10QSB 1 markland.txt ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: September 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ COMMISSION FILE NUMBER 000-28863 MARKLAND TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) FLORIDA 84-1334434 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) #207 - 54 DANBURY ROAD RIDGEFIELD, CT 06877 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE) (203) 894-9700 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of November 11, 2004, there were 51, 564,458 shares of common stock, $0.0001 par value, of the registrant issued and outstanding. Transitional Small Business Disclosure Format (CHECK ONE): Yes [ ] No [X] ================================================================================ MARKLAND TECHNOLOGIES, INC. FORM 10-QSB TABLE OF CONTENTS SEPTEMBER 30, 2004 PAGE ---- PART I. FINANCIAL INFORMATION: Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheet at September 30, 2004........... 1 Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2004 and 2003............................. 2 Condensed Consolidated Statement of Stockholders' Equity For the Three Months Ended September 30, 2004................................ 3 Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2004 and 2003....................... 6 Notes to Condensed Consolidated Financial Statements................. 7 Item 2. Management's Discussion and Analysis or Plan of Operations....25 Item 3. Controls and Procedures.......................................36 PART II. OTHER INFORMATION Item 1 Legal Proceedings.............................................36 Item 2. Changes in Securities and Use of Procedures...................37 Item 6. Exhibits and Reports on 8-K...................................39 Signatures -------------------------------------------------------------------------------- Statements contained in this Form 10-QSB, which are not historical facts constitute forward-looking statements and are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "may", "will", "expect", "anticipate", "believe", "estimate", "continue", and similar words. You should read statements that contain these words carefully. All forward-looking statements included in this Form 10-QSB are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Each forward-looking statement should be read in conjunction with the financial statements and notes thereto in Part I, Item 1, of this quarterly report and with the information contained in Item 2 together with Management's Discussion and Analysis or Plan of Operation contained in our annual report on Form 10-KSB for the year ended June 30, 2004, as amended on October 20, 2004, including, but not limited to, the section therein entitled "Risk Factors." PART I. FINANCIAL INFORMATION MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30, 2004 (Unaudited) ASSETS CURRENT ASSETS: Cash $ 6,012,443 Accounts receivable 6,188,908 Other current assets 389,652 ------------- TOTAL CURRENT ASSETS 12,591,003 ------------- PROPERTY AND EQUIPMENT- NET OF ACCUMULATED DEPRECIATION OF $87,505 1,040,128 ------------- OTHER ASSETS Deferred financing costs, net of accumulated amortization of $22,697 518,523 Amortizable intangible assets, net of accumulated amortization of $1,464,389 13,658,555 Goodwill 9,876,472 Technology rights - Acoustic Core 1,300,000 ------------- TOTAL OTHER ASSETS 25,353,550 ------------- TOTAL ASSETS $ 38,984,681 ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 8,295,667 Accrued expenses and other current liabilities 1,776,124 Unearned contract revenue 126,795 Convertible secured notes, net of discount 218,071 Current portion of long-term debt 2,537,061 ------------- Total Current liabilities 12,953,718 NON-CURRENT LIABILITIES Long-term debt, less current portion 7,479,763 ------------- TOTAL LIABILITIES 20,433,481 ------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Series A redeemable convertible preferred stock - no par value; 30,000 authorized, issued and outstanding; liquidation preference 300,000 of $300,000 Series C 5% cumulative convertible preferred stock - $.0001 par value; 8,000 authorized; 0 issued and outstanding; -- Series D convertible preferred stock - $.0001 par value; 40,000 authorized; 17,725 issued and outstanding; liquidation preference of $17,725,000 2 Common stock - $.0001 par value; 500,000,000 authorized; 47,902,785 shares issued and outstanding 4,784 Additional paid-in capital 54,349,359 Unearned compensation (14,572,976) Accumulated deficit (21,529,969) ------------- TOTAL STOCKHOLDERS' EQUITY 18,551,200 ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 38,984,681 =============
The accompanying notes are an integral part of these condensed consolidated financial statements 1 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF LOSS For The Three Months Ended September 30, 2004 and 2003 (Unaudited) 2004 2003 ------------- ------------- REVENUES $ 15,769,851 $ 306,724 COST OF REVENUES 12,442,893 256,956 ------------- ------------- GROSS PROFIT 3,326,958 49,768 ------------- ------------- OPERATING EXPENSES: Selling, general and administrative 3,571,040 497,812 Amortization of compensatory element of stock issuances for selling, general and administrative fees (1,143) 401,980 Loss on disposal of equipment 23,722 -- Amortization of intangible assets 481,992 33,334 ------------- ------------- TOTAL OPERATING EXPENSES 4,075,611 933,126 ------------- ------------- OPERATING LOSS (748,653) (883,358) ------------- ------------- OTHER EXPENSES (INCOME), NET Interest expense 503,215 28,578 Other income, net (5,847) -- ------------- ------------- TOTAL OTHER EXPENSES, NET 497,368 28,578 ------------- ------------- NET LOSS (1,246,021) (911,936) Deemed Dividend To Preferred Stockholders -- 90,000 Preferred Stock Dividend - Series C -- 65,689 ------------- ------------- NET LOSS APPLICABLE TO COMMON STOCKHOLDERS $ (1,246,021) $ (1,067,625) ============= ============= BASIC AND DILUTED LOSS PER COMMON SHARE: $ (0.03) $ (0.22) ============= ============= WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (AFTER 1-60 REVERSE SPLIT) 38,352,594 4,746,887 ============= =============
The accompanying notes are an integral part of these condensed consolidated financial statements 2 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES Condensed Consolidated Statement Of Stockholders' Equity For The Three Months Ended September 30, 2004 SERIES A CONVERTIBLE SERIES C CONVERTIBLE COMMON STOCK PREFERRED STOCK PREFERRED STOCK ------------ --------------- --------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------ ------ ------ ------ ------ ------ Balance - July 1, 2004 31,856,793 $3,180 30,000 $300,000 - - Conversion of Series D convertible preferred stock into common stock 11,699,747 1,170 - - - - Stock issued in connection with consulting and employment agreements 3,286,816 328 - - - - Amortization of employment and consulting agreements - - - - - - Stock issued in connection with - - - reset rights of private placement investors 833,333 83 - - - - Stock issued for services provided in connection with acquisition of EOIR 226,096 23 - - - - Fair value of warrants and beneficial conversion feature on convertible secured notes - - - - - - Net loss - - - - - ---------------------------------------------------------------------------- Balance - September 30, 2004 47,902,785 $4,784 30,000 $300,000 0 0 ============================================================================ The accompanying notes are an integral part of these condensed consolidated financial statements
3 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES Condensed Consolidated Statement Of Stockholders' Equity For The Three Months Ended September 30, 2004 SERIES D CONVERTIBLE UNEARNED PREFERRED STOCK COMPENSATION --------------- ------------ SHARES AMOUNT AMOUNT ------ ------ ------ Balance- July 1, 2004 22,786 $ 2 $(15,176,116) Conversion of Series D convertible preferred stock into common stock (5,061) Stock issued in connection with consulting and employment agreements -- -- 640,300 Amortization of employment and consulting agreements -- -- (37,160) Stock issued in connection with reset rights of private placement investors -- -- -- Stock issued for services in connection with acquisition of EOIR -- -- -- Fair value of warrants and beneficial conversion feature on convertible secured notes -- -- -- Net loss -- -- -- ------------------------------------------ Balance-September 30, 2004 17,725 $ 2 $(14,729,976) ========================================== The accompanying notes are an integral part of these condensed consolidated financial statements
4 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES Condensed Consolidated Statement Of Stockholders' Equity For The Three Months Ended September 30, 2004 ADDITIONAL TOTAL PAID-IN ACCUMULATED STOCKHOLDERS' CAPITAL DEFICIT EQUITY AMOUNT AMOUNT AMOUNT ------ ------ ------ Balance - July 1, 2004 $ 50,864,718 $(20,283,948) $ 15,707,836 Conversion of Series D convertible preferred stock into common stock (1,170) -- Stock issued in connection with consulting and employment agreements (22,611) -- 18,017 Amortization of employment and consulting agreements -- -- (37,160) Stock issued in connection with reset rights of private placement investors (83) -- -- Stock issued for services in connection with acquisition of EOIR 108,505 -- 108,528 Fair value of warrants and beneficial conversion feature on convertible secured notes 4,000,000 -- 4,000,000 Net loss -- (1,246,021) (1,246,021) --------------------------------------------------- Balance - September 30, 2004 $ 54,349,359 $(21,529,969) $ 18,551,200 =================================================== The accompanying notes are an integral part of these condensed consolidated financial statements
5 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS For The Three Months Ended September 30, 2004 And 2003 (Unaudited) 2004 2003 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(1,246,021) $ (911,936) Adjustment to reconcile net loss to net cash used in operating activities: Depreciation 77,456 -- Amortization of intangible asset 481,993 33,334 Amortization of debt discount -- 20,833 Loss on disposal of equipment 23,772 -- Non cash interest expense 314,166 -- Amortization and reimbursement of compensatory stock grants (19,194) 401,980 Changes in operating assets and liabilities: Accounts receivable (834,641) (28,090) Prepaid expenses and other assets (104,582) 11,889 Accounts payable 4,069,967 200,582 Accrued expenses and other current liabilities (259,057) 21,921 ------------ ------------ NET CASH PROVIDED BY(USED IN) OPERATING ACTIVITIES 2,503,859 (249,487) ------------ ------------ CASH USED IN INVESTING ACTIVITIES: Proceeds from sale of property and equipment 2,100 -- Additional transaction costs relating to purchase of EOIR (61,611) -- Purchase of ASI assets -- (85,000) Purchase of equipment (66,749) -- ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES (126,260) (85,000) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of preferred stock -- 360,000 Proceeds from convertible promissory note (net) 3,458,780 -- Repayments of notes payable (325,024) (3,404) Repayments of credit line (600,000) -- ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 2,533,756 356,596 ------------ ------------ NET INCREASE IN CASH 4,911,355 22,109 CASH - BEGINING 1,101,088 5,465 ------------ ------------ CASH - ENDING $ 6,012,443 $ 27,574 ============ ============ The accompanying notes are an integral part of these condensed consolidated financial statements
6 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) 2004 2003 --------- -------- Cash paid during the years for: Interest $ 178,520 $ -- ========== ========= Taxes $ -- $ -- ========== ========= Non-cash investing and financing activities: Conversion of accounts payable into common stock $ -- $450,000 ========== ========= Acquisition of ASI Assets by issuance of common stock $ -- $850,000 ========== ========= Accrued dividends on preferred stock $ -- $ 65,689 ========== =========
