-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QmIR/4fmsCIUWAT+6WCDZ/kQ/Als3//Zg6LNoVRKo7HzaHiYZRwnRP17Vvif2Zrb 41nAT9TE4FGtvTWzNjGoIw== 0001185185-06-000132.txt : 20060406 0001185185-06-000132.hdr.sgml : 20060406 20060406165208 ACCESSION NUMBER: 0001185185-06-000132 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060406 DATE AS OF CHANGE: 20060406 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANCED OPTICS ELECTRONICS INC CENTRAL INDEX KEY: 0001020657 STANDARD INDUSTRIAL CLASSIFICATION: OPTICAL INSTRUMENTS & LENSES [3827] IRS NUMBER: 880365136 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-24511 FILM NUMBER: 06745591 BUSINESS ADDRESS: STREET 1: 8301 WASHINGTON NE STREET 2: #5 CITY: ALBUQUERQUE STATE: NM ZIP: 87113 BUSINESS PHONE: 5057977878 MAIL ADDRESS: STREET 1: 8301 WASHINGTON NE STREET 2: #5 CITY: ALBUQUERQUE STATE: NM ZIP: 87113 10KSB 1 adot10ksb123105.txt ADOT 10-KSB 12.31.05 U. S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: December 31, 2005 Commission file No. 0-24511 ADVANCED OPTICS ELECTRONIC, INC. (Name of small business issuer in its charter) NEVADA 88-0365136 (State of incorporation) (IRS Employer Identification No.) 8301 Washington NE, Suite 5, Albuquerque, New Mexico 87113 (Address of principal executive offices including zip code) Issuer's telephone number, including area code: (505) 797-7878 Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.001 par value (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. ____ The issuer's revenues for its most recent fiscal year were $0. The aggregate market value of the voting stock held by non-affiliates of the issuer on March 31, 2006 was approximately $5,938,000 based upon the closing price of such stock on that date of approximately $ 0.001. The number of issuer's shares of Common Stock outstanding including shares issued to affiliates as of March 31, 2006 was 7,433,836,349. Transitional Small Business Disclosure Format (check one): Yes No X ---- ---- TABLE OF CONTENTS Forward Looking Statements PART I Item 1. Description of Business..............................................3 Item 2. Description of Property..............................................9 Item 3. Legal Proceedings...................................................10 Item 4. Submission of Matters to a Vote of Security Holders.................10 PART II Item 5. Market for Common Equity and Related Stockholder Matters............10 Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations...............................12 Item 7. Financial Statements.......................................F-1 to F-36 Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...............................16 Item 8A. Evaluation of Controls and Procedures...............................17 PART III Item 9. Directors and Executive Officers of the Registrant..................17 Item 10. Executive Compensation..............................................19 Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters........................20 Item 12. Certain Relationships and Related Transactions......................21 Item 13. Exhibits List.......................................................22 Item 14. Principal Accountant Fees and Services..............................23 SIGNATURES 2 Forward - Looking Statements - ---------------------------- This Form 10-KSB contains forward-looking statements about the business, financial condition and prospects of the Company that reflect assumptions made by management and management's beliefs based on information currently available to it. The Company can give no assurance that the expectations indicated by such forward-looking statements will be realized. If any of management's assumptions should prove incorrect, or if any of the risks and uncertainties underlying such expectations should materialize, the Company's actual results may differ materially from those indicated by the forward-looking statements. The key factors that are not within the Company's control and that may have a direct bearing on operating results include, but are not limited to, the acceptance by customers of the Company's products, the Company's ability to develop new products cost-effectively, the ability of the Company to raise capital in the future, the development by competitors of products using improved or alternative technology, the retention of key employees and general economic conditions. There may be other risks and circumstances that management is unable to predict. When used in this Form 10-KSB, words such as, "believes," "expects," "intends," "plans," "anticipates" "estimates" and similar expressions are intended to identify forward-looking statements, although there may be certain forward-looking statements not accompanied by such expressions. All forward-looking statements are intended to be covered by the safe harbor created by Section 21E of the Securities Exchange Act of 1934. PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL Advanced Optics Electronics, Inc. (ADOT-OTC BB) is a technology company based in Albuquerque, New Mexico. Its primary focus is in image display and recognition technology. The company maintains an R&D facility and manufacturing plant, and is engaged in building large-scale flat panel displays, utilizing its patented technology, and production of color recognition optical devices. The Company was organized as a Nevada corporation on May 22, 1996. On November 7, 1996, the Company acquired the business and patents of PLZTech, a company involved in the development of flat panel displays. COMPANY OVERVIEW We are a developmental stage technology company with our primary focus on image display and recognition technology. Two products that are in development from this technology are large-scale flat panel displays, which utilize our patented technology, and color recognition optical devices. We are currently continuing our research, development, prototyping, and manufacturing of our products and the underlying technology. We are in the process of making the transition from a developmental stage company to producing and selling our product lines. We plan to focus on producing and selling our large-scale flat panel displays for the outdoor advertising billboard industry, which represents the first time that our technology is available to this industry. We are in negotiations to acquire a billboard location in Florida and intend to retrofit it with our technology in order to learn more about the outdoor billboard market and advertising customer needs and industry requirements. In addition, there are other markets and applications that represent opportunities for additional sources of business, and we are beginning to explore these markets and applications, such as e-cinema, lighting sources, stadium and sports applications and systems, control and status monitoring, and environmental warning systems. 3 Initially, we plan to sell our color recognition optic devices through e-commerce and retail locations to the blind and visually impaired. We are exploring additional markets for these devices for industrial, scientific and manufacturing applications. COMPANY BACKGROUND We were incorporated as a Nevada corporation on May 22, 1996. In November 1996, we acquired all the assets of PLZTech, Inc., including all of its patents and research and development activities. The transaction was accounted for as a purchase, and all assets acquired and liabilities assumed were recorded at their fair market values, as determined in accordance with accounting principles generally accepted in the United States of America. Intangible assets of PLZTech acquired in the purchase transaction were carried at historical book values. Research and development costs of PLZTech were expensed as incurred. PLZTech was incorporated in November 1992 in the state of Colorado and was engaged in the business of research and development of flat panel displays. Prior to our acquisition of the business and patents of PLZTech, we had minimal business activities and had essentially just started our own research and development activities. INDUSTRY BACKGROUND Our flat panel displays fit into a growing niche that is part of the broad visual communications market, which includes printing, photography, television, billboard, etc. In particular, our flat panel displays fit within the billboard sub-category of the broad visual communications market. Billboards include various niches commonly identified as painted signs, architectural signage, electric signs, programmable signs and large video displays. According to the Outdoor Advertising Association of America, outdoor advertising was a $5.8 billion industry in 2004, which was 6% higher than the previous year. The billboard segment of the outdoor advertising market represents 62% of total outdoor expenditures and topped $3.62 billion in 2004. We believe that the advantages of our flat panel displays for the outdoor advertising billboard industry will be significant. Our flat panel displays have the benefit in comparison to traditional printed billboards of providing dynamic, eye-catching ads and rapid change of display images from a remote site. Billboard companies could benefit by increasing revenues per sign by being able to sell the same space to different advertisers at different times during the day, with the ability to immediately access and change each sign via the remote site. Advertisers could benefit substantially because they would be able to reach their target audience with greater precision. The market for our color recognition optical device, ("Color-Chek") is the population of the visually impaired, industrial manufacturing and in thermal imaging applications for the military. We plan to initially focus on the visually impaired. The company's unique and novel conception and implementation of hardware and firmware determines the color optically and expresses the results with vocal responses. The company will establish marketing arrangements for the distribution to retail locations after a supply has been manufactured and inventoried. STRATEGY After conducting extensive research in various industries, including laptop computers, high definition televisions and outdoor advertising billboards to determine which market would be best suited for producing and selling products utilizing our technology, we decided to concentrate our complete attention and efforts on marketing to the outdoor electronic advertising billboard industry. According to the Outdoor Advertising Association of America, advertising space was sold on approximately 390,000 billboards in 2004. Our goal is to create a line of products utilizing our technology that is scalable both in terms of size and resolution to meet a wide range of requirements related to potential customers' economics, billboard locations and intended use. We believe that, due to the Highway Beautification Act, the number of billboards nationwide will not increase dramatically but should remain stable in the future. We expect that advertisers will increase their focus on securing and developing prime billboard locations. The customer base for billboards is diversifying as more advertisers are attracted to this medium. Our market penetration analysis is based on capturing and converting existing sites in a stable market and expanding the indoor market. The first phase will be targeting the prime billboard locations that generate monthly advertising revenues of approximately $25,000 or more per location. It is estimated that there are approximately 700 of these locations in the United States and another 1,500 outside of the United States. 4 Long-term contracts could potentially limit our access to the desired prime location sites during our start-up period. However, we believe that the trend is to use shorter-term contracts with significant turnover of advertisers, which favors the use of our flat panel displays because of the ease and speed with which images can be changed from a remote site. Revenues will be derived from a combination of direct sales of flat panel displays, owned and operated flat panel displays, leasing, licensing, and partnerships. PRODUCTS AND MARKETS Our primary initial product that will be marketed to users of the outdoor advertising industry is the flat panel display. Our flat panel displays will provide an image measuring approximately three meters by eight meters, which is similar in size to existing printed billboards. We believe that the major advantages of our flat panel displays include better viewing quality, affordability, customer system integrity, and an almost immediate change of display images from a remote site. We believe that our flat panel displays and underlying software system represent an innovative approach to advertising that takes advantage of the recent technological convergence of billboard media, broadcast media and the Internet. Our principal product market consists of the outdoor advertising billboard industry, which until now has primarily relied on printed billboards for outdoor advertising. We believe that the user base for outdoor billboards is diversifying and growing as more advertisers are attracted to this medium of advertising, and this industry is experiencing rapid consolidation through mergers and acquisitions driven by the larger billboard companies. Our product and marketing strategy includes leveraging the underlying growth and excellent fundamentals of the existing outdoor advertising market. We anticipate that this strategy will also create a new segment of the outdoor advertising billboard market for our flat panel displays. We have completed a film that is being distributed as a marketing tool throughout the outdoor advertising billboard industry to potential purchasers of our flat panel displays both in the United States and internationally. In addition, there are other markets and applications that represent opportunities for additional sources of business, and we are beginning to explore these markets and applications, such as e-cinema, lighting sources, stadium and sports applications and systems, control and status monitoring. The other product that is in development is the color recognition optical sensing device (Color-Chek). We believe the major advantages of our product are a cheaper cost for the level of resolution and flexibility relative to our competitors. The market for this product will primarily be to the color-blind and visually impaired. However, we are exploring other markets where color recognition may be beneficial such as in underwater and space applications. SUPPLIERS AND AVAILABILITY OF RAW MATERIALS We have identified several suppliers of the basic components of our systems. We anticipate this technology to continue to develop and mature, which will create more suppliers, lower prices and greater availability. We are continually evaluating suppliers of subassemblies and components and researching alternatives. We are sensitive not only to the quality and cost of the parts and pieces supplied but also the strategic importance of multiple supplier relationships. MANUFACTURING, DISTRIBUTION, INSTALLATION AND MAINTENANCE OF OUR PRODUCTS We have established relationships with contract manufacturing facilities for the production of our flat panel displays. We intend to establish a larger manufacturing facility for assembling our flat panel displays in preparation for larger scale operations. Our flat panel displays will be shipped directly from our manufacturing facilities to our customers, and we intend to promote, market and sell our products through direct sales channels. We plan to outsource manufacturing of Color-Chek out to facilities in the US and Mexico. We also plan to maintain and repair our products for a specific warranty period and offer maintenance contracts beyond the warranty period. In addition, we intend to investigate the possibility of contracting with United States and international third party service providers for on-site installation, maintenance and repair of our flat panel displays. 5 CUSTOMERS Panels - ------ According to the Outdoor Advertising Association of America, there were approximately 151,000 30-sheet billboards that measure approximately 12 feet by 24 feet and approximately 106,000 8-sheet billboards that measure approximately 6 feet by 12 feet in the United States in 2004. We believe that many of these billboards represent potential retrofit sites for the installation of our flat panel displays. It is estimated that the four leaders in this industry account for approximately half of the outdoor advertising billboard market and the top ten billboard owners represent 61% of this market. The balance of the outdoor advertising billboard market is composed of smaller individual companies that nevertheless control prime high-traffic billboard locations and, as such, represents a significant component of our target market. We consider these companies to be our potential primary customers. In addition to upgrading their billboard sites to attract higher revenue generating advertising accounts, we believe that these potential customers are considering new potential outdoor venues in locations such as Times Square in New York City, which would be an additional source of revenue for us. Media companies have been acquiring billboard owners in order to offer packages of television, radio and newly acquired outdoor space to advertisers. We believe that the concentration of ownership and the convergence of media are beneficial trends to market and sell our flat panel. We intend to initiate customer contact by directly communicating with potential customers, including the four leaders of the outdoor advertising billboard industry, and providing them the marketing film that we have produced about our flat panel displays. We are developing a marketing department to initiate contact, process each transaction and coordinate with our manufacturing department for production and delivery of our flat panel displays. Color-Chek - ---------- There are approximately 8,000,000 visually impaired individuals in the United States according to the 2000 US Census. These individuals would be the initial target market for this product to assist them in day to day life that may require color recognition. Other potential customer bases include industrial manufacturing for color recognition on assembly lines and military sales for application in low-light environments. COMPETITION Panels - ------ We will compete with the existing billboard techniques of hand painted or printed and pasted signs. Recently, there has been a trend toward creating the art digitally, but these images are still printed on large sheets and pasted up. We believe these forms of billboard presentations will only be viable in low density, low traffic areas. In comparison, our flat panel displays include high brightness, full color, superior image quality, wide viewing angle with excellent outdoor readability, relatively low cost compared with competing electronic billboard technologies, high reliability and rapid change of display images from a remote site. We will compete against other established forms of electronic display technology, and we believe that our products and technologies will continue to face substantial competition as the market and technologies evolve. Existing and potential competitors such as Toshiba, Sharp, Hitachi and Mitsubishi possess substantially greater product development capabilities and financial, technical, marketing or human resources than we do. These companies manufacture electronic displays that utilize liquid crystal displays, or passive LCD technology such as lap-top computer screens, and cathode ray tubes such as traditional TV set display technology, which currently dominate the electronic billboard market. However, we believe that the products based on these technologies are limited and new technologies being developed, including ours, will significantly improve the performance of electronic displays in the future and displace existing products in the electronic billboard market. Many companies, including Daktronics, Inc., SI Diamond Technology, Inc. and Universal Display Corporation have, or are developing, other technologies utilizing carbon field emissions, incandescent lamps, inorganic electroluminescence, organic light emitting diodes, polymeric light emitting diodes, gas plasma and vacuum fluorescent lamps. Furthermore, although we believe our products will be superior to established advertising billboard products, we cannot assure you that business customers will prefer our technology sufficiently to be willing to pay for it at the price at which it will be offered. We recently set the sales prices of our flat panel displays measuring approximately three meters by two meters and three meters by eight meters at $395,000 and $1,490,000, respectively. 6 We believe that the technologies that we have developed are superior to other existing technologies when combining the issues of brightness, image quality and cost required for electronic billboards. Other existing technologies that we compete with include: o Low resolution devices which have a grainy picture and do not allow certain colors to be viewed in direct sunlight and have a high initial cost; o Incandescent bulbs that are high maintenance and offer poor graphics; o Electromechanical systems that have poor image qualities and limited colors; and o CRT's and passive LCD's that have a long useful life and an existing manufacturing base, but are expensive to produce. We believe that our flat panel displays utilizing our display technology offers numerous advantages and features in comparison to the existing products of our competitors currently available, including: o The brightest electronic billboard display at 35,000 nits and the widest viewing angle; o The smallest dot pitch for outdoor large-scale displays at eight millimeter dot pitch, providing high definition television picture quality; o 24-bit true color and full motion video at up to 120 frames per second; o Broadcast and simulcast applications including real-time live video and streaming video feeds with operation from a remote site; o Use of digital visual interface, or DVI, industry standard protocol for high speed data linking and digital video interfacing; o Satellite linkage for the ability to operate multiple flat panel displays from a single remote site; o Modular assembly in one meter increments for scaleable and shapeable architectures and ease of transportability for mobile operations and use; and o Weather resistance for outdoor applications and a continual use life of at least five years. Color-Chek - ---------- There are a number of competitors in the optical recognition to speech device market. At least 11 of these companies have products on the market currently with several more that have announced plans to release products in the next few years. All of the competitors products are more expensive and in some cases less functional that the Company's product Color-Chek. INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS (STATUS) Advanced Optics holds the following patents and patents pending: o Patent #5,198,920 relating to a Transverse Pixel Formation for Spatial Light Modulator. o Patent pending for COLOR-CHEK, a hand-held color check optical recognition device. Our success will depend on our ability to protect our proprietary technology and other intellectual property rights. We acquired the patent relating to the transverse pixel format when we acquired all the assets of PLZTech, Inc. in November 1996. Although we have been awarded the patent and have filed an application for a patent, the degree of protection offered by these patents or the likelihood that pending patents will be issued is uncertain. Any unauthorized use of our proprietary technology could result in costly and time-consuming litigation to enforce our proprietary rights. RESEARCH AND DEVELOPMENT ACTIVITIES In the year ended December 31, 2005, $ 26,528 was spent on research and development activities. In 2004 $362,638 was spent on research and development activities. We believe that continued investment in product development is critical to attaining our strategic objectives and, as a result, expect product development expenses to increase significantly in future periods. We expense product development costs as they are incurred. 