
Issuance of preferred stock for note $ -- $ 446,928 $ --
</TABLE>

See accompanying notes.

15
<PAGE> 16
XXSYS TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

Consolidation. The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiary, Composite Retrofit
Corporation. All intercompany accounts have been eliminated in consolidation.

Cash and Cash Equivalents. Cash and cash equivalents consist of
investments with an original maturity of three months or less.

Stock Subscription Receivable. The stock subscription receivable of
$380,000 represents cash received by the Company in October 1995 as partial
payment for stock purchased under a stock purchase agreement that the Company
signed on September 1, 1995. The stock subscription receivable is shown as a
current asset because the amount was received prior to the issuance of these
financial statements. An amount still owed the Company as part of the September
1, 1995, agreement totaling $176,000 is reported as a contra-equity account
titled, "Note receivable for common stock."

Inventory. Inventory is stated at the lower of cost or market using the
first-in, first-out method of inventory valuation.

Machinery, Equipment and Furniture. Machinery, equipment and furniture
are stated at cost and are being depreciated on a straight-line basis over
estimated useful lives of three to five years.

Patents. Costs incurred in obtaining patents are being amortized over
periods averaging seven years.

Revenue Recognition. A majority of the Company's revenue to date has
been derived from services performed under cost reimbursement and fixed-price
research contracts. Under fixed-price research contracts, revenues are generally
recognized upon shipment of deliverable items under the contract. For
cost-reimbursement contracts, revenues are recorded as earned when the work is
performed under the terms of the contract.

Research and Development. Research and development costs are expensed
as incurred.

Income Taxes. The Company adopted the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes," effective
October 1, 1991. Net operating losses may be carried forward to offset future
taxable income of the Company. At September 30, 1995, these carry forwards were
approximately $10,000,000 and $5,000,000 for federal and state tax purposes,
respectively, and expire in 2001 through 2010. As a result of a change in
ownership in 1991, certain restrictions imposed by Section 382 of the Internal
Revenue Code will limit the utilization of the loss carry forwards to
approximately $1,000,000 per year.

Major Customers. Two customers accounted for 51% and 29% of 1995
revenues. In 1994 two customers represented 48% and 44% of revenues and in 1993
represented 71% and 18% of revenues.

Net Loss Per Share. Net loss per share is based on the weighted average
number of shares of common stock outstanding. Conversion of preferred stock and
exercise of stock options have been excluded, as the effect of their inclusion
would be anti-dilutive.

Reclassifications. Certain items in the prior year financial statements
have been reclassified to conform to the 1995 presentation.

Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

16
<PAGE> 17
2. DEFERRED ACQUISITION COSTS

In October 1993 the Company began negotiations for the acquisition of a
composite materials company with revenues in excess of $100 million. The Company
was unable to complete the transaction as originally contemplated. However,
negotiations were continued with third parties regarding a joint bid or a
transaction in which the Company would not be a direct purchaser but would have
a significant minority interest in a new company that would make the
acquisition.

The Company incurred costs in excess of $1,100,000 for legal fees,
appraisals, environmental studies and other due diligence. These costs were
deferred pending completion of a purchase transaction or, alternatively, the
termination of all negotiations.

In September 1995 the owner of the target company announced a pending
sale to another party. The Company and its former president filed suit claiming
breach of contract and breach of fiduciary relationship by the purchaser.
Pursuant to a settlement agreement reached in October 1995, the Company received
a cash payment of $1,300,000 (net of legal fees). In addition, the Company will
receive annual payments of up to $250,000 for six years pursuant to a consulting
contract between the target and the Company. The target company also agreed to
offer a five-year material supply contract and to provide product and/or
technical services (for research and development, materials testing, etc.).

In November 1995 a claim for fees in connection with the Company's
attempted acquisition of the target company was placed against the Company by
its previous investment banker, H. J. Meyers & Co., Inc. ("HJM") (formerly
Thomas James Associates, Inc.). HJM claims that the Company's aforementioned
settlement with the purchaser of the target company qualifies as a "Transaction"
under the terms of the Company's earlier investment banking agreement with HJM,
and that HJM is entitled to an investment banking fee. HJM is seeking $400,000
as its share of the Company's settlement and is willing to waive its right of
first refusal to be the Underwriter of a warrant redemption as a part of that
settlement amount. The Company denies the settlement with purchaser represents a
Transaction and is disputing HJM's claim. Further, the Company has decided not
to engage a broker-dealer to act as warrant solicitation agent when the warrants
are redeemed.

3. NOTES PAYABLE

Notes payable at September 30, 1995 include $100,000 borrowed from four
individuals in May 1994. The notes have an interest rate of 10% per annum. The
original maturity date of these notes has been extended several times, most
recently until September 30, 1995, in consideration for five-year warrants to
purchase a total of 170,000 shares of common stock at $1.00 per share. The notes
were repaid in October 1995. Also included in notes payable is $93,000 borrowed
from an individual in August and September 1995, due on October 28, 1995 plus
interest at 10% per annum. This note was repaid in December 1995.

In March and May 1995 the Company borrowed $410,000 from two parties.
The notes were due in July 1995 plus interest at 10% per annum. In July 1995 the
noteholders elected to convert the notes into 465,909 shares of restricted
common stock ($0.88 per share) and exercise warrants to purchase 246,000 shares
of common stock for $61,500 ($0.25 per share). In August 1995 the noteholders
notified the Company of their desire to rescind the note conversion and warrant
exercise due to delays in the registration of these securities. Subsequent to
September 30, 1995, the Company finalized the terms of a rescission of the
conversion agreements and the warrant exercise and signed new notes payable at
10% annual interest beginning September 12, 1995, totaling $502,552, which
includes $410,000 in original loans, $61,500 tendered originally for the
warrants and accrued interest to that date. The rescission has been recorded as
of September 30, 1995. The new notes payable are due on October 11, 1996, or
upon the Company receiving no less than $2 million from any equity offering,
whichever occurs sooner. Based on management's current plans for repayment,
these new notes are recorded as short term liabilities. As a separate inducement
for these transactions, a total of 605,682 five-year warrants to purchase common
stock at $6.00 a share were granted.

