XXSYS TECHNOLOGIES INC /CA, 10KSB, 1997-01-13

XXSYS TECHNOLOGIES INC /CA
10KSB, 1997-01-13
COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH

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

FORM 10-KSB

(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, 1996

[ ] 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, 1996: $568,965

The market value of voting stock held by non-affiliates of the registrant as of
December 31, 1996, was approximately $18 million.

Shares of Common Stock outstanding at December 31, 1996: 7,270,101

DOCUMENTS INCORPORATED BY REFERENCE

Exhibit 10.33 is incorporated by reference into the Index, Item 13 (a) of this
Form 10-KSB. Item 11, Security Ownership of Certain Beneficial Owners and
Management is incorporated by reference to the 1997 Proxy Statement to be filed.

<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 non-destructive
testing and measurement techniques for advanced materials in the defense
industry. In response to the defense cutbacks of the early 1990s and their
impact on the developing markets for advanced materials, the Company initiated
efforts in 1993 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 upgrade structurally
deficient or corroded structures that support highway bridges and buildings that
could collapse during seismic activity or from corrosive decay. 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 upgrade
aging bridges, buildings and other privately owned structures by wrapping the
structural columns with composite materials.

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 bridge and building
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
is an approved alternative to the current method of using welded steel jackets
in California. It has received support of both federal and state research and
development (R&D) funds totaling about $5.2 million, including $1.2 million in
grants directly 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 and full-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 operations to date have been insignificant.
In March 1996 the Company completed the build of its second-generation
Robo-Wrapper(TM) and used the new machine 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 alternative method of retrofitting
publicly-owned highway bridge columns in the State of California that meet
certain criteria in a composite specification. In September 1996 the Company
completed its first commercial retrofit project on a parking structure in
California and conducted a demonstration of a corrosion retrofit in Utah. In
December 1996 the Company completed its first seismic retrofit of a bridge for
Caltrans. The Company estimates there are approximately 20,000 publicly-owned
bridge columns in California to be retrofitted over the next four years, of
which approximately 50% are believed by the Company to be presently eligible for
retrofitting pursuant to the composite specification.

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 engaged in retrofitting building columns and publicly-owned highway bridge
columns for seismic safety and for corrosion rehabilitation. The company
estimates that the State of California will spend approximately $2 billion on
seismic retrofit of 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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The Company is focusing its initial marketing efforts on the planned
retrofitting of publicly-owned bridge and building columns in the states of
California, Utah, Washington and Illinois. The Company intends to also
demonstrate its Robo-Wrapper(TM) technology in other potential markets which
have seismic or corrosion problems. 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.

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. An 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 along the West
Coast, 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.

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 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 currently uses
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
commercial curing system takes two to three consecutive cures of eight foot
sections requiring about eight hours per column, including setup

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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 UCSD. The Powell Laboratory conducted tests of seven 4/10ths scale
concrete columns and a full scale column bent 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.

Owners and general contractors usually 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. The
Company currently maintains product liability insurance coverage in the
approximate amount of $4,000,000 per year. However, there can be no assurance
that the Company will be able to continue 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
involving product liability, insufficient insurance coverage could have a
material adverse affect on the Company's ability to conduct operations.

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 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 manufacturing 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 uses an original equipment manufacturer for the manufacture of
Robo-Wrapper(TM) and curing systems. To ensure confidentiality of trade secrets
the Company may machine certain critical parts and perform some portion of the
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. Thiokol Corporation is also in the process of qualifying its
materials. The Company intends to purchase materials from one 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 increase in the cost of
either material could have a material adverse affect on the composite retrofit
technologies. To protect against supply shortages and price increases, the
Company intends to negotiate with carbon fiber and resin suppliers for long term
supply agreements.

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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 publicly-owned
structures. The Company intends to enter into license or joint venture
arrangements with construction firms involved in seismic retrofitting as a
specialty subcontractor. The prime contractor will be responsible for bidding on
public or private retrofit projects, and conducting the actual retrofitting. The
Company will 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, paid a license fee for the technology and rental fee for equipment 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
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 bid 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.

Important aspects of the Company's marketing strategy include
development and dissemination of educational materials for the various target
groups through seminars and short-courses, and 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 completed two
retrofit contracts to date. However, it does not expect to generate significant
revenues from work until Spring 1997. The Company anticipates it will be
primarily dependent on the Caltrans market and building column retrofits for
most of its revenue in 1997.

COMPETITION

The Company will face competition from current and future retrofit
methods. 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. Hexel Fyfe Company received approval from Caltrans to wrap
structures in April 1996, the same time as the Company. 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 than 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,
1996, 1995, and 1994 were $98,350, $115,304, and $277,789 respectively. These
amounts represent direct expenditures by the Company and do not include
approximately $4 million of federal and state grant funds paid directly to third
parties, such as UCSD and Hexcel, Inc. (formerly Hercules, Inc.), for purposes
of developing and validating the Robo-Wrapper(TM) technology.

The Company participated in several federally-funded joint research and
development projects in fiscal 1996. The Company completed its participation in
a bridge infrastructure renewal program funded by the U.S. Department of
Defense, Advanced Research Projects Agency (ARPA). The Company received matching
funds grants of $514,000 from the ARPA program, all of which had been earned as
of September 30, 1996. The purpose of the ARPA program was to validate and
demonstrate carbon composite jacketing. The Company applied its grant money
under the ARPA program towards the cost of independent testing of wrapped
columns by Powell Laboratories of UCSD.

The Company continues to participate in 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

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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; Hexcel, 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 $537,059, of which $380,311 has been earned program
to date as of September 30, 1996. The Company also has a $250,000 matching fund
grant from the State of California's Trade and Commerce Agency for the NIST
program, of which $205,671 has been earned program to date as of September 30,
1996.