7 EMPLOYEES As of December 31, 2005, the Company has 9 full-time employees. The Company also contracted with other personnel and subcontractors for various projects on an as-needed basis. The Company hired a full time controller in 2005 in order to support our efforts in meeting new reporting requirements. The Company has hired two additional technicians in 2005. There are no explicit plans to hire additional personnel at this time but, from time to time, the Company expects to hire additional personnel in order to carry out its business strategy. The Company files annual reports on Form 10-KSB, quarterly reports on Form 10-QSB, current reports on Form 8-K and proxy and information statements and amendments to reports files or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended. The public may read and copy these materials at the SEC's Public Reference Room at 450 Fifth St NW, Washington, DC 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Company and other companies that file materials with the SEC electronically. The Company's main office is located at 8301 Washington St NE, Suite 5, Albuquerque, NM 87113. The Company's phone number at that address is 505-797-7878. BIOMODA - ------- Beginning with its 2004 annual report on form 10-KSB, the Company has consolidated its financial statements with Biomoda, Inc.'s (Biomoda) This has been done in order to comply with FIN 46, a pronouncement that became effective for years ending after December 15, 2004. The nature of Biomoda's business is substantially different from that of Advanced Optics Electronics, Inc. More information about Biomoda is available in Biomoda's 2005 10-KSB which is accessible from the SEC website. The SEC website (http://www.sec.gov) contains reports and information statements and other information regarding Biomoda and other companies that file materials with the SEC electronically. Biomoda's plan for the next twelve months is to verify and refine its assay, design its kit, prepare for clinical studies, and initiate a dialogue with the FDA relative to our approval submission. Biomoda is relying on a bridge financing arrangement with Advanced Optics Electronics, Inc., an affiliated public company, and also intends to raise additional funds from its effective Form SB-2 Registration Statement during the next six months. Biomoda is currently leasing Laboratory equipment from Advanced Optics Electronics, Inc. on a month to month basis and intends to purchase this equipment when adequate funds are raised. Its initial product is a diagnostic test for lung cancer that will be performed out of body by using a sputum sample from the patient. The test does not require any invasive sample taking. The sample will be sent to a clinical lab where a procedure will be performed to determine the presence, or not, of lung cancer or precancerous cells. The diagnostic test can be used for other cell samples and the intent is to create and market products to diagnose and screen for other prevalent cancers such as cervical, bladder, and colorectal. Management has determined that the initial markets will be among the developed nations of Europe, North America, and Japan. We are also pursuing markets in India, Russia, and Eastern Europe. This has been determined on the basis of available healthcare delivery and payer infrastructure. Japan is leading the world in this area and has instituted a nationwide lung cancer-screening program. BIOMODA PRODUCT DEVELOPMENT AND REGULATORY STRATEGY Management of Biomoda expects to continue assay validation work and seek to register its product with the FDA in 2005. There are several business models, product types and regulatory routes that Biomoda is evaluating including: ASR, 510K, PMA and IVD kits Research Use Only (RUO) or Investigational Use Only (IUO): An RUO test can be sold to organizations that are conducting research in a particular area. The product cannot be used to make any diagnostic or clinical decision for a patient. An IUO test is a complete kit that is used in a formal clinical trial. The results can be used in the clinical trial only. ASR: This is the FDA designation for Analyte Specific Reagent. There are generally two classes: Class I & Class II. Class I is considered to the lowest risk. Biomoda's ASR product is a Class I and only requires registration and meeting the FDA standards. This product is viewed as a component for a assay developed in-house by Medical Reference Laboratories. 510K: This is the FDA designation for approvals that are based on "Substantial Equivalence" with previously approved products and does require approval prior to marketing. There are generally three classes: Class I, Class II, & Class III. Depending on the indication established with the FDA, Biomoda's product will 8 either be Class I or Class II, if Biomoda proceeds with this product approval route. This product will be a kit developed to determine the presence of abnormal cells in a body fluid sample. PMA: This is the FDA designation for approvals for new product indications (no Substantial Equivalence) and does require approval prior to marketing. There are generally two classes: Class II, & Class III. If Biomoda proceeds with this approval route, Biomoda's expects this product to be Class III due to indication of diagnostic for a specific cancer. IVD: This is an industry designation for In Vitro Diagnostic. Products in the industry are either reagents or kits. Kits would include the key components required to conduct the assay for the specific indication stated in the package insert. Reagents are single components used in assays developed by a Reference Labs. The lab will be required to have met the FDA CLIA (current Clinical Laboratory Improvement Act) regulations to market a diagnostic. Biomoda is evaluating several cancers with a focus on large markets that are in need of the most immediate diagnostic support. These include: lung, bladder and cervical. The products are subject to FDA registration or approval and to post-approval FDA reporting requirements. Costs in complying with regulatory and legislative matters such as the Clinical Laboratory Improvement Amendment of 1988 (CLIA), which regulates the quality and reliability of medical testing in the U.S., adverse changes in zoning laws, tax laws, or other laws affecting the medical and diagnostic industry may prove to be a major obstacle, both in respect of time and costs, in our research and development. The timing of regulatory filings and approvals, if any, for the Company's products are made less certain by the Company's strategy of seeking one or more collaborative arrangements with development and marketing partners, which may require that a collaborative partner be responsible for seeking and obtaining regulatory approvals either in foreign countries or in the U.S. Biomoda intends to market its products throughout the world. There are numerous regulatory agencies that regulate the sale of diagnostic and therapeutic products, and these agencies may be affected or influenced by criteria materially different than those of the FDA. The sale of Biomoda's products may be materially affected by the policies of these regulatory agencies or the domestic politics of the countries involved. Biomoda has not applied for and does not now have the approval of any foreign country to sell its products for diagnostic or therapeutic use. Biomoda's lung cancer product validation is projected to be complete by year-end and a contract manufacturing relationship is projected to be established by year-end. Based on these benchmarks, ASR registration and product listing can be completed by that time also. At that juncture reagent sales can begin. This is estimated to cost an additional $500,000. Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $300,000 will be required. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months to plan, execute, and document. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Biomoda's current intention regarding regulatory strategy is to initiate product introductions via an ASR registration and potentially migrate up the regulatory spectrum as markets require. Biomoda's products are subject to FDA registration or approval and to post-approval FDA reporting requirements. Biomoda's current intention regarding regulatory strategy is to initiate product introductions via an ASR registration and potentially migrate up the regulatory spectrum as markets require. Biomoda's management expects to continue assay validation work and commence registration of its product with the FDA in 2006. There are several business models, product types and regulatory routes that Biomoda is evaluating including: licensing, ASR, 510K, PMA for IVD kits and reagents. Biomoda is evaluating several cancers with a focus on large markets that are in need of the most immediate diagnostic support. These include: lung, bladder and cervical. See item 6, below, for discussion of estimated costs and timetables for development of these tests. ITEM 2. DESCRIPTION OF PROPERTY The company leases its headquarters facility of approximately 7,500 square feet at 8301 Washington NE, Suite 5 in Albuquerque, New Mexico. This includes the 9 executive offices, research and development facility and manufacturing plant, approximately 500 square feet of which is sublet to Biomoda, Inc. The facility is in good condition with no material defects or deferred maintenance. The facility is leased from unaffiliated third parties under a lease that is currently on month to month status. ITEM 3. LEGAL PROCEEDINGS On December 10, 2004, the Company and another entity filed a lawsuit in the State of New Mexico against an individual ("the DEFENDANT") to recover $13,500,000 for damages and injunctive relief arising out of the intentionally tortuous conduct of the Defendant. On December 23, 2004, instead of filing a counterclaim, the Defendant filed a lawsuit against the Company and others for alleged malicious abuse of process, defamation, civil conspiracy, prima facie tort, and intentional infliction of emotional distress, but did not allege any amount of damages. On January 26, 2005, the Company filed a motion to dismiss that lawsuit. Because of the inherent uncertainties, a favorable or unfavorable outcome could not be determined as of this date as well as the amount or range of potential recovery by the Company in the event of favorable outcome or loss to the Company in the event of an unfavorable outcome. On April 5, 2005 an insurance carrier for the Company confirmed that it would provide legal counsel for the Company in the defense of the claims brought by the above referenced Defendant. On April 8, 2005 the Company was awarded damages in the sum of $13,500,269 as a result of a two separate judgments against two former co-defendants of the above referenced Defendant. The Court's order also provides that the defendants must pay the Company an additional $905,794 as pre-judgment interest. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock began trading on the NASDAQ Bulletin Board Market ("OTC") under the symbol "ADOT" during the first quarter of 1997. Prior to that time the stock was not listed or traded on any organized market system. The holders of the Company's Common Stock are entitled to one vote per share. The Common Stock holders do not have preemptive rights to purchase, subscribe for, or otherwise acquire any shares of Common Stock. The table below sets forth the high and low bid prices for the Common Stock for each quarter within the last two fiscal years as reported by Prophet Financial Systems. These over-the-counter market quotations may reflect inter-dealer prices without retail mark-up, markdown or commission and may not necessarily represent actual transactions. Common Stock Bid - -------------------------- -------------------------- -------------------------- High Low - -------------------------- -------------------------- -------------------------- Fiscal 2005: - -------------------------- -------------------------- -------------------------- 1st Quarter $.002 $.001 - -------------------------- -------------------------- -------------------------- 2nd Quarter .001 .0005 - -------------------------- -------------------------- -------------------------- 3rd Quarter .001 .0002 - -------------------------- -------------------------- -------------------------- 4th Quarter .001 .0002 - -------------------------- -------------------------- -------------------------- Fiscal 2004: - -------------------------- -------------------------- -------------------------- 1st Quarter .007 .001 - -------------------------- -------------------------- -------------------------- 2nd Quarter .003 .001 - -------------------------- -------------------------- -------------------------- 3rd Quarter .051 .002 - -------------------------- -------------------------- -------------------------- 4th Quarter .086 .004 - -------------------------- -------------------------- -------------------------- As of December 31, 2005 the Company estimates that there were approximately 10,000 shareholders and the closing price of the Company's common stock was $.0003. The Company has never paid cash dividends on its Common Stock and does not anticipate paying cash dividends in the near future. 10 PENNY STOCK Until the Company's shares qualify for inclusion in the NASDAQ system, the public trading, if any, of the Company's Common Stock will be on the OTC Bulletin Board. As a result, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the price, of the Common Stock offered. The Company's Common Stock is subject to provisions of Section 15(g) and Rule 15g-9 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), commonly referred to as the "penny stock rule." Section 15(g) sets for the certain requirements for transactions in penny stocks, and Rule 15g-9(d) incorporates the definition of "penny stock" that is found in Rule 3a51-1 of the Exchange Act. The SEC generally defines "penny stock" to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. If the Company's Common Stock is deemed to be a penny stock, trading in the shares will be subject to additional sales practice requirements on broker-dealers who sell penny stock to persons other than established customers and accredited investors. "Accredited investors" are persons with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse. For transactions covered by these rules, broker-dealers must make a special suitability determination for the purchase of such security and must have the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt the rules require the delivery, prior to the first transaction of a risk disclosure document, prepared by the SEC, relating to the penny stock market. A broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information for the penny stocks held in an account and information to the limited market in penny stocks. Consequently, these rules may restrict the ability of broker-dealer to trade and/or maintain a market in the Company's Common Stock and may affect the ability of the Company's shareholders to sell their shares. RECENT SALES OF UNREGISTERED SECURITIES During October 2004, the Company sold 118,000,000 shares of common stock for $161,970 in cash; all shares were sold for less than $0.01. During November 2004, the Company sold 160,000,000 shares of common stock for $2,777,200 in cash; all shares were sold for less than $0.01. During December 2004, the Company sold 145,000,000 shares of common stock for $224,350 in cash; all shares were sold for less than $0.01. During October 2004, the Company issued 27,400,000 shares of common stock for services, which were valued at $57,540 (based on the closing market price on the date of grant, which was less than $0.01). The Company recorded such amounts in the accompanying statement of operations. During October 2004 the Company purchased a net of 2,225,000 shares of common stock (based on the fair market value on the date of transaction, which were less than $0.01) held as treasury stock. During December 2004, the Company purchased a net of 11,000,000 shares of common stock (based on the fair market value on the date of transaction, which were less than $0.01) held as treasury stock. As of December 31, 2005, the status of the common stock of the Company was: 7,000,000,000 shares authorized and 6,023,836,349 shares issued and outstanding. During the year ended December 31, 2005, the Company issued 2,634,700,000 shares for cash of $1,147,474 and 21,000,000 shares of common stock for debentures in the amount of $31,122. All investors are "Accredited Investors" within the meaning of Regulation D. All the investors who acquired the common stock and the debenture investors had a pre-existing relationship of a business nature with ADOT for a considerable period of time prior to acquiring the securities. No media advertising (advertisements, articles, notice or other communication published in any newspaper, magazine or similar media or broadcast over television on radio) or general solicitation was employed in reaching the investors or used to bring ADOT to the attention of the investors. The Company claims exemption from registration pursuant to Section 4 (2) of the Securities Act of 1933 which exempts a transaction not constituting a public offering. 11 EQUITY COMPENSATION PLANS
- ---------------------------------------------------------------------------------------------------------- EQUITY COMPENSATION PLANS - ---------------------------------------------------------------------------------------------------------- Plan Category Number of Securities to Weighted-Average Remaining available for be issued upon exercise Exercise Price of future issuance under equity of outstanding Options, outstanding Options, compensation plans Warrants and Rights (#) Warrants and Rights ($) (excluding securities reflected in column (A)) (#) - ----------------------- ------------------------- -------------------------- ----------------------------- Equity Compensation 400,000 $0.02 9,600,000 Plans approved by security holders - ----------------------- ------------------------- -------------------------- ----------------------------- Equity Compensation 800,000 $0.03 N/A Plans not approved by security holders - ----------------------- ------------------------- -------------------------- ----------------------------- Total 800,000 9,600,000 - ----------------------- ------------------------- -------------------------- -----------------------------
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS ADVANCED OPTICS - --------------- LIQUIDITY AND CAPITAL RESOURCES The Company relies upon the current placement of its securities to provide capital for its development of prototype units and manufacturing operations. The Company's holding in its subsidiary, Biomoda, Inc may provide additional liquidity. Overall, the Company had negative cash flows of $520,134 for the year ended December 31, 2005 resulting from $1,734,071 used in the Company's operating activities, $119,855 provided by the Company's investing activities and $1,094,082 of cash provided by financing activities. Net cash used in operating activities of $1,734,071 for the year ended December 31, 2005 was primarily due to $2,105,065 in operating expenses, of which $1,027,087 is General and administrative and $900,424 is Payroll and related expense. Net cash provided by investing activities of $119,855 for the year ended December 31, 2005 was primarily due to proceeds of sale of GenoMed stock of 184,046. In 2004, a significantly greater amount of cash was used in investing, primarily $900,000 used to purchase stock in GenoMed, Inc. During the first quarter of 2004, Advanced Optics Electronics, Inc. purchased 33,354,230 shares of GenoMed, Inc., for $900,000. This represented 17.09% of the outstanding shares of GenoMed, Inc. at that time. At December 31, 2005 the Company held 27,350,821 shares. GenoMed, Inc. is a publicly traded biotech company working in genomics based disease management. Net cash provided by financing activities of $1,094,082 for the year ended December 31, 2005 was primarily due to the proceeds of $1,147,173, from the sale of 2,655,700,000 shares of common stock. The Company is actively pursuing all potential financing options as it looks to secure additional funds to both stabilize and grow its business operations. Management will review any financing options at its disposal and will judge each potential source of funds on its individual merits. There can be no assurance that the Company will be able to secure additional funds from debt or equity financing, or if they can, that it will be on terms favorable to the Company or existing stockholders. During the year ended December 31, 2004 in accordance with the applicable convertible debentures agreement, the Company issued 103,000,000 shares of common stock at a conversion price of approximately $0.011 in connection with the conversion of notes payable approximating $505,000, including approximately $160,000 of accrued interest, and recorded a loss on settlement of debt of $620,000. In 2005, 21,000,000 shares were issued in conversion, valued at $31,122. 12 RESULTS OF CONTINUING OPERATIONS As of December 31, 2005, The Company had a marketable securities portfolio valued at $902,027. The Companies' combined monthly cash burn-rate is approximately $165,000. This represents approximately six months of operating funds. The Company is actively pursuing potential financing options as it looks to secure additional funds to both stabilize and grow its business operations. Management will review any financing options at its disposal and will judge each potential source of funds on its individual merits. There can be no assurance that the Company will be able to secure additional funds from debt or equity financing, or if they can, that it will be on terms favorable to the Company or existing stockholders. The Company is currently in the process of final assembly, test and system integration of approximately 1500 of its display subassemblies. This will create a 2 meter by 3 meter display. It is anticipated that this work can be completed in the fourth quarter of 2006. Additional research and development is anticipated and planned in electrical and mechanical realms. These include but are not limited to: power systems and distribution, heat dissipation, and weatherproofing. There are no expected sales of significant equipment. The Company had been developing and manufacturing electronic signs under a contract to deliver two signs. At December 31, 2004, the contract was terminated by mutual consent of both parties and a 100% provision for contract losses was provided. During 2004, the Company expensed the balance of its contract to deliver two flat panel displays resulting in a charge of $1,000,944 in the Consolidated Statements of Operations. The cancellation of the contract to purchase two signs was negotiated to the satisfaction of both parties and memorialized in a Settlement Agreement and Mutual Release. Although the contract to purchase two signs has been canceled through a Settlement Agreement, we continue to work on completing this initial sign and the associated development work. We currently employ four full-time electronic technicians and a supervisor working specifically on this project. We have completed 20 panels that create a five square meter sign. We are working out issues of electrical power and distribution. We will also need to solve technical details surrounding cooling and weather-proofing. We have encountered many development and engineering hurdles throughout the course of this project. The underlying factors related to cost overruns associated with the project are: changes in engineering staff; inadequate transition documentation; faulty parts; manufacturing and assembly problems both internal and outsourced; and expense allocation decisions relative to Research and Development. Operating expenses decreased by $1,179,930 to $2,105,065 during the year ended December 31, 2005 compared to $3,284,995 for the year ended December 31, 2004. Asset impairment decreased by $365,314 professional fees decreased by $51,044 and research and development decreased by $632,331, general and administrative decreased by $466,058 from $1,493,145 to $1,027,087 and payroll expense increased by $352,253 from $548,171 to $900,424 from 2004 to 2005. This was due to changes in classification of research related payroll costs in 2005. General and administrative expenses consist of expenses for executive and administrative personnel, facilities, professional services, travel, general corporate activities, and the depreciation and amortization of office furniture and leasehold improvements. Product development expenses consist primarily of consulting fees associated with the development and enhancement of our flat panel displays and continued testing of disease detection protocol(s). R&D decreased primarily because of a lower level of activity. We believe that continued investment in product development is critical to attaining our strategic objectives and, as a result, expect product development expenses to increase significantly in future periods. We expense product development costs as they are incurred. Two of the largest changes were in asset impairment and inventory, approximately $395,000, which decreased to zero in 2005 and general and administrative, largely due to a decrease of approximately $427,000 in financial consulting and investor relations. Asset impairment included removing from the balance sheet investments in the stock of Beaver Information Technology, Inc., a foreign corporation, of $273,000 and Electronic Film Market Online, Inc., of $88,000. As a consolidated entity, Advanced Optics' operating expenses decreased substantially in 2005, from approximately $3,300,000 to $2,100,000, as explained above, by classification. Loss on contract, had been over $1,000,000 in 2004 and was zero in 2005. Other income (expense) consists primarily of interest, gain or loss on marketable securities and debt settlement losses. This item increased from $(762,128) to $49,286, largely because extinguishment of debt resulted in a gain of $620,980 in 2004. 