In March 1994 the Company borrowed $190,000 pursuant to a note
agreement. Interest at the rate of 14% per annum was payable monthly. The note
was repaid upon the scheduled maturity date of March 31, 1995.

4. RELATED PARTY TRANSACTIONS

17
<PAGE> 18
Related party accrued expenses consist of salaries, severance and
vacation pay due to current and former officers of the Company.

In July 1994 the Board of Directors granted, to the then president of
the Company, the right to dispose of the asset "deferred acquisition expenses"
(consisting of a due diligence package, including contracts, appraisals and
environmental studies on a targeted company). Upon any such disposal, the
individual was to receive a commission of one third of the price obtained, up to
a maximum amount of $100,000. As part of the litigation settlement described in
Note 2, the former executive received $100,000.

In March 1995, in connection with the resignation of two officers, the
Company assigned to those individuals and a then director of the Company the
corporate opportunity to pursue two other acquisitions. In the event an
acquisition is completed, the Company is to receive a payment of $100,000. As
part of this agreement, in April 1995 the Company's chairman received six-month
options to purchase 100,000 shares of the Company's stock owned by the director
and 175,000 shares held by his related corporation for a total purchase price of
$187,500. These options were exercised in October 1995.

5. COMMITMENTS

The Company leases its office facilities pursuant to a lease that
extends to October 31, 1998. The remaining rent commitment at September 30, 1995
is $206,600. Rent expense was $63,790 in 1995, $60,000 in 1994, and $59,242 in
1993. On September 15, 1995, the Company signed a five-month construction
contract for $312,000 to design and build the second-generation
Robo-Wrapper(TM), which was completed in mid-March 1996. The Company paid
$166,574 to turn on the contract on September 15, 1996. The balance of payments
to be made were structured around milestones, none of which had been completed
by September 30, 1995.

6. STOCKHOLDERS' EQUITY

Preferred Stock:

In May 1994 the Company sold to the brother of Gloria C. L. Ma, an
officer and director of the Company, in a private transaction 4,500 shares of
Series A Preferred Stock in exchange for the assignment of a non-recourse
promissory note made by Dr. Ma in the principal amount of $450,000, plus
$198,750 of accrued interest, secured by a second deed of trust on real
property. The non-recourse promissory note has an interest rate of 10% per annum
and is due in January 1999, including accrued interest. Each preferred share has
a liquidation preference of $100, is redeemable at the Company's option at a
price of $120 per share, and is convertible at any time into 80 shares of the
Company's common stock.

In May 1996 Dr. Ma reduced the note and accrued interest due the
Company by making a cash payment of $309,916 and relinquishing her rights to
deferred salaries, accrued vacation, and unreimbursed travel and entertainment
expense, partially offset by other amounts she owed the Company, the net of
which reduced the note a further $137,012. The total amount of $446,928 was
known prior to publishing this financial statement and has been reported as an
asset in "Long-term notes receivable." The remaining balance due under the note
together with accrued interest, which total $263,698 on September 30, 1995, and
$218,697 on September 30, 1994, have been included in a contra-equity account,
"Notes receivable for Preferred Stock."

Of the amount paid by Dr. Ma on the note in May 1996, $264,272 was
first applied to a reduction of accrued interest and the remaining amount of
$182,656 was applied to a reduction in principal on the note. The remaining
principal balance on the note on May 21, 1996, was $267,344.

Warrants:

At September 30, 1992, the Company had warrants outstanding which
entitle the holders to purchase 2,755,120 shares of Common Stock at prices from
$0.68 to $5.60 a share. Of these warrants, 112,500 had been issued from February
1992 to July 1992 in connection with bridge loans to the Company, and were
valued at $193,500. An additional warrant to purchase 2,620 shares had been
issued on February 1, 1992, in connection with consulting services and were
valued at $4,820. Warrants to purchase 2,400,000 shares of common stock at $4.00
a share (after giving effect to anti-dilution adjustments) were issued as part
of the Company's July 1992 initial public offering ("IPO"). Additionally, the

18
<PAGE> 19
underwriter received a warrant to purchase 240,000 shares at $5.40 a share
(after giving effect to anti-dilution adjustments).

On July 31, 1992, the Company sold 800,000 units of its securities at
$7.50 per unit in an IPO, each unit consisting of two shares of common stock and
two five-year warrants to purchase shares of common stock. As a result of
anti-dilution provisions in the warrant agreement, the $6.00 per share exercise
price was adjusted downward to $4.19 per share on March 10, 1995. Subsequent
changes in capitalization which are subject to anti-dilution provisions now
entitle the holder of each warrant to purchase 1-1/2 shares of common stock at
$4.00 per common share. A total of 2,400,000 shares of common stock are now
purchasable at $4.00 per common share based on 1,600,000 publicly traded
warrants outstanding. The warrants are redeemable at the Company's option at
$0.05 per warrant on 30 days written notice prior to July 30, 1997.

The Company also issued to the underwriter, for nominal consideration,
a warrant to purchase 80,000 units consisting of two shares of common stock and
two redeemable common stock purchase warrants, exercisable to July 30, 1997. The
purchase price of the units is $9.00 per unit. The exercise price of the
warrants included in these units is $8.40. The prices of the underwriter's units
and warrants are also subject to antidilution adjustments.