On November 27, 1996, the Company was awarded a grant of $97,688 for
the development of a rugged low cost, easy to implement ultrasonic sensor system
that can be used for monitoring the manufacturing process of composite armor
structural parts, using the Company's wire waveguide technology.

The Company intends to conduct continued research and development in
the area of non-destructive testing and measurement, 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. In April 1996 the Company filed a patent
application for a method of measuring the cure rate of resins used with
composites using an ultrasonic wire waveguide. All four 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 technology license agreements,
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 December 30, 1996, the Company had 24 full time employees, of whom
ten were in operations, seven in executive or administrative positions, five in
marketing and sales, and two were engaged in engineering and research. 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 14,000 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, pursuant to two leases that extend to August 31, 1997,
($5,888 per month for 6,927 square feet) and October 31, 1998 ($5,600 per month
for 7,100 square feet). Should additional facilities be required, the Company
believes that adequate space continues to be available in the San Diego area.

ITEM 3. LEGAL PROCEEDINGS.

The Company and its Chief Executive Officer is currently involved with
a legal proceeding with its former president in which the former president has
claimed he is entitled to a share of certain future consulting fees that the
Company expects to receive. There are no other 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.

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 1996.

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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, 1996.

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

Year ended September 30, 1996:

<S> <C> <C>
First Quarter 6 1/2 4 3/8
Second Quarter 6 2 1/4
Third Quarter 6 5/8 3 5/8
Fourth Quarter 4 1/4 2 11/16

Year ended September 30, 1995:

First Quarter 2 1/8 7/8
Second Quarter 2 7/8
Third Quarter 1 7/8 1 5/16
Fourth Quarter 7 1/8 1 9/16
</TABLE>

On December 31, 1996, the closing price for the Company's Common Stock
was $2.8125 per share. As of that date, the Company had 229 stockholders of
record and approximately 3,313 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, 1996, 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 and sales and marketing expense of promoting these new applications.

RESULTS OF OPERATIONS

Fiscal Year 1996 Compared to Fiscal Year 1995

Revenues for the fiscal year ended September 30, 1996, were $568,965
compared to $408,867 in the prior fiscal year, an increase of $160,098 or 39%.
The increase is primarily attributable to continued work performed under the
matching funds grants of $537,059 from the National Institute of Standards and
Technology (NIST) and $514,000 from the Advanced Research Projects Agency
(ARPA), which were used to help commercialize the Company's carbon composite
jacketing technology for seismic retrofit. The grant funds were instrumental in
the Company obtaining approval of the Company's composite retrofit technology by
the California Department of Transportation ("Caltrans") in April 1996. The
Company also completed its first seismic retrofit of a parking structure in
California and a demonstration project for corrosion rehabilitation on a bridge
structure for the Utah Department of Transportation in fiscal year 1996.

The Company continued to depend on federal and state grant programs for
its primary revenue sources in fiscal 1996. Revenues in fiscal 1996 were derived
primarily from work performed under the NIST grant, which represented $269,320,
or 47% of Company revenues and the ARPA grant, representing $116,279 or 20% of
revenues. Work performed by the Company under the NIST program also earned
$151,876 or 27% of Company

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revenues from the State of California. At September 30, 1996, the Company had
approximately $156,748 of funding remaining under the NIST grant and $44,329 of
funding from the California matching funds grant.

Total operating expenses increased by $946,993 (45%) in fiscal 1996 to
$3,050,919. The cost of services was $550,315, or 97% of contract revenues. In
comparison, the cost of services in fiscal 1995 was $225,202, or 55% of contract
revenues. This higher percentage in fiscal 1996 was the result of the cost of
penetration and introduction of the Company's technology in the form of
demonstration projects in new commercial markets. The Company's gross profit
margin is expected to improve as it moves from smaller demonstration projects to
the more typical larger scale contracts. Selling, general and administrative
expenses were $2,402,254 in fiscal 1996, an increase of $638,834 or 36% over
fiscal 1995. The increase reflects additional staffing costs in support of
expanded bidding on contract work, as well as increased expenses for marketing
and sales, investor relations and fund raising activities. Research and
development costs decreased in fiscal 1996, to $98,350 from $115,304 in the
prior year, a decrease of 15%, as a greater portion of the Company's R&D efforts
was performed under funded research contracts.

Interest income of $85,493 in fiscal 1996 was 78% higher than in the
prior year, the result of interest earned on cash received from a legal
settlement and from the sale of common stock. Interest expense decreased 51% to
$52,076 as the Company had a significant reduction in its average borrowings.

The net loss for the year ended September 30, 1996, was $2,075,718
compared to $1,753,121 in the prior year, an increase of $322,597 or 18%. The
loss per share in fiscal 1996 was $0.33, compared to the loss per share of $0.34
in fiscal 1995. The decline on a per share basis is the result of a higher
average number of shares outstanding.

The Company had current assets of $1,519,471 as of September 30, 1996,
representing an increase of $890,686 over the prior fiscal year ended September
30, 1995. The increase is primarily the result of the sale of Common Stock
throughout the year to fund operations. Funds raised by the Company have been
necessary for the construction of Robo-Wrapper(TM) equipment and marketing and
sales activities that will generate revenues in the future. The Company
continued modest increases in its cash position to $184,489, and increase of
$35,927 over the prior year. Net cash used in operating activities of $2,057,596
was funded by $1,672,916 in financing activities and $420,607 from investing
activities. Financing activities included the receipt of $705,000 from the sale
of common stock and $623,783 from exercises of warrants and employee stock
options to purchase Common Stock.

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
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.

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<PAGE> 9

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.