13 BIOMODA, INC. - ------------- Biomoda is a biomedical development company. The Company's direct ownership of Biomoda, as of December 31, 2005, was approximately 16.0%. Two officers of Advanced Optics Electronics, Inc. are securities holders of Biomoda in addition to the ADOT ownership. Biomoda has filed a revised SB2 registration statement with the Securities and Exchange Commission, which has been declared effective February 11, 2005. Biomoda is offering 6,000,000 shares at $3.00 per share (for an aggregate offering of $18,000,000). It is anticipated that a public market for Biomoda's securities will be created in the second quarter of 2006. A market for Biomoda's shares has not been established; therefore the potential value of the Company's investment cannot be measured. There can be no assurance that if the Company were to sell such investment that it would be able to on terms favorable to the Company or for the initial offering price. Factors such as dilution, blockage and a lack of a market may be encountered. Biomoda has been in the development stage since it began operations on January 3, 1990 and has not generated any revenues from operations and there is no assurance of any future revenues. As of December 31, 2005, Biomoda had accumulated deficit of approximately $3,091,000 and a working capital deficit of approximately $1,956,000. In addition, Biomoda did not generate any cash from operations and had no cash reserve dedicated to fund expenditures. These factors create an uncertainty as to Biomoda's ability to continue as a going concern. LIQUIDITY AND CAPITAL RESOURCES Since inception, Biomoda has funded operations primarily through private placement of equity securities to third parties and to ADOT and loans from Advanced Optics Electronics, Inc. As of December 31, 2005 it had raised net proceeds of approximately $2,762,000, of which approximately $1,391,000 was loaned by ADOT. On May 1, 2002, Biomoda entered into a line of credit agreement (the "Agreement") with Advanced Optics Electronics, Inc., an affiliated entity, ("Advanced Optics") with an annual interest rate of 5%. On May 1, 2003 the agreement was extended. Biomoda had negative cash flows of $1,336 for the year ended December 31, 2005 resulting from $496,325 used in Biomoda's operating activities, $35,383 used in Biomoda's investing activities and $530,372 of cash provided by financing activities. Cash used in operating activities was primarily $538,555 in operating expenses, of which $141,284 is General and Administrative, $278,050 is Research and Development and $83,174 is professional fees. Cash used in investing activities was for payments for patents and intangibles. Cash provided by financing activities was due to the proceeds from a line of credit from an affiliated entity. Biomoda's total assets are $241,691 at December 31, 2005. Of this, $225,853 is patent costs, net of accumulated amortization of $71,900. Its liabilities of 1,972,240 primarily consist of its debt to Advanced Optics of $1,491,523 and payables and accrued liabilities of $331,715. Stockholders' deficit as of December 31, 2005 is $1,730,549. RESULTS OF CONTINUING OPERATIONS Biomoda has been in the development stage since it began operations on January 3, 1990 and has not generated any revenues from operations and there is no assurance of any future revenues. As of December 31, 2005, Biomoda had accumulated deficit of approximately $3,101,000 and a working capital deficit of approximately $1,966,000. In addition, Biomoda did not generate any cash from operations and had no cash reserve dedicated to fund expenditures. These factors create an uncertainty as to Biomoda's ability to continue as a going concern. Biomoda has recorded no revenue from its inception through December 31, 2005. In 2005, the net loss was $624,726. The loss from operations was $538,555 in 2005 and $2,874,849 since inception. Most of its expense is related to product development. Product development expenses consist primarily of personnel expenses, consulting fees and lab expenses. Research development and technical costs were $278,050 in 2005 and $1,698,750 since inception. Management believes, however, that continued investment in product development is critical to attaining our strategic objectives and, as a result, expect product development expenses to increase significantly in future periods. Biomoda expenses product development costs as they are incurred. Operating expenses decreased by $169,825 or 24% to $538,555 during the year ended December 31, 2005 compared to $708,380 for the year ended December 31, 2004. This was due largely to a decrease of $159,000 in research and development costs. General and administrative expenses consist of expenses for executive and 14 administrative personnel, facilities, professional services, travel and general corporate activities. General and administrative costs decreased to $83,174 in 2005 from $134,218 in 2004 due to decreases in salary expense. We expect general and administrative costs to increase in the future as our business matures and develops. The following is a discussion of costs and time factors associated with developing products for these cancers: a. Lung: Validation is projected to be complete by year-end and a contract manufacturing relationship is projected to be established by year-end. Based on these benchmarks, ASR registration and product listing can be completed by that time also. At that juncture reagent sales can begin. This is estimated to cost an additional $500,000. Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $300,000 will be required. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months to plan, execute, and document. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Partial funding will be provided from reagent sales. It is estimated additional funding of a minimum of $2 to $3 million will be required b. Bladder: Validation is projected to be complete by 4th quarter 2006. The formulation is expected to be identical to that for lung; therefore manufacturing will be in place. Based on this benchmark, FDA product listing and registration will only require an update. Funding will be provided by reagent sales revenue. Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $100,000 will be required based on the assumption that a 510K of lung cancer has been approved. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months to plan, execute, and document. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Partial funding will be provided from reagent sales. It is estimated additional funding of $2 million will be required. c. Cervical: Validation is projected to be complete by 3rd quarter 2007. The formulation is expected to be identical to that for lung; therefore manufacturing will be in place. Based on this benchmark, FDA product listing and registration will only require an update. Funding will be provided by reagent sales revenue. Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $100,000 will be required based on the assumption that a 510K of lung cancer has been approved. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months planning, executing, and documenting. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Partial funding will be provided from reagent sales. It is estimated additional funding of $2 million will be required. Costs in complying with regulatory and legislative matters such as the Clinical Laboratory Improvement Amendment of 1988 (CLIA), which regulates the quality and reliability of medical testing in the U.S., adverse changes in zoning laws, tax laws, or other laws affecting the medical and diagnostic industry may prove to be a major obstacle, both in respect of time and costs, in our research and development. 15 INFLATION Management believes that inflation has not had a material effect on the Company's results of operations. ACCOUNTING MATTERS Critical Accounting Policies - ---------------------------- In December 2001, the SEC requested that all registrants list their "three to five most critical accounting policies" in the MD&A. The SEC indicated that a 'critical accounting policy" is one which is both important to the portrayal of the Company's financial condition and results, and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Consolidation of variable interest entities - ------------------------------------------- In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB 51." The primary objectives of FIN No. 46 are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (variable interest entities or "VIEs") and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entity's activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46 for public entities that are small business issuers, as defined ("SBIs"), are as follows: (a) For interests in special-purpose entities: periods ended after December 15, 2003; and (b) For all other VIEs: periods ending after December 15, 2004. The December 2003 amendment of FIN No. 46 also includes transition provisions that govern how an SBI which previously adopted the pronouncement (as it was originally issued) must account for consolidated VIEs. As disclosed in Note 7 of the notes to consolidated financial statements, the Company is associated with Biomoda, Inc. Because of common ownership between the Company and Biomoda and other factors discussed in FIN No. 46R, the Company has complied with the pronouncement and consolidated the two companies' financial statements. See note 7 for the impact of adoption of the standard. Estimates - --------- Critical estimates made by management are, among others, estimates for current and deferred taxes, deferred tax valuation allowances, recoverability of intangible assets, realization of costs in excess of billings on uncompleted contract, collectibility of contract receivable, estimation of costs for long-term contracts, allowance for loss on contracts, recoverability of investment in and advances to Biomoda, Inc., valuation of marketable securities, and the valuation of other assets. Actual results could materially differ from those estimates. ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS The consolidated financial statements and notes to consolidated financial statements thereto, together with the report thereon of Malone & Bailey, PC (the Company's principal accountants) dated March 30, 2006 included elsewhere in this report, are incorporated by reference in answer to this Item 7. Following the above referenced report are the consolidated financial statements and notes to consolidated financial statements thereto, together with the report thereon of Malone & Bailey, PC (Biomoda's principal accountants) dated March 22, 2006 included elsewhere in this report, are incorporated by reference in answer to this Item 7. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. In a Current Report on Form 8-K filed on February 6, 2006, we dismissed our 16 former auditor, Kabani & Co., Inc. and retained Malone & Bailey, PC in a Current Report on Form 8-K filed on February 10, 2006, The decision to change auditors was approved by our board of directors. We did not have any disagreements with our former auditor on any matter of accounting principles or practices, disclosure, or auditing scope or procedure. ITEM 8A. EVALUATION OF CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the period covered by the annual report, which is December 31, 2005. Based upon that evaluation, the CEO and CFO concluded that, as of December 31, 2005, our disclosure controls and procedures were effective in timely alerting management to the material information relating to us required to be included in our periodic filings with the SEC. Based on their most recent evaluation as of the Evaluation Date, the CEO and the CFO have also concluded that there are no significant deficiencies in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Company's ability to record, process, summarize and report financial information, and such officers have identified no material weaknesses in the Company's internal controls over financial reporting. However, during the year ended December 31, 2005, the Company hired a Controller to evaluate and revise its existing control policies and procedures, including our disclosure controls and procedures, and to implement more effective and efficient controls and procedures. CHANGES IN CONTROLS AND PROCEDURES There were no significant changes made in our internal controls over financial reporting during the nine months ended September 30, 2005 that have materially affected or are reasonably likely to materially affect these controls. The Company, however, is evaluating changes to its existing controls or adding controls to improve the design effectiveness of its system. LIMITATIONS ON THE EFFECTIVENESS OF INTERNAL CONTROL The Company's management, including the CEO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material errors. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations on all internal control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, and/or by management override of the control. The design of any system of internal control is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in circumstances, and/or the degree of compliance with the policies and procedures may deteriorate. Because of the inherent limitations in a cost-effective internal control system, financial reporting misstatements due to error or fraud may occur and not be detected on a timely basis. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. The following sets forth information, as of December 31, 2005, concerning the Company's directors and executive officers: Name Age Position Since Michael Pete 62 President, Director July 1994 Leslie S. Robins 68 Exec. Vice Pres., Secretary, November 1992 Chairman John J. Cousins 49 Vice President, Treasurer June 1999 Dr. Linda Obenour 63 Director June 2004 The Company elects its Board of Directors at meetings of shareholders. In the event of a vacancy due to resignation, removal or death, the remaining duly elected Directors may fill such vacancy until the next meeting of the shareholders. Officers of the Company are elected by the Board of Directors, 17 which shall at a minimum elect a president, a secretary and a treasurer to hold office for one year and thereafter until their successors are elected. The Board of Directors may, from time to time, by resolution, appoint one or more vice presidents, assistant secretaries, assistant treasurers and transfer agents of the Company as it may deem advisable, prescribe their duties; and fix their compensation. MICHAEL PETE has been President and a director of the Company since May 1996, and prior to joining us, he served in the same capacities with the Company's predecessor, PLZ Tech, since July 1994. From 1990 to 1994, Mr. Pete was President of SEES New Mexico Inc., working with federal research and development labs in Los Alamos and Sandia to create and implement information management systems. From 1982 to 1990, Mr. Pete was President of Phoenix Filtration Systems, and from 1979 to 1981, he was a technical management consultant in the Office of the Secretary for the United States Department of Energy. From 1977 to 1979, Mr. Pete was a project manager for the consulting firm of Booz, Allen and Hamilton, and from 1975 to 1977, he was Office Director of the Low Income Weatherization Federal Energy Administration in Washington, D.C. Mr. Pete has a B.A. from Williams College and attended Stanford University Graduate School of Business and Political Science. LESLIE S. ROBINS has been Executive Vice President, Secretary and Chairman of the Board of the Company since May 1996, and prior to joining us, he served in the same capacities with the Company's predecessor, PLZ Tech, since November 1992. From November 1989 to December 1992, Mr. Robins was Managing Partner of Coronado Group, performing analyses of small technology companies, and from May 1986 to June 1989, he was Executive Vice President of Triton Productions Inc. From September 1978 to October 1987, Mr. Robins was Managing Partner of Longview Management; serving as investment managers for individuals in the entertainment industry. Mr. Robins has a B.S. from the University of Miami and attended Harvard Business School. JOHN J. COUSINS, Vice President of Finance and Treasurer - Mr. Cousins began his business career as a design engineer for Ampex Corp and the American Broadcasting Company. After receiving his MBA from the Wharton School he held several senior financial management positions focusing on capital markets and business development. He is also President of Biomoda, Inc. He holds undergraduate degrees from Boston University and the Lowell Institute School at MIT. LINDA C. OBENOUR, MD, Director has been a member of our Board of Directors since June 2004 .Dr. Obenour has had a private practice in Ophthalmology for over 30 years. Dr. Obenour has spent the majority of her career in Houston, Texas after graduating from Duke University Medical School and taking her residency at Baylor College of Medicine. In the late 1990's she was personal ophthalmologist of George H. W. Bush. Since 1972, Dr. Obenour has been certified Board Eligible by the American Academy of Ophthalmology. She has extensive postgraduate training, teaching and research experience, and numerous publications. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers and persons who own more than ten percent of a registered class of the Company's equity securities to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are requited by SEC regulations to furnish the Company with copies of all Sections 16(a) forms they file. To the Company's knowledge, based solely on the review of copies of such reports furnished to the Company and written representations that no other reports were required and to the best of its knowledge, during the year ended December 31, 2005, all Section 16(a) filing requirements applicable to the Company's officers, directors and greater than ten percent shareholders were complied with. FAMILY RELATIONSHIPS There are no family relationships between or among the directors, executive officers or persons nominated or charged by the Company to become directors or executive officers. INVOLVEMENT IN LEGAL PROCEEDINGS To the best of the Company's knowledge, during the past five years, none of the following occurred with respect to a present or former director or executive officer of the Company: (1) Any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time; (2) Any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); (3) Being subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of any competent jurisdiction, permanently or temporarily enjoining barring, suspending or other wise limiting his involvement in any type of business, securities or banking activities; and (4) Being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated. 18 CODE OF ETHICS For the year ended December 31, 2005, the Company did not have formal written values and ethical standards. However, the Company management does communicate values and ethical standards during company wide meetings. AUDIT COMMITTEE FINANCIAL EXPERT The Company does not have an independent audit committee. Since our securities are not currently listed on or with a national securities exchange or national securities association, we are not required to have an independent audit committee. Therefore, the Company has not designated an audit committee financial expert. The Company currently is in the process of identifying independent audit committee members, including a financial expert to serve on our audit committee and we expect to continue this process in 2005. ITEM 10. EXECUTIVE COMPENSATION The following table discloses the annual and long-term compensation earned for services rendered in all capacities by the Company's Chairman of the Board and President and the Company's other most highly compensated executive officers for 2002, 2003 and 2004:
Summary Compensation Table - -------------------------- ---------- --------------------------------------- ------------------------- --------- -------------- Annual Compensation Long-Term Compensation Awards - -------------------------- ---------- --------------------------------------- ------------------------- --------- -------------- Other Annual Restricted Securities LTIP All Other Compensation Stock Underlying Payouts Compensation (1) Award(s) Options - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- Name and Principal Year Salary ($) Bonus ($) ($) ($) (#) ($) ($) Position - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- Michael Pete, President, Director - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2005 $ 24,000 -- -- -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2004 $ 38,500 -- -- -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2003 $ 13,325 -- -- -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- Leslie S. Robins, Chairman of the Board and Exec. VP - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2005 $222,767 -- $ 7,932 (1) -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2004 $356,331 -- $ 7,932 (1) -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2003 $552,444 -- $ 8,500 (1) -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- John J. Cousins, VP Finance - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2005 $109,406 -- -- -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2004 $112,335 -- -- -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2003 $113,965 -- -- -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- Dr. Linda Obenour, 2005 $ 0 $ 16,000 (2) Director - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- -------------- 2004 -- -- $ 12,000 (3) -- -- -- -- - -------------------------- ---------- ------------- ---------- -------------- ---------- -------------- --------- --------------
19 (1) Represents the value of an automobile used by Mr. Robins. (2) Directors Fee OPTION GRANTS IN FISCAL YEAR 2005 None. Aggregated Option Exercises In Fiscal Year 2005 And Option Values At December 31, 2005 The following table provides summary information concerning the shares of common stock represented by outstanding stock options held by our Chief Executive Officer and two other executive officers as of December 31, 2005.