In February 1993, the Company issued 50,000 warrants to purchase common
stock at prices ranging from $0.80 to $3.00 per share in connection with
services and were valued at $17,200.

During October through December 1993, the Company issued warrants to
purchase 114,285 shares of Common Stock (at prices ranging from $0.25 to $1.75
per share) to consultants in connection with services and were valued at
$150,000. One of the consultants was a director. Also during 1994 fiscal year,
100,000 warrants to purchase Common Stock at $0.20 per share were issued to a
director in connection with a stock sale. Additionally, in May 1994, 50,000
warrants were issued to purchase Common Stock at $1.00 per share in connection
with debt. The effect of any valuation was immaterial.

In March 1995 a director was granted a warrant to purchase 100,000
shares at $0.25 per share and was valued at $100,000. In June 1995 a second
director was granted a warrant to purchase 50,000 shares at $1.63 per share, and
the Chairman of the Company was granted a warrant to purchase 250,000 shares at
a price of $1.79 per share. Warrants issued in June 1995 were above the market
price on the date of grant. Warrants issued to the Chairman and the directors
have a term of five years. The Chairman's warrants have immediate vesting and
the two directors' warrants vest over a two-year period of service.

A total of 120,000 warrants to purchase Common Stock at $1.00 per share
were issued in connection with loan extensions in November 1994 (60,000) and
March 1995 (60,000), and were valued at $25,234 and $31,034 respectively.
Additionally, effective September 12, 1995, a total of 605,682 five-year
warrants to purchase common stock at $6.00 a share were granted in connection
with the rescissions of stock conversion agreements and warrant exercises and
the issuance of 10% notes payable due October 11, 1996. The closing price of
common stock on that date was 5 3/32, accordingly, no value was assigned to the
warrants.

In fiscal 1995, 427,740 warrants to purchase Common Stock at $1.95 to
$6.00 a share were issued in connection with stock sales. Included were 75,740
underwriters warrants to purchase Common Stock at $1.95 a share were issued in
December 1994 in connection with a stock sale, and were not valued.
Additionally, effective August 30, 1995, 352,000 five-year warrants to purchase
common stock at $6.00 a share were granted in connection with a private
placement of 211,200 shares common stock at $5.00 a share. The closing price of
common stock on that date was 3 3/8, accordingly, no value was assigned to the
warrants.

19
<PAGE> 20
Total warrants issued in connection with services, stock sales and debt
extensions, as well as warrants exercised, are shown in the following table.

<TABLE>
<CAPTION>
NUMBER VALUATION
OF SHARES PRICE PER SHARE RECORDED
--------- --------------- --------

<S> <C> <C> <C>
Balance - September 30, 1992 2,755,120 $0.68 - $5.40 $ 198,320
Warrants issued for services 50,000 $0.80 - $3.00 17,200

--------- ----------
Balance - September 30, 1993 2,805,120 215,520

Warrants issued for services 114,285 $0.25 - $1.75 150,000
Warrants issued with stock sale 100,000 $0.20 --
Warrants issued with debt 50,000 $1.00 --

--------- ----------
Balance - September 30, 1994 3,069,405 365,520

Warrants issued for services 400,000 $0.25 - $1.79 100,000
Warrants issued with stock sale 427,740 $1.95 - $6.00 --
Warrants issued with debt extension 725,682 $1.00 - $6.00 56,268
Warrants exercised (200,000) $0.20 - $0.25 --

--------- ----------
Balance - September 30, 1995 4,422,827 $ 521,788

</TABLE>

Warrant balances as of September 30, 1994, are shown in the following
table categorized by exercise price for warrants granted, grant dates, shares
exercisable, and expiration dates.

<TABLE>
<CAPTION>
PRICE OF
DATE OF COMMON
NUMBER OF WARRANT WARRANT STOCK ON DATE DATE OF
DATE OF GRANT WARRANTS EXERCISE PRICE EXPIRATION OF GRANT EXERCISE

20
<PAGE> 21
Warrant balances as of September 30, 1995, are shown in the following
table categorized by exercise price for warrants granted, grant dates, shares
exercisable, and expiration dates.

<TABLE>
<CAPTION>
PRICE OF
DATE OF COMMON
NUMBER OF WARRANT WARRANT STOCK ON DATE DATE OF
DATE OF GRANT WARRANTS EXERCISE PRICE EXPIRATION OF GRANT EXERCISE

<S> <C> <C> <C> <C> <C> <C>
2/92-7/92 112,500 $ 0.80000 5 Years $ 2.50000
2/1/92 2,620 $ 0.68700 1/21/97 $ 2.50000
7/31/92 2,400,000 $ 4.00000 7/30/97 $ 3.00000
7/31/92 240,000 $ 5.40000 7/30/97 $ 3.00000
2/12/93 10,000 $ 0.80000 2/11/98 $ 2.50000
2/12/93 40,000 $ 3.00000 1/31/97 $ 2.50000
10/21/93 14,285 $ 1.75000 10/20/00 $ 1.75000
5/10/94 50,000 $ 1.00000 5/10/99 $ 1.25000
11/30/94 60,000 $ 1.00000 11/99/99 $ 1.56250
12/19/94 75,740 $ 1.95000 12/15/99 $ 1.75000
3/1/95 60,000 $ 1.00000 2/28/00 $ 1.75000
3/23/95 50,000 $ 0.25000 3/23/01 $ 1.25000
3/23/95 50,000 $ 0.25000 3/23/02 $ 1.25000
6/23/95 25,000 $ 1.63000 6/23/01 $ 1.62500
6/23/95 25,000 $ 1.63000 6/23/02 $ 1.62500
6/24/95 250,000 $ 1.79000 6/23/00 $ 1.62500
9/12/95 295,455 $ 6.00000 9/11/00 $ 5.03125
9/12/95 147,727 $ 6.00000 9/11/00 $ 5.03125
9/12/95 162,500 $ 6.00000 9/11/00 $ 5.03125
9/15/95 352,000 $ 6.00000 9/11/00 $ 5.43750
------- --------- ---------
Total/average
at 9/30/95 4,422,827 $ 4.01521 $ 3.23898
========= ========== =========
</TABLE>

Common Stock:

The Company sold 1,600,000 shares of its common stock in an initial
public offering on July 31, 1992. The shares were part of 800,000 units priced
at $7.50 per unit, the units also including five-year warrants to purchase
shares of common stock.