The accompanying notes are an integral part of these condensed consolidated financial statements 7 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED STATEMENTS For The Three Months Ended September 30, 2004 and 2003 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of Markland Technologies, Inc. and Subsidiaries ("Markland" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, without being audited, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operation results for the three months ended September 30, 2004 are not necessarily indicative of the result that may be expected for the year ending June 30, 2005. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company's 10-KSB for the year ended June 30, 2004 filed with the Securities and Exchange Commission. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of Markland as a going concern. Markland has incurred net losses of $1,246,021 and $1,067,625 for the three months ended September 30, 2004 and 2003, respectively. Markland has limited finances and may require additional funding in order to market and license its products. During the three months ended September 30, 2004, Markland issued secured convertible promissory notes and warrants to purchase shares of common stock and received net proceeds of approximately $3,460,000 which, if not converted, is repayable between March 15, 2005 and September 30, 2005 (see Note 6). There is no assurance that Markland can reverse its operating losses, or that it can raise additional capital to allow it to continue its planned operations. These factors raise substantial doubt about Markland's ability to continue as a going concern. Markland's ability to continue as a going concern remains dependent upon the ability to obtain additional financing or through the generation of positive cash flows from continuing operations. These financial statements do not include any adjustments relating to the recoverability of recorded asset amounts that might be necessary as a result of the above uncertainty. While Markland has experienced operating losses in the past, due to the acquisition of EOIR, management believes the operating portion of the business will be cash flow positive in fiscal 2005. Management's business plan is to continue to grow the customer base and revenues and to control and monitor operating expenses and capital expenditures. Management believes that the business as currently constituted will produce positive cash flow which, together with the current cash levels, will enable Markland to meet existing financial obligations as they come due during the current fiscal year. However, management can provide no assurance that the performance of the business will meet these expectations. Markland is subject to risks common to companies in the Homeland Defense Technology industry, including, but not limited to, development by its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology and loss of significant customers. Since the United States Government represents substantially all of Markland's current revenue, the loss of this customer would have a material adverse effect on Markland's future operations. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION --------------------------- The consolidated financial statements include the accounts of Markland and its wholly-owned subsidiaries, Security Technology, Inc. ("STI"), Ergo Systems, Inc. ("Ergo"), Science and Technology Research Corporation, Inc. ("STR") and E-OIR Technologies, Inc. ("EOIR"). All significant inter-company balances and transactions have been eliminated in consolidation. 8 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS ------------------------------------------------------- The preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates that are particularly susceptible to change are the determination of the fair value of assets acquired and liabilities assumed in business combinations, impairment of identified intangible assets, goodwill and long lived assets, the fair value of equity instruments issued, valuation reserves on deferred tax assets and revenue and costs recognized on long-term, fixed-price contracts. CONCENTRATIONS -------------- Markland has cash balances in banks in excess of the maximum amount insured by the FDIC as of September 30, 2004. Substantially all revenue is generated from contracts with Federal government agencies. Consequently, substantially all accounts receivable are due from Federal government agencies either directly or through other government contractors. CASH AND CASH EQUIVALENTS ------------------------- Cash equivalents include interest-bearing deposits with original maturities of three months or less. ALLOWANCE FOR DOUBTFUL ACCOUNTS ------------------------------- The allowance for doubtful accounts reflects management's best estimate of probable losses inherent in the accounts receivable balance. Management determines the allowance based on economic conditions, historical experience with customers and other currently available evidence. Markland's receivables are from government contracts. Markland has not experienced any losses in accounts receivable and has provided no allowance at September 30, 2004 or 2003. PROPERTY AND EQUIPMENT ---------------------- Property and equipment are valued at cost and are being depreciated over their useful lives using the straight-line method for financial reporting. Routine maintenance and repairs are charged to expense as incurred. Expenditures which materially increase the value or extend useful lives are capitalized. Property and equipment are depreciated using straight-line methods over the estimated useful lives of assets as follows: Computers and equipment 3 years Furniture and fixtures 5-7 years Vehicles 5 years Software 3 years Property and equipment consisted of the following at September 30, 2004: Software $ 89,783 Computer equipment 561,780 Vehicles 71,008 Structures 313,790 Furniture and fixtures 91,273 ------------- $ 1,127,633 Less accumulated depreciation (87,505) $ 1,040,128 ============== Depreciation expense for the three months ended September 30, 2004 and 2003 was $77,456 and $0, respectively. 9 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) INCOME TAXES ------------ The Company accounts for income taxes using the asset and liability method. 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, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. A deferred tax asset is recorded for net operating loss and tax credit carry forwards to the extent that their realization is more likely than not. The deferred tax benefit or expense for the period represents the change in the deferred tax asset or liability from the beginning to the end of the period. REVENUE RECOGNITION ------------------- We recognize revenue when the following criteria are met: (1) we have persuasive evidence of an arrangement, such as contracts, purchase orders or written requests; (2) we have completed delivery and no significant obligations remain, (3) our price to our customer is fixed or determinable, and (4) collection is probable. We recognize revenues at the time we perform services related to border security logistic support. With respect to our revenues from our chemical detectors, we recognize revenue under the units-of-delivery method. At the time the units are shipped to the United States Navy, the Company recognizes as revenue the contract price of each unit and recognizes the applicable cost of each unit shipped. As of June 30, 2004, the Company had completed delivery of all outstanding orders under the contract. Revenues from time and materials contracts are recognized as costs are incurred. Revenues from firm fixed price contracts are recognized on the percentage-of-completion method, either measured based on the proportion of costs recorded to date on the contract to total estimated contract costs or measured based on the proportion of labor hours expended to date on the contract to total estimated contract labor hours, as specified in the contract. Provisions for estimated losses on all contracts are made in the period in which such losses become known. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revision to cost and income and are recognized in the period in which the revisions are determined. The Company participates in teaming agreements where they are the primary contractor and they participate with other organizations to provide services to the Federal government. The Company has managerial and oversight responsibility for team members as well as the responsibility for the ultimate acceptability of performance under the contract. The Company includes as revenues the amounts that they bill under the teaming arrangements and include as direct costs amounts that are reimbursable or paid to team members. UNEARNED REVENUE ---------------- Unearned revenue represents cash collection in excess of revenue earned from fixed price contracts. FAIR VALUE OF FINANCIAL INSTRUMENTS ----------------------------------- The financial statements include various estimated fair value information at September 30, 2004, as required by Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." Financial instruments are initially recorded at historical cost. If subsequent circumstances indicate that a decline in the fair value of a financial asset is other than temporary, the financial asset is written down to its fair value. Unless otherwise indicated, the fair values of financial instruments approximate their carrying amounts. By their nature, all financial instruments involve risk, including credit risk for non-performance by counterparties. The maximum potential loss may exceed any amounts recognized in the consolidated balance sheets. The fair value of cash, accounts receivable, bank line of credit and long-term debt approximate their recorded amounts because of their relative market and settlement terms. The fair value of the notes payable issued to the former owners of EOIR (see Note 3) have been recorded at their fair value, as determined by an independent valuation, which is less than the face value due to a below market interest rate. The fair value of the secured convertible promissory notes issued on September 21, 2004 have been recorded at their fair value which is less than the face value due to a debt discount and warrants issued in conjunction with the loan. ADVERTISING COSTS ----------------- Advertising costs are expensed as incurred. For the three months ended September 30, 2004 and 2003, no advertising and promotion expenses were incurred. SHIPPING COSTS -------------- Delivery and shipping costs are included in cost of revenue in the accompanying consolidated statements of loss. RESEARCH AND DEVELOPMENT ------------------------ Research and development costs are charged to expense as incurred. Markland capitalizes costs related to acquired technologies that have achieved technological feasibility and have alternative uses. Acquired technologies which do not meet this criteria are expensed as research and development costs. 10 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) REVERSE STOCK SPLIT/LOSS PER SHARE ---------------------------------- Share amounts and per share data have been restated to reflect a 1 for 60 reverse stock split effective as of October 27, 2003. Basic and diluted net loss per common share has been computed based on the weighted average number of shares of common stock outstanding during the periods presented. Common stock equivalents, consisting of convertible debt, Series A and Series D Convertible preferred stock, options and warrants were not included in the calculation of the diluted loss per share because their inclusion would have had the effect of decreasing the loss per share otherwise computed. IMPAIRMENT OF INTANGIBLE ASSETS ------------------------------- The Company records as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired. Statements of Financial Accounting Standards (SFAS ) No. 142, "Goodwill and Other Intangible Assets", prescribes a two-step process for impairment testing of goodwill, which is performed annually, as well as when an event triggering impairment may have occurred. The first step tests for impairment, while the second step, if necessary, measures the impairment. The Company has elected to perform its annual analysis during the fourth quarter of each fiscal year. No indicators of impairment were identified in the three months ended September 30, 2004 and 2003. IMPAIRMENT OF LONG-LIVED ASSETS ------------------------------- Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets", Markland continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. An impairment loss is recognized when expected cash flows are less than the asset's carrying value. Accordingly, when indicators or impairment are present, Markland evaluates the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying assets. Markland's policy is to record an impairment loss when it is determined that the carrying amount of the asset may not be recoverable. No impairment charges were recorded in the three months ended September 30, 2004 and 2003. STOCK-BASED COMPENSATION ------------------------ At September 30, 2004, as permitted under SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", which amended SFAS No. 123, "Accounting for Stock-Based Compensation", Markland has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangements as defined by Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees", and related interpretation including Financial Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation", an interpretation of APB No. 25. Had the Company followed the fair value method in accounting for its stock-based employee compensation it would have had the following effect on the net loss for the three months ended September 30, 2004.: 2004 2003 ---- ---- Net loss as reported $ 1,246,021 $(1,067,625) Add: stock based employee compensation benefit included in net loss (19,143) -- Deduct stock based employee compensation expense based under fair value based method 173,902 -- ------------ ------------ Pro forma net loss $ 1,439,060 $(1,067,625) ============ ============ Basic and diluted loss per share - as reported $ (0.03) $ (0.22) Basic and diluted loss per share - pro forma $ (0.04) $ (0.22)