Year-End Option Values Number of Securities Underlying Value of Unexercised Unexercised Options In-the-Money Options Shares Acquired Value December 31, 2005 December 31, 2005 Name on Exercise (#) Realized ($) Exercisable (#) Unexercisable (#) Exercisable ($) Unexercisable ($) - ---- --------------- ------------ ---------------- ----------------- ---------------- ----------------- Michael Pete -- -- 150,000 -- $3,000 -- John Cousins -- -- 250,000 -- $5,000 -- Total -- -- 400,000 -- $8,000 --
On January 4, 1999, the Company established the Incentive Stock Option Plan (the "Plan"). Pursuant to the Plan, up to 10,000,000 shares of the Company's common stock may be granted as options to key employees. The exercise dates of the options are based on the related agreement, as approved by the Board of Directors. The Plan expires on January 4, 2009. Options awarded under the Plan mature four years from the date of the grant and vest ratably over one to two year periods. LONG-TERM INCENTIVE PLANS As of December 31, 2005 there is no long-term incentive plan. DIRECTOR COMPENSATION Non-employee directors of the Company received $16,000 in 2005 for Directors Fees. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENIFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information known to the Company with respect to beneficial ownership of the Company's Common Stock as of March 25, 2006 by (a) each person known to the Company to beneficially own more than five percent of the Company's Common Stock, (b) each Director, (c) the Named Executive Officers, and (d) all Directors and executive officers as a group. Unless otherwise indicated in the footnotes to the table, the beneficial owners named have, to the knowledge of the Company, sole voting and investment power with respect to the shares beneficially owned, subject to community property laws where applicable. As of December 31, 2005 there were 6,023,836,349 shares outstanding. 20 Percent Number of Shares Beneficially Name of Beneficial Owner (1) Beneficially Owned Owned ----------------------------- -------------------- ------------- Leslie Robins*...................... 10,831,546 * Michael Pete*....................... 325,000(2) * John Cousins*....................... 400,000(3) * *All directors and executive officers as a group 1,556,546 * - ------------------ *Less than 1.0%. (1) The address of all persons who are executive officers or directors of the Company is in care of the Company, 8301 Washington Street NE, Suite 5, Albuquerque New Mexico 87113. (2) Includes 150,000 shares of common stock issuable upon exercise of options which are currently exercisable. (3) Includes 250,000 shares of common stock issuable upon exercise of options, which are currently exercisable. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 The Company believes that the beneficial owners of securities listed above, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the Commission and generally includes voting or investment power with respect to securities. Shares of stock subject to options or warrants currently exercisable or exercisable within 60 days, are deemed outstanding for purposes of computing the percentage of the person holding such options or warrants, but are not deemed outstanding for purposes of computing the percentage of any other person. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS NOTES RECEIVABLE As of December 31, 2004, the Company had net advances to an officer approximating $67,300. The advances accrued interest at rates ranging from 5% to 6% and were due on demand. As these notes receivable were with a shareholder and a Company officer, the Company had classified these amounts as a decrease to stockholders' equity at December 31, 2004. During 2005, the Company advanced approximately $472,000 to Biomoda under a line of credit agreement (see below). The advances accrue interest at 5% and are due on demand. Investment In Biomoda, Inc As of December 31, 2005, the Company owned 1,132,285 or 15.75% of the 7,187,282 outstanding shares of Biomoda, a development stage company involved primarily in the development of technology for the early detection of lung cancer. As a development stage company, Biomoda has not had any revenues as of December 31, 2005. In compliance with FASB FIN 46, Advanced Optics Electronics, Inc. has consolidated its financial statements with those of Biomoda at December 31, 2005 and 2004. Biomoda has filed a SB-2 registration statement with the Securities and Exchange Commission, in which they are offering 6,000,000 shares of its common stock. The initial offering price is $3.00 per share, however the price that Biomoda, and the Company, will be able to sell the shares is not determinable. A market for Biomoda's shares has not been established; therefore the potential value of the Company's investment cannot be measured. There can be no assurance that if the Company was to sell such investment that it would be able to on terms favorable to the Company or for the initial offering price. Factors such as dilution, blockage and a lack of market may be encountered. For the year ended December 31, 2001, the Company reported its investment under the cost method since its ownership was not sufficient for the investment to be accounted for using the equity method. During 2002, the Company's influence over Biomoda increased such that the investment qualified for accounting under the equity method. The Company recognized the proportionate interest in Biomoda's net loss for the year ended December 31, 2005 and 2004 until such time as the net investment without regard to the advance was reduced to zero. 21 ITEM 13. EXHIBITS, FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES Indexes to financial statements appear after the signature page to this Form 10-KSB. - -------------------------------------------------------------------------------- Exhibits - -------------------------------------------------------------------------------- 2 Plan of Acquisition, Reorganization, None arrangement liquidation, or succession - --------- ------------------------------------------- -------------------------- 3.1 Articles of Incorporation Incorporated by reference to Exhibit 3(I) of the Company's Registration Statement No.1000-24511 on Form10-SB filed June 23,1998. - --------- ------------------------------------------- -------------------------- 3.2 By-Laws Incorporated by reference to Exhibit 3(ii) of the Company's Registration Statement No.1000-24511 on Form 10-SB filed June 23,1998. - --------- ------------------------------------------- -------------------------- 4 Instruments defining the rights of Incorporated by reference holders, including Indentures to Exhibit 3.2 - --------- ------------------------------------------- -------------------------- 7 Opinion re: liquidation preference Incorporated by reference to Exhibit 3.2 - --------- ------------------------------------------- -------------------------- 10.1 Incentive Stock Option Plan Incorporated by reference to Exhibit 10.1 - --------- ------------------------------------------- -------------------------- 10.2 Lease Agreement Advanced Optics Incorporated by reference Electronics, Inc. and JMP Company Inc to Exhibit 10.2 of the Company's Registration Statement No.1000-24511 on Form10-SB filed June 23,1998. - --------- ------------------------------------------- -------------------------- 10.3 State of Nevada Corporate Charter Incorporated by reference to Exhibit 10.3 of the Company's Registration Statement No.1000-24511 on Form 10-SB filed June 23,1998. - --------- ------------------------------------------- -------------------------- 24 Power of Attorney Incorporated by reference to Exhibit 3.2 - --------- ------------------------------------------- -------------------------- 31.1 Certification of Chief Executive Officer Filed Herewith pursuant to Section 302 of the Sarbanes Oxley Act of 2002 - --------- ------------------------------------------- -------------------------- 31.2 Certification of Chief Financial Officer Filed Herewith pursuant to Section 302 of the Sarbanes Oxley Act of 2002 - --------- ------------------------------------------- -------------------------- 32.1 Certification Pursuant To 18 U.S.C. Filed Herewith ss.1350, As Adopted Pursuant To Section 906 Of The SARBANES-OXLEY ACT OF 2002 - --------- ------------------------------------------- -------------------------- 32.2 Certification Pursuant To 18 U.S.C. Filed Herewith ss.1350, As Adopted Pursuant To Section 906 Of The SARBANES-OXLEY ACT OF 2002 - --------- ------------------------------------------- -------------------------- REPORTS ON FORM 8-K In a Current Report on Form 8-K filed on January 13, 2005, we dismissed our former auditor, Squar Milner Reehl & Williamson, LLP and hired Singer Lewak Greenbaum & Goldstein, LLP. The decision to change auditors was approved by our board of directors. We did not have any disagreements with our former auditor on any matter of accounting principles or practices, disclosure, or auditing scope or procedure. 22 In a Current Report on Form 8-K filed on March 4, 2005, we dismissed our former auditor, Singer, Lewak, Greenbaum & Goldstein LLP. On March 4, 2005, we engaged Kabani & Co., Inc. as our new auditor. The decision to change auditors was approved by our board of directors. We did not have any disagreements with our former auditor on any matter of accounting principles or practices, disclosure, or auditing scope or procedure. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES AUDIT FEES The aggregate fees billed by our auditors for professional services rendered in connection with the audit of our annual consolidated financial statements for the fiscal years ended December 31, 2004 and 2005 were $45,000 and $60,300 respectively. AUDIT-RELATED FEES Our auditors did not bill any additional fees for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements. TAX FEES The aggregate fees billed by our auditors for professional services for tax compliance, tax advice, and tax planning were approximately $3,000 and $2,500 for the fiscal years ended December 31, 2004 and 2005. ALL OTHER FEES The aggregate fees billed by our auditors for all other non-audit services, such as attending meetings and other miscellaneous financial consulting, for the fiscal years ended December 31, 2004 and 2005 were $0 and $0 respectively. POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT SERVICES OF INDEPENDENT AUDITOR The Company does not have an audit committee. Therefore, the Board of Directors is responsible for pre-approving all audit and permitted non-audit services to be performed for us by our independent auditor. 23 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report on Form 10KSB to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: April 6, 2006 ADVANCED OPTICS ELECTRONICS, INC. BY:/s/John J. Cousins ------------------ John J. Cousins Vice President of Finance (Principal Accounting Officer) BY:/s/Leslie S. Robins ------------------- Leslie S. Robins Executive Vice President (Principal Executive Officer) 24 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ------------------------------------------------------- To the Board of Directors Advanced Optics Electronics, Inc. (A Development Stage Company) Albuquerque, New Mexico We have audited the accompanying consolidated balance sheet of Advanced Optics Electronics, Inc. (a development stage company) as of December 31, 2005, and the related consolidated statements of operations, stockholder's deficit and cash flows for the year then ended and the period from May 22, 1996 (inception) to December 31, 2005. These financial statements are the responsibility of Advanced Optics Electronics, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements for the period from May 22, 1996 (inception) through December 31, 2004 were audited by other auditors whose reports expressed unqualified opinions on those statements. The consolidated financial statements for the period from May 22, 1996 (inception) through December 31, 2004 include total revenues and net loss of $0 and $19,825,110, respectively. Our opinion on the consolidated statements of operations, stockholders' deficit and cash flows for the period from May 22, 1996 (inception) through December 31, 2005, insofar as it relates to amounts for prior periods through December 31, 2004, is based solely on the reports of other auditors. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advanced Optics Electronics, Inc. as of December 31, 2005, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company is a development stage company which experienced significant losses since inception with no significant revenues. Also discussed in Note 1 to the consolidated financial statements, a significant amount of additional capital will be necessary to advance the development of the Company's products to the point at which they may become commercially viable. Those conditions, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding these matters are also described in Note 1. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Malone & Bailey, PC Houston, Texas www.malone-bailey.com March 30, 2006 25 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ------------------------------------------------------- To the Stockholders and Board of Directors Advanced Optics Electronics, Inc. We have audited the accompanying consolidated statements of operations, consolidated stockholders' equity (deficit) and comprehensive income and consolidated statements of cash flows of Advanced Optics Electronics, Inc., a Nevada Corporation (the "Company") for the year ended December 31, 2004. 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 of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of Advanced Optics Electronics, Inc.'s operations and its cash flows for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. The Company's financial statements are prepared using the generally accepted accounting principles applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company had deficit accumulated during the development stage of $19,825,110 at December 31, 2004, which included a net loss of $5,048,067 for the year ended December 31, 2004. These factors as discussed in Note 1 to the financial statements, raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. KABANI & COMPANY, INC. CERTIFIED PUBLIC ACCOUNTANTS Huntington Beach, California April 13, 2005 26 ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) CONSOLIDATED BALANCE SHEET December 31, 2005 ASSETS Current Assets Cash and cash equivalents $ 92,518 Marketable securities 902,027 Other current assets 24,252 ------------- Total current assets 1,018,797 Intangibles, net of accumulated amortization of $71,900 194,576 Property and Equipment, net of accumulated depreciation of $438,380 120,328 Other Assets Notes receivable and deposits 54,406 ------------- $ 1,388,107 ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 165,546 Accrued expenses 363,658 Advances from shareholders 149,002 Advances from officer - Convertible debenture 88,574 ------------- Total current liabilities 766,780 ------------- Commitments and Contingencies Stockholders' Equity Preferred stock, $0.001 par value, 10,000,000 shares authorized; no shares issued and outstanding - Common stock, $0.001 par value, 7,000,000,000 shares authorized; 6,023,836,349 shares issued and outstanding 6,023,836 Treasury stock, at cost (12,660) Additional paid in capital 16,326,251 Accumulated other comprehensive gain 164,789 Deficit accumulated during the development stage (21,880,889) ------------- Total stockholders' equity 621,327 ------------- $ 1,388,107 ============= - ------------------------------------------------------------------------------- See accompanying notes to the consolidated financial statements. F-1 ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 2005 and 2004 From May 22, 1996 (Inception) Through December 31, 2005
May 22, 1996 (Inception) Through December 31 2005 2004 2005 ------------ ------------ ------------ REVENUES $ -- $ -- $ -- OPERATING EXPENSES General and administrative 1,027,087 1,493,145 11,632,050 Payroll and related 900,424 548,171 2,433,221 Research and development 26,528 658,859 2,128,177 Professional Fees 83,174 134,218 253,555 Depreciation & amortization 52,727 40,219 178,207 Licensing Fees 15,125 15,776 53,101 Inventory write-off -- 29,293 29,293 Asset impairment -- 365,314 592,884 ------------ ------------ ------------ Total operating expenses 2,105,065 3,284,995 17,300,488 LOSS ON CONTRACT -- 1,000,944 2,255,944 ------------ ------------ ------------ OPERATING LOSS (2,105,065) (4,285,939) (19,556,432) ------------ ------------ ------------ OTHER INCOME (EXPENSES) Interest income 4,572 3,397 84,953 Realized gain (loss) on marketable equity securities 84,099 (98,560) (43,829) Other investment gains -- -- 59,784 Loss from investment in Biomoda, Inc. -- -- (289,750) Gain (loss) on disposal of assets -- 786 (3,520) Gain (loss) on settlement of debts -- (620,980) (556,088) Interest expense (39,385) (47,322) (1,324,258) Other income -- 551 551 ------------ ------------ ------------ Total other income (expenses) 49,286 (762,128) (2,072,157) ------------ ------------ ------------ NET LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE & EXTRAORDINARY LOSS (2,055,779) (5,048,067) (21,628,589) EXTRAORDINARY LOSS -- -- (189,280) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- -- (63,020) ------------ ------------ ------------ NET LOSS $ (2,055,779) $ (5,048,067) $(21,880,889) ============ ============ ============ OTHER COMPREHENSIVE (LOSS) GAIN Unrealized loss on marketable securities 174,480 (27,140) 164,789 ------------ ------------ ------------ COMPREHENSIVE LOSS (1,881,299) (5,075,207) (21,716,100) ============ ============ ============ Basic and diluted net loss per common share $ (0.000) $ (0.002) ============ ============ Basic and diluted weighted average common shares outstanding 4,379,768,678 2,887,373,986 ============ ============
- ------------------------------------------------------------------------------- See accompanying notes to the consolidated financial statements. F-2 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE INCOME For The Period From May 22, 1996 (Inception) Through December 31, 2005 - --------------------------------------------------------------------------------
Preferred Stock Common Stock ---------------------------- ---------------------------- Shares Amount Shares Amount ------------ ------------ ------------ ------------ Balance at May 22, 1996 (Inception) -- $ -- -- $ -- Stock issued to incorporators for cash -- -- 500,000 500 Stock issued for the net assets of PLZ Tech, Inc. -- -- 4,500,000 4,500 Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1996 -- -- 5,000,000 5,000 Stock issued for cash and services -- -- 2,281,212 2,281 Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1997 -- -- 7,281,212 7,281 Stock issued for cash -- -- 10,979,275 10,979 Stock issued for services -- -- 2,751,000 2,751 Stock issued in exchange for note receivable -- -- 315,000 315 Purchase and retirement of treasury stock -- -- (472,200) (472) Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1998 -- -- 20,854,287 20,854 Stock issued for cash -- -- 8,681,624 8,682 Stock issued for services -- -- 17,094,313 17,094 Intrinsic value of beneficial conversion feature of notes payable -- -- -- -- Fair value of warrants related to notes payable -- -- -- -- Purchase and retirement of treasury stock -- -- (489,251) (489) Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1999 -- -- 46,140,973 46,141 Stock issued for cash 710 1 782,000 782 Stock issued for services -- -- 3,955,202 3,955 Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- -- -- Exercise of stock options for notes receivable -- -- 1,850,000 1,850 Amortization of discount of convertible preferred stock -- -- -- -- Exercise of preferred stock conversion feature -- -- 9,200,000 9,200 Issuance of convertible debentures -- -- -- -- Exchange of preferred stock for convertible debentures (710) (1) -- -- Intrinsic value of convertible debenture -- -- -- -- De-investment in Wizard Technologies -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2000 -- -- 61,928,175 61,928 Stock issued for cash -- -- 1,382,778 1,383 Stock issued for services -- -- 10,461,498 10,461 Purchase of treasury stock -- -- -- -- Amortization of discount on convertible debentures -- -- -- -- Stock issued upon debt conversion -- -- 7,064,886 7,065 Net loss -- -- -- -- ------------ ------------ ------------ ------------ - ---------------------------------------------------------------------------------------------------------- See accompanying notes to the consolidated financial statements. F-3 Balance, December 31, 2001 -- -- 80,837,337 80,837 Stock issued for cash -- -- 315,845,000 315,845 Stock issued for services -- -- 115,768,000 115,768 Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- -- -- Exercise of stock options for notes receivable -- -- 1,100,000 1,100 Advances to officer -- -- -- -- Reclass of accrued interest with note receivable -- -- -- -- Stock issued upon debt conversion -- -- 78,695,566 78,696 Retroactive application of equity method for investment in Biomoda, Inc. -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2002 -- -- 592,245,903 592,246 Stock issued for cash -- -- 1,477,760,000 1,477,760 Stock issued for services -- -- 367,249,994 367,250 Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- -- -- Accrued interest on advances to officer -- -- -- -- Cancellation of stock issued for note receivable -- -- (2,950,000) (2,950) Stock issued upon debt conversion, including $67,000 of interest -- -- 320,830,452 320,830 Gain on sale of available for sale securities -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2003 -- -- 2,755,136,349 2,755,136 Stock issued for cash -- -- 462,800,000 462,800 Stock issued for services -- -- 47,200,000 47,200 Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- -- -- Stock issued upon debt conversion, including $166,240 of interest -- -- 103,000,000 103,000 Unrealized gain (loss) on marketable securities -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2004 -- -- 3,368,136,349 3,368,136 Stock issued for cash -- -- 2,634,700,000 2,634,700 Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- -- -- Expense advances to officer, net of accrued interest -- -- -- -- Stock issued upon debt conversion -- -- 21,000,000 21,000 Unrealized gain (loss) on marketable securities -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2005 -- $ -- 6,023,836,349 $ 6,023,836 ============ ============ ============ ============