In March 1994 the Company sold 70,000 shares of common stock for
$50,000 and issued a five-year warrant to purchase 100,000 shares at a price of
$0.20 per share. This warrant was exercised in February 1995.

In June 1994 the Company issued 387,989 shares of common stock to three
creditors in settlement of liabilities of $387,989. Of these shares, 119,501 may
be redeemed by the Company at $1.25 per share through June 1998. The remaining
268,488 shares are subject to redemption at a price to be negotiated.

On December 12, 1994 the Company issued a 5% Convertible Note due
December 31, 1997 in the aggregate principal amount of $800,000. The note was
convertible into common stock at a discount to market, with $400,000 convertible
beginning on January 26, 1995 and $400,000 beginning on February 26, 1995. The
entire principal amount was converted to 1,231,030 shares of common stock during
January and February 1995. Warrants to purchase 75,740 shares of common stock at
a price of $1.95 were issued in connection with this financing.

During fiscal year 1995 the Company converted $57,500 owed to two
consultants and other debt of $27,289 into 84,789 shares of common stock. Also
during 1995, The Company issued 82,074 shares of common stock to employees and a
consultant as additional compensation (valued at $90,173).

21
<PAGE> 22
In February 1995 the Company received $20,000 upon the exercise of a
warrant to purchase 100,000 shares of Common Stock at $0.20 a share. In March
1995 the Company received $25,000 upon the exercise of a warrant to purchase
100,000 shares of common stock at $0.25 a share.

In March and May 1995 the Company borrowed $410,000 from two
individuals. These notes were subject to a conversion agreement into 465,909
shares of common stock in July 1995, which was later rescinded together with a
rescission of warrants to purchase 246,000 shares of common stock at a price of
$0.25 per share, in exchange for extending the notes.

On September 1, 1995, the Company agreed to a private placement of
$1,056,000 in exchange for common stock to be sold to an uncle of the Company's
chairman at a price of $3.00 per share. The closing price of the common stock
was 3 3/4 on that day. In December 1995 the purchase agreement was renegotiated
to $5.00 a share for a total of 211,200 common shares to be issued. In
connection with this transaction, the Company issued 352,000 five-year warrants
to purchase common stock at $6.00 a share. Of the total purchase commitment,
$176,000 consisted of a two-year note (shown as a reduction of stockholders'
equity) and the balance was paid in cash. A portion of the cash ($360,000) was
not received until October 3, 1995 and is shown in the consolidated balance
sheet as a subscription receivable at September 30, 1995.

7. STOCK OPTIONS

A total of 550,000 shares of common stock are reserved for issuance
upon the exercise of options to be granted pursuant to the Company's 1991 Stock
Option Plan. Options may be granted to officers, directors and employees.
Transactions in the plan are summarized below:

<TABLE>
<CAPTION>
Options
Available Options Price
for Grant Outstanding Per Share
--------- ----------- ---------

<S> <C> <C> <C>
Outstanding at September 30, 1992 174,000 26,000 $2.52
Granted (146,600) 146,000 $2.25-$2.75
Canceled 42,000 (42,000) $2.25-$2.75
Authorized 350,000 --
-------- --------
Outstanding at September 30, 1993 419,400 130,600 $2.25-$2.63
Granted (89,000) 89,000 $0.63-$2.26
Canceled 122,800 (122,800) $1.52-$2.52
-------- --------
Outstanding at September 30, 1994 453,200 96,800 $0.63-$2.52
Granted (245,249) 245,249 $1.50-$1.88
Canceled 108,800 (108,800) $1.50-$2.52
-------- --------
Outstanding at September 30, 1995 290,751 233,249 $0.63-$2.50
</TABLE>

22
<PAGE> 23
In addition to these options granted pursuant to the 1991 Stock Option
Plan, options to purchase 30,000 shares of common stock at $2.29 per share are
outstanding. These options are currently exercisable and expire in September
1996.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

<TABLE>
<CAPTION>
NAME AGE POSITION

<S> <C> <C>
Gloria C. L. Ma, Ph.D. 47 Chairman and Chief Executive Officer

Lawrence D. Cercone, Ph.D. 51 Vice President of Engineering

Gregory P. Hanson, CMA 49 Chief Financial Officer

Andrew J. Lampe 63 Director of Marketing and Sales

William J. Dale 62 Director of the Company

Walter Geer 46 Director of the Company
</TABLE>

DR. MA is co-founder of the Company and served as President or Chairman
from its inception in 1985 to September 1991, Executive Vice President from
September 1991 to July 1994, and thereafter as Chairman. She resumed the
position of Chief Executive Officer in April 1995. Before founding the Company,
Dr. Ma was President of Zealot & Company, Ltd., a privately held investment
company in Hong Kong. She received undergraduate and masters degrees in genetics
from McGill University (Montreal) and a Ph.D. degree in molecular biology from
the University of California, San Diego. Dr. Ma is a member of the Board of
Overseers to the Chancellor of the University of California, San Diego, and the
San Diego Technology Council, appointed by San Diego Mayor, Susan Golding.