Liquidity and Capital Resources

During its 1995 and 1996 fiscal years the Company operated with modest
cash resources. In the 1996 fiscal year, funding of approximately $598,000 was
received pursuant to grants from several government agencies in support of
research and development activities. As of September 30, 1996, 201,077 remained
available under these grants. However, in order to meet all of its operating
expenses, the Company has relied heavily on the sale of common stock and the
exercise by holders of warrants to purchase stock to raise additional funds. Net
cash received from such transactions in fiscal 1996 were approximately
$1,253,783. These funds were used to reduce accounts payable and repay
outstanding notes payable resulting primarily from the acquisition effort.

As of September 30, 1996, the Company had total current assets of
$1,519,471, including cash and cash equivalents of $184,489, accounts receivable
of $75,602 and stock subscriptions receivable of $1,149,933. The Company's
current liabilities as of September 30, 1996, were $570,328. The Company had
positive working capital of $949,143 as of the same date, which represents an
improvement of $1,828,657 over the working capital position at September 30,
1995. 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 through
demonstration projects, 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 reduced the note by an additional $137,012 by offsetting certain
deferred salaries, accrued vacation and unreimbursed travel and entertainment
expenses.

The Company estimates that it will require approximately $5.5 million
of additional capital in the 1997 fiscal year 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 sell additional stock and obtain lease financing on the equipment.
Two of the Company's shareholders have the first right of refusal on the next $3
million in equity financing of the Company. However, there can be no assurance
that the Company will be able to obtain capital from these sources should the
need arise.

9
<PAGE> 10

Impact of Inflation

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

ITEM 7. FINANCIAL STATEMENTS.

PAGE
----

Report of Independent Auditors 11

Consolidated Balance Sheets at September 30, 1996 and 1995 12

Consolidated Statements of Operations for the years ended 13
September 30, 1996, 1995 and 1994

Consolidated Statements of Stockholders' Equity for the three 14
years ended September 30, 1996

Consolidated Statements of Cash Flows for the years ended 15
September 30, 1996, 1995 and 1994

Notes to Consolidated Financial Statements 16

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, 1996 and 1995 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years ended September 30, 1996. 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, 1996 and 1995, and the consolidated
results of its operations and cash flows for each of the three years ended
September 30, 1996, in conformity with generally accepted accounting principles.

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

New York, New York
January 10, 1997

11
<PAGE> 12
XXSYS TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
ASSETS 1996 1995
------------ ------------
Current Assets:
<S> <C> <C>
Cash and cash equivalents $ 184,489 $ 148,562
Accounts receivable 75,602 46,623
Stock subscription receivable (Note 1) 1,149,933 380,000
Inventory 19,480 --
Prepaid expenses and other 89,967 53,600
------------ ------------
Total current assets 1,519,471 628,785

Machinery, equipment and furniture, net of
accumulated depreciation of $478,640 and $ 340,220 962,705 439,047

Cash in escrow (Note 3) 175,000 --
Deferred costs (Note 2) -- 1,102,181

Patents, net of amortization of $121,058 and $ 86,298 44,532 59,796
------------ ------------
Total assets $ 2,701,708 $ 2,676,737
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 324,823 $ 521,699
Accrued compensation 37,119 40,640
Accrued liabilities 112,019 57,982
Related party accrued expenses 20,564 192,426
Current portion, long-term debt 75,803 695,552
------------ ------------
Total current liabilities 570,328 1,508,299

Long-term debt, less current portion (Note 4) 67,848 --
Commitments and contingencies (Note 6)

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
Shares authorized -- 20,000,000;
Issued and outstanding -- 7,270,101 / 6,067,082 15,099,537 12,068,535

Accumulated deficit (12,986,117) (10,910,399)
Note receivable for preferred stock (306,288) (263,698)
Note receivable for common stock (193,600) (176,000)
Deferred compensation -- --
------------ ------------
Total stockholders' equity 2,063,532 1,168,438
------------ ------------
Total liabilities and shareholders' equity $ 2,701,708 $ 2,676,737
============ ============
</TABLE>

See accompanying notes

12
<PAGE> 13
XXSYS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,

1996 1995 1994
----------- ----------- -----------
Revenues:
<S> <C> <C> <C>
Sales $ -- $ -- $ --
Contract revenues 568,965 408,867 266,890
----------- ----------- -----------
Total revenues 568,965 408,867 266,890

Operating expenses:
Cost of equipment sales -- -- --
Cost of services 550,315 225,202 58,521
Selling, general and administrative 2,402,254 1,763,420 1,356,531
Research and development 98,350 115,304 277,789
----------- ----------- -----------
Total operating expenses 3,050,919 2,103,926 1,692,841
----------- ----------- -----------

Operating loss (2,481,954) (1,695,059) (1,425,951)

Interest income 85,493 48,098 30,037
Other income 372,819 -- --
Interest expense (52,076) (106,160) (16,835)
----------- ----------- -----------

Net loss $(2,075,718) $(1,753,121) $(1,412,749)
=========== =========== ===========

Net loss per share $ (0.33) $ (0.34) $ (0.36)
=========== =========== ===========

Weighted average number of shares
outstanding 6,231,437 5,083,169 3,938,826
=========== =========== ===========
</TABLE>

See accompanying notes.