F-4 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE INCOME For The Period From May 22, 1996 (Inception) Through December 31, 2005 - --------------------------------------------------------------------------------
Treasury Stock Additional ----------------------------- Paid In N/R Shares Amount Capital Stockholder ------------ ------------ ------------ ------------ Balance at May 22, 1996 (Inception) -- $ -- $ -- $ -- Stock issued to incorporators for cash -- -- 24,500 -- Stock issued for the net assets of PLZ Tech, Inc. -- -- 281,096 -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1996 -- -- 305,596 -- Stock issued for cash and services -- -- 362,720 -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1997 -- -- 668,316 -- Stock issued for cash -- -- 1,281,728 -- Stock issued for services -- -- 293,719 -- Stock issued in exchange for note receivable -- -- 28,685 -- Purchase and retirement of treasury stock -- -- (39,913) -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1998 -- -- 2,232,535 -- Stock issued for cash -- -- 855,101 -- Stock issued for services -- -- 1,469,320 -- Intrinsic value of beneficial conversion feature of notes payable -- -- 174,610 -- Fair value of warrants related to notes payable -- -- 125,000 -- Purchase and retirement of treasury stock -- -- (10,643) -- Purchase of treasury stock (229,000) (41,760) -- -- Sale of treasury stock 85,000 11,130 24,334 -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 1999 (144,000) (30,630) 4,870,257 -- Stock issued for cash -- -- 1,012,710 -- Stock issued for services -- -- 1,726,197 -- Purchase of treasury stock (63,500) (46,486) -- -- Sale of treasury stock 142,400 22,542 54,771 -- Exercise of stock options for notes receivable -- -- 220,150 -- Amortization of discount of convertible preferred stock -- -- 159,677 -- Exercise of preferred stock conversion feature -- -- 533,678 -- Issuance of convertible debentures -- -- 263,830 -- Exchange of preferred stock for convertible debentures -- -- (869,678) -- Intrinsic value of convertible debenture -- -- 227,898 -- De-investment in Wizard Technologies -- -- (59,583) -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2000 (65,100) (54,574) 8,139,907 (193,427) Stock issued for cash -- -- 66,844 -- Stock issued for services -- -- 412,284 -- Purchase of treasury stock (251,700) (16,215) -- -- Amortization of discount on convertible debentures -- -- 143,875 -- Stock issued upon debt conversion -- -- 147,008 -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ - ------------------------------------------------------------------------------------------------------------ See accompanying notes to the consolidated financial statements. F-5 Balance, December 31, 2001 (316,800) (70,789) 8,909,918 (193,427) Stock issued for cash -- -- 229,816 -- Stock issued for services -- -- 366,301 -- Purchase of treasury stock (1,400,000) (8,732) -- -- Sale of treasury stock 507,800 72,887 (65,058) -- Exercise of stock options for notes receivable -- -- 20,900 (22,000) Advances to officer -- -- -- (34,300) Reclass of accrued interest with note receivable -- -- -- (59,175) Stock issued upon debt conversion -- -- 348,324 -- Retroactive application of equity method for investment in Biomoda, Inc. -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2002 (1,209,000) (6,634) 9,810,201 (308,902) Stock issued for cash -- -- 4,553,055 -- Stock issued for services -- -- 1,464,845 -- Purchase of treasury stock (13,250,000) (61,943) -- -- Sale of treasury stock 9,950,000 24,846 31,707 -- Accrued interest on advances to officer -- -- -- (2,397) Cancellation of stock issued for note receivable -- -- (241,050) 244,000 Stock issued upon debt conversion, including $67,000 of interest -- -- 337,563 -- Gain on sale of available for sale securities -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2003 (4,509,000) (43,731) 15,956,321 (67,299) Stock issued for cash -- -- 656,231 -- Stock issued for services -- -- 207,580 -- Purchase of treasury stock (9,800,000) (41,724) -- -- Sale of treasury stock 14,100,000 48,260 -- -- Stock issued upon debt conversion, including $166,240 of interest -- -- 1,022,790 -- Unrealized gain (loss) on marketable securities -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2004 (209,000) (37,195) 17,842,922 (67,299) Stock issued for cash -- -- (1,487,526) -- Purchase of treasury stock (22,205,000) (15,926) -- -- Sale of treasury stock 1,804,000 40,461 (39,267) -- Expense advances to officer, net of accrued interest -- -- -- 67,299 Stock issued upon debt conversion -- -- 10,122 -- Unrealized gain (loss) on marketable securities -- -- -- -- Net loss -- -- -- -- ------------ ------------ ------------ ------------ Balance, December 31, 2005 (20,610,000) $ (12,660) $ 16,326,251 $ -- ============ ============ ============ ============
F-6 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE INCOME For The Period From May 22, 1996 (Inception) Through December 31, 2005 - --------------------------------------------------------------------------------
Deficit Other Accumulated Total Comprehensive During the Stockholders' Income Development Stage equity (deficit) ------------ ------------ ------------ Balance at May 22, 1996 (Inception) $ -- $ -- $ -- Stock issued to incorporators for cash -- -- 25,000 Stock issued for the net assets of PLZ Tech, Inc. -- -- 285,596 Net loss -- (76,902) (76,902) ------------ ------------ ------------ Balance, December 31, 1996 -- (76,902) 233,694 Stock issued for cash and services -- -- 365,001 Net loss -- (84,690) (84,690) ------------ ------------ ------------ Balance, December 31, 1997 -- (161,592) 514,005 Stock issued for cash -- -- 1,292,707 Stock issued for services -- -- 296,470 Stock issued in exchange for note receivable -- -- 29,000 Purchase and retirement of treasury stock -- -- (40,385) Net loss -- (752,111) (752,111) ------------ ------------ ------------ Balance, December 31, 1998 -- (913,703) 1,339,686 Stock issued for cash -- -- 863,783 Stock issued for services -- -- 1,486,414 Intrinsic value of beneficial conversion feature of notes payable -- -- 174,610 Fair value of warrants related to notes payable -- -- 125,000 Purchase and retirement of treasury stock -- -- (11,132) Purchase of treasury stock -- -- (41,760) Sale of treasury stock -- -- 35,464 Net loss -- (2,765,862) (2,765,862) ------------ ------------ ------------ Balance, December 31, 1999 -- (3,679,565) 1,206,203 Stock issued for cash -- -- 1,013,493 Stock issued for services -- -- 1,730,152 Purchase of treasury stock -- -- (46,486) Sale of treasury stock -- -- 77,313 Exercise of stock options for notes receivable -- -- 28,573 Amortization of discount of convertible preferred stock -- -- 159,677 Exercise of preferred stock conversion feature -- -- 542,878 Issuance of convertible debentures -- -- 263,830 Exchange of preferred stock for convertible debentures -- -- (869,679) Intrinsic value of convertible debenture -- -- 227,898 De-investment in Wizard Technologies -- -- (59,583) Net loss -- (3,827,873) (3,827,873) ------------ ------------ ------------ Balance, December 31, 2000 -- (7,507,438) 446,396 Stock issued for cash -- -- 68,227 Stock issued for services -- -- 422,745 Purchase of treasury stock -- -- (16,215) Amortization of discount on convertible debentures -- -- 143,875 Stock issued upon debt conversion -- -- 154,073 Net loss -- (1,985,142) (1,985,142) ------------ ------------ ------------ - ------------------------------------------------------------------------------------------------------ See accompanying notes to the consolidated financial statements. F-7 Balance, December 31, 2001 -- (9,492,580) (766,041) Stock issued for cash -- -- 545,661 Stock issued for services -- -- 482,069 Purchase of treasury stock -- -- (8,732) Sale of treasury stock -- -- 7,829 Exercise of stock options for notes receivable -- -- -- Advances to officer -- -- (34,300) Reclass of accrued interest with note receivable -- -- (59,175) Stock issued upon debt conversion -- -- 427,020 Retroactive application of equity method for investment in Biomoda, Inc. -- (97,674) (97,674) Net loss -- (1,285,830) (1,285,830) ------------ ------------ ------------ Balance, December 31, 2002 -- (10,876,084) (789,173) Stock issued for cash -- -- 6,030,815 Stock issued for services -- -- 1,832,095 Purchase of treasury stock -- -- (61,943) Sale of treasury stock -- -- 56,553 Accrued interest on advances to officer -- -- (2,397) Cancellation of stock issued for note receivable -- -- -- Stock issued upon debt conversion, including $67,000 of interest -- -- 658,393 Gain on sale of available for sale securities 17,449 -- 17,449 Net loss -- (3,900,959) (3,900,959) ------------ ------------ ------------ Balance, December 31, 2003 17,449 (14,777,043) 3,840,833 Stock issued for cash -- -- 1,119,031 Stock issued for services -- -- 254,780 Purchase of treasury stock -- -- (41,724) Sale of treasury stock -- -- 48,260 Stock issued upon debt conversion, including $166,240 of interest -- -- 1,125,790 Unrealized gain (loss) on marketable securities (27,140) -- (27,140) Net loss -- (5,048,067) (5,048,067) ------------ ------------ ------------ Balance, December 31, 2004 (9,691) (19,825,110) 1,271,763 Stock issued for cash -- -- 1,147,174 Purchase of treasury stock -- (15,926) Sale of treasury stock -- -- 1,194 Expense advances to officer, net of accrued interest -- -- 67,299 Stock issued upon debt conversion -- -- 31,122 Unrealized gain (loss) on marketable securities 174,480 -- 174,480 Net loss -- (2,055,779) (2,055,779) ------------ ------------ ------------ Balance, December 31, 2005 $ 164,789 $(21,880,889) $ 621,327 ============ ============ ============
- ------------------------------------------------------------------------------- See accompanying notes to the consolidated financial statements. F-8 ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2005 and 2004 and for the Period From May 22, 1996 (Inception) Through December 31, 2005
May 22, 1996 (Inception) Through December 31, 2005 2004 2005 ------------ ------------ ------------ Cash flows from operating activities: Net loss $ (2,055,779) $ (5,048,067) $(21,880,889) Adjustments to reconcile net loss to net cash used in operating activities: Intrinsic value of conversion features -- -- 610,603 Write off of organization costs/goodwill -- -- 63,020 Extraordinary loss -- -- 189,280 Inventory write off -- 29,293 29,293 Amortization of discount on convertible notes and -- preferred stock -- -- 295,209 Loss (Gain) on marketable securities (84,099) 98,560 43,829 Loss on disposal of assets -- (786) 3,520 Loss on investment in Biomoda, Inc. -- -- 289,750 Issuance of common stock for services -- -- 6,504,726 Issuance of Biomoda common stock and options for services -- 254,780 165,000 Issuance of notes payable for services -- 18,000 50,000 Exchange of investment securities for services 153,428 -- 153,428 Increase in excess of costs and earnings over billings on uncompleted contract -- -- (2,050,000) Increase in allowance for loss on contract -- 795,000 2,050,000 Loss (Gain) on extinguishment of debt -- 620,980 556,088 Interest accrued on convertible debentures 8,481 -- 317,985 Interest earned on note receivable from stockholder and related parties -- -- (17,823) Depreciation and amortization 52,727 40,218 716,167 Bad debt expense -- -- 15,000 Asset impairment -- 365,314 592,884 Other non-cash expenses 1,476 -- 34,923 Accrued interest -- -- 30,667 Expense advances to officer 67,299 -- 67,299 Gain on forgiveness of debt to officer (51,351) -- (51,351) Changes in operating assets and liabilities: Decrease (Increase) in other current assets (6,806) 26,233 (19,019) Decrease in inventory -- -- (35,293) (Decrease) Increase in accounts payable, accrued and other liabilities 180,553 (164,019) 206,493 ------------ ------------ ------------ Net cash provided by (used in) operating activities (1,734,071) (2,964,495) (11,069,211) ------------ ------------ ------------ F-9 Cash flows from investing activities: Purchases of property and equipment (3,780) (61,276) (521,860) Additions to Patent, trademark and license fee, net of extraordinary gain (34,106) (63,742) (114,878) Investment in GenoMed (21,478) (900,000) (921,478) Proceeds from sale of GenoMed stock 184,046 -- 184,046 Investment in Biomoda, Inc. -- -- (383,845) Proceeds from sale of Biomoda, Inc. stock -- -- 28,930 Advances to Biomoda, Inc. -- -- (38,432) Advances from shareholders -- 4,445 14,009 Sale of marketable securities -- 152,122 192,787 Purchases of marketable securities -- (536,000) (645,334) Cash of variable entity on consolidation -- -- 155 Increase in notes receivable (4,827) (14,579) (54,406) Purchase of other assets -- -- (245,579) ------------ ------------ ------------ Net cash used in investing activities 119,855 (1,419,029) (2,505,885) ------------ ------------ ------------ Cash flows from financing activities: Principal repayments on notes payable and capital leases (38,359) -- (308,346) Proceeds from notes payable -- -- 622,776 Issuance of common stock for cash 1,147,173 1,119,031 12,470,891 Issuance of Biomoda common stock for cash -- 60,000 60,000 (Increase) decrease in note receivable stockholder -- -- (5,422) Proceeds from sale of treasury stock 1,194 48,260 226,613 Purchase of treasury stock (15,926) (41,724) (274,303) Proceeds from issuance of convertible debt -- -- 1,270,965 Principal repayments on convertible debt -- (154,000) (395,560) ------------ ------------ ------------ Net cash provided by financing activities 1,094,082 1,031,567 13,667,614 ------------ ------------ ------------ Net (decrease) increase in cash (520,134) (3,351,957) 92,518 Cash at beginning of period 612,652 3,964,609 -- ------------ ------------ ------------ Cash at end of period $ 92,518 $ 612,652 $ 92,518 ============ ============ ============ Supplemental disclosure of cash flow information Cash paid during the year for: Interest $ -- $ 451 ============ ============= Income taxes $ 50 $ 50 ============ ============= Non-cash transactions: Stock issued for debt conversion $ 31,122 $ 1,125,790 ============ ============= Change in unrealized gain (loss) on marketable securities $ 174,480 $ (27,140) ============ =============
F-10 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND NATURE OF OPERATIONS Advanced Optics Electronics, Inc. (the "Company") and Biomoda, Inc ("Biomoda"), a consolidated entity, are development stage technology companies focusing respectively on the development and production of large-scale flat panel displays and cancer detection methods. The Company's stock trades on the Over The Counter Bulletin Board under the symbol "ADOT." The Company plans to focus on producing and selling the large-scale flat panel displays for outdoor advertising billboards. The Company is developing a color recognition optical device and plans to initially focus on marketing it as a color identifier to the visually impaired and as a teaching aid for small children. The Company's unique and novel conception and implementation of hardware and firmware determines color optically and expresses the results with vocal responses. The Company intends to establish marketing arrangements for the distribution to retail locations after a supply has been manufactured and inventoried. Since May 22, 1996 ("Inception"), the Company has primarily been engaged in the research and development of its products. Once the research and development is complete, the Company will begin to manufacture and obtain new contracts. The Company is in the development stage and has not generated revenues from any product sales. The Company believes that its planned products will produce sufficient revenues in the future. There are no assurances, however, that the Company will be able to produce such products, or if produced, that they will be accepted in the market place. The Company's research and development work in 2005 has not completed the initial product as expected. Completion of the product is now expected in the latter half of 2006. In mid 2002, the Company's Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") replaced Biomoda's management team, affecting a change in control. The Company also owns 15.75% of Biomoda's outstanding common stock. On August 13, 2003, Biomoda formed a 100% owned subsidiary known as Biomoda Holdings, Inc., a Nevada corporation, for the purpose of research, development, production and marketing of medical and biomedical products. As of December 31, 2005, the Company owned 1,132,285 or 15.75% of the 7,187,282 outstanding shares of Biomoda. Two of the Company's officers own 12.24%, collectively, of Biomoda's outstanding shares. The Company subleases office space and lab equipment to Biomoda and two of the Company's officers are also officers of Biomoda. The Company has been the primary source of funding to Biomoda since 2002 through advances made under a line of credit agreement. The Company is considered the primary beneficiary as it stands to absorb the majority of Biomoda's, called herein as the variable interest entity, expected losses. Since Biomoda and the Company are considered entities under common control for accounting purposes, the Company measures the assets and liabilities of Biomoda at their carrying amounts in consolidation. (Note 6) Biomoda's primary focus is on early cancer detection technology. Its novel cell-labeling technology is globally patented for the detection of pre-cancerous - -------------------------------------------------------------------------------- F-11 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- and cancerous conditions in human fluid samples and tissue. This technology, based on a compound called Tetrakis Carboxy Phenyl Porphine (TCPP), was developed at St. Mary's hospital in Colorado and Los Alamos National Laboratories. Biomoda obtained a worldwide exclusive license to the TCPP technology from the University of California in late 1995, and began new research broadening the scope of the original patent and technology. Biomoda received its first patent in the Company's name (patent 6,838,248) issued on January 4, 2005 to detect pre-cancerous and cancerous conditions in all human tissue. Biomoda began the commercialization process by trademarking the technology as CyPath. Management expects to continue assay valuation work and register its product with the FDA in 2006. Biomoda's products are subject to FDA registration or approval and to post-approval FDA reporting requirements. Biomoda's current intention regarding regulatory strategy is to initiate product introductions via an ASR registration and potentially migrate up the regulatory spectrum as markets require. Biomoda's management expects to continue assay validation work and commence registration of its product with the FDA in the later half of 2006. There are several business models, product types and regulatory routes that Biomoda is evaluating including licensing, ASR, 510K, PMA for IVD kits and reagents. Biomoda is evaluating several cancers with a focus on large markets that are in need of the most immediate diagnostic support. These include: lung, bladder and cervical. The following is a discussion of costs and time factors associated with developing products for these cancers: a. Lung: Validation is projected to be complete by year-end and a contract manufacturing relationship is projected to be established by year-end. Based on these benchmarks, ASR registration and product listing can be completed by that time also. At that juncture reagent sales can begin. This is estimated to cost an additional $500,000. Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $300,000 will be required. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months to plan, execute, and document. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Partial funding will be provided from reagent sales. It is estimated additional funding of a minimum of $2 to $3 million will be required b. Bladder: Validation is projected to be complete by 4th quarter 2006. The formulation is expected to be identical to that for lung; therefore manufacturing will be in place. Based on this benchmark, FDA product listing and registration will only require an update. Funding will be provided by reagent sales revenue. - -------------------------------------------------------------------------------- F-12 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $100,000 will be required based on the assumption that a 510K of lung cancer has been approved. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months to plan, execute, and document. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Partial funding will be provided from reagent sales. It is estimated additional funding of $2 million will be required. c. Cervical: Validation is projected to be complete by 3rd quarter 2007. The formulation is expected to be identical to that for lung; therefore manufacturing will be in place. Based on this benchmark, FDA product listing and registration will only require an update. Funding will be provided by reagent sales revenue. Class I/II 510K can be completed as judged appropriate for the business and will require approximately 6 to 9 months effort to prepare documentation and receive FDA approval. During that time kit manufacturing can be initiated. Partial funding will be provided from reagent sales revenue. It is estimated additional funding of $100,000 will be required based on the assumption that a 510K of lung cancer has been approved. PMA will require clinical studies to be completed and will be initiated when it is viewed as appropriate for the business. This will require on the order of 18 months planning, executing, and documenting. During that time kit manufacturing can be initiated. FDA approval will require 6 to 9 months. Partial funding will be provided from reagent sales. It is estimated additional funding of $2 million will be required. Costs in complying with regulatory and legislative matters such as the Clinical Laboratory Improvement Amendment of 1988 (CLIA), which regulates the quality and reliability of medical testing in the U.S., adverse changes in zoning laws, tax laws, or other laws affecting the medical and diagnostic industry may prove to be a major obstacle, both in respect of time and costs, in our research and development. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include accounts of the Company and the accounts of the variable interest entity, Biomoda, Inc. (Note 6). All significant inter-company accounts and transactions have been eliminated in consolidation. DEVELOPMENT STAGE AND GOING CONCERN The Company has been in the development stage since inception, and has not generated any revenues from operations and there is no assurance of any future revenues. - -------------------------------------------------------------------------------- F-13 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- o The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the normal course of business. As of December 31, 2005, the Company has accumulated deficit of $21,679,276. The Company's total assets exceeded the total liabilities by $621.327. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. The Company may require additional funding for continuing research and development, obtaining acceptance in the market place and for the commercialization of its product. There can be no assurance that the Company will be able to obtain sufficient additional funds when needed, or that such funds, if available, will be obtainable on terms satisfactory to the Company. Management has taken action to address these matters, which include: o Retention of experienced management personnel with particular skills in the development and commercialization of such product. o The Company is seeking new contracts. o The Company has an equity method investment in a start-up company, which management hopes will be profitable (see Note 5). o The Company is seeking investment capital through the public markets and private placements. Management plans to obtain revenues from product sales, but there are no significant commitments for purchases of any of the proposed products. In the absence of significant sales and profits, the Company may seek to raise additional funds to satisfy its working capital requirements through the additional sales of debt and equity securities. There is no assurance that the Company will be able to obtain sufficient additional funds when needed, or that these funds will be obtainable on terms satisfactory to the Company. The successful outcome of future activities cannot be determined at this time and there is no assurance that if achieved, the Company will have sufficient funds to execute its intended business plan or generate positive operating results. RISKS AND UNCERTAINTIES The Company operates in a highly competitive industry that is subject to intense competition. The Company has no operating history and has not generated revenue from its business operations. As a development stage entity, the Company faces risks and uncertainties relating to its ability to successfully implement its business strategy. Among other things, these risks include the ability to develop and sustain revenue growth; managing expanding operations; competition; attracting, retaining and motivating qualified personnel; maintaining and developing new strategic relationships; and the ability to anticipate and adapt to the changing markets. Therefore, the Company may be subject to uncertainties, including financial, operational, technological, regulatory and other risks associated with an emerging business, including the potential risk of business failure. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with - -------------------------------------------------------------------------------- F-14 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management are, among others, deferred tax valuation allowances, estimation of costs for long-term contracts, allowance for loss on contracts, expected losses of the variable interest entity, valuation of marketable securities and the valuation of other assets. Actual results could materially differ from those estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments when it is practicable to estimate that value. The carrying amount of the Company's cash, marketable securities, accounts payables, accrued expenses and convertible debentures approximates their estimated fair values due to the short-term maturities of those financial instruments. The fair value of related party transactions is not determinable due to their related party nature. CASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company defines cash equivalents as all highly liquid debt instruments purchased with a maturity of three months or less, plus all certificates of deposit. MARKETABLE SECURITIES The Company classifies its investments in marketable securities as "available-for sale" in accordance with the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). The Company does not have any investments classified as "trading" or "held to maturity". Available-for-sale securities consist of equity securities and are carried at fair value with the unrealized gain or loss, net of tax, reported in other comprehensive income. The fair value of investment securities was determined based on available market information. Following is a summary of marketable securities classified as available for sale as of December 31, 2005: Cost Basis Fair Market Value Unrealized Gain ---------- ----------------- --------------- Marketable securities -Common stock $ 737,238 $ 902,027 $ 164,789 Available-for-sale securities consist of securities in GenoMed and are carried at fair value with the unrealized gain or loss, net of tax, reported in accumulated other comprehensive income. The fair value of marketable securities was determined based on available market information. During the year ended December 31, 2005, the Company transferred 2,571,409 shares valued at $69,364 to consultants in exchange for services. - -------------------------------------------------------------------------------- F-15 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- CONCENTRATIONS OF CREDIT RISK The financial instruments that potentially expose the Company to a concentration of credit risk principally consist of cash. The Company places its cash with high credit quality institutions. From time to time the Company maintains cash balances at certain financial institutions in excess of the Federal Deposit Insurance Corporation ("FDIC") limit of $100,000. At December 31, 2005, such balances in excess of the FDIC limit approximated $-0-. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets, ranging from three to ten years. Maintenance and repairs are charged to expense as incurred. Significant renewals and betterments are capitalized. At the time of retirement or other disposition of property and equipment, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in the statement of operations. INTANGIBLE ASSETS - PATENTS Costs incurred in connection with securing a patent, as well as attorneys fees, have been capitalized and amortized over seventeen years using the straight line-method. See Note 3 for additional information about patents. Costs related to patents pending are amortized beginning upon issuance of the related patents LONG-LIVED ASSETS Statement of Financial Accounting Standards ("SFAS") 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which supercedes SFAS 121, addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If the cost basis of a long-lived asset is greater than the projected future undiscounted net cash flows from such asset (excluding interest), an impairment loss is recognized. Impairment losses are calculated as the difference between the cost basis of an asset and its estimated fair value. SFAS 144 also requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sales, abandonment or in a distribution to owners) or is classified as held for sale. Assets to be disposed are reported at the lower of the carrying amount or fair value less costs to sell. The provisions of this statement for assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly initiated commitments to plan to sell such assets, as defined, by management. As a result, management cannot determine the potential effects that adoption of SFAS 144 will have on the financial statements with respect to future disposal decisions, if any. Although no provision for impairment was recorded in 2005, a year-end total loss on impairment since inception was $592,884. There can be no assurance, however, that market conditions will not change or demand for the Company's products or services will increase, which could result to additional impairment of long-lived assets. - -------------------------------------------------------------------------------- F-16 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- DEBT SETTLEMENT In April 2002, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections as of April 2002." SFAS 145 provides guidance for income statement classification of gains and losses on extinguishments of debt. Such gains and losses must be analyzed to determine if they meet the criteria for extraordinary item classification based on the event being both unusual and infrequent. The Company adopted SFAS 145 beginning January 1, 2003. During 2004, the Company recorded a loss of $620,980 on settlement of debt. The Company has determined that loss is not extraordinary in nature. REVENUE RECOGNITION In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 104 ("SAB 104"), "Revenue Recognition," which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the Securities and Exchange Commission. As the Company accounts for long-term contracts in accordance to SOP 81-1 (see below), management believes that the Company's revenue recognition policy conforms to SAB 104. In accordance with Statement of Position 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts," the Company accounts for revenue and costs related to its long-term contract in process by the completed-contract method, whereas during the period from Inception to December 31, 1999, revenue and costs were determined by the percentage-of-completion method. The completed-contract method of accounting was adopted in 2000 due to the Company's uncertainty regarding contract cost estimates. The financial statements of the period from Inception to December 31, 1999, were restated to apply the completed contract method retroactively. The effect of the accounting change had no effect on net loss or loss per share previously reported for 1999 or for the period from Inception to December 31, 1999. RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred. INCOME TAXES Under SFAS 109, "Accounting for Income Taxes," deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is provided for significant deferred tax assets when it is more likely than not that such assets will not be recovered. - -------------------------------------------------------------------------------- F-17 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- BASIC AND DILUTED LOSS PER COMMON SHARE Under SFAS 128, "Earnings Per Share," basic earnings per common share is computed by dividing income available to common stockholders by the weighted average number of common shares assumed to be outstanding during the period. Diluted earnings per share is computed similar to basic earnings per share except the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common share were dilutive (using the treasury stock method).. Because the Company has incurred net losses, basic and diluted loss per share is the same as additional potential common shares would be anti-dilutive. STOCK-BASED COMPENSATION The Company accounts for stock-based compensation issued to employees using the intrinsic value based method as prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock issued to Employees." Under the intrinsic value based method, compensation expense is the excess, if any, of the fair value of the stock at the grant date or other measurement date over the amount an employee must pay to acquire the stock. Compensation expense, if any, is recognized over the applicable service period, which is usually the vesting period. SFAS 123, "Accounting for Stock-Based Compensation," if fully adopted, changes the method of accounting for employee stock-based compensation plans to the fair value based method. For stock options and warrants, fair value is determined using an option pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option or warrant, stock volatility and the annual rate of quarterly dividends. Compensation expense, if any, is recognized over the applicable service period, which is usually the vesting period. The adoption of the accounting methodology of SFAS 123 is optional and the Company has elected to continue accounting for stock-based compensation issued to employees using APB 25; however, pro forma disclosures, as the Company adopted the cost recognition requirement under SFAS 123, are required to be presented (see below). For stock-based compensation issued to non-employees, the Company uses the fair value method of accounting under the provisions of SFAS 123. FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB 25" clarifies the application of APB 25 for (a) the definition of employee for purpose of applying APB 25, (b) the criteria for determining whether a plan qualifies as a non compensatory plan, (c) the accounting consequence for various modifications to the terms of a previously fixed stock option or award and (d) the accounting for an exchange of stock compensation awards in a business combination. Management believes that the Company accounts for transactions involving stock compensation in accordance with FIN 44. SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123," provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both - -------------------------------------------------------------------------------- F-18 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. At December 31, 2005, the Company has one stock-based employee compensation plan (the "Plan"), which is described more fully in Note 11. The Company accounts for the Plan under the recognition and measurement principles of APB 25, and related interpretation. No stock-based compensation cost is recognized in net loss. Stock options granted under the Plan have exercise prices equal to the market value of the underlying common stock on the dates of grant. The following table illustrates the effect on net income and loss per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation. 2005 2004 ---------------- --------------- Net loss: As reported $ (2,055,779) $ (5,048,067) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards -- -- ---------------- --------------- Pro forma $ (2,055,779) $ (5,048,067) ================ =============== Basic and diluted net loss per share: As reported $ (0.00) $ (0.00) ================ =============== Pro forma $ (0.00) $ (0.00) ================ =============== The above pro forma effects of applying SFAS 123 are not necessarily representative of the impact on reported net loss for future years. The Company did not grant any options during the years ended December 31, 2005 and 2004. COMPREHENSIVE INCOME The Company reports comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income." SFAS 130 establishes standards for the reporting and display of comprehensive income and its components. SFAS No. 130 requires unrealized holding gains and losses, net of related tax effects, on available for sale securities to be included in comprehensive income until realized. REPORTING SEGMENTS Statement of financial accounting standards No. 131, Disclosures about segments of an enterprise and related information (SFAS No. 131), which superseded statement of financial accounting standards No. 14, Financial reporting for segments of a business enterprise, establishes standards for the way that public enterprises report information about operating segments in annual financial - -------------------------------------------------------------------------------- F-19 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- statements and requires reporting of selected information about operating segments in interim financial statements regarding products and services, geographic areas and major customers. SFAS No. 131 defines operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performances. The Company allocates resources and assesses the performance based upon information from two reporting units, Advanced Optics Electronics, Inc. and Biomoda, Inc. ADVERTISING The Company expenses the cost of advertising when incurred. Advertising costs for the years ended December 31, 2005 and 2004 were immaterial to the financial statements, and are included in general and administrative expenses in the accompanying statement of operations. SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements ("EITF 05-6.") EITF 05-6 provides guidance on determining the amortization period for leasehold improvements acquired in a business combination or acquired subsequent to lease inception. The guidance in EITF 05-6 will be applied prospectively and is effective for periods beginning after June 29, 2005. EITF 05-6 is not expected to have a material effect on its consolidated financial position or results of operations. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This statement applies to all voluntary changes in accounting principles and requires retrospective application to prior periods' financial statements of changes in accounting principle, unless such would be impracticable. This statement also makes a distinction between "retrospective application" of an accounting principle and the "restatement" of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We are evaluating the effect the adoption of this interpretation will have on the Company's financial position, cash flows and results of operations. In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment, an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires companies to recognize in the statement of operations the grant- date fair value of stock options and other equity-based compensation issued to employees. FAS No. 123R is effective beginning in the Company's second quarter of 2006. The Company is evaluating the effects adoption of SFAS 123R will have on its financial statements. In December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of Nonmonetary Assets." The Statement is an amendment of APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The Company believes that the adoption of this standard will have no material impact on its financial statements. - -------------------------------------------------------------------------------- F-20 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- In December 2004, the FASB issued Staff Position No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The American Jobs Creation Act of 2004 (the "Act") introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. The FASB staff believes that the lack of clarification of certain provisions within the Act and the timing of the enactment necessitate a practical exception to the Statement 109 requirement to reflect in the period of enactment the effect of a new tax law. Accordingly, an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying Statement 109. The Company is currently assessing the impact of the Act on its financial position and results of operations but does not believe that the Act will likely provide the Company with the ability to recognize a reduction of income tax expense. In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments." The EITF reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss and how that criteria should be applied to investments accounted for under SFAS No. 115, "ACCOUNTING IN CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES." EITF 03-01 also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. Additionally, EITF 03-01 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the Financial Accounting Standards Board (FASB) delayed the accounting provisions of EITF 03-01; however the disclosure requirements remain effective for annual reports ending after June 15, 2004. The Company will evaluate the impact of EITF 03-01 once final guidance is issued. In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB 51." The primary objectives of FIN No. 46 are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (variable interest entities or "VIEs") and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entity's activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46 for public entities that are small business issuers, as defined ("SBIs"), are as follows: (a) For interests in special-purpose entities: periods ended after December 15, 2003; and (b) For all other VIEs: periods ending after December 15, 2004. The December 2003 amendment of FIN No. 46 also includes transition provisions that govern how an SBI which previously adopted the pronouncement (as it was originally issued) must account for consolidated VIEs. As disclosed in Note 6, the Company is associated with Biomoda, Inc. Because two officers of the Company also serve as officers of Biomoda and other factors discussed in FIN No. 46R, the Company has complied with the pronouncement and consolidated, at this time, the two Company's financial statements. See note 6 for the impact of adoption of the standard. - -------------------------------------------------------------------------------- F-21 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- EARNINGS PER SHARE Earnings per share for the years ended December 31, 2005 and 2004 were determined by dividing net income for the periods by the weighted average number of both basic and diluted shares of common stock and common stock equivalents outstanding. Stocks to be issued are regarded as common stock equivalents and are considered in diluted earnings per share calculations. 2. PROPERTY AND EQUIPMENT Property and equipment consist of the following at December 31, 2005: Machinery and equipment $ 386,861 Furniture and fixtures 107,183 Automobiles 43,313 Leasehold improvements 21,351 -------------------- 558,708 Less accumulated depreciation and amortization (438,380) -------------------- $ 120,328 ==================== 3. PATENTS Biomoda has entered into license agreements with a major university and national laboratory to obtain rights for the purpose of developing, manufacturing, and selling products using its patented technologies. Under such agreement, Biomoda will pay royalties at varying rates based upon the level of revenues from licensed products. The agreement continues as long as any licensed patents remain in force. Biomoda has not incurred any royalty expense during the period from January 3, 1990 (inception) to December 31, 2005. Biomoda also pays an annual fee in the amount of $15,000 to renew such license agreement. All patent costs are held in Biomoda. The gross carrying amount is $266,476 and accumulated amortization is $71,900. Amortization expense for 2005 is $16,107. Amortization expense for the Company's intangible assets over the next five fiscal years is estimated to be: 2006-$16,107, 2007-$16,107, 2008-$16,107, 2009-$16,107 and 2010-$16,107. Biomoda has entered into a license agreement with the University of California to license two patents related to TCCP. As provided in the license agreement and its amendments, US Patents No. 5,162,231 and No. 5,391,547 are licensed by the University to Biomoda. The license agreement is in good standing and there are no defaults of the license provisions. Biomoda, Inc. has been awarded US Patent No. 6,838,248. The company is also applying for one CIP and one Divisional Patent. - -------------------------------------------------------------------------------- F-22 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- The following table provides further outlines on the key referenced patents: - -------------------------------------------------------------------------------- Country Title Patent No. Issue Date Expiration Date ================================================================================ US COMPOSITIONS AND METHODS 6,838,248 1/4/05 1/4/22 OF DETECTING PRE-CANCEROUS CONDITIONS IN CELL AND Application was filed for TISSUE SAMPLES USING a Continuation In Part 5,10,15,20 - TETRAKIS additional patent. {CARBOXYPHENYL} PORPHINE - -------------------------------------------------------------------------------- US METHOD USING 5,10,15,20 - 5,162,231 11/10/1992 11/10/2009 TETRAKIS {R-CARBOXYPHENYL} PORPHINE FOR DETECTING CANCERS OF THE LUNG - -------------------------------------------------------------------------------- US METHOD USING 5,10,15,20 - 5,391,547 2/21/1995 2/21/2012 TETRAKIS {R-CARBOXYPHENYL} PORPHINE FOR TREATING CANCERS OF THE LUNG - -------------------------------------------------------------------------------- Biomoda has received foreign patents in sixteen countries protecting U.S. Patents No. 5,162,231 and No. 5,391,547, noted above in table. These patents have been issued in Austria, Belgium, Denmark, France, Germany, Italy, Netherlands, Spain, Sweden, Australia, Brazil, Canada, Japan, Korea, Russia, and the United Kingdom and are effective until 6/17/2011. 4. RELATED PARTY TRANSACTIONS ADVANCES FROM SHAREHOLDERS As of December 31, 2005, Biomoda had advances and accrued interest of approximately $149,000 payable to two of its stockholders. Such advances historically bore interest at 10% per annum. On December 31, 2003, a third stockholder of Biomoda agreed to forgive all accrued interest payable to him in the amount of approximately $25,000, which represents the gain on forgiveness of debt in the accompanying statements of operations. In 2004, he accepted 200,000 shares of common stock as repayment of the remaining balance. Interest expense related to such advances for the years ended December 31, 2005 and 2004 and for the period from Inception through December 31, 2005 were approximately $14,000, $12,000, and $137,000 respectively. - -------------------------------------------------------------------------------- F-23 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- 5. INVESTMENT IN GENOMED, INC. On January 8, 2004, the Company entered into a Stock Purchase Agreement (the "Agreement") with GenoMed, Inc., a Florida corporation ("GenoMed") whereby the Company purchased approximately 33,300,000 shares of restricted common stock of GenoMed for $900,000 in cash, representing approximately 17.9% of the total outstanding shares of GenoMed immediately after the execution of the Agreement. 6. VARIABLE INTEREST ENTITY-BIOMODA, INC. Per FIN 46 (R), Interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, which replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, addresses consolidation by business enterprises of variable interest entities, which have one or more of the following characteristics: 1. The equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties, including the equity holders. 2. The equity investors lack one or more of the following essential characteristics of a controlling financial interest: a. The direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights b. The obligation to absorb the expected losses of the entity c. The right to receive the expected residual returns of the entity. 3. The equity investors have voting rights that are not proportionate to their economic interests, and the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. At December 31, 2005, the Company owned 1,132,285 or 15.75% of the 7,187,282 outstanding shares of Biomoda, Inc. ("Biomoda"), a development stage company involved in the development of technology for the early detection of lung cancer. In addition, two of the Company's officers own approximately 12%, collectively, of Biomoda's outstanding shares. Further, the Company subleases office space and lab equipment to Biomoda and two of the Company's officers are also officers of Biomoda. Finally, the Company has been the sole source of funding to Biomoda since 2002 through advances made under a line of credit agreement. Such advances totaled $1,491,523 at December 31, 2005 and interest income of $59,947.has been recorded. All of these amounts have been eliminated in consolidation. The Company is considered the primary beneficiary as it stands to absorb the majority of the VIE's expected losses. Since Biomoda and the Company are considered entities under common control, the Company measures the assets and liabilities of Biomoda at their carrying amounts in consolidation. - -------------------------------------------------------------------------------- F-24 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- The accounts of Biomoda that have been consolidated with the Company as per Interpretation 46 of ARB 51 at December 31, 2005 are as follows: Cash $ 24 Other current assets 6,436 Patents, net 194,576 Property and equipment, net 9,378 Accounts payable 106,129 Accrued expenses 225,586 Advances from Biomoda stockholders 149,002 From inception through December 31, 2005, Biomoda has generated no revenues. The Company has charged $31,277 against non-current assets in December 31, 2005 to consolidate Biomoda's account. In 2006, Biomoda anticipates being able to raise its own funds in the public equity market. In this case, Biomoda may be able to sustain its own operations, repay its obligation to the Company, and hire its own officers. In such case, the Company may no longer be considered the primary beneficiary and the results of Biomoda may be deconsolidated. There can be no assurance that Biomoda will be able to raise sufficient funds to repay its obligation to the Company and become self-sustaining in its operations. 7. ACCRUED EXPENSES Accrued expenses consisted of the following as of December 31, 2005: Payroll taxes $ 186,051 Contingency 121,834 Accrued expense 11,189 Accrued Interest 12,184 License fees 15,000 Other 17,400 ------ $ 363,658 =========== - -------------------------------------------------------------------------------- F-25 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- 8. CONVERTIBLE DEBENTURES On September 15, 2000, the Company entered into an agreement to issue a total of $10,000,000 in convertible debentures which bear interest at an annual rate of 8 percent. The Company authorized the initial sale of $2,000,000 of the convertible debentures, and entered into a structured facility with purchasers (the "Purchasers") in which the Purchasers shall be obligated to purchase the remaining $8,000,000 of convertible debentures at certain obligation dates, as defined. The Company's right to require the Purchasers to purchase debentures commences on the actual effective date of the registration of the Company's securities in an amount equal to the securities that would be convertible upon issuance of the debentures. The related agreement provides for a limit on the amount of obligation debentures that the Company may require the Purchasers to purchase in a given month. On September 15, 2000, the Company issued $500,000 of the initial $2,000,000 in unsecured convertible debentures discussed above. Effective as of the issuance date, the debentures are convertible into shares of common stock at the lesser of a 25 percent discount to the average of the three lowest closing bid prices during the thirty trading days prior to the issue date of this note and a 20 percent discount to the average of the three lowest closing bid prices for the ninety trading days prior to the conversion date, as defined. The debentures were issued in exchange for $430,000 in cash, $20,000 in legal services and $50,000 in commissions. The commissions have been capitalized as debt origination costs and are being amortized to interest expense over the life of the debentures. The embedded intrinsic value of the beneficial conversion feature was estimated to be approximately $239,000, which was immediately charged to interest expense. The convertible debentures also include detachable warrants for the purchase of 500,000 shares of common stock at an exercise price of $0.38 per share, which vested upon grant and expire in September 2005. Management has estimated the fair market value of these warrants at $25,000 (based on the Black Scholes pricing model pursuant to SFAS 123 and EITF 00-27) and immediately charged such amounts to interest expense. On November 7, 2000, the Company entered into an agreement that modified outstanding convertible preferred agreements. The new agreement resulted in the exchange of outstanding preferred stock for the Company's 7.5% convertible debentures and other consideration. The total amount of the convertible debentures approximated $741,000, including $31,000 of interest. The debentures are convertible into shares of common stock at the lesser of the stock's closing price on March 8, 2000 and 77.5% of the average of the five lowest closing bid prices for 20 days before November 2, 2000. The intrinsic value of the conversion feature was estimated to be approximately $228,000, which was immediately charged to expense. The convertible debentures also include detachable warrants for the purchase of 71,000 shares of common stock, which value was insignificant. The principal balance of the convertible debentures at December 31, 2004 amounts to $102,977. During 2001, the Company issued convertible debentures totaling $500,000. The debentures are convertible into shares of common stock at the lesser of (i) 75 percent of the average of the three lowest closing bid prices for 30 days before August 30 and November 19, 2001 or (ii) 80% of the average of the three lowest closing bids during the 90 days prior to the conversion date. The embedded intrinsic value of the beneficial conversion feature was estimated to be $143,875 and immediately charged to interest expense. These debentures were retired in 2004. - -------------------------------------------------------------------------------- F-26 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- During the year ended December 31, 2004 in accordance with the applicable convertible debentures agreement, the Company issued 103,000,000 shares of common stock at a conversion price of approximately $0.0109 in connection with the conversion of notes payable of $505,060, including $166,240 of accrued interest, and recorded a loss on settlement of debt of $620,730. Other conversions produced net losses of $250, for a total of $620,980. During the year ended December 31, 2005, the Company issued 21,000,000 shares of common stock for its convertible debentures. Conversion price per share shall be the lesser of 75% of the average of the three lowest closing bid prices during the 30 trading days prior to but not including the issue date of the debentures and 80% of the average of the three lowest closing bid prices during the 90 trading days immediately prior to but not including the conversion date, which is approximately $0.01 per share. These shares were valued at approximately $31,000. A balance of $83,041 is being carried for this debenture on the Company's financial records as of December 31. 2005. The following table summarizes these transactions: 2005 2004 ---- ---- Shares issued to retire debentures 21,000,000 320,830,452 Approximate value per share $ 0.0015 $0.0021 -------- -------- Total value of shares issued 31,122 658,393 Cash payments rendered -0- 255,811 Carrying value of debt retired 31,122 954,375 -------- -------- Gain (loss) on retirement of debt $ -0- $40,171 ======== ======== 9. INCOME TAXES During fiscal 2005 and 2004, the provision for taxes (substantially all deferred) differs from the amounts computed by applying the U.S. Federal income tax rate of 34% to income before provision for taxes as a result of the following: 2005 2004 ----------- ----------- Computed "expected" tax (benefit) expense $ (697,000) $ (1,716,000) Addition to (reduction) in income taxes resulting from: State income taxes, net of (123,000) (303,000) federal benefit Change in deferred tax asset valuation allowance 820,000 2,008,000 Other 11,000 ----------- ----------- $ -- $ -- =========== =========== The total valuation allowance increased by $820,000 and $2,008,000 during the years ended December 31, 2005 and 2004, respectively. - -------------------------------------------------------------------------------- F-27 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- The effects of temporary differences that give rise to significant portions of the deferred taxes at December 31, 2005 are presented below: Deferred tax asset: Tax net operating loss carryforwards $ 8,316,000 Deferred tax asset valuation allowance (8,316,000) ------------------ $ -- ================== At December 31, 2005, Advanced Optics Electronics, Inc. had tax net operating loss carryforwards of approximately $22,291,000 and $12,283,000 available to offset future taxable federal and state income, respectively. If not utilized to offset future taxable income, the carryforwards will expire in various years through 2024. In the event the Company was to experience a greater than 50% change in ownership as defined in Section 382 of the Internal Revenue Code, the utilization of the Company's tax net operating loss carryforwards could be severely restricted. 10. STOCKHOLDERS' EQUITY PREFERRED STOCK The Company's articles of incorporation authorize up to 10,000,000 shares of $0.001 par value preferred stock. Shares of preferred stock may be issued in one or more classes or series at such time as the Board of Directors determine. As of December 31, 2005, there were no shares of preferred stock outstanding. TREASURY STOCK During the year ended December 31, 2005 the Company purchased 24,605,000 shares of its common stock as treasury shares for approximately $16,000 and sold 1,804,000 shares for approximately $1,200. In 2004, the Company purchased 9,800,000 shares for approximately $42,000 and sold 14,100,000 shares for approximately $48,000. COMMON STOCK The Company was initially capitalized through the issuance of 500,000 shares for $25,000 in cash. In November 1996, the Company issued 4,500,000 shares in exchange for the outstanding shares of PLZ Tech, Inc. The transaction was accounted for as a purchase and net assets of $285,596, consisting primarily of patents and equipment, were recorded. In previous financial statements, the Company did not present unclaimed shares resulting from the merger with PLZ Tech, Inc. as outstanding shares. In the accompanying 1997 and prior financial statements the number of shares outstanding has been restated to include these shares. In 1997, The Company issued 155,000 shares of common stock in exchange for $24,800 in cash, and in accordance with the applicable convertible note payable agreement, the Company issued 369,545 shares of common stock at conversion prices of less than $0.01 in connection with the conversion of notes payable of approximately $59,128. - -------------------------------------------------------------------------------- F-28 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- In 1997, the Company issued 1,756,667 shares of common stock in exchange for the following services; Advice on Bringing in Additional Investors, Radio Interviews, Market Sponsorship, Market Reports, and Canadian Investor Participation. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at $281,072. In 1998, The Company issued 9,274,811 shares of common stock in exchange for $1,292,707 in cash, net of sales commissions and other direct costs. Certain of these sales included price maintenance agreements resulting in the issuance of an additional 1,704,464 shares of stock. In 1998, the Company issued 2,751,000 shares of common stock in exchange for the following services; Market Sponsorship, Canadian Investor Participation, Locating Asian Investors, Employee Bonus and Incentive, and the Production of a Corporate Promotional Video. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at $296,470. The Company also issued 315,000 shares to an officer in exchange for a note receivable of $29,000. The note bears interest at the rate of 7 percent with interest due semiannually and the principal due July 2001. In 1999, the Company repurchased 489,251 shares of its outstanding stock for $11,132 in cash. These shares were retired. The Company also repurchased 229,000 shares for $41,760 and resold 85,000 of these shares for $35,464. The remaining 144,000 treasury shares have been recorded at cost. In 1999, the Company also sold 8,681,624 shares for $863,782 in cash, and issued 17,094,313 shares of common stock in exchange for the following services; Market Research, Capital Raising Advice, Employee Bonus and Incentive, Market Reports, and the Production of a Corporate Promotional Video. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at $1,486,414. During the year ending December 31, 2000, the Company sold 782,000 shares of its common stock for $1,013,493 in cash, and issued 3,955,203 shares of common stock in exchange for the following services; Capital Raising, Market Research, Financial Consulting, Investor Relations Reports, Legal, Employee Bonus and Incentive and Company Reports. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at $1,730,152. The value of the services is included in the costs and expenses on the Statements of Operations. In 2000, in accordance with the applicable convertible note payable agreement, the Company issued 9,200,000 shares of common stock at conversion prices of less than $0.01 in connection with the conversion of notes payable of approximately $542,878. Also, an officer of the Company exercised 1,850,000 stock options at a price of $0.12 per share. The Company issued notes receivable to the officer in the amount of $220,000 for the shares. Interest for the first quarter was prepaid. During the year ended December 31, 2001, the Company sold 1,382,778 shares for $68,227 in cash and issued 10,461,498 shares of common stock in exchange for the following services; Financial Consulting, Marketing, Legal Fee for Debenture Issuance, Advice on bringing in additional investors, Market Sponsorship, - -------------------------------------------------------------------------------- F-29 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- Investor Relations Reports, the Production of Corporate Promotional Videos, and Employee Bonus and Incentive . In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at $422,745. The value of such services is included with costs and expenses in the statement of operations In 2001, in accordance with the applicable convertible note payable agreement, the Company issued 7,064,886 shares of common stock at conversion prices of less than $0.01 in connection with the conversion of notes payable of approximately $154,073. During the year ended December 31, 2002, the Company sold 315,845,000 shares of common stock for $545,661 in cash; all shares were sold for less than $0.01. During the year ended December 31, 2002, the Company issued 115,768,000 shares of common stock in exchange for the following services; Product Marketing, Advice on Bringing in Additional Investors, Canadian Investor Participation, Legal Fees for Debenture Issuance Securities Placement and Market Sponsorship. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at $482,069 (based on the closing market price on the date of grant, which was less than $0.02). The Company recorded such amounts in the accompanying statement of operations. During the year ended December 31, 2002, the Company issued 507,800 shares of common stock (based on the fair market value on the dates of grant, which were less than $0.01) held as treasury stock for cash totaling $7,829 on a first-in, first-out basis. During the year ended December 31, 2002, the Company purchased 1,400,000 shares of common stock held as treasury stock for cash totaling $8,732. In January 2002, the Company issued 1,100,000 shares of its outstanding stock in connection with the exercise of stock options by an officer of the Company for a note receivable, which is due on demand, totaling $22,000. The Company has recorded the note receivable as an increase to stockholders' deficit in the accompanying balance sheet. During the year ended December 31, 2002, in accordance with the applicable convertible note payable agreement, the Company issued 46,018,635 shares of common stock at conversion prices of less than $0.01 in connection with the conversion of notes payable of approximately $73,000, including approximately $25,000 of accrued interest. During the year ended December 31, 2002, in accordance with the applicable convertible note payable agreement, the Company issued 30,511,931 shares of common stock at conversion prices of approximately $0.01 in connection with the conversion of notes payable of approximately $319,000, including approximately $20,000 of accrued interest. During the year ended December 31, 2002, in accordance with the applicable convertible note payable agreement, the Company issued 2,165,000 shares of - -------------------------------------------------------------------------------- F-30 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- common stock at conversion prices of approximately $0.02 in connection with the conversion of notes payable of approximately $35,000, including approximately $2,000 of accrued interest. During the year ended December 31, 2003, the Company sold approximately 1,477,760,000 shares of common stock for cash approximating $6,031,000; all shares were sold for less than $0.03. During the year ended December 31, 2003, the Company issued approximately 367,250,000 shares of common stock in exchange for the following services; Marketing, Financial Consulting, Securities Placement Legal Fee for Debenture Issuance, Investor Relations Reports, Capital Raising Advice, Legal, Advice on bringing in additional investors and Canadian Investor Participation. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at approximately $1,832,000 (based on the closing market price on the date of grant, which was less than $0.03). The Company recorded such amounts in the accompanying statement of operations. During the year ended December 31, 2003, in accordance with the applicable convertible note payable agreement, the Company issued approximately 320,830,000 shares of common stock at conversion prices of less than $0.01 in connection with the conversion of notes payable principal approximating $591,000 and accrued interest approximating $67,000. In December 2003, the Company cancelled notes receivable from an officer in lieu of the return of 2,950,000 shares of common stock to the Company (which were cancelled) that were originally granted in fiscal 2000 and 2002 from the exercise of stock options for such notes receivable. During the year ended December 31, 2004, the Company issued 47,200,000 shares of common stock in exchange for the following services; Canadian Investor Participation, Advice on bringing in additional investors, and Market Sponsorship. In each instance, the value of stock issued was determined by discounting to 70% of the closing price on the day of issuance. These shares were valued at approximately $255,000. The Company recorded such amounts in the accompanying condensed statements of operations. During the year ended December 31, 2004, the Company issued 103,000,000 shares of common stock for its convertible debentures. Conversion price per share shall e the lesser of 75% of the average of the three lowest closing bid prices during the 30 trading days prior to but not including the issue date of the debentures and 80% of the average of the three lowest closing bid prices during the 90 trading days immediately prior to but not including the conversion date, which is approximately $0.01 per share. The value of these shares was $1,126,000. The Company incurred a loss on settlement of debt of about $621,000 in connection with the conversion of notes payable approximating $505,000, including approximately $166,000 of accrued interest. During the year ended December 31, 2004, the Company issued 462,800,000 shares of common stock for cash, which were valued at approximately $1,119,000. In October 2004, the Company's Board of Directors authorized the increase of the number of shares of the Company's common stock to 4,000,000,000. - -------------------------------------------------------------------------------- F-31 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- During the year ended December 31, 2005, the Company issued 1,551,700,000 shares of common stock for cash, which were valued at approximately $935,000. During the year ended December 31, 2005, the Company issued 21,000,000 shares of common stock for its convertible debentures. Conversion price per share shall be the lesser of 75% of the average of the three lowest closing bid prices during the 30 trading days prior to but not including the issue date of the debentures and 80% of the average of the three lowest closing bid prices during the 90 trading days immediately prior to but not including the conversion date, which is approximately $0.01 per share. These shares were valued at approximately $31,000. During the year ended December 31, 2005, the Company increased its authorized shares to 7,000,000,000. STOCK OPTIONS On January 4, 1999, the Company established the Incentive Stock Option Plan (the "Plan"). Pursuant to the Plan, up to 10,000,000 shares of the Company's common stock may be granted as options to key employees with exercise prices at least equal to the fair market value on the date of grant. The exercise dates of the options are based on the related agreement, as approved by the Board of Directors. The Plan expires on January 4, 2009. Options awarded under the Plan mature four years from the date of grant and vest ratably over one to two year periods. The following is a status of the stock options outstanding at December 31, 2005 and 2004 and the changes during the two years then ended:
Year Ended Year Ended December 31, 2005 December 31, 2004 --------------------------------- ---------------------------------- Weighted Weighted Average Average Options Price Options Price --------------- ------------- --------------- ------------- Outstanding, beginning of year 400,000 $0.02 3,175,000 $0.23 Granted - - - - Exercised - - - - Cancelled/Terminated - - (2,775,000) 0.34 --------------- ------------- --------------- ------------- Outstanding and exercisable, end of year 400,000 $0.02 400,000 $0.02 =============== ============= =============== ============= Weighted average fair value of options granted during the year - - ============= =============
- -------------------------------------------------------------------------------- F-32 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- The following table summarizes information related to stock options outstanding at December 31, 2005:
Options Outstanding Options Exercisable ------------------------------------------------- --------------------------------- Weighted Average Weighted Weighted Remaining Average Average Contractual Exercise Exercise Exercise Price Number Life (Years) Price Number Price - ------------------- ------------- -------------------- --------------- ----------------- ---------------- $0.02 400,000 0.04 $ 0.02 400,000 $ 0.02 -------------- ------------- --------------- -------------- - ------------------- ------------------------------------------------------------------------------------------
There were no stock options granted in 2005 and 2004. WARRANTS From time to time, the Company issues warrants to employees and to third parties pursuant to various agreements. In January 2002, the Company issued warrants to two directors to purchase 300,000 shares of the Company's common stock. The exercise price of the warrants is $0.02 per share (the fair market value of the Company's common stock on the date of grant) and vested immediately. The warrants expire five years from the date of issuance. - -------------------------------------------------------------------------------- F-33 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- The following represents a summary of warrants outstanding for the years ended December 31, 2005 and 2004:
Year Ended December 31, Year Ended December 31, 2005 2004 ----------------------------------- ----------------------------------- Weighted Weighted Warrants Average Price Warrants Average Price ---------------- --------------- ---------------- --------------- Outstanding, beginning of year 4,796,000 $0.11 8,646,000 $0.06 Granted - - - - Exercised - - - - Cancelled/Terminated (3,996,000) 0.13 (3,850,000) 0.05 ---------------- --------------- ---------------- --------------- Outstanding and exercisable, end of year 800,000 $0.03 4,796,000 $0.11 ================ =============== ================ =============== Weighted average fair value of warrants granted during the year - - ============= =============
The following table summarizes information related to warrants outstanding at December 31, 2005:
Warrants Outstanding Warrants Exercisable ------------------------------------------------- ---------------------------------- Weighted Average Weighted Weighted Remaining Average Average Contractual Exercise Exercise Exercise Price Number Life (Years) Price Number Price - ------------------- -------------- -------------------- ------------------ ------------------- ---------------- $0.02 300,000 0.04 $ 0.02 300,000 $ 0.02 $0.31-0.33 500,000 0.30 0.03 500,000 0.03 -------------- ------------- --------------- ------------ 800,000 $ 0.11 800,000 $ 0.03 - ------------------- -------------------------------------------------------------------------------------------
There were no warrants issued in 2004 and 2005. 11. IMPAIRMENT OF ASSETS During the year ended December 31, 2004, the Company purchased 75 shares Electronic Film Market Online, Inc. in the amount of $88,000 and 18,000 shares of common stock of Beaver Information Technology (BIT), a Philippine based company, representing 9% of the issued and outstanding common stock of BIT for $273,710. Both Companies are privately held. The Company evaluated its investments based upon the fair market value of similar assets and wrote off the total amount of investments of $361,710 at this time. This is part of the asset impairment in the accompanying consolidated statements of operations. - -------------------------------------------------------------------------------- F-34 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- As disclosed in the note #1 to the financial statements, an impairment loss is recognized when estimates of future undiscounted cash flows expected to result from the use of an asset and its eventual disposition are less than its carrying amount. At the time such flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values and any impairment amount is charged to operations. Accordingly, based on these evaluations and in comparison of such investments with its market value, management adjusted the carrying value of investments to zero at October 31, 2004. 12. COMMITMENTS AND CONTINGENCIES LEASES The Company leases the facilities in which it operates. Payments for the office facility are $4,225 per month and are currently month-to-month. In addition, during the year ended December 31, 2002, the Company entered into a month-to-month sublease with Biomoda, Inc. (see Note 6), in which the Company is to receive $300 per month. In February 2004, the Company entered into a 25-month lease agreement for its West Coast office. Monthly rental is $2,413 per month from February 1, 2004 to February 28, 2006. Minimum annual rentals subsequent to December 31, 2005 are as follows: Year Amount 2006 $ 29,861 2007 29,861 -------- Total $ 59,722 ======== Rental expense for operating leases approximated $63,000 and $77,000 for the years ended December 31, 2005 and 2004 respectively and approximated $390,000 for the period from Inception through December 31, 2005. Rental income from the sublease to Biomoda, Inc. approximated $3,600 for both years ended December 31, 2005 and 2004, and $14,000 for the period from Inception through December 31, 2005 and has been included in operating expenses in the accompanying statement of operations. LITIGATION From time to time, the Company may be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination or breach of contract actions incidental to the normal operations of the business. The Company is currently not involved in any such litigation which management believes could have a material adverse effect on its financial position or results from operations. - -------------------------------------------------------------------------------- F-35 - -------------------------------------------------------------------------------- ADVANCED OPTICS ELECTRONICS, INC. (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 - -------------------------------------------------------------------------------- The Company and Biomoda have filed an action seeking the court to declare that a contingent obligation to a former employee of Biomoda is not due until after Biomoda's IPO is funded. The contingency is reflected on the balance sheet. In April, 2005 the Company was awarded damages in the amount of $13,500,269 as a result of two separate judgments in favor of the Company against two party defendants. The Company has not accounted for the now $14,000,000+ judgment because the amount to be collected is still uncertain. To be conservative, the Company has assigned zero value at this time. NOTE 13. SEGMENTS AND MAJOR CUSTOMERS The Company has two reportable segments consisting of (1) producing and selling large-scale flat panel displays for outdoor advertising billboards and its color identifier for the vision impaired; (2) early cancer detection technology. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on sales, gross profit margins and operating profit before income taxes. The following is information for the Company's reportable segments for the years ended December 31, 2005 and 2004 (in thousands):
2005 2004 ADOT Biomoda Unallocated Total ADOT Biomoda Unallocated Total Revenue $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- Loss on Operations (1,566) (539) -0- (2,105) (3,578) (708) -0- (4,286) Depreciation and amortization 32 21 -0- 53 25 15 -0- 40 Interest expense 13 26 -0- 39 18 30 -0- 48 Capital expenditure 4 35 39 539 278 -0- 817 Net Loss $(1,491) $ (565) $ -0- $(2,056) $(4,289) $ (759) $ -0- $(5,048)
NOTE 14. SUBSEQUENT EVENTS In the first quarter of 2006, 1,345,000,000 shares were issued for cash in the amount of $418,600 and 65,000,000 shares were issued for services valued at $6,370. During February 2006, the Company increased its authorized shares to 8,000,000,000. - -------------------------------------------------------------------------------- F-36 EX-31 2 ex311.txt ADOT EXHIBIT 31.1 Exhibit 31.1 CERTIFICATION OF CEO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Leslie Robins, the Chief Executive Officer of Advanced Optics Electronics, Inc., certify: 1. I have reviewed this annual report on Form 10-KSB of Advanced Optics Electronics, Inc. (the "registrant"); 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15e)) for the registrant and have: (a) Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report was being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures as the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 6, 2006 /s/ Leslie Robins ------------------- -------------------------------------- Leslie Robins, Chief Executive Officer EX-31 3 ex312.txt ADOT EXHIBIT 31.2 Exhibit 31.2 CERTIFICATION OF CFO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John Cousins, the Chief Financial Officer of Advanced Optics Electronics, Inc., certify: 1. I have reviewed this annual report on Form 10-KSB of Advanced Optics Electronics, Inc. (the "registrant"); 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15e)) for the registrant and have: (a) Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report was being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures as the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 6, 2006 /s/ John Cousins ------------------- --------------------------------------- John Cousins, Chief Financial Officer EX-32 4 ex321.txt ADOT EXHIBIT 32.1 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. ss.1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Advanced Optics Electronics, Inc. (the "Company") on Form 10-KSB for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Leslie Robins, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Leslie Robins ----------------- Leslie Robins Chief Executive Officer April 6, 2006 A signed original of this written statement required by Section 906, an other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 5 ex322.txt ADOT EXHIBIT 32.2 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. ss.1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Advanced Optics Electronics, Inc. (the "Company") on Form 10-KSB for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, John Cousins, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ John Cousins ---------------- John Cousins Chief Financial Officer April 6, 2006 A signed original of this written statement required by Section 906, an other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----