11 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS ---------------------------------------------- In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability. Many of those instruments were previously classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have any impact on our financial position or results of operations. In December 2003, the FASB issues FASB Interpretation No. 46R ("FIN 46R"), "Consolidation of Variable Interest Entities". FIN 46R expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46R requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or is entitled to receive a majority of the entity's residual returns or both. The adoption of this interpretation did not have any impact on our financial position or results of operations. 3. ACQUISITIONS PURCHASE OF SCIENCE AND TECHNOLOGY RESEARCH, INC. ------------------------------------------------- In October 2003, Markland completed the acquisition of 100% of the common stock of Science and Technology Research, Inc., a Maryland corporation ("STR"), by its subsidiary, Security Technology, Inc., a Delaware Corporation ("STI"), through a merger of STI with newly formed STR Acquisition Corporation, a Maryland Corporation. STR is a producer of the U.S. Navy's Shipboard Automatic Chemical Agent Detection and Alarm System (ACADA). The Navy deploys the "man-portable" point detection system to detect all classic nerve and blister agents as well as other chemical warfare agent (CWA) vapors. The aggregate purchase price of STR was $6,475,000 and consisted of $900,000 in cash, which was paid in October 2003, 1,539,779 shares of common stock valued at $5,100,000, a promissory note of $375,000 and acquisition costs of $100,000. The promissory note bears no interest and, pursuant to amended terms, became due in full on October 15, 2004. Holders of the shares of common stock were granted piggy-back registration rights. The promissory note is collateralized by all of the assets of STR and 40% of the common stock of STR held by Markland. At September 30, 2004 the remaining unpaid balance on the note was $50,000. Markland also entered into a consulting agreement with the principal shareholder and employee of STR (see Note 11). PURCHASE OF E-OIR TECHNOLOGIES, INC. ------------------------------------ On June 29, 2004, Markland acquired all of the outstanding stock of E-OIR Technologies, Inc. ("EOIR") for $8,000,000 in cash and $11,000,000 in principal amount of five year notes secured by the assets and stock of EOIR. EOIR is a provider of technology and services to the US Army Night Vision Laboratories and has expertise in wide area remote sensing using both electro-optic and infrared technologies. The acquisition was consummated in furtherance of Markland's stated strategy of making synergistic acquisitions in order to provide products and services to Homeland Defense, the Department of Defense and U.S. Intelligence Agencies. 12 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) In connection with this acquisition, Markland has also adopted a Stock Incentive Plan (see Note 9). Unaudited pro forma financial information for the three months ended September 30, 2003, had the acquisitions of STR and EOIR been completed as of July 1, 2003, is as follows: MARKLAND-STR-EOIR 2003 (IN THOUSANDS) ------------------------------------------------------------------------ Revenues $ 12,930 ======== Operating Loss $ (19) ======== Net loss applicable to common stockholders $ (482) ======== Net loss applicable to common stockholders per common share $ (0.10) ======== 4. AMORTIZATION OF INTANGIBLE ASSETS Amortizable intangible assets consist of the following at September 30, 2004: Amortizable intangibles - EOIR $ 11,755,000 Amortizable intangibles - Ergo 400,000 Amortizable intangibles - ASI 1,000,000 Amortizable intangibles - STR 1,967,944 -------------- Total amortizable intangibles $ 15,122,944 Accumulated amortization (1,464,389) -------------- Net amortizable intangibles $ 13,658,555 ============== The intangible assets entitled "Acoustic Core" which has a carrying value of $1,300,000 are not available for commercial sale as of September 30, 2004. Accordingly, no amortization expense has been recorded through September 30, 2004. Amortization expense was $481,993 and $33,334 for the three months ended September 30, 2004 and 2003, respectively. 5. LINES OF CREDIT BANK LINE OF CREDIT ------------------- EOIR has a $600,000 line of credit with Virginia Community Bank. It is secured by current accounts receivable with variable interest at the prime lending rate (4.75% at September 30, 2004) plus 1%. The line of credit expires in April, 2005. There was no balance due as of September 30, 2004. 6. LONG-TERM DEBT NOTE PAYABLE - AI ----------------- In December 2003, Markland signed a note to finance an insurance premium. This note was fully paid as of September 30, 2004. NOTE PAYABLE - STR ACQUISITION ------------------------------ On October 1, 2003, Markland issued a note in the amount of $375,000 in connection with the acquisition of STR. This note is payable in full by October 15, 2004. The outstanding balance at September 30, 2004 was $50,000. On March 15, 2004, Markland agreed to pay to George Yang $40,000 of cash and issue an additional 50,000 shares of common stock valued at $66,500 in exchange for his agreement to extend the note to October 15, 2004. These amounts were charged to interest expense in the statement of loss for the year ended June 30, 2004. Accounts Payable at September 30, 2004 include $40,000 related to this agreement. 13 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) NOTES PAYABLE - EOIR ACQUISITION -------------------------------- On June 29, 2004, EOIR issued notes guaranteed by Markland in the face amount of $11,000,000 in connection with the acquisition of EOIR's common stock. These notes accrue interest at 6% compounded monthly and interest is payable in quarterly installments over 60 months in addition to annual principal payments. The fair market value of these notes is $9,532,044 as determined by an independent valuation. The discount of $1,467,956 is being amortized to interest expense over the life of the notes. During the three months ended September 30, 2004, $73,398 was amortized to interest expense. OTHER LONG-TERM BANK DEBT ------------------------- Markland's other long-term bank debt consists of the following as of September 30, 2004: Wachovia Bank, secured by a vehicle, dated November, 2001 with monthly payments of $877 including interest of 6.1% $21,288 First Market Bank, secured by research equipment, dated October, 2002 with monthly payments of $3,715 including interest of LIBOR plus 2.75% (5.23% at September 30, 2004) 139,530 First Market Bank, dated July, 2002 with monthly payments of $15,278 plus interest of LIBOR plus 2.75%, (5.23% at September 30, 2004) 130,540 First Market Bank, secured by leasehold improvements, dated March 19, 2003 with monthly payments of $3,514 including interest of 5.05% 53,753 American Honda Finance, secured by vehicle, dated March 24, 2003 with monthly payments of $406 including interest of 4.70% 16,272 -------- $361,383 ========
CONVERTIBLE NOTE AND WARRANT PURCHASE AGREEMENT ----------------------------------------------- On September 21, 2004, Markland Technologies, Inc. entered into a Purchase Agreement with DKR Soundshore Oasis Holding Fund, Ltd. and DKR Soundshore Strategic Holding Fund, Ltd. (together the "Investors") pursuant to which the Company sold warrants to purchase shares of common stock (the "Warrants") and secured convertible promissory notes (the "Convertibles Notes") for the aggregate consideration of $4,000,000. The Convertible Notes are initially convertible into $5,200,000 of common stock at a price of $0.80 per share, subject to certain adjustments as defined in the Purchase Agreement. The Purchase Agreement contains standard representations, covenants and events of default. Occurrence of an event of default allows the Investors to accelerate the payment of the Convertible Notes and/or exercise other legal remedies, including foreclosing on collateral. The Warrants entitle the Investors to purchase an aggregate of 5,200,000 shares of our common stock, at any time and from time to time, through September 21, 2009. The Convertible Notes are in the aggregate principal amount of five million two hundred thousand dollars ($5,200,000) and accrue interest daily at the rate of eight percent (8%) per year on the then outstanding and unconverted principal balance of the Convertible Notes. Under the terms of the Convertible Notes, Markland is required to pay $4,000,000 of the outstanding principal and interest by March 15, 2005, and the remaining outstanding balance by September 21, 2005. At anytime, and at the option of the Investors, the outstanding principal and accrued interest of the Convertible Notes may be converted into shares of Markland's common stock. The Company has granted a security interest in and a lien on substantially all of its assets to the Investors pursuant to the terms of a Security Agreement, dated September 21, 2004. 14 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) As part of this financing, James LLC, the largest holder of Series D Preferred Stock, agreed not to sell any of its holdings of Series D Preferred Stock until the earlier to occur of: (1) notice from the Company and the investors that the transactions contemplated had been completed had been terminated, or (2) March 15, 2005. However, pursuant to the terms of the lock-up agreement, James, LLC may still convert their Series D shares and sell the underlying shares of common stock in accordance with Rule 144 of the Securities Act of 1933, as amended. In exchange, Markland agreed that under certain conditions, if they did not redeem the Series D stock by January 15, 2005, they would issue to James LLC a warrant to purchase 1,088,160 shares of our common stock at $.80 per share. Subject to conditions set forth in the Purchase Agreement, the Company may require the Investor to purchase $1,000,000 of Additional Notes on the Additional Closing Date. On September 21, 2004, Markland estimated the fair value of the Warrants and allocated the gross proceeds of $4,000,000 on a relative fair value basis between the Convertible Notes and the Warrants. Based on this analysis, Markland estimated that the relative fair value of the Warrants and Convertible Notes were approximately $1,659,000 and $2,341,000, respectively. Based on the initial conversion price of $0.80 per share, Markland estimated that the Convertible Notes could convert into 6,500,000 shares of common stock and the effective conversion price was approximately $0.36 per share. Accordingly, Markland determined that there was a beneficial conversion feature of approximately $3,054,000. Since the beneficial conversion feature exceeded the carrying value of the Convertible Notes, the recognition of the beneficial conversion feature was limited to $2,341,000. The value of the warrants and beneficial conversion feature were recorded as additional paid in capital. The Convertible Notes were recorded net of the fair value of the Warrants and beneficial conversion feature at $0 and will be accreted to $5,200,000, the face value of the Convertible Notes, over the term of those notes. Non-cash interest expense related to the accretion of this discount was $218,071 for the three months ended September 30, 2004. In conjunction with the issuance of these Convertible Notes and Warrants, Markland incurred financing costs of $541,220. These costs have been recorded in Other Assets as deferred financing costs and are being amortized to interest expense over the term of the Convertible Notes. Non-cash interest expense related to the amortization of deferred financing costs was $22,697 in the three months ended September 30, 2004. 7. EQUITY LINE On September 10, 2003, Markland entered into a Private Equity Credit Agreement with Brittany Capital Management, Ltd. ("Brittany"). Markland agreed to issue and sell to Brittany up to $10,000,000 worth of its common stock over the next three years. Prior to any sales, Markland is required to file a registration statement with the Securities and Exchange Commission, relating to the shares to be issued, and to have such registration statement declared effective. There can be no assurances that Markland will receive any proceeds from this agreement. As of September 30, 2004, Markland has not drawn down on this equity line and no shares have been registered by Markland related to this agreement. For all periods presented, Markland has determined that the fair value of this Put was not material. 8. STOCKHOLDERS' EQUITY PREFERRED STOCK: ---------------- The Company is authorized to issue 5,000,000 shares of preferred stock which may be issued in series with such designations, preferences, stated values, rights qualifications, or limitations as determined by the Board of Directors. 15 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK ----------------------------------------------- On June 30, 2003, Markland issued 30,000 shares of our Series A Non-Voting Redeemable Convertible Preferred Stock in satisfaction of our remaining obligations under a promissory note. The Series A Preferred Stock has no par value, is non-voting and has a stated value of $10 per share. The Series A Preferred Stock is convertible at any time at the option of the Company, and cannot be converted by the holder. This stock is convertible at the rate of three shares of Series A Preferred Stock for each share of common stock. This conversion rate may be adjusted at any time by the Company as a result of either the sale of the Company or as a result of a stock split or stock dividend that is issued by the Company while these shares remain outstanding. The Company shall have the right, but not the obligation to, at any time after the issuance of these shares to redeem all or any portion of the outstanding shares of Series A Preferred Stock from the holder in cash at the stated value of $10 per share by sending notice to the holder. The Series A Preferred Stock has a liquidation preference of $10 per share. This stock does not accrue dividends. SERIES C 5% CUMULATIVE CONVERTIBLE PREFERRED STOCK -------------------------------------------------- The Series C Preferred Stock is non-voting and has a liquidation preference of $1,000 per share. The holders of the Series C Preferred Stock are entitled to receive dividends on each share of preferred stock, which shall accrue on a daily basis at the rate of 5% per annum on the sum of the liquidation preference plus all accumulated and unpaid dividends thereon. These dividends shall accrue whether or not they have been declared or there are legally available funds with which to pay them, and at the option of the holders are payable either in cash or in unrestricted common stock. The Series C Preferred Stock is redeemable at any time by Markland, and cannot be converted by the holders without written permission for a period of 6 months following the issuance of the shares and then only 10% may be converted per month thereafter. The Series C Preferred Stock is convertible at the option of the holder at a conversion price ranging from 65% to 80% of the common stock's market price at the time of the conversion. At September 30, 2004, there were no shares of Series C Preferred Stock issued or outstanding. 8. STOCKHOLDERS' EQUITY (CONT) SERIES D CONVERTIBLE PREFERRED STOCK ------------------------------------ Shares of the Series D Convertible Preferred Stock have a liquidation preference of $1,000 per share, are non-voting, do not accrue dividends, are redeemable by Markland anytime and are convertible into shares of Markland's common stock at a conversion price ranging from 65% to 80% of the common stock's market price at the time of the conversion. The Series D preferred stock is convertible at the option of the stockholder at any time. The number of shares of our common stock into which each share of Series D preferred is convertible is determined by dividing $1,000 by the discounted bid price. The "discounted" bid price is the average closing bid price of our common stock during the five business days immediately preceding the conversion date multiplied by the applicable discount factor, as set forth below. 