13
<PAGE> 14

XXSYS TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED SEPTEMBER 30, 1996

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

Stock issued in settlement of debt 196,152 549,227 549,227
Increase in interest receivable on notes (60,190) (60,190)
Exercise of employee stock options 32,751 75,000 75,000
Exercise of warrants 452,884 548,783 548,783
Sale of common stock 514,997 1,474,933 1,474,933
Stock issued for services 6,235 24,057 24,057
Warrants issued for services 120,000 120,000
Assignment of stock powers 239,002 239,002
Net loss (2,075,718) (2,075,718)
-------- --------- ----------- ---------- ------------- ------- -----------
Balances at September 30, 1996 $450,000 7,270,101 $15,099,537 $(499,888) $(12,986,117) $ -- $ 2,063,532
-------- --------- ----------- ---------- ------------- ------- -----------
</TABLE>

See accompanying notes

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

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
1996 1995 1994
----------- ----------- -----------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $(2,075,718) $(1,753,121) $(1,412,749)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization 173,180 241,538 131,927
Non-cash compensation 143 224,548 37,500
Accrued interest income (60,190) (45,001) (16,875)
Changes in assets and liabilities:
Investments -- -- 1,163,500
Cash in escrow (175,000) -- --
Accounts receivable (28,979) (6,223) (30,842)
Inventories (19,480) 26,045 61,125
Prepaid expenses (36,367) (47,928) 46,864
Accounts payable (196,876) (385) 550,706
Accrued liabilities and other 241,105 51,686 (79,409)
Related party accrued expenses 120,586 35,767 156,659
----------- ----------- -----------
Net cash used in operating activities (2,057,596) (1,273,074) 608,406

Cash flows from investing activities:
Purchase of machinery and equipment (662,078) (275,790) (277,719)
Deferred acquisition costs 1,102,181 -- (579,199)
Other assets (19,496) (30,096) 79,998
----------- ----------- -----------
Net cash used in investing activities 420,607 (305,886) (776,920)

Cash flows from financing activities:
Sale of common stock 705,000 500,000 50,000
Exercise of warrants and stock options 623,783 45,000 --
Assignment of stock powers 239,002 -- --
Issuance of convertible notes -- 800,000 --
Issuance of other notes payable 234,184 564,500 38,800
Repayment of notes payable (283,533) (190,700) --
Payments of related party debt 154,480 -- (284,305)
----------- ----------- -----------
Net cash from financing activities 1,672,916 1,718,800 (195,505)

Net increase (decrease) in cash 35,927 139,840 (364,019)
Cash and cash equivalents--beginning of year 148,562 8,722 372,741
----------- ----------- -----------

Cash and cash equivalents at end of year $ 184,489 $ 148,562 $ 8,722
=========== =========== ===========

Supplemental information:
Cash interest paid $ 23,610 $ 15,208 $ 16,835
Issuance of warrants $ 120,000 $ 156,268 $ 150,000
Stock issued for accounts payable $ -- $ 84,789 $ 387,989
Stock issued for services $ 23,914 $ 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 Subscriptions Receivable. The stock subscriptions receivable at
September 30, 1996, of $1,149,933 represents cash received by the Company from
October 1, 1996, to December 31, 1996, as payment for common stock purchased
under stock purchase agreements that the Company signed on September 12, 1996.
The stock subscription receivable at September 30, 1995, 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 subscriptions receivable are shown as current assets because
the amounts were received prior to the issuance of the financial statements for
both the 1995 and 1996 fiscal years. An amount still owed the Company as part of
the September 1, 1995, agreement totaling $193,600 (including accrued interest
of $17,600) as of September 30, 1996, and $176,000 as of September 30, 1995, are
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. Inventory as of September 30,
1996, was as follows:

<TABLE>
<S> <C>
Raw materials $ 1,555
Work in process 17,925
-------
Total Inventory $19,480
</TABLE>

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, 1996, these carry forwards were
approximately $13,000,000 and $6,500,000 for federal and state tax purposes,
respectively, and expire in 2001 through 2011. 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. Three major customers accounted for 47%, 27% and 20%
of 1996 revenues. In 1995 two customers represented 51% and 29% of revenues and
in 1994 represented 48% and 44% 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.

16
<PAGE> 17

Reclassifications. Certain items in the prior year financial statements
have been reclassified to conform to the 1996 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.

Fair Value of Financial Instruments. Effective March 31, 1996, the
Company adopted Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value Financial Instrument," which requires disclosure
of fair value information about financial instruments whether or not recognized
in the balance sheet. The carrying amounts reported in the balance sheet for
cash, trade receivables, accounts payable and accrued expenses approximate fair
value based on the short-term maturity of these instruments.

Accounting for Long-lived Assets. In March 1995, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 121, "Accounting For The Impairment Of Long-lived Assets And For Long-lived
Assets To Be Disposed Of." SFAS No. 121 requires the Company to review
long-lived assets and certain identifiable assets and any goodwill related to
those assets for impairment whenever circumstances and situations change such
that there is an indication that the carrying amounts may not be recoverable.
The Company plans to adopt this policy for measuring the recoverability of its
long-lived assets in fiscal 1997.

Stock Based Compensation. The Company accounts for stock transactions
in accordance with APB Opinion No. 25, "Accounting For Stock Issued To
Employees." In accordance with Statement of Financial Accounting Standards No.
123, "Accounting For Stock-Based Compensation," the Company intends to adopt the
pro forma disclosure requirements of Statement No. 123 in fiscal 1997.

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 $175,000 (net of legal fees) 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.). The Company's former president received $100,000 as part of the
settlement agreement.

In October 1996 the former president of the Company claimed he is
entitled to a share of the ongoing consulting fees to be received by the Company
in connection with the settlement agreement. Funds are held in escrow until a
determination is made by court order. The Company denies the former president is
entitled to a share of the consulting fees. A claim for fees was also made by a
former investment banker in 1995, which the Company considered to be a frivolous
claim. No further action is pending or expected.

3. CASH IN ESCROW

Cash in escrow represents the Company's contractural share of payment
of a consulting fee made part of a settlement of a lawsuit in 1995, net of legal
fees. The funds are held in escrow pending settlement of a dispute between the
Company and its former president. All of the conditions of the payment of the
funds from escrow to the Company

17
<PAGE> 18

have been satisfied, however, the escrow agent has declined to take further
action without the withdrawal of a claim made by the former president, or a
court order instructing the escrow agent to make payment to the Company. At the
Company's request the escrow agent has filed an interpleader action with the
appropriate court for resolution.