DR. CERCONE was appointed Vice President of Engineering in August 1994.
For the prior five years he has been an adjunct professor at the University of
Wyoming. Prior to 1989 Dr. Cercone owned an engineering firm specializing in the
design and manufacture of composite machinery and was employed by Ciba
Composite, Celanese Corp. and Stauffer Chemical. Dr. Cercone has a Ph.D. in
Chemical Engineering from Massachusetts Institute of Technology.

MR. HANSON was appointed Vice President and Chief Financial Officer
(CFO) of the Company in October 1995. From May 1993 to September 1995, Mr.
Hanson held a number of financial positions with Titan Information Systems
Corporation, a diversified telecommunications company, including acting CFO.
From January 1992 to May 1993, Mr. Hanson served at CFO of Onsite Energy, an
energy service and finance company. From February 1990 to December 1991, Mr.
Hanson was CFO for Catrel USA, a waste resource recovery company. Prior to 1989
he held management positions with Ford Motor Company and Solar Turbines
Incorporated (a Caterpillar subsidiary). Mr. Hanson has a B.S. degree in
Mechanical Engineering from Kansas State University and an M.B.A. degree from
the University of Michigan. He is a Certified Management Accountant and has
passed the examination for Certified Public Accountants.

MR. LAMPE has served as Director of Marketing and Sales since February
1, 1996. From October 1994 to January 1996, Mr. Lampe served as an independent
transportation and marketing consultant. From February 1992 to October 1994, Mr.
Lampe was Director of Government Relations for Amtech Systems Corporation. From
November 1972 to January 1992, Mr. Lampe served as Manager of Government
Relations of the Traffic Control Materials Division of 3M Company. In his
positions with Amtech and 3M Company, he was responsible for representing his
employer's new products and technologies in the highway safety industry before
government agencies and other regulatory bodies, and working with those agencies
in developing policies, regulations and standards for the implementation of the
new products and applications.

23
<PAGE> 24
MR. DALE is President of Silverado Capital, Inc., a San Diego-based
company engaged in arranging the exchange of international currencies and in the
international marketing of biorational plant growth enhancers. From 1980 to
1989, Mr. Dale was a partner in a San Diego law firm dealing with corporate and
securities law matters. Prior to that, he was a sole practitioner for two years
and for eight years was general counsel for an agricultural management company.
Mr. Dale received a B.A. degree in Economics from Allegheny College and an LL.B.
degree from the University of Pennsylvania.

MR. GEER is a co-founder and President of Greymar Development, LLC, a
full-service residential real estate development company, and President of North
County Homes, a developer of a master planned community of automated housing.
Mr. Geer has over 25 years of building industry and construction experience,
working with both public and private sector organizations, particularly in the
field of introducing new and non-traditional building and construction
technologies. He has served as a consultant, speaker or expert witness to the
California State Senate, the United States Congress, the Harvard Joint Center
for Housing, the U.S./Mexico Border Trade Alliance, the American Institute of
Architects, the National Association of Home Builders, the State Senate of
Hawaii, the European Reconstruction Bank, and numerous local and regional
building departments and universities. Mr. Geer received a Bachelor of
Architecture degree from California Polytechnic at San Luis Obispo, California.

All directors serve for a term of one year and until their
successors are duly elected and qualified. All officers serve at the discretion
of the Board of Directors.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Directors, officers and each beneficial owner of more than 10% of the
Common Stock of the Company are required by Section 16(a) of the Securities
Exchange Act of 1934 to file reports periodically disclosing their transactions
in the Company's securities. Based on a review of such reports, the Company has
noted that Form 4 and/or Form 5 was not filed on the specified due dates by Dr.
Ma, Law Biu Biu, William Dale, Walter Geer, and Lawrence Cercone.

ITEM 10. EXECUTIVE COMPENSATION.

COMPENSATION OF DIRECTORS

Directors who are employees are not compensated for their services.
Non-employee directors are compensated for their services as directors in the
form of options to purchase Common Stock of the Company under the 1991 Stock
Option Plan (the "Plan"). Directors who are not full-time employees of the
Company will, automatically and without action by the Board or Committee, be
granted under the Plan, for each year of service as a director, a five-year
option to purchase 4,000 shares of Stock, in addition to any other compensation
payable (including other stock options which may be granted) to directors for
their services. Such options under the Plan are granted annually beginning on
the date a person becomes an outside director. Each such option becomes
exercisable one year after the date of grant, subject to continuing service as a
director. Options granted pursuant to being a director are exercisable only
during the time the person remains a director or within one year thereafter.
Directors are also reimbursed for out-of-pocket expenses incurred in connection
with attendance at meetings or other Company business.

Non-employee directors may be paid consulting fees for special
consultation concerning corporate development matters. On March 23, 1995, Mr.
Dale received warrants to purchase up to 100,000 shares of common stock at a
price of $0.25 per share as a separate inducement in connection with his
performance of services to the Company as an outside consultant and were valued
at $100,000. One-half of Mr. Dale's warrants vest on March 23, 1996 and the
balance vest on March 23, 1997. On June 23, 1995, Mr. Geer received warrants to
purchase up to 50,000 shares of common stock at a price of $1.63 per share as a
matter of separate inducement to serve on the Board of Directors of the Company.
One-half of Mr. Geer's warrants vest on June 24, 1996, and the balance vest on
June 24, 1997. Mr. Geer's exercise price was slightly above market price.