16 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) ------------------------------------------------------------ ------------------- AVERAGE CLOSING BID PRICE (1) DISCOUNT FACTOR ----------------------------- --------------- ------------------------------------------------------------ ------------------- $15.00 or less 80% ------------------------------------------------------------ ------------------- more than $15.00, but less than or equal to $30.00 75% ------------------------------------------------------------ ------------------- more than $30.00, but less than or equal to $45.00 70% ------------------------------------------------------------ ------------------- more than $45.00 65% ------------------------------------------------------------ ------------------- ---------------------- (1) After an adjustment for a 1-for-60 reverse stock split effective October 27, 2003. The Series D preferred stock can be converted only to the extent that the Series D stockholder will not, as a result of the conversion, hold in excess of 9.999% of the total outstanding shares of our common stock. During the three months ended September 30, 2004, 5,061 shares of Series D were converted into 11,699,747 common shares of the Company. At September 30, 2004 there were 17,725 shares of Series D outstanding. REVERSE STOCK SPLIT ------------------- On September 4, 2003, Markland's board of directors approved a resolution to effect a one-for-sixty reverse stock split. This action was subsequently approved by shareholder action which was approved by written consent of the Markland shareholders who held at least a majority of the voting power of the common stock, at least 67% of the voting power of the Series C Cumulative Convertible Preferred Stock, and at least 67% of the voting power of the Series D Cumulative Convertible Preferred Stock. As a result, each sixty shares of common stock was converted automatically into one share of common stock. To avoid the issuance of fractional shares of common stock, each fractional share resulting from the reverse split was rounded up to a whole share. The reverse stock split did not reduce the 500,000,000 shares of common stock that Markland is authorized to issue. The resolution, which impacts shareholders of record as of September 5, 2003 became effective on October 27, 2003. All share amounts and per share data have been restated to reflect this reverse stock split. COMMON STOCK ISSUANCES ---------------------- Markland has entered into compensation agreements with certain officers and a consultant (see Note 11) which provide for, among other things, certain performance-based stock grants. In connection with these agreements, Markland issued 3,020,707 shares of common stock during the three months ended September 30, 2004. Due to the indeterminate number of shares to be issued under these agreements, Markland accounts for these stock compensation plans under variable accounting. During the three months ended September 30, 2004, Markland also issued the following: o 266,109 shares of its common stock to other employees and consultants as compensation o 11,699,747 shares of its common stock on conversion of 5,061 Series D shares. o 833,333 shares of its common stock in connection with satisfying reset rights of an existing investor and a result of the Convertible Note and Warrant Purchase Agreement entered into on September 21, 2004 (see Note 6). 17 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) o 226,096 shares with a fair value of $108,528 of its common stock issued as finders fees in connection with its acquisition of EOIR which was recorded as additional goodwill. For the three months ended September 30, 2004, Markland recognized unearned compensation, par value and additional paid in capital and stock compensation expense (benefit) of $(603,140), $(622,283) and $(19,143) respectively. Markland has established the following reserves for the future issuance of common stock as follows: Reserve for the exercise of warrants 19,903,549 Reserve for stock option plans 25,000,000 Reserve for conversion of Series A Preferred Stock 10,000 Reserve for conversion of Series D Preferred Stock 28,421,474 -------------- Total reserves 73,335,023 ============== The Company is also obligated to issue certain shares under employment and consulting agreements (see Note 11). 9. OPTIONS AND WARRANTS In conjunction with the Company's acquisition of EOIR, the Company adopted the 2004 Stock Incentive Plan ("the Plan"). The Plan authorizes the Company to issue up to 25,000,000 common shares in the form of options, stock awards, performance share awards or stock appreciation rights. On June 29, 2004, the Company issued options to eleven former minority owners of EOIR who have continued employment with the Company. These options have a ten year term and vest ratably over a five year period. Ten of these employees received options to purchase 9,345,737 shares of common stock at a price of $.3775. On the date of grant, the intrinsic value of these options, $3,528,016, was recorded as unearned stock-based compensation and additional paid in capital. This intrinsic value will be amortized to stock compensation over the five year vesting period. One employee received five options, each of which allows for the purchase of a number of shares equal to .11799575 times a fraction of $1,600,000 divided by the fair value of the stock on the vesting date. One of these options vests each year for the next five years. The exercise price of these options will be one-half the fair value of the stock on the vesting date. The intrinsic value of these options based on the fair value of the stock on September 30, 2004 is $471,983. This intrinsic value has been recorded as unearned stock-based compensation and additional paid in capital. Due to the variable nature of the exercise price and number of shares to be issued under these options, the intrinsic value will be remeasured each period until the terms are fixed. The intrinsic value of each option will be amortized over the vesting periods. As of September 30, 2004, the maximum number of shares issuable under these options is 1,210,213. For the three months ended September 30, 2004, the Company recorded $198,848 in non-cash compensation relating to the above options. Markland has also agreed to grant options to purchase an additional 5,000,000 shares of common stock to employees of EOIR in the future. Markland expects that these options will vest over five years after the date of grant and will have an exercise price equal to the fair market value of the common stock on the date of grant. There were no options issued in the three months ended September 30, 2004 and no options were vested at September 30, 2004. At September 30, 2004, the Company had the following outstanding warrants: 18 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) Number of Shares Exercise Date of Exercisable Price Expiration ----------------- ----------------- ------------------ Issued in conjunction with April 2, 2004 private placement 3,333,333 $1.25 April 2, 2007 333,333 $1.40 April 2, 2007 Issued in conjunction with April 16, 2004 private placement 3,333,333 $1.50 April 16, 2007 25,000 $2.00 April 16, 2007 50,000 $1.00 April 21, 2004 Issued in conjunction with May 3, 2004 private placement 7,098,750 $1.50 May 3, 2007 May 3, 2007 529,800 $1.50 Issued in conjunction with September 21, 2004 September 21, convertible note 5,200,000 $1.50 2009 ----------------- Total 19,903,549 ================= Weighted average exercise price $1.45 ================= Weighted average remaining life 3.52 years ==================
10. NET LOSS PER SHARE Securities that could potentially dilute basic earnings per share ("EPS") in the future, and that were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the periods presented, consists of the following: Shares Potentially Issuable ------------------ Series A Redeemable Convertible Preferred Stock 10,000 Series D Convertible Preferred Stock (convertible at 80% of market value) 28,421,474 Stock options 10,555,950 Warrants 19,903,549 Employment and consulting agreements 14,415,564 ---------- Total as of September 30, 2004 73,306,537 ==========
11. COMMITMENTS AND CONTINGENCIES COMPENSATION AGREEMENTS ----------------------- Effective January 2003, Markland entered into a one-year compensation agreement with the former chief executive officer and three three-year agreements with an officer, the president and chief financial officer, and two consultants to Markland, Robert Tarini and Verdi Consulting, which provided for aggregate remuneration of $47,500 per month. One of these agreements provided for the issuance of 1.67% of Markland's outstanding common stock in multiple installments in 2003. A final issuance occurred as of December 31, 2003, so that the total amount of shares issued equaled 1.67% of the outstanding common stock as of December 31, 2003. In addition, these agreements provided in total for the issuance of 5.01% of the Company's outstanding common stock in four installments in 2003 on a fully diluted basis based upon certain performance criteria being met. If necessary, an additional issuance will occur in January 2004, so that the total amount of shares issued will equal 5.01% of the outstanding common stock calculated on a fully-diluted basis assuming the conversion of all convertible securities as of December 31, 2003. 19 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) All of the shares issuable under these four agreements were earned as of January 1, 2004. Accordingly, a total of 1,410,719 shares were issued, of which 119,360 were issued during the year ended June 30, 2003 and 1,291,359 were issued during the year ended June 30, 2004. On May 12, 2004, Markland entered into five-year compensation agreements with two executives, the chairman and chief executive officer and the president and chief financial officer, and a consultant, Verdi Consulting. These agreements, which are effective on January 1, 2004, provide for the following remuneration: Base annual remuneration of $300,000 each (an aggregate of $900,000) payable over the five-year period ending January 2, 2009; Discretionary bonuses over the term of the agreement of up to 300% of the base remuneration; and Conditional stock grants over the period commencing April 1, 2004 through January 2, 2008, based on defined performance criteria. The stock grants, if all earned, entitle each of the three parties to receive up to 7.5% of Markland's common stock on a fully diluted basis. These grants are earned according to the following schedule: Grant 1 2.5% April 1, 2004 Grant 2 1.0% July 1, 2004 Grant 3 1.0% October 1, 2004 Grant 4 1.0% January 2, 2005 Grant 5 1.0% January 2, 2006 Grant 6 0.5% January 2, 2007 Grant 7 0.5% January 2, 2008 The number of shares of common stock to be granted on each grant date is equal to the product of (a) the number of fully diluted shares outstanding at the grant date and (b) the stock percentage associated with that grant date. In the event of a change in control of Markland during the period covered by the agreement, each executive/consultant will automatically be granted all remaining stock grants and will be due cash and expense compensation for the shorter of (i) three years from the date of the change in control, or (ii) until the end of the term of the agreement. A change in control is defined by the agreements as a change in the majority ownership of the equity of Markland, or the resignation or termination of the majority of the board of directors within a two month period, or the replacement of the CEO or the President of Markland. In June 2004, these agreements were modified to remove the anti-dultion provision. During the three months ended September 30, 2004, a total of 3,020,706 shares of common stock were issued under these new agreements. In connection with the STR acquisition, Markland entered into a one year consulting agreement, as amended on March 17, 2004, with the former President and principal of STR ("Consultant"). In consideration for the consulting services to be rendered by Consultant, Markland shall pay to Consultant the sum of $285,000 (the "fee"). The fee shall be payable as follows: $25,000 is payable on July 15, 2004, a second payment in the amount of $35,000, is payable on August 15, 2004, a third payment in the amount of $60,000 is payable on September 15, 2004, a fourth payment in the amount of $60,000 is payable on October 15, 2004, a fifth payment in the amount of $60,000 is payable on November 15, 2004 and the sixth and final payment in the amount of $45,000 is payable on December 15, 2004. As of September 30, 2004, Markland has accrued $225,625 related to this agreement. 20 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) FACILITY RENTAL --------------- STR leases its location in Fredericksburg, VA, on a month-to-month basis without a formal agreement. Rent expense relating to this location was $6,937 per month. We have a three year lease for our executive offices of approximately 1,000 square feet located in Ridgefield, Connecticut and a month-to-month lease for a manufacturing facility of approximately 5,000 square feet located in Fredericksburg, Virginia. We also have an administrative office in Providence, RI which is utilized under a monthly sublease comprising approximately 4,000 square feet. EOIR, our wholly owned subsidiary, holds a four-year lease for its executive and administrative offices of approximately 5,420 square feet in Woodbridge, Virginia. The lease, which has an option to renew for an additional three-year term, expires on September 30, 2005. EOIR also leases approximately 5,000 square feet in Spotsylvania, Virginia, where it houses its software development unit. This lease is currently on a month-to-month basis. We also have several offices located in Fredericksburg, VA. One office with approximately 4,722 sq ft., with a 1 year lease, one with 1,200 sq ft. with a 5 year lease, one with 10,000 sq ft., with a 5 year lease, and one with 4,200 sq ft., with a five year lease. Monthly lease amounts for these facilities total approximately $31,000. INCOME TAXES ------------ The Company is currently delinquent on its corporate federal and state income tax filings. The Company expects that its net operating loss carryforwards will be sufficient to offset any taxable income. As a result, no provision for income taxes or any related penalties or interest has been recorded for the three months ended September 30,2004. GOVERNMENT CONTRACTS -------------------- The Company's billings related to certain U.S. Government contracts are based on provisional general & administrative and overhead rates which are subject to audit by the contracting government agency. The Company has limited experience with these audits. 