4. FINANCING ARRANGEMENTS

Long-term debt at September 30, 1996, consists of the following:

<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Equipment financing - computers, printers $ 26,113 $ 0
Equipment financing - copiers 61,494 0
Pre-paid insurance financing 56,044 0
Other notes payable 0 695,552
-------- --------
143,651 695,552
Less current portion 75,803 695,552
-------- --------
$ 67,848 $ 0
</TABLE>

During the year ended September 30, 1996, the Company repaid or
converted to common stock all notes payable that were outstanding as of
September 30, 1995. In October 1995 the Company repaid $100,000 in notes
payable, originally borrowed from four individuals in May 1994. The notes had an
interest rate of 10% per annum. In December 1995, the Company repaid a note
payable for $93,000 borrowed from an individual in August and September 1995
plus accrued interest at 10% per annum. On August 16, 1996, the Company
converted $502,552 in debt plus $46,675 in accrued interest to 196,152 shares of
restricted common stock under Regulation S at a price of $2.80 a share.

Also during the year ended September 30, 1996, the Company entered into
financing arrangements with credit companies for both office equipment and for
prepaid insurance premiums. On January 23, 1996, the Company received financing
of $16,173 for a copy machine, having monthly payments extending over 48 months
at an interest rate of 8.435%. On May 24, 1996, the Company received financing
on an insurance policy of $41,340, with monthly payments extending over eleven
months at an interest rate of 7.74%. On June 30, 1996, the Company received
financing for a copier machine of $49,584, with monthly payments extending over
60 months at an interest rate of 10.1475%. On August 16, 1996, the Company
received an equipment loan of $26,113, at a rate of 17.626% with monthly
payments extending over a term of 34 months. On August 18, 1996, the Company
received financing for a second insurance policy premium for $32,976, with
payments extending over nine months at an interest rate of 7.3%.

On May 3, 1996, an officer loaned the Company $25,000 and an additional
$25,000 on May 15, 1996, both at an annual interest rate of 10%. The Company
repaid the loan on August 22, 1996, including $1,438 in interest. On August 1,
1996, the Chairman loaned $18,000 to the Company at an annual interest rate of
10%. The Company repaid the loan on August 22, 1996, including $108 in interest.

5. RELATED PARTY TRANSACTIONS

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 October 1995.

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. See also, Preferred
Stock, Note 7, for additional transactions of the Chairman.

18
<PAGE> 19

6. COMMITMENTS

The Company leases its office facilities pursuant to two leases that
extend to August 31, 1997, and October 31, 1998. The remaining rent commitment
at September 30, 1996 is $211,367. Rent expense was $86,158 in fiscal year 1996,
$63,790 in 1995, and $60,000 in 1994. On October 14, 1996, the Company signed a
four-month construction contract for $312,475 (including tax) to design and
build a smaller, lighter weight Robo- Jr.(TM), which is expected to be completed
by mid-January 1997. The Company paid $80,812 to turn on the contract on October
14, 1996. The balance of payments to be made were structured around milestones,
of which $134,688 remains to be paid in 1997.

7. 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 a note and accrued interest payable to the
Company by making a cash payment of $309,916 and offsetting deferred salaries,
accrued vacation, and unreimbursed travel and entertainment expense through that
date, partially offset by other amounts she owed the Company, the net of which
reduced her note a further $137,012. The remaining balance due the Company under
the note together with accrued interest, which total $306,288 on September 30,
1996, $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 after her payment on the note at May 21, 1996, was $267,344.

Warrants:

At fiscal year ended September 30, 1993, the Company had warrants
outstanding which entitle the holders to purchase 2,805,120 shares of Common
Stock at prices from $0.68 to $5.60 a share.

Fiscal year 1994. In fiscal year 1994, the Company issued 264,285
warrants to purchase shares of Common Stock and none of the warrants were
exercised. From October 1, 1993, through December 31, 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.

Fiscal year 1995. In fiscal year 1995, the Company issued 1,553,422
warrants to purchase shares of Common Stock and 200,000 warrants were exercised.

In connection with services that have been or will be provided to the
Company, warrants were issued to purchase a total of 400,000 shares of Common
Stock. 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.

In connection with stock sales in fiscal 1995, the Company issued
427,740 warrants to purchase Common Stock at $1.95 to $6.00 a share. Included
were 75,740 underwriters warrants to purchase Common Stock at $1.95 a share were

19
<PAGE> 20
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.

In connection with extension of debt, the Company issued warrants to
purchase a total of 725,682 shares of Common Stock. 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 February 1995, a warrant to purchase 100,000 shares of Common Stock
at $0.20 a share was exercised. In March 1995, a warrant to purchase 100,000
shares of Common Stock at $0.25 a share was exercised.

20
<PAGE> 21

Fiscal year 1996. During fiscal 1996 warrants to purchase 237,386
shares of Common Stock were issued and warrants to purchase 487,720 shares of
Common Stock were exercised. On January 17, 1996, the Company issued warrants to
a consultant to purchase 100,000 shares of common stock, including 50,000 shares
at $4.00 a share and 50,000 shares at $3.50 a share in connection with services
to be performed over a six-month period. The warrants were valued at $44,000 and
$76,000 respectively. The consulting agreement has been terminated. See also
Note 7, Common Stock for Common Stock issued as a result of exercises of
warrants.