24
<PAGE> 25
COMPENSATION OF EXECUTIVE OFFICERS

The following table shows for the fiscal years ended September 30,
1995, 1994, and 1993, certain compensation paid by the Company, including
salary, bonuses, stock options, and certain other compensation, to its past
President and Chief Executive Officer, Paul W. Pendorf and its current Chairman
and CEO, Dr. Gloria C.L. Ma.. No other executive officer received cash
compensation in excess of $100,000 in any such year.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
------------------------------------------- -------------------------------------
COMPEN- RESTRICTED OPTIONS ALL OTHER
NAME AND SATION STOCKS GRANTED COMPEN-
PRINCIPAL POSITION YEAR SALARY(1) BONUS OTHER(2) (# SHARES) (# SHARES) SATION
- ------------------ ---- --------- ----- -------- ---------- ---------- ---------

<S> <C> <C> <C> <C> <C> <C> <C>
Gloria Ma 1995 $110,250 $ 52,780(3) $ 2,667 55,000 349,249 --
(Chairman & CEO) 1994 94,500 -- -- -- -- --
1993 94,500 5,000 -- -- 18,000 --

Paul W. Pendorf(4) 1995 $ 77,564(5) $ -- $ 2,667 -- -- --
(Past President) 1994 119,400 -- --(6) -- -- --
1993 126,000 -- -- -- 24,000 --
</TABLE>

- -----------------------------
(1) Salary includes deferred compensation in the year earned for each of the
named executive officers.
(2) Dr. Ma and Mr. Pendorf each received $2,667 from the Company in fiscal
year 1995 for certain personal guarantees made on behalf of the Company.
(3) The amount for Dr. Ma reflects the value of 55,000 shares of restricted
Common Stock given throughout fiscal year 1995.
(4) Mr. Pendorf resigned as the Company's President and Chief Executive
Officer on March 25, 1995.
(5) Mr. Pendorf's compensation in fiscal year 1995 includes $63,000 in
severance pay from the Company.
(6) In July 1994 the Company's Board of Directors granted to Mr. Pendorf the
right to dispose of a due diligence package, including contracts,
appraisals and environmental studies, on a proposed acquisition target.
Upon such disposal, Mr. Pendorf was to receive a commission of one third
of the price obtained, up to a maximum of $100,000. Mr. Pendorf received
$100,000 in fiscal year 1996 as part of a settlement agreement related
to this matter.

25
<PAGE> 26
On June 23, 1995, in recognition for Dr. Ma's efforts in completing the
management reorganization, in fund-raising activities, in winning government
research grants and for successfully completing the seismic testing programs,
the Company granted Dr. Ma 50,000 shares of Common Stock and a five-year warrant
to purchase a total of 250,000 shares of Common Stock at an exercise price of
$1.79 per share (closing price on June 23, 1995 plus 10%). Also on June 23, 1995
Dr. Ma received an option to purchase 99,249 shares of Common Stock at a price
of $1.79 per share under the 1991 Stock Option Plan, as amended February 5,
1994. Options she received under the 1991 Stock Option Plan vest at a rate of
25% per year beginning with the first 25% vesting on July 3, 1996. On March 3,
1995 Dr. Ma received 5,000 shares of Common Stock following the successful
completion of the field demonstration of the Robo-Wrapper(TM) on the Santa
Monica viaduct in Los Angeles.

The following table sets forth information concerning various options
held at September 30, 1995. No stock options were exercised by any executive
officer in fiscal 1995.

AGGREGATED OPTION VALUES AT 1995 FISCAL YEAR END

<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
NUMBER OF IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT FISCAL
AT FISCAL YEAR-END YEAR-END (A)
------------------ ------------
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE
------------- -------------

<S> <C> <C>
Gloria Ma 291,751/108,249 $749,645/$280,199
</TABLE>

(A) Based upon the closing market price of the Company's Common Stock as
reported on NASDAQ on January 31, 1996.

EMPLOYMENT CONTRACTS

The Company has employment agreements with each of its executive
management team. Dr. Ma's employment agreement has been in effect since
September 1, 1991, and is terminable by vote of a majority of the board of
directors or by Dr. Ma upon three month's notice. Her agreement contains
provisions that prohibit competition with the Company for a period of two years
after the termination of employment. The employment agreement is terminated in
the event of the officer's death or disability and may be terminated for cause.
One-year employment agreements are also in place for Dr. Lawrence D. Cercone and
Gregory P. Hanson and require two-month's notice if there is voluntary
termination by either employee.

26
<PAGE> 27
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following table sets forth, as of January 31, 1996, certain
information regarding the beneficial ownership of Common Stock by each person
known to the Company to own more than five percent of the outstanding Common
Stock, each director of the Company, and all directors and executive officers as
a group:

<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF BENEFICIAL PERCENT
NAME AND ADDRESS OWNERSHIP(7) OF CLASS

<S> <C> <C>
Directors, Nominees and Officers:

Dr. Gloria C. L. Ma 933,651(8) 14.5%
4619 Viewridge Avenue
San Diego, CA 92123

William J. Dale 60,558(9) *
1150 Joshua Way
Vista, CA 92083

Walter Geer -- *
5070 North 40th Street, Suite 120
Phoenix, AZ 85018

All officers and directors 1,002,179(10) 15.4%
as a group (5 persons)

Other 5% Beneficial Owners:

Law Biu Biu 1,289,161(11) 21.0%
171 Prince Edward Road, Suite 204
Kowloon, Hong Kong

Tung Bik Lin 443,182(12) 6.7%
Apartment 2D
29 Conduit Road, Hong Kong
</TABLE>

* Represents holdings of less than one percent

- -----------------------------
(7) Except for Dr. Ma, who beneficially owns 14.7%, no current director
beneficially owns more than 1% of the Company's outstanding shares.
(8) Includes 291,751 shares which Dr. Ma has the right to acquire within 60
days of February 26, 1996, through the exercise of options. Dr. Ma is the
niece of Law Biu Biu.
(9) Includes 54,000 shares which Mr. Dale has the right to acquire within 60
days of February 26, 1996, through the exercise of options.
(10) Includes an aggregate of 345,751 shares which the directors and executive
officers have the right to acquire within 60 days of February 26, 1996,
through the exercise of options.
(11) Law Biu Biu is the uncle of Dr. Ma.
(12) Represents an aggregate of 443,182 shares which Tung Bik Lin has the
right to acquire within 60 days of February 26, 1996, through the
exercise of options.