12. INCOME TAXES There was no provision for federal or state income taxes for the three months ended September 30, 2004 and 2003, due to the Company's operating losses and a full valuation reserve. The Company's deferred tax asset before valuation allowance is approximately $7,800,000 and at September 30, 2004 consisted primarily of net operating loss carry forwards. The change in the valuation allowance for the three months ended September 30, 2004 was approximately $1,200,000. When filed, the Company's net operating loss carry forwards of approximately $19,000,000 will expire in varying amounts through 2024. The use of the federal net operating loss carry forwards may be limited in future years as a result of ownership changes in the Company's common stock, as defined by section 382 of the Internal Revenue Code. The Company has not completed an analysis of these changes. The Company has provided a full valuation reserve against the deferred tax asset because of the Company's loss history and significant uncertainty surrounding the Company's ability to utilize its net operating loss and tax credit carryforward. 21 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) 13. RELATED PARTY TRANSACTIONS Robert Tarini, our chief executive officer is also chief executive officer of Syquest, Inc. Syquest performs software and engineering development for the Markland Group and provides approximately 4000 sq ft of office space to the Company in Providence, RI. During the three months ended September 30, 2004 Syquest provided $65,359 in engineering and software services and charged 18,000 for rent. The Company believes that all transactions described above were made on terms no less favorable to it than those obtainable from unaffiliated third parties. All future transactions, if any, with its executive officers, directors and affiliates will be on terms no less favorable to it than those that will be obtainable from unrelated third parties at the time such transactions are made. 14. LITIGATION On June 28, 2004, Charles Wainer filed a civil suit against the Company in Florida state court alleging breach of a stock purchase agreement and breach of an employment agreement stemming from Wainer's sale of his business to a predecessor of the Company and his subsequent employment thereat. In the complaint, Wainer alleges Markland owes him $300,000 cash, some unspecified portion of $700,000 in stock, some unspecified portion of $86,000 cash for lease payments, and approximately $20,000 in back-pay. The Company believes that these claims are without merit and plans to vigorously defend the action. On August 11, 2004, the Company answered the complaint and denied any liability. On or about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the Circuit Court of Spotsylvania County, Virginia, against the Company, EOIR, our wholly owned subsidiary, and our Chief Executive Officer and Director, Robert Tarini. Mr. Moulton was the largest single shareholder of EOIR prior to its acquisition by the Company, owning approximately 67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000 in cash and a promissory note of EOIR in the approximate principal amount of $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR by the Company. In his complaint Mr. Moulton asserts, among other things, that the Company breached its obligations under the Stock Purchase Agreement, dated June 29, 2004, pursuant to which the Company acquired EOIR, by terminating Mr. Moulton's employment with EOIR and removing him from the EOIR board of directors. Mr. Moulton is seeking damages allegedly suffered by his loss of employment, extreme emotional distress, and costs incurred to enforce his contractual rights. In addition, he is seeking certain other equitable relief including, the appointment of a receiver to oversee the management of EOIR until these promissory notes issued to former EOIR shareholders at the closing of the acquisition are paid in full and a declaratory judgment that the Company's actions constitute an event of default under these promissory notes allowing for the acceleration of all amounts (approximately $11,000,000) due thereunder. The Company is a guarantor of these notes. The Company believes that the allegations in this lawsuit are entirely without merit. The Company has filed an answer denying Mr. Moulton's allegations and opposing vigorously all equitable relief sought. The Company has also filed a demurrer seeking to dismiss certain claims. The Company is considering bringing various claims against Mr. Moulton either by counterclaim or in a separate action. In addition, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. 22 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) 15. SUBSEQUENT EVENTS SUBSEQUENT STOCK ISSUANCES -------------------------- Between September 30, 2004, and November 12, 2004, executives and consultants of the company were issued 3,616,438 shares of common stock based on employment agreements, on July 1, and October 1, 2004, RESIGNATION OF DIRECTOR ----------------------- On November 1, 2004, Gregory A. Williams notified the Board of Directors of Markland Technologies, Inc. of his resignation from the Board of Directors of the Company and his positions as Director, Executive Vice President, Chief Financial Officer, and Chief Operating Officer of the Company's wholly owned subsidiary, EOIR Technologies, Inc. ("EOIR"). Mr. Williams was a shareholder of EOIR prior to the acquisition of EOIR by the Company on June 29, 2004. To the knowledge of the Company, Mr. Williams' resignation was not in connection with any disagreement concerning matters relating to the Company's operations, policies or practices. On November 1, 2004, Mr. Williams, the Company, and EOIR entered into an Agreement and General Release detailing the terms and conditions of Mr. Williams' resignation (the "Separation Agreement"). The Separation Agreement states, among other things, that (a) the Company is to pay Mr. Williams twelve months of severance and all accrued and unused vacation time, (b) Mr. Williams is entitled to retain all benefits until the earlier of December 31, 2005 or when Mr. Williams finds new employment, (c) the vesting of 40% of the non-statutory stock options held by Mr. William is accelerated; and (e) Mr. Williams reaffirms his confidentiality and non-competition obligations and agrees not to compete with or solicit employees from EOIR for a period of twelve months. EQUITY FINANCING ---------------- On November 9, 2004, we entered into a Securities Purchase Agreement (the "Securities Purchase Agreement") with Harborview Master Fund, LP and Southridge Partners, LP (the "Investors") pursuant to which we sold warrants to purchase shares of our common stock and secured convertible promissory notes for the aggregate consideration of $1,350,000. We received net proceeds of $1,174,500 from this private placement. We intend to use the proceeds from this offering for working capital. The offer and sale of these securities was made in reliance on Section 4(2) of Securities Act of 1933, as amended. The Investors are "accredited investors" within the meaning of Regulation D. The Securities Purchase Agreement contains standard representations, covenants and events of default. Occurrence of an event of default allows the Investors to accelerate the payment of the notes and/or exercise other legal remedies, including foreclosing on collateral. The notes issued in connection with this private placement are in the aggregate principal amount of one million seven hundred fifty five thousand dollars ($1,755,000) and accrue interest daily at the rate of eight percent (8%) per year on the then outstanding and unconverted principal balance of the notes. The notes will mature on November 9, 2005. At any time, and at the option of the Investors, the outstanding principal and accrued interest of the notes may be converted into shares of our common stock at an initial conversion price per share of $0.80. Under the terms of each these notes, we are required to pay a principal amount on each note equal to the consideration paid by the Investor holding such note plus any accrued interest by March 15, 2005, and the remaining outstanding balance by November 9, 2005. If we do not make the March 15, 2005 prepayment, the conversion price will be adjusted from $0.80 per share to the lower of (i) $0.80 and (ii) a floating rate equal to 80% of average closing price per share of our common stock for the five trading days preceding conversion. 23 MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: For The Three Months Ended September 30, 2004 and 2003 (Unaudited) In the event we issue common stock or common stock equivalents at a price per share below the then effective conversion price of the convertible notes, the conversion price will be reduced to that lower price per share. The warrants issued in connection with this private placement entitle the Investors to purchase an aggregate of 2,193,750 shares of our common stock, at any time and from time to time, through November 9, 2009. Under the terms of the warrants, if we do not make a prepayment of an aggregate of $1,350,00 in principal, plus any interest having accrued thereon, on the notes issued to the Investors in this private placement by March 15, 2005, the exercise price of the warrant will be reduced from $1.50 to the lesser of (i) $0.792 and (ii) 80% of the average closing price per share of our common stock on the date the adjustment is made. Adjustments are also required in the event that we issue common stock or common stock equivalents at a price per share below the then effective exercise price of the warrants. The exercise price will be reduced to that lower price per share In the event any of the foregoing adjustments are made, the warrants will become exercisable for a number of shares equal to the aggregate exercise price (i.e., the exercise price per share multiplied by the number of underlying shares) prior to the adjustment divided by the adjusted exercise price per share. We have agreed to prepare and file with the SEC a registration statement covering the resale of all of the shares of our common stock issuable upon conversion of the notes and the exercise of the warrants issued in connection with this private placement, as provided in the Securities Purchase Agreement dated November 9, 2004. The investors in our September 21, 2004 private placement have consented to the inclusion of the Investors, and additional selling shareholders with piggy back registration rights, in the filing of the registration statement on Form SB-2 to be filed in connection with our September 21, 2004 private placement. In addition, they have waived their rights to liquidated damages pursuant to the Registration Rights Agreement dated September 21, 2004, that would have been paid for our filing of the registration statement on November 10, 2004. The terms of the Securities Purchase Agreement with the Investors requires that if either: (i) the registration statement is not declared effective by December 20, 2004, or within five trading days after the SEC notifies us that the registration will not be reviewed or is not subject to further review or comments; or (ii) this registration statement is suspended for more than an aggregate of 20 trading days, whether or not consecutive, in any twelve-month period, we will be required to pay each of the Investors liquidated damages in an amount equal to 2% of such Investor's investment amount, half of which may, at our option, be paid in common stock of equivalent value. Such value shall be determined based on the lower of (i) the average of the closing price of our common stock for the five days preceding the payment date and (ii) the closing price of our common stock on the day preceding the date that stock is delivered to the Investors. We have granted a security interest in and a lien on substantially all of our assets to the Investors pursuant to the terms of the Securities Purchase Agreement, dated November 9, 2004. This security interest is subordinated to the security interests granted in connection with the acquisition of EOIR and the September 21, 2004 private placement. 24 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE OTHER FINANCIAL INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES APPEARING ELSEWHERE IN THIS FORM 10-QSB. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF A VARIETY OF FACTORS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-QSB. WE WILL NOT UPDATE THESE FORWARD-LOOKING STATEMENTS UNLESS THE SECURITIES LAWS AND REGULATIONS REQUIRE US TO DO SO. OVERVIEW The following management's discussion and analysis of financial condition and results of operations is organized as follows: o OVERVIEW. This section provides a general description of Markland, its business and recent developments and events that have occurred since 2002 that we believe are important in understanding the results of operations and financial condition and to anticipate future trends. In addition, we have provided a brief description of our acquisition of EOIR Technologies, Inc., an event that impacts the comparability of the results being analyzed. o RESULTS OF OPERATIONS. This section provides an analysis of Markland's results of operations for the fiscal quarters ended September 30, 2004 and September 30, 2003. This analysis is presented on a consolidated basis. o LIQUIDITY AND CAPITAL RESOURCES. This section provides an analysis of Markland's cash flows for the fiscal quarters ended September 30, 2004 and September 30, 2003, as well as a discussion of recent financing arrangements including financings that were closed on September 21, 2004 and November 9, 2004. o CRITICAL ACCOUNTING POLICIES. This section discusses certain critical accounting policies that we consider important to Markland's financial condition and results of operations, and that required significant judgment and estimates on the part of management in application. Markland's significant accounting policies, including the critical accounting policies discussed in this section, are summarized in the notes to the accompanying consolidated financial statements. OVERVIEW BACKGROUND GENERAL. We provide to the United States Department of Defense ("DOD") and to various other United States Intelligence Agencies ("INTEL"); remote sensing technology products, and services to protect our country's military personnel and infrastructure assets. We also provide to the Department of Homeland Security ("Homeland Security"); products, services and emerging technologies to protect our country's borders, infrastructure assets and personnel. Our mission is to build world-class integrated solutions for the Homeland Security ("Homeland Security"), DOD and INTEL marketplaces via expansion of our existing contracts, development of our emerging technologies and acquisition of synergistic revenue producing assets. We have undergone material changes to our business and our financial structure during the period covered by the financial statements included in this Form 10-QSB. Our business, as it exists today, consists of four business areas: remote sensor systems for military and intelligence applications, chemical detection, border security and advanced technologies. 25 Our primary sources of operating revenue are from our wholly owned subsidiary E-OIR Technologies, Inc. ("EOIR"), which was acquired by us on June 29, 2004. EOIR offers products and services which include; (i) design and fabrication of customized remote sensor systems and platforms for DOD, INTEL and Homeland Security applications; (ii) remote sensor data collection, data signal processing and data exploitation; and (iii) training in the use of remote sensor systems and data. These efforts involve systems engineering, system integration, prototyping, manufacturing and field data collections as well as data analysis and processing. Prior to the acquisition of EOIR, our primary sources of operating revenue were sales of our automatic chemical agent detection and alarm system produced by our wholly owned subsidiary Science and Technology Research Inc. ("STR"), border security logistics products and services provided by our wholly owned subsidiary Ergo Systems, Inc. ("ERGO"), and Small Business Investment Research ("SBIR") funded research grants for the development of gas plasma antenna technology. Our acquisition of EOIR has materially changed our business. We completed our acquisition of EOIR on June 29, 2004. We have included a discussion of certain financial information concerning EOIR in our discussion and analysis of our financial condition and results of operations. Information concerning the EOIR acquisition can be found in our Current Report on Form 8-K/A filed with the SEC on September 13, 2004 (File #000-28863) which includes audited financial statements for EOIR for the years ended December 31, 2003 and December 31, 2002, and unaudited financial statements for the three months ended March 31, 2004, as well as unaudited pro forma information for fiscal year ended June 30, 2003 and the nine months ended March 31, 2004. MARKLAND BUSINESS REMOTE SENSOR SYSTEMS FOR MILITARY AND INTELLIGENCE APPLICATIONS Our acquisition of EOIR on June 29, 2004, a company which provides remote sensing technology products and services to the United States Department of Defense and to various other United States Intelligence Agencies, is a very important part of our ongoing business strategy of creating a world-class integrated portfolio of solutions for the Homeland Security, DOD and INTEL marketplaces. EOIR's most significant source of revenues is an Omnibus Contract with the United States Army Night Vision and Electronic Sensors Directorate which has a total potential value of approximately $406 million over its five year period of performance. Approximately 86% of EOIR revenues for its fiscal year ended December 31, 2003, were derived from this contract. The Omnibus Contract has an extensive and varied scope that requires us to provide a very broad range of products and technical services. For those products and technical services that EOIR does not possess in-house, we have and continue to subcontract to our team members and other subcontractors as necessary. CHEMICAL DETECTOR In October 2003, our subsidiary, Security Technology, Inc., acquired all of the common stock of Science and Technology Research, Inc., a chemical detector manufacturer, as part of our ongoing business strategy of creating an integrated portfolio of homeland security solutions. STR has a contract with the U.S. Navy to be the sole producer of the U.S. Navy's shipboard Automatic Chemical Agent Detection and Alarm System used to detect all classic nerve and blister agents as well as other chemical warfare agent vapors. STR's sole source of revenues is this contract with the United States Navy which has a total potential value of approximately $37,000,000 over its period of performance. As of June 30, 2004, we had completed delivery pursuant to all outstanding orders under this contract. We are experiencing a decline in demand for our chemical detector unit from the U.S. Navy. We plan to compensate for this reduced demand by marketing this technology to new customers within the Homeland Security marketplace and by combining it with other technologies for sale to customers other than the US Navy. During the three months ended September 30, 2004 our subsidiary STR recognized approximately $66,032 of revenue from this contract. 26 We are presently working on the design of a next generation "point" chemical detector product, which will also operate using Ion Mobility Spectrography (IMS) cell technology and provide networked wireless communication capability. On December 23, 2003, the U.S. Navy signed a ten-year non-exclusive license agreement with us to transfer certain chemical detection technology intellectual property rights to us. We believe the license will allow us to further expand the applications for the "point" chemical detection technology and market the technology to non-defense customers such as foreign governments and commercial entities. The company is combining "stand off" chemical detection technologies from EOIR which are based on hyper spectral infra red technology with the "point" chemical detection technology of STR which is based on Ion Mobility Spectroscopy. This integrated and combined chemical detection capability we believe will accelerate penetration into new markets for the chemical detection products we now offer and will help to increase our revenues in the next fiscal year for chemical detection products. BORDER SECURITY We acquired the assets of Ergo Systems, Inc., in January 2003. This acquisition provided us with contracts with the Department of Homeland Security to maintain, integrate, and implement design enhancements to border security systems installed at U.S. ports of entry for the Dedicated Commuter Lane, which is part of a larger U.S. Customs and Immigration and Naturalization Service initiative to reduce wait times, improve data accuracy, and improve overall efficiencies at all border crossings for both freight and passengers. During the fiscal year we entered into a teaming agreement with Accenture, who was recently awarded the US VISIT Contract. The purpose of this contract is to secure our borders and expedite the entry/exit process while enhancing the integrity of our immigration system and respecting the privacy of visitors to the US. We have recently been awarded a subcontract which enables the company to derive revenues from the US VISIT Contract. During the three months ended September 30,2004 our subsidiary Ergo Systems, Inc. recognized approximately $196,588 of revenue from these contracts. Management believes that the potential for increased revenues has been greatly enhanced by this subcontract award. ADVANCED TECHNOLOGIES Through research and development as well as intellectual property acquisitions, we have established a portfolio of advanced and emerging technologies, which we intend to commercialize and utilize within our own proprietary products or license out for the purpose of revenue generation. These advanced technologies and intellectual property are as follows: o Gas plasma antenna, o Vehicle stopping system, o Acoustic Core(TM) signature analysis, o APTIS(TM) human screening portal, and o Cryptography software. Of these five advanced technologies we believe that the nine issued and pending U.S. patents related to gas plasma antenna technology with demonstrated applications in the fields of ballistic missile defense, phased array radar, and forward deployed decontamination have the most demonstrated potential to create future sustained revenue streams. 27 COMPANY HISTORY EVENTS PRIOR TO FISCAL 2002. Markland, previously known as Quest Net, was incorporated in Colorado in November 1995, under the name "A.P. Sales Inc." In December 1998, A.P. Sales Inc. dissolved as a Colorado corporation, redomiciled in Florida and changed its name to Quest Net Corp. In 2001 our only asset was the stock of a subsidiary, CWTel, Inc. ("CWTel"), a company in the telecommunications business. We acquired this company in March 2000 and secured our payment obligations with 30,000 shares of our Series A Non-Voting Redeemable Convertible Preferred Stock. CWTel filed for bankruptcy and was liquidated on March 11, 2002. After the bankruptcy of our subsidiary, we had no active business operations. On June 30, 2003, we issued 30,000 shares of our Series A Non-Voting Redeemable Convertible Preferred Stock in satisfaction of our remaining obligations to the holder of the security interest. On March 15, 2001, we acquired all the outstanding capital stock of a company called Vidikron of America, Inc. ("Vidikron"), a development stage company in the business of creating digital broadband and wireless networking solutions for the internet. The sole stockholder of Vidikron was Markland LLC. To acquire Vidikron we issued 10 shares of our convertible Series B Preferred Stock to Markland LLC. Markland LLC converted all of its Series B Preferred Stock in June 2001, which, resulted in Markland LLC owning approximately 85% of our then outstanding common stock. There is no Series B Preferred Stock outstanding. At this time we changed our name to Markland Technologies, Inc. On October 19, 2000 we executed a promissory note for $3,500,000 in favor of James LLC. In July 2001, after the Vidikron acquisition, James LLC elected to convert $2,500,000 of the principal amount of its $3,500,000 promissory note, together with $125,000 accrued interest, into shares of our common stock. In September 2001, we assumed all of Vidikron's rights and obligations under a $3,500,000 secured revolving credit facility with Market LLC. These transactions made Market LLC our senior secured lender. EVENTS DURING FISCAL 2002. In May 2002, we received a notice of default from Market LLC. In June of 2002, we transferred all the stock of Vidikron to Market LLC in partial satisfaction of our indebtedness to Market LLC. After this partial payment, we still owed Market LLC $500,000. Our disposition of the business of Vidikron was treated as a discontinued operation. As a result, we recorded a loss of $3,259,421 for the fiscal year ended June 30, 2002 resulting from discontinued operations. At this point in our history we again had no active business operations. In fiscal 2003, we recorded a gain of $998,713 resulting from the settlement of certain liabilities and obligations recorded in previous periods in connection with the discontinued operations. EVENTS DURING FISCAL 2003. In December 2002, we entered into a transaction with Eurotech Ltd., ipPartners, Inc., Market LLC, and James LLC. Pursuant to this transaction, the following took place: o We formed a subsidiary corporation called Security Technology, Inc. o Eurotech transferred certain rights to its Acoustic Core Technology(TM) to our subsidiary. o Crypto.com Inc. (a subsidiary of Eurotech) and ipPartners, Inc. transferred certain rights to their cryptology technologies to our subsidiary. o 90% of the shares of our common stock held by Market LLC and James LLC were retired. o We issued shares of common stock representing 80% of our then issued and outstanding common stock to Eurotech, Ltd. and shares of common stock representing 10% of our then issued and outstanding shares of common stock to ipPartners, Inc. o We issued $5,225,000 in stated value of our Series C 5% Cumulative Convertible Preferred Stock to Market LLC and James LLC in satisfaction of $5,225,000 of convertible notes held by Market LLC and James LLC and in exchange for their agreement to surrender 4,498,638 shares of our common stock. 