F-10

NOTES TO FINANCIAL STATEMENTS(CON’T)

.

Note 2

RelatedPartyTransactions

Note payable to officer at December 31, 1997 and 1998, consist of the following:

1997

1998

Unsecured note payable, maturing January 1,
2028, monthly installments of $807
including interest at 8.90% at December 31, 1998.
The rate adjusts every six months, based on the
6 month LIBOR rate plus 6.25%, with a 1.00%
maximum change every six months, and a minimum
and maximum interest rate of 7.90% and 13.90%
respectively.
Less current maturities

$

101,250
788

$

100,467
771

$

100,462

$

99,696

Future maturities are as follows:

1999
2000
2001
2002
2003
Thereafter

$

771
842
920
1,006
1,099
95,829

$

100,467

Interest expense for related parties was $8,465 in 1997 and $8,550 in 1998.

Amounts due from officer are unsecured and non-interest bearing.Due from officer is scheduled
for monthly repayment at the rate of 1/20th of Mr. Palmer’s salary when Mr. Palmer starts to
receive a salary.

The Company rented office and warehouse facilities from an officer of the Company on a month-
to-month basis throughout 1997 and 1998.Total occupancy related expense, including certain real
estate taxes, utilities and repairs paid to the officer was $2,354 in 1997 and $3,977 in 1998.

F-11

NOTES TO FINANCIAL STATEMENTS(CON’T)

.

Note 3

Stockholders'Equity

Stock option plan:

The Company has reserved 1,000,000 shares of common stock for issuance under an incentive
stock option plan established in 1986.Under the plan, options are granted at prices determined by
the Board of Directors.It is the Company’s policy to not grant any options at a price less than the
current market or sales price.No options have been granted as of December 31, 1998.The
incentive stock option plan matures in 2001.

Stock options:

Certain stockholders are able to purchase additional common stock related to the issuance of stock
options.At December 31, 1996, there were 850,000 options outstanding and exercisable.During
1997, options to purchase 100,000 shares were granted at an exercise price of $1.00 per share.
No options shares expired, were canceled, or exercised during 1997.At December 31, 1997 there
were 950,000 options outstanding and exercisable.

During 1998, 177,500 options were exercised at a weighted-average price of $.29 per share, and
272,500 options expired at a weighted-average price of $.23 per share.No options were granted
during 1998.At December 31, 1998, there were 500,000 options outstanding and exercisable at a
weighted-average exercise price of $.52 per share and a weighted-average remaining contractual
life of 31 months; the outstanding options are comprised of 400,000 shares exercisable at $.40 per
share expiring December 31, 2000 and 100,000 shares exercisable at $1.00 per share expiring
December 31, 2003.

Stock warrants:

Certain stockholders were able to purchase additional stock with stock warrants attached to
common stock issued.At December 31, 1996 there were 815,993 warrants outstanding and
exercisable.During 1997, 130,000 shares were exercised at a weighted-average exercise price of
$.20 per share.At December 31, 1997 there were 685,993 warrants outstanding and exercisable.

During 1998, 411,826 warrants were exercised at a weighted-average exercise price of $.20 per
share, and the remaining 274,167 warrants expired at a weighted-average exercise price of $.21
per share.No warrants were granted during 1998, and there are no warrants outstanding at
December 31, 1998.

Common shares issued as consideration:

Common shares have been issued periodically for patents, inventory, consulting services, rent and
customer lists.The amount assigned to each transaction is based upon contractual agreements.

Stock based compensation:

The Company applies APB Opinion No. 25 in accounting for its stock incentive plans.
Accordingly, no compensation cost has been recognized for options granted.There are no charges
or credits to expense with respect to the granting or exercise of options since the options were
issued with exercise prices at or exceeding fair market value on their respective dates of grant.
However, using an option pricing model to determine the fair value of the options and considering
the expected option life, anticipation of no dividends, and the risk-free interest rate, determining
compensation cost for stock-based compensation plans consistent with SFAS 123 would not have
had a material impact on reported net income of the Company.

F-12

NOTES TO FINANCIAL STATEMENTS(CON’T)

.

Note 4

IncomeTaxes

The Company recorded no provision for income tax expense for the periods ended December 31,
1997 and 1998.

A valuation allowance has been established for the deferred tax asset because management
determined it is more likely than not that the deferred tax asset will not be realized.The
Company’s valuation allowance increased $59,700 from December 31, 1997 to December 31,
1998, due to net operating losses incurred during 1998.At December 31, 1998, for income tax
purposes, the Company had federal and state net operating loss carry forwards of approximately
$742,000 available that expire through the year 2013.

Note 5

CommitmentsandContingencies

Warranty:

The materials assembled by the Company generally carry warranties provided by the manufacturers
against product failure.In addition, the Company provides a warranty of its assembled product
workmanship.Management has determined that no warranty reserve was necessary as of
December 31, 1997 and 1998.

Year 2000 (Y2K):

The Company has completed its own Y2K assessment and management has not found any internal
issues that would cause significant operational problems.However, due to external factors beyond
the Company’s control such as general economic conditions, it is uncertain as to whether the Year
2000 issue will impact the Company’s operations in any significant way.

Note 6

OperatingLeases

In April of 1997, the Company began leasing space under a non-cancelable operating lease
expiring April 15, 1999.Under this agreement, the Company issued 124,110 shares of common
stock totaling $49,644.This was recorded as prepaid rent expense and is being amortized to rent
expense over the lease term.In addition to the common stock, the Company makes a monthly cash
payment for rent.As of the date of this report, management has entered into discussions to extend
this lease for a period of one year upon similar terms.

Rent expense totaled $23,852 and $31,559 for the years ended December 31, 1997 and 1998.

Deferred tax assets and liabilities were comprised of the following at December 31

1997

1998

Deferred tax asset - net operating losses
Less valuation allowance
Net deferred tax assets
Deferred tax liabilities
Total deferred income taxes

$

235,800
235,800
-
-
-

$

295,500
295,500
-
-
-

$

$