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>
COMMON PRICE PER VALUATION
SHARES SHARE RECORDED
------ ----- --------

<S> <C> <C> <C>
Balance - September 30, 1993 2,805,120 $0.68 - $5.60 215,520

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

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

Warrants issued for services 100,000 $3.50 - $4.00 120,000
Warrants issued with debt extension 137,386 $ 6.00 --
Warrants redeemed (2,248,140) $ 4.00 --
Warrants exercised (487,720) $0.80 - $4.00 --
----------
Balance - September 30, 1996 1,924,353
</TABLE>

21
<PAGE> 22

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>
DATE OF COMMON STOCK DATE OF
NUMBER OF WARRANT WARRANT PRICE DATE OF EXERCISE OR
DATE OF GRANT WARRANTS EXERCISE PRICE EXPIRATION GRANT REDEMPTION
------------- -------- -------------- ---------- ----- ----------
<S> <C> <C> <C> <C> <C> <C>
2/92-7/92 112,500 $ 0.80000 5 Years $ 2.50000 81,250 by 9/96

2/1/92 2,620 $ 0.68700 1/21/97 $ 2.50000 4/3/96
7/31/92 2,400,000 $ 4.00000 7/30/97 $ 3.00000 9/12/96
7/31/92 240,000 $ 5.40000 7/30/97 $ 3.00000
2/12/93 10,000 $ 0.80000 2/11/98 $ 2.50000 6,250 in 5/96
2/12/93 40,000 $ 3.00000 1/31/97 $ 2.50000
10/21/93 14,285 $ 1.75000 10/20/00 $ 1.75000
12/30/93 100,000 $ 0.25000 3/15/99 $ 1.62500 1/28/95
3/15/94 100,000 $ 0.20000 3/15/99 $ 1.50000 2/9/95
5/10/94 50,000 $ 1.00000 5/10/99 $ 1.25000 5/22/96
------ --------- ---------
Total/average
at 9/30/94 3,069,405 $ 3.66058 $ 2.84511
========= ========= =========
</TABLE>

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.

2/92-7/92 112,500 $ 0.80000 5 Years $ 2.50000 81,250 by 9/96
2/1/92 2,620 $ 0.68700 1/21/97 $ 2.50000 4/3/96
7/31/92 2,400,000 $ 4.00000 7/30/97 $ 3.00000 9/12/96
7/31/92 240,000 $ 5.40000 7/30/97 $ 3.00000
2/12/93 10,000 $ 0.80000 2/11/98 $ 2.50000 6,250 in 5/96
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 5/22/96
11/30/94 60,000 $ 1.00000 11/99/99 $ 1.56250 5/22/96
12/19/94 75,740 $ 1.95000 12/15/99 $ 1.75000 12/19/95
3/1/95 60,000 $ 1.00000 2/28/00 $ 1.75000 5/22/96
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>

22
<PAGE> 23

Warrant balances as of September 30, 1996, are shown in the following
table categorized by exercise price for warrants granted, grant dates, shares
exercisable, and expiration dates.

2/92-7/92 31,250 $ 0.80000 5 Years $ 2.50000
7/31/92 240,000 $ 5.40000 7/30/97 $ 3.00000
2/12/93 3,750 $ 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
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
12/15/95 137,386 $ 6.00000 12/14/00 $ 5.68750
1/17/96 50,000 $ 3.50000 1/16/00 $ 4.68750
1/17/96 50,000 $ 4.00000 1/16/00 $ 4.68750
------
Total/average
at 9/30/96 1,924,353 $ 4.64749 $ 4.03069
--------- ========== =========
</TABLE>

Common Stock:

Fiscal year 1994. 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.

Fiscal year 1995. 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.

Also 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).

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

23
<PAGE> 24

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.

Fiscal year 1996. On October 3, 1995, the Company received cash in the
amount of $380,000 as part of a subscription receivable related to a private
placement of $1,056,000, in exchange for 211,200 shares of common stock sold to
an uncle of the Company's chairman at a price of $5.00 a share under a purchase
agreement dated September 1, 1995. Cash in the amount of $500,000 had already
been received by September 30, 1995. Of the total purchase commitment, $176,000
remains as a two-year note payable to the Company at an interest rate of 10% per
year, due September 29, 1997, and is reported as a contra-equity account in
shareholders equity.

During fiscal year 1996, holders of warrants exercised their rights to
purchase 452,884 shares of Common Stock at a net purchase price of $548,783. On
December 27, 1995, the Company received $147,693 upon the exercise of a warrant
to purchase 75,740 restricted shares of common stock at $1.95 a share. On April
3, 1996, the Company received $1,800 upon the exercise of a warrant that had
been issued prior to the Company's initial public offering in 1992, to purchase
2,620 restricted shares of common stock at $0.687 a share. On May 22, 1996, the
Company received $5,000 for the exercise of a warrant issued in connection with
a bridge loan prior to the Company's initial public offering in 1992 to purchase
6,250 restricted shares of Common Stock at $0.80 a share. On May 22, 1996, a
group of investors exercised their rights under a warrant agreement to receive
135,128 shares of restricted common stock in a "cash-less" exercise, by
tendering 34,872 of a total of 170,000 shares that could be purchased by these
investors under that same warrant agreement that were "in-the-money" by $3.875 a
share ($4.875 market price at the time of exercise less the $1.00 exercise
price).

On August 12, 1996, the Company called for redemption of its 1,600,000
publicly traded warrants (previously NASDAQ: XSYSW). Total cost of redemption
was $278,134, including $74,938 in payments to holders at $0.05 a warrant
(1,498,760 warrants actually redeemed) and $203,196 in other costs (primarily
filing fees and printing and legal expense) to register shares of Common Stock
underlying the publicly traded warrants and other warrants and restricted stock.
Holders of 101,240 publicly traded warrants exercised their rights to purchase
151,846 shares of Common Stock at $4.00 a share for $607,384.

During September 1996 the Company received $65,040 for the exercise of
warrants issued in connection with consulting services and bridge loans prior to
the Company's initial public offering in 1992, and the purchase of 81,300 shares
of Common Stock at $0.80 a share.