28 We are not a majority-owned subsidiary of Eurotech, Ltd. due to the issuances of additional common stock. In January of 2003, we acquired all of the common stock of Ergo Systems, Inc. ("Ergo"), a provider of security logistic support and related product development services. Ergo has a contract with the United States government to provide border security logistic support at five ports of entry. In consideration for this acquisition, we agreed to pay $400,000 in cash, payable at certain milestones related to our research efforts. During the year ended June 30, 2004, we recognized $955,736 from these services. In March of 2003, we entered into an agreement to acquire the intellectual property (including patents), equipment and government contracts relating to our gas plasma antenna technology from ASI Technology Corporation, but this transaction did not close until September 30, 2003. In consideration for this acquisition we issued 283,333 shares of common stock valued at $850,000 and agreed to pay $150,000. During the year ended June 30, 2004, we recognized revenue of $261,479 from SBIR research grants related to this technology. EVENTS DURING FISCAL 2004. In October of 2003, we acquired all of the common stock of Science and Technology Research Corporation, Inc. ("STR"). This company is the producer of the U.S. Navy's shipboard automatic chemical agent detection and alarm system. In consideration for this acquisition, we issued 1,539,779 shares of common stock valued at $5,100,000 and paid $900,000 in cash, and issued a promissory note for $375,000. During the year ended June 30, 2004, we recognized revenue of $4,796,715 from sales of our automatic chemical agent detection and alarm system to the U.S. Navy. We also entered into a consulting agreement with the former principal shareholder and employee. On June 29, 2004, we acquired all of the outstanding stock of EOIR for $8,000,000 in cash and $11,000,000 in principal amount of five year notes secured by the assets and stock of EOIR. EOIR is a provider of technology and services to the United States Army Night Vision and Electronic Sensors Directorate and has expertise in wide area remote sensing using both electro-optic and infrared technologies. Markland intends to continue to use the assets of EOIR for this purpose. We expect that EOIR will represent a majority of Markland's revenues going forward. We expect that these sensor science products will be our most significant revenue producing business. FINANCING ACTIVITIES. We have financed our business activities through borrowings and private placements of our securities to institutional investors. We have engaged in the following financing activities: o In October 2003, we borrowed $1,400,000 from Bay View Capital, LLC. This borrowing was repaid in April 2004. o At various times between April 2003 and March 2004 we have raised an aggregate of approximately $3,832,000 through private placements of our Series D Preferred Stock to an institutional investor. o On April 2, 2004, we sold 3,333,333 shares of common stock and warrants to purchase 3,333,333 shares of our common stock for gross proceeds of $2,000,000 to three investors in a private placement. o On April 16, 2004, we sold 2,500,000 shares of our common stock and warrants to purchase 2,500,000 shares of our common stock for gross proceeds of $2,000,000 to ten investors in a private placement. 29 o On May 3, 2004, we sold 7,098,750 shares of our common stock and warrants to purchase 7,098,750 shares of our common stock for gross proceeds of $5,679,000 to 34 investors in a private placement. o As of April 2004, all of our Series C Cumulative Convertible Preferred Stock has been converted into common stock and none remains outstanding. o On June 30, 2004, we sold 3,500 shares of Series D Preferred Stock to an institutional investor for $2,000,000 in connection with the acquisition of EOIR. EVENTS AFTER FISCAL 2004 ------------------------ o On September 21, 2004, we sold secured convertible promissory notes and warrants to purchase shares of common stock to two institutional investors for approximately $4,000,000. FINANCING ACTIVITIES AFTER SEPTEMBER 30, 2004 --------------------------------------------- o On November 9, 2004 we sold convertible promissory notes and warrants to purchase shares of common stock to two institutional investors for approximately $1,350,000. RESULTS OF OPERATIONS COMPARISON OF SEPTEMBER 2003 AND SEPTEMBER 2004 REVENUE: Revenue for the fiscal quarter ended September 30, 2004 was $15,769,851 compared to $306,724 for the same period in 2003. Our EOIR subsidiary accounted for approximately 98% of these revenues in the three months ended September 30, 2004 EOIR's most significant source of revenues is a contract with the United States Army Night Vision and Electronic Sensors Directorate. Approximately 84% of our revenues were received from this contract. We expect orders to continue at current levels under this contract, however, no assurance can be given that they will continue or continue at current levels. COST OF REVENUES: Cost of revenues for the fiscal quarter ended September 30, 2004 was $12,442,893, compared to $256,956 for the same period in 2003. Cost of revenues increased as a result of an increase in sales resulting from our acquisition of EOIR. We expect that cost of revenues will increase if sales increase, but that our gross margins will improve with increased sales as we expect to increase the sale of higher margin products and services into our revenue base as we better diversify our customer and contract base. Gross profits for the quarter ended September 30, 2004 was $3,326,958 compared to $49,768 for the same period in 2003. Gross profits increased as a result of additional revenue from the acquisition of EOIR. Gross profit as a percentage of revenue was approximately 21%. We expect this percentage to increase if sales from our EOIR subsidiary increase. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and administrative expense for the quarter ended September 30, 2004 was $3,571,040 compared to $497,812 in the same period in 2003. Selling, general and administrative expense was primarily composed of payroll, consultants, legal and accounting fees, and vendors. The increase in selling, general and administrative expense was primarily due to increases in staff resulting from the acquisition of EOIR and increases due to related sales growth. As reported on our current report on Form 8-K/A filed with the SEC on September 13, 2004, EOIR's selling, general and administration expense was $5,622,521 and $5,188,798, for the fiscal years ended December 31, 2003 and 2002 respectively. 30 RESEARCH AND DEVELOPMENT: During the fiscal quarter ended September 30, 2004, we did not spend anything on research and development activities. During the fiscal year ended 2003, $522,657 was spent on research and development activities. During the fiscal year ended June 30, 2004, we reduced our research and development efforts to concentrate our financial resources on product marketing activities. We do not expect to have material research and development expenses in the near term. COMPENSATORY ELEMENT OF STOCK ISSUANCES FOR SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Compensatory element of stock issuances for selling, general and administrative expenses for the quarters ended September 30, 2004 and September 30, 2003 was a benefit of $19,143 and a charge of $401,980, respectively. In the fiscal quarter ended September 30, 2004, this amount consisted of a negative charge as a result of revaluations made at quarters end to unearned compensation balances. We do not expect such negative charges to recur. We use our equity to compensate management and consultants who provide services to us. We expect to continue to do so in the future. For this reason we expect to continue to incur such charges. OPERATING LOSS: Loss from operations for the quarter ended September 30, 2004 was $748,653. This loss resulted primarily from selling, general and administrative expenses, which were offset by gross profit. We believe that we will incur non-cash charges for the compensatory element of stock issuances in future quarters. Such charges will increase operating loss or reduce operating profit if we have operating profits. Loss from operations for the quarter ended September 30, 2003 was $883,358. This loss resulted primarily from non-cash charges for the compensatory element of stock issuances of $401,980 and from selling, general and administrative expenses, which were offset to a small extent by gross profit. INTEREST EXPENSE: Interest expense for the quarter ended September 30, 2004 and September 30, 2003 was $503,215 and $28,578 respectively. Interest and financing expense was from notes payable issued for bridge financing, premium financing arrangements and other financing costs. In connection with our acquisition of EOIR, EOIR issued, and we guaranteed, $11,000,000 in original principal amount of notes due to the former stockholders of EOIR. These notes bear interest at the rate of six (6%) percent per annum and must be repaid within the next five years. The carrying value of these notes is $9,605,442 at September 30, 2004. We expect significant increases in interest expense as a result of this financing and the convertible debt financing completed on September 21, 2004. PREFERRED STOCK DIVIDENDS: There were no Preferred Stock dividends for the quarter ended September 30, 2004. All of Series C Preferred Stock has been converted. As a result none is outstanding. 31 Preferred Stock dividends for the quarter ended September 30, 2003 were $155,689. This consisted of deemed dividends to the holder of our Series C Preferred Stock of $65,689 and deemed dividends to the holder of our Series D Preferred Stock of $90,000. We expect to continue to finance our operations with additional debt and equity financing including, possibly, additional sales of our Series D Preferred Stock with beneficial conversion features. Such financing could result in additional charges for preferred stock dividends and conversions of Series D Preferred Stock into common stock. NET LOSS APPLICABLE TO COMMON STOCKHOLDERS: Net loss applicable to common stockholders for the quarters ended September 30, 2004 and September 30,2003 was $1,246,021 ($0.03 per share) and $1,067,625 ($0.22 per share) respectively. Our weighted average number of shares outstanding on September 30, 2004 and September 30, 2003 were 38,352,594 and 4,746,887, respectively. The reduction in net loss per share from the prior period is due primarily to the increase in number of shares outstanding. Shares outstanding increased primarily as a result of our financing activities. LIQUIDITY AND CAPITAL RESOURCES During the quarter ended September 30, 2004, we experienced $2,503,859 of positive cash flow from operating activities. This cash flow was the result of a loss of $1,246,021 from continuing operations offset in part by non-cash charges for amortization of intangible asset of $481,933 non-cash interest payments of $314,166 and an increase in accounts payable of $4,069,967. On June 29, 2004, we acquired all of the outstanding stock of EOIR for $8,000,000 in cash and $11,000,000 in principal amount of five year notes secured by the assets and stock of EOIR. These notes bear interest at the rate of six (6%) percent per annum and must be repaid within the next five years. The carrying value of these notes is $9,605,442 at September 30, 2004. We expect significant increases in interest expense as a result of this financing. On September 21, 2004, we sold secured convertible promissory notes and warrants for the aggregate consideration of $4,000,000 and in the aggregate principal amount of $5,200,000. These notes accrue interest at the rate of eight percent (8%) per annum and are due and payable within one year. The carrying value of this note is $218,071 at September 30, 2004 and the balance will be accreted over the life of the loan. We believe that required investment capital will be available to us, but there can be no assurance that we will be able to raise funds on terms acceptable to us, or at all. We have the ability to adjust the level of research and development and selling and administrative expenses to some extent based on the availability of resources. However, reductions in expenditures could delay development and adversely affect our ability to generate future revenues. Any equity-based source of additional funds could be dilutive to existing equity holders and the dilution could be material. The lack of sufficient funds from operations or additional capital could force us to curtail or scale back operations and would therefore have an adverse effect on our business. Other than cash and cash equivalents, we have no unused sources of liquidity at this time. We expect to incur additional operating losses as a result of expenditures for research and development and marketing costs for our security products and technologies. The timing and amounts of these expenditures and the extent of our operating losses will depend on many factors, some of which are beyond our control. Accordingly, there can be no assurance that our current expectations regarding required financial resources will prove to be accurate. We anticipate that the commercialization of our technologies may require increased operating costs; however, we cannot currently estimate the amounts of these costs. 32 GOING CONCERN For three months ended September 30, 2004 and September 30, 2003, we incurred a loss from continuing operations of $1,246,021 and $ 911,936 respectively. We have limited finances and require additional funding in order to market and license our products. There is no assurance that we can reverse our operating losses, or that we can raise additional capital to allow us to continue our planned operations. These factors raise substantial doubt about our ability to continue as a going concern. The report of our independent registered public accounting firm for the fiscal year 2004 includes an explanatory paragraph as to the uncertainty that we will continue as a going concern. While we have experienced operating losses in the past, due to our acquisition of EOIR, the operating portion of our business is currently cash flow positive. Our business plan is to continue to grow our customer base and our revenues and to control and monitor operating expenses and capital expenditures. In addition, after the conclusion of the 2004 fiscal year, we consummated a financing through which we realized net cash of approximately $3,460,000, which if not converted is repayable by September 30, 2005. We believe that our business as currently constituted will produce positive cash flow which, together with our current cash levels, will enable us to meet our existing financial obligations as they come due during the current fiscal year. However, we can provide no assurance that the performance of our business will meet our expectations. OFF-BALANCE SHEET ARRANGEMENTS We have no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders. EFFECT OF INFLATION AND CHANGES IN PRICES Management does not believe that inflation and changes in price will have a material effect on operations. CRITICAL ACCOUNTING POLICIES The preparation of Markland's financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities as of the date of the financial statements and the amounts of revenues and expenses recorded during the reporting periods. We base our estimates on historical experience, where applicable, and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions. The sections below present information about the nature of and rationale for our critical accounting policies. PRINCIPLES OF CONSOLIDATION Our consolidated financial statements include the accounts of Markland and its wholly-owned subsidiaries, Security Technology, Inc., Ergo Systems, Inc., Science and Technology Research Corporation, Inc and E-OIR Technologies, Inc. We have eliminated all significant inter-company balances and transactions. 