27
<PAGE> 28
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

In May 1994, the Company sold to the brother of Dr. Gloria Ma,
Chairman and Chief Executive Officer of the Company, in a private transaction
4,500 shares of Series A Preferred Stock in exchange for the assignment of a
non-recourse promissory note made by Dr. Ma in the principal amount of $450,000,
plus $198,750 of accrued interest, secured by a second deed of trust on real
property. The nonrecourse promissory note has an interest rate of 10% per annum
and is due in January 1999, including accrued interest. Each preferred share has
a liquidation preference of $100, is redeemable at the Company's option at a
price of $120 per share, and is convertible at the option of the holder into 80
shares of the Company's Common Stock. (See also Note 6 to the Financial
Statements, Shareholders' Equity, Preferred Stock.)

In July 1994, the Board of Directors granted to the then president
of the Company, the right to dispose of the asset "deferred acquisition
expenses" (consisting of a due diligence package, including contracts,
appraisals and environmental studies on a targeted company representing in
excess of $1,000,000 expended by the Company). Upon any such disposal, the
individual was to receive a commission of one-third of the price obtained, up to
a maximum amount of $100,000. In September 1995, the owner of the target company
announced a pending sale to another party. The Company and its former president
filed suit claiming breach of contract and breach of fiduciary relationship by
the purchaser. Pursuant to a settlement agreement reached in October 1995, the
Company received a cash payment of $1,300,000 (net of legal fees). In addition,
the Company will receive annual payments of up to $250,000 for six years
pursuant to a consulting contract between the target and the Company. The target
company also agreed to offer a five-year material supply contract and to provide
product and/or technical services (for research and development, materials
testing, etc.). As part of the litigation settlement the former executive
received $100,000.

On September 1, 1995, the Company agreed to sell 352,000 shares of
restricted Common Stock to an uncle of Dr. Ma in consideration of $1,056,000
($3.00 per share). The last sale price of the Common Stock quoted on the NASDAQ
Small Cap Market on that day was $3.75. In December 1995, the purchase agreement
was renegotiated to provide for the Company's sale of a total of 211,200 shares
of restricted Common Stock at $5.00 per share, plus a five year Warrant to
purchase 352,000 shares of restricted common stock at $6.00 a share. Of the
total purchase commitment, $176,000 consisted of a two-year note (shown as a
reduction of shareholders' equity) and the balance was paid in cash.

The Company has in the past conducted, and intends in the future to
conduct, all related party transactions involving the Company on terms no less
favorable than could be obtained from unaffiliated parties and approved by the
majority of the independent and disinterested members of the Company's board of
directors. In addition, any loans by the Company to officers, directors,
shareholders or affiliates will be approved by a majority of the independent and
disinterested directors.

28
<PAGE> 29
PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.

(a)(1) Index to Financial Statements

<TABLE>
<CAPTION>
Page
----

<S> <C>
Report of Independent Auditors 11

Consolidated Balance Sheets at September 30, 1995 and 1994 12

Consolidated Statements of Operations for the years ended 13
September 30, 1995, 1994 and 1993

Consolidated Statements of Stockholders' Equity for the 14
three years ended September 30, 1995

Consolidated Statements of Cash Flows for the years ended 15
September 30, 1995, 1994 and 1993

Notes to Consolidated Financial Statements 16-23
</TABLE>

(a)(2) Exhibits

The exhibits listed in the accompanying index to exhibits are filed as
part of this annual report.

(b) Reports on Form 8-K

No reports on Form 8-K were filed during the quarter ended September
30, 1995.

29
<PAGE> 30
XXSYS TECHNOLOGIES, INC.

INDEX TO EXHIBITS

(Item 13(a))