Other Common Stock transactions. On January 12, 1996, the Company
granted 50 shares of common stock, valued at $143, to a part-time employee. On
January 19, 1996, the Company issued 6,185 shares of common stock as payment for
services to four consultants, valued at $23,914, for an average of $3.87 a
share. On May 21, 1996, the Company assigned its rights to redeem certain
restricted shares of common stock to a third party for $239,002. On August 16,
1996, the Company converted $502,552 in debt plus $46,675 in accrued interest to
196,152 shares of restricted common stock under Regulation S at a price of $2.80
a share.

On September 12, 1996, the Company agreed to two private placements
totaling $2,000,000 in exchange for common stock at a price equal to 80% of the
20 prior trading days. A portion of the cash ($325,000) was received prior to
the fiscal year ended September 30, 1996, and $1,149,933 was received between
October 1, 1996, and December 31, 1996, and is shown in the consolidated balance
sheet as a subscription receivable at September 30, 1996. The average share
price of the Common Stock issued to date as a result of this arrangement is
$2.86. The remaining funds to be received under this private placement are
$525,067.

24
<PAGE> 25
8. 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 and 1,000,000 shares for issuance under the 1996 Stock Option Plan.
Options may be granted to officers, directors and employees. Transactions in the
various plans are summarized below:

<TABLE>
<CAPTION>
OPTIONS
AVAILABLE GRANTED PRICE
FOR GRANT OPTIONS PER SHARE
--------- ------- ---------
1991 STOCK OPTION PLAN
<S> <C> <C> <C>
Balance at September 30, 1993 419,400 130,600 $2.25-$2.63
Granted (89,000) 89,000 $0.63-$2.26
Canceled 56,049 (56,049) $1.52-$2.52
------------- -------------
Balance at September 30, 1994 386,449 163,551 $0.63-$2.52
Granted (332,249) 332,249 $1.50-$1.88
Canceled 108,800 (108,800) $1.50-$2.52
------------- -------------
Balance at September 30, 1995 163,000 387,000 $0.63-$2.50
Granted (163,000) 163,000 $3.63-$4.69
Canceled 0 0
------------- -------------
Balance at September 30, 1996 0 550,000

1996 STOCK OPTION PLAN
Balance at September 30, 1995 1,000,000 0
Granted (30,000) 30,000 $3.63
Canceled 0 0
------------- -------------
Balance at September 30, 1996 970,000 30,000 $3.63
</TABLE>

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

None.

25
<PAGE> 26
PART III

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

NAME AGE POSITION

Gloria C. L. Ma, Ph.D. 48 Chairman and Chief Executive Officer

Michelle M. Mueller 42 Executive Vice President

Lawrence D. Cercone, Ph.D. 52 Vice President of Engineering

Gregory P. Hanson, CMA 50 Chief Financial Officer

Andrew J. Lampe 64 Director of Marketing and Sales

William J. Dale 63 Director of the Company

Robert E. Farris 68 Director of the Company

Walter Geer 47 Director of the Company

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.

MS. MUELLER was appointed Executive Vice President in mid-September
1996. For the past eleven years Ms. Mueller has been with The Titan Corporation,
where she reached the position of Vice President, in charge of administration,
commercial real estate, and corporate communications. Prior to that she held
management positions with E. F. Hutton Life Insurance Company and The Bendix
Corporation. Ms. Mueller has a B.A. in Communications from Eastern Michigan
University, a masters degree in mass communications from Morehead State
University, and an M.B.A. degree from Syracuse University.

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 as 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

26
<PAGE> 27
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.

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. FARRIS is a former Federal Highway Administrator. Mr Farris has a
long distinguished career in transportation administration, both at the federal
and state government level. For the past seven years, he has been working with
industry as an international consultant on transportation issues with special
emphasis on the development of public/private partnerships. From 1986 to 1989
Mr. Farris served as the Federal Highway Administrator, a position appointed by
President Reagan and confirmed by the Untied States Senate. This position is one
of four top administrative offices in the U.S. Department of Transportation. Mr.
Farris had responsibility for more than 3,000 employees and a budget in excess
of $13 billion.

MR. GEER is a co-founder and President of Greymar Associates, LLC, a
full-service residential real estate development company. 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 5 was not filed on the specified due dates by Dr. Ma, Law Biu
Biu, William Dale, Walter Geer, Gregory Hanson, and Lawrence Cercone.

ITEM 10. EXECUTIVE COMPENSATION.

Item 10 is incorporated by reference to the proxy statement to be
filed on or about January 31, 1997.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Item 11 is incorporated by reference to the proxy statement to be
filed on or about January 31, 1997.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Item 12 is incorporated by reference to the proxy statement to be
filed on or about January 31, 1997.

27
<PAGE> 28
PART IV

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

(a)(1) Index to Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Report of Independent Auditors 11

Consolidated Balance Sheets at September 30, 1996 and 1995 12

Consolidated Statements of Operations for the years ended 13
September 30, 1996, 1995 and 1994

Consolidated Statements of Stockholders' Equity for the 14
three years ended September 30, 1996

Consolidated Statements of Cash Flows for the years ended 15
September 30, 1996, 1995 and 1994

Notes to Consolidated Financial Statements 16
</TABLE>

(a)(2) Exhibits

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

Reports on Form 8-K

On October 31, 1996, the Company filed a current report on Form 8-K
giving evidence that the Company is in compliance with the minimum
listing requirements for Nasdaq, as of September 30, 1996.

28
<PAGE> 29
XXSYS TECHNOLOGIES, INC.

INDEX TO EXHIBITS

(Item 13(a))
Exhibit
Number Description
- ------ -----------

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.

29
<PAGE> 30
Exhibit
Number Description
- ------ -----------

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.
10.33 (11) Current report on Form 8-K, giving evidence of compliance
with the minimum listing requirements for Nasdaq.
10.34 Two private placements of restricted common stock in the
amount of $1,000,000 each, dated September 15, 1996.