<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------

<S> <C>
3.1 (1) Restated Articles of Incorporation.
3.1.1 (3) Certificate of Amendment to Articles of Incorporation.
3.2 (1) Restated Bylaws.
4.0 (4) Certificate of Determination for Registrant's Series A Preferred Stock.
10.1 (1) Employment Agreement dated September 7, 1991 between Registrant and Gloria C.L. Ma.
10.2 Lease Agreement dated October 26, 1995 between Registrant and Viewridge Business Park.
10.3 (1) Form of Indemnification Agreement between Registrant and its officers and directors.
10.4 1991 Stock Option Plan dated December 14, 1991, as amended.
10.5 (2) Warrant dated August 12, 1992 issued to H. J. Meyers & Co., Inc.
10.6 (2) Stock Escrow Agreement among Registrant, American Stock Transfer and Trust Company and
certain stockholders of Registrant.
10.7 (2) Agreement between certain of Registrant's stockholders and H. J. Meyers & Co., Inc. with
respect to transferability of shares.
10.8 (2) Letter agreement between Registrant and H. J. Meyers & Co., Inc. pertaining to mergers and
acquisitions.
10.9 (1) Form of Warrant issued in 1992 bridge financing.
10.10 (3) Memorandum of Understanding dated February 12, 1993 among the members of the Advanced
Composite Technology Transfer (ACTT) Consortium.
10.11 (3) Cooperation Agreement dated July 21, 1993 among Composite Retrofit Corporation, Hercules
Incorporated, FCI Constructors, and Ciba Composites Division, Ciba-Geigy Corporation.
10.12 (5) Warrant Agreement dated December 30, 1993 between the Company and Mr. S. Georgiev.
10.13 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $35,000.
10.14 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $20,000.
10.15 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $10,000.
10.16 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $35,000.
10.17 (6) Form of Warrant Agreement issued to holders of Registrant's Promissory Note dated May 10,
1994.
10.18 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement dated May 10, 1994, in
the amount of $35,000.
10.19 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement dated May 10, 1994, in
the amount of $20,000.
10.20 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement dated May 10, 1994, in
the amount of $10,000.
10.21 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement dated May 10, 1994, in
the amount of $35,000.
10.22 (7) Form of Warrant Agreement issued to holders of Registrant's Promissory Notes, Amended
November 30, 1994.
10.23 (7) Letter Agreement between Company and Steven Georgiev dated January 4, 1995.
10.24 (8) Agreement regarding separation of employment of Paul W. Pendorf and William J. Timmerman
dated March 25, 1995.
10.25 (9) Registrant's Promissory Note dated March 25, 1995 in the amount of $200,000 and related
Warrant Agreement.
10.26 (9) Registrant's Promissory Note dated March 26, 1995 in the amount of $100,000 and related
Warrant Agreement.
10.27 (9) Registrant's Promissory Note dated May 10, 1995 in the amount of $110,000 and related Warrant
Agreement.
10.28 (10) Registrant's Promissory Note dated July 28, 1995 in the amount of $93,000 and related Warrant
Agreement.
</TABLE>

30
<PAGE> 31
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------

<S> <C>
10.29 (10) Registrant's Promissory Note in the amount of $247,202, effective September 12, 1995,
together with related Warrant Agreement and rescission of agreement to accept common stock in
lieu of loan.
10.30 (10) Registrant's Promissory Note in the amount of $123,601, effective September 12, 1995,
together with related Warrant Agreement and rescission of agreement to accept common stock in
lieu of loan.
10.31 (10) Registrant's Promissory Note in the amount of $131,749, effective September 12, 1995,
together with related Warrant Agreement and rescission of agreement to accept common stock in
lieu of loan.
10.32 (10) Private placement of restricted common stock in the amount of $1,056,000 and related warrant
agreement.
</TABLE>

Notes:

(1) Incorporated by reference to Form S-1 dated July 16, 1992, File No.
33-47018.
(2) Incorporated by reference to Form 10-K for the year ended September 30,
1992.
(3) Incorporated by reference to Form 10-K for the year ended September 30,
1993.
(4) Incorporated by reference to Form 8-K dated May 12, 1994.
(5) Incorporated by reference to Form 10-QSB for the quarter ended December
31, 1993.
(6) Incorporated by reference to Form 10-QSB for the quarter ended June 30,
1994.
(7) Incorporated by reference to Form 10-QSB for the quarter ended December
31, 1994.
(8) Incorporated by reference to Form 8-K dated April 10, 1995.
(9) Incorporated by reference to Form 10-QSB for the quarter ended June 30,
1995.

(10) Incorporated by reference to the original Form 10-KSB for the year
ended September 30, 1995, filed on January 15, 1996.

31
<PAGE> 32
SIGNATURES

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

XXSYS TECHNOLOGIES, INC.

June 18, 1996 By: /s/ Gloria C. L. Ma
-------------------------------
Gloria C. L. Ma
Chairman and Chief Executive Officer

By: /s/ Gregory P. Hanson
-------------------------------
Gregory P. Hanson
Chief Financial Officer
(Principal Financial and
Accounting Officer)

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

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----

<S> <C> <C>
/s/ Gloria C. L. Ma Chairman, Chief Executive June 18, 1996
- ------------------------------ Officer and Director
Gloria C. L. Ma

/s/ Gregory P. Hanson Chief Financial Officer June 18, 1996
- ------------------------------
Gregory P. Hanson

/s/ Walter Geer Director June 18, 1996
- ------------------------------
Walter Geer

Director
- ------------------------------
William J. Dale
</TABLE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM
10-KSBA FOR THE PERIOD ENDED SEPTEMBER 30, 1995.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1995
<PERIOD-START> OCT-01-1994
<PERIOD-END> SEP-30-1995
<EXCHANGE-RATE> 1
<CASH> 148,562
<SECURITIES> 0
<RECEIVABLES> 873,551<F1>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 628,785
<PP&E> 779,267
<DEPRECIATION> 340,220
<TOTAL-ASSETS> 2,676,737
<CURRENT-LIABILITIES> 1,508,299
<BONDS> 0
0
450,000
<COMMON> 12,068,535
<OTHER-SE> (439,698)<F2>
<TOTAL-LIABILITY-AND-EQUITY> 2,676,737
<SALES> 408,867
<TOTAL-REVENUES> 408,867
<CGS> 225,202
<TOTAL-COSTS> 225,202
<OTHER-EXPENSES> 1,878,724
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 106,160
<INCOME-PRETAX> (1,753,121)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,753,121)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,753,121)
<EPS-PRIMARY> (0.34)
<EPS-DILUTED> 0
<FN>
<F1>INCLUDES LONG TERM NOTE RECEIVABLE OF $446,928, SUBSCRIPTION RECEIVABLE OF
$380,000 AND TRADE RECEIVABLE OF $46,623.
<F2>INCLUDES NOTE RECEIVABLE FOR COMMON STOCK OF $176,000 AND NOTE RECEIVABLE FOR
PREFERRED STOCK OF $263,698, WHICH ARE CONTRA-EQUITY ACCOUNT.
</FN>

</TABLE>