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.
(11) Incorporated by reference to Form 8-K dated October 31, 1996.

30
<PAGE> 31
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.

January 10, 1997 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 January 10, 1997
- ---------------------------------- Officer and Director
Gloria C. L. Ma

/s/ Gregory P. Hanson Chief Financial Officer January 10, 1997
- ----------------------------------
Gregory P. Hanson

/s/ Robert E. Farris Director January 10, 1997
- ----------------------------------
Robert E. Farris

/s/ Walter Geer Director January 10, 1997
- ----------------------------------
Walter Geer

/s/ William J. Dale Director January 10, 1997
- ----------------------------------
William J. Dale
</TABLE>

<PAGE> 1
Exhibit 10.34
(Four pages)

September 12, 1996

Mrs. Li Sau Foon
c/o Wardley Securities Ltd.
3rd Floor Hutchison House
10 Harcourt Road
Hong Kong

SUBJECT: Private Placement of Restricted Common Stock of XXsys Technologies,
Inc.

Dear Mrs. Li:

Thank you for your interest in purchasing $1 million in restricted
common stock of XXsys Technologies, Inc. I am happy to offer to you these
securities based on the following terms and conditions:

1. The purchase price shall be 80% of the prior 20-day trading average for
the common stock traded on the Nasdaq Small Cap Exchange. However, such
share price shall not be less than $2.75 a share.

2. The Closing of the stock purchase shall occur on or before October 31,
1996, payable in two installment as specified in paragraph 3 below.
Funds are to be received in our U.S. account indicated below by the
specified dates. Wire transfer instructions are as follows:

Morgan Guaranty & Trust Company
15 Broad Street
New York, NY 10015
ABA #021 000 238
Account # 72200011
Prudential Securities Inc.

For further credit to:
0EO-968473 17
XXsys Technologies, Inc.

3. The Company will accept up to 50% of the purchase price by September
30, 1996 and the balance by October 31, 1996.

4. You will agree to a twelve-month lock up of the stock certificate from
the date of investment or until the common stock maintains an average
price of $3.50 a share or better for 20 continuous trading days. The
shares will be registered in your name or however you should choose to
be registered.

32
<PAGE> 2
5. During the lock up period you will be entitled to vote your shares
accordingly on any matters that may come before the shareholders for
vote as though you were in possession of such certificates.

6. The Company agrees to give you a first right of refusal on
participating in up to $3 million in additional financing between
January 1, 1997, and December 31, 1997, on the terms that the Company
may be offering at that time.

Should you decide to proceed with the investment in XXsys, please
acknowledge the terms and conditions of purchase by executing a copy of this
letter and returning to me at your earliest convenience. I have also enclosed a
stock subscription agreement to be filled out and executed by you for the
purchase of these shares. Thank you again for your interest in XXsys.

Best Regards,

/s/ Dr. Gloria Ma

Dr. Gloria Ma
Chairman and Chief Executive

READ AND AGREED: DATE:

/s/ Li Sau Foon September 15, 1996
- ------------------------ -----------------------
Li Sau Foon

33
<PAGE> 3
September 12, 1996

Tung Bik Lin
c/o Wardley Securities Ltd.
3rd Floor Hutchison House
10 Harcourt Road
Hong Kong

SUBJECT: Private Placement of Restricted Common Stock of XXsys Technologies,
Inc.

Dear Ms. Tung:

Thank you for your interest in purchasing $1 million in restricted
common stock of XXsys Technologies, Inc. I am happy to offer to you these
securities based on the following terms and conditions:

1. The purchase price shall be 80% of the prior 20-day trading average for
the common stock traded on the Nasdaq Small Cap Exchange. However, such
share price shall not be less than $2.75 a share.

Morgan Guaranty & Trust Company
15 Broad Street
New York, NY 10015
ABA #021 000 238
Account # 72200011
Prudential Securities Inc.

For further credit to:
0EO-968473 17
XXsys Technologies, Inc.

3. The Company will accept up to 50% of the purchase price by September
30, 1996 and the balance by October 31, 1996.

34
<PAGE> 4
5. During the lock up period you will be entitled to vote your shares
accordingly on any matters that may come before the shareholders for
vote as though you were in possession of such certificates.

Best Regards,

/s/ Dr. Gloria Ma

Dr. Gloria Ma
Chairman and Chief Executive

READ AND AGREED: DATE:

/s/ Tung Bik Lin September 15, 1996
- ------------------------ -----------------------
Tung Bik Lin

<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10-KSB
for the fiscal year ended September 30, 1996.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> SEP-30-1996
<CASH> 184,489
<SECURITIES> 0
<RECEIVABLES> 1,225,535<F1>
<ALLOWANCES> 0
<INVENTORY> 19,480
<CURRENT-ASSETS> 1,519,471
<PP&E> 1,441,345
<DEPRECIATION> 478,640
<TOTAL-ASSETS> 2,701,708
<CURRENT-LIABILITIES> 570,328
<BONDS> 0
0
450,000
<COMMON> 15,099,537
<OTHER-SE> (499,888)<F2>
<TOTAL-LIABILITY-AND-EQUITY> 2,701,708
<SALES> 568,965
<TOTAL-REVENUES> 568,965
<CGS> 550,315
<TOTAL-COSTS> 550,315
<OTHER-EXPENSES> 2,500,604
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 52,076
<INCOME-PRETAX> (2,075,718)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,075,718)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,075,718)
<EPS-PRIMARY> (0.33)
<EPS-DILUTED> 0
<FN>
<F1>Includes stock subscription receivable $1,149,933.
<F2>Note receivable for common stock of $193,600 and note receivable for preferred
stock of $306,288 are shown as contra-equity accounts.
</FN>

</TABLE>