33 CONCENTRATIONS Statement of Financial Accounting Standards ("SFAS") No. 105, "Disclosure of Information about Financial Instruments With Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk," requires that we disclose any significant off-balance-sheet and credit risk concentrations. We are subject to concentrations of credit risk because the majority of our revenues and accounts receivable are derived from the US Navy, Computer Science Corporation and The Department of Homeland Security, none of whom is required to provide collateral for amounts owed to us. We do not believe that we are subject to any unusual credit risks, other than the normal level of risk attendant to operating our business. As of September 30,2004, , we had cash balances in banks in excess of the maximum amount insured by the FDIC. In addition, we derive substantially all of our contract revenue from contracts with Federal government agencies. Consequently, substantially all of our accounts receivable are due from Federal government agencies either directly or through other government contractors. IMPAIRMENT OF GOODWILL AND AMORTIZABLE INTANGIBLES In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," we review goodwill for impairment annually, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of our business enterprise below its carrying value. The impairment test requires us to estimate the fair value of our overall business enterprise down to the reporting unit level. We estimate fair value using both a discounted cash flows model, as well as an approach using market comparables, both of which are weighted equally to determine fair value. Under the discounted cash flows method, we utilize estimated long-term revenue and cash flows forecasts developed as part of our planning process, as well as assumptions of terminal value, together with an applicable discount rate, to determine fair value. Under the market approach, fair value is determined by comparing us to similar businesses (or guideline companies). Selection of guideline companies and market ratios require management's judgment. The use of different assumptions within our discounted cash flows model or within our market approach model when determining fair value could result in different valuations for goodwill. ESTIMATED USEFUL LIVES OF AMORTIZABLE INTANGIBLE ASSETS We amortize our amortizable intangible assets over the shorter of the contractual/legal life or the estimated economic life. We are amortizing the intangible assets acquired as of a result of the Ergo and ASI acquisitions over a three-year life commencing with the date of acquisition. With respect to the Science & Technology Research, Inc. and EOIR Technologies, Inc. acquisitions, consistent with independent business valuations, we are amortizing the intangible assets or ten years and nine years respectively. IMPAIRMENT OF LONG-LIVED ASSETS Pursuant to SFAS No. 144, we continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. We recognize an impairment loss when the carrying value of an asset exceeds expected cash flows. Accordingly, when indicators or impairment of assets are present, we evaluate the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying business. Our policy is to record an impairment loss when we determine that the carrying amount of the asset may not be recoverable. No impairment charges were recorded for the three months ended September 30, 2004 and 2003. 34 REVENUE RECOGNITION We recognize product revenue when the following criteria are met: (1) we have persuasive evidence of an arrangement, such as agreements, purchase orders or written requests; (2) we have completed delivery and no significant obligations remain, (3) our price to our customer is fixed or determinable, and (4) collection is probable. We recognize revenues at the time we perform services related to border security logistic support. With respect to our revenues from our chemical detectors, we recognize revenue under the units-of-delivery method. At the time the units are shipped to the warehouse of the United States Navy, the Company recognizes as revenues the contract price of each unit and recognizes the applicable cost of each unit shipped. As of June 30, 2004, we had completed delivery pursuant to all outstanding orders under this contract. Revenues from time and materials contracts are recognized as costs are incurred. Revenues from firm fixed price contracts are recognized on the percentage-of-completion method, either measured based on the proportion of costs recorded to date on the contract to total estimated contract costs or measured based on the proportion of labor hours expended to date on the contract to total estimated contract labor hours, as specified in the contract. Prvisions for estimated losses on all contracts are made in the period in which such losses become known. Changes in job performace, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract sttlements may result in revision to cost and income and are recognized in the period in which the revisions are determined. The Company partcipates in teaming agreements where they are the primary contractor and they participate with other organizations to provide services to the Federal government. The IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In December 2003, the FASB issues FASB Interpretation No. 46R ("FIN 46R"), "Consolidation of Variable Interest Entities". FIN 46R expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46R requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or is entitled to receive a majority of the entity's residual returns or both. The adoption of this interpretation did not have any impact on our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability. Many of those instruments were previously classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have any impact on our financial position or results of operations. 35 ITEM 3. CONTROLS AND PROCEDURES. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on our management's evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act")) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Prior to the acquisition of EOIR, the limited size of our internal financial and controls staff did not permit a significant amount of time or expense on monitoring and oversight of our general administrative and financial functions. In the course of management's ongoing evaluation of our controls and procedures, management has concluded that, due to the limited amount of resources available for general administrative and financial matters prior to the acquisition of EOIR the Company: (i) had a less than desirable number of people performing a majority of the financial duties, (ii) lacked the desired internal financial and controls staff resources for a comprehensive internal audit function, and (iii) and in some cases had not been able to promptly accumulate and process all of our data and reports on a timely basis. Management believes that at this time, in light of existing newly instituted staff and controls, which include additional administrative personnel acquired with EOIR, and the recent addition of an outside consultant, the risks associated with a lack of segregation of duties and limited staff have been largely mitigated. However, management will periodically reevaluate the situation, and as necessary, will put in place additional internal staff and controls to prevent a lack of discipline around policies and procedures in our administrative and financial matters. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There is no change in our internal control over financial reporting during our first fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On June 28, 2004, Charles Wainer filed a civil suit against the Company in Florida state court alleging breach of a stock purchase agreement and breach of an employment agreement stemming from Wainer's sale of his business to a predecessor of the Company and his subsequent employment thereat. In the complaint, Wainer alleges Markland owes him $300,000 cash, some unspecified portion of $700,000 in stock, some unspecified portion of $86,000 cash for lease payments, and approximately $20,000 in back-pay. The Company believes that these claims are without merit and plans to vigorously defend the action. On August 11, 2004, the Company answered the complaint and denied any liability. 36 On or about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the Circuit Court of Spotsylvania County, Virginia, against the Company, EOIR, our wholly owned subsidiary, and our Chief Executive Officer and Director, Robert Tarini. Mr. Moulton was the largest single shareholder of EOIR prior to its acquisition by the Company, owning approximately 67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000 in cash and a promissory note of EOIR in the approximate principal amount of $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR by the Company. In his complaint Mr. Moulton asserts, among other things, that the Company breached its obligations under the Stock Purchase Agreement, dated June 29, 2004, pursuant to which the Company acquired EOIR, by terminating Mr. Moulton's employment with EOIR and removing him from the EOIR board of directors. Mr. Moulton is seeking damages allegedly suffered by his loss of employment, extreme emotional distress, and costs incurred to enforce his contractual rights. In addition, he is seeking certain other equitable relief including, the appointment of a receiver to oversee the management of EOIR until these promissory notes issued to former EOIR shareholders at the closing of the acquisition are paid in full and a declaratory judgment that the Company's actions constitute an event of default under these promissory notes allowing for the acceleration of all amounts (approximately $11,000,000) due thereunder. The Company is a guarantor of these notes. The Company believes that the allegations in this lawsuit are entirely without merit. The Company has filed an answer denying Mr. Moulton's allegations and opposing vigorously all equitable relief sought. The Company has also filed a demurrer seeking to dismiss certain claims. The Company is considering bringing various claims against Mr. Moulton either by counterclaim or in a separate action. In addition, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES. During the period ending September 30, 2004, various holders of the Company's Series D Convertible Preferred Stock converted shares of preferred stock into shares of common stock. The total shares issued under such conversions was approximately 11,568,137. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering. On July 28, 2004, we issued 1,006,902 shares of our common stock to each of Robert Tarini and Verdi Consulting, 301,370 shares of common stock to Kenneth Ducey, Jr. and 705,532 shares of common stock to Asset Growth Company in connection with employment and consulting agreements. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering. For more information concerning this transaction please refer to Note 11 of our Condensed Consolidated Financial Statements. During the three months ended September 30, 2004, the Company issued an aggregate of 227,776 shares of common stock to various consultants and employees under existing contacts. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as sales not involving a public offering. 37 Pursuant to employment agreements dated July 15, 2004, the company issued 38,333 shares of common stock to two employees on August 26, 2004. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering. On September 9, 2004, the Company issued 226,096 shares of common stock to Tameracq Partners, Inc. pursuant to a consulting agreement in connection with the Company's recent mergers and acquisitions. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering. On September 21, 2004, we entered into a Purchase Agreement with DKR Soundshore Oasis Holding Fund, Ltd. and DKR Soundshore Strategic Holding Fund, Ltd, pursuant to which we sold warrants to purchase 6,500,000 shares of our common stock and secured convertible promissory notes in the principal amount of $5,200,000, for the aggregate consideration of $4,000,000. We received net proceeds of $3,480,000 from this private placement. The offer and sale of these securities was made in reliance on Section 4(2) of Securities Act of 1933, as amended. For more information concerning this transaction please refer to Note 6 of our Condensed Consolidated Financial Statements. On September 22, 2004, the Company issued 833,333 shares to investors that participated in the Company's April 2, 2004 private placement in exchange for their waiver and release of certain rights. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering. SUBSEQUENT STOCK ISSUANCES -------------------------- On October 4, 2004, we issued 1,205,479 shares of our common stock to each of Robert Tarini and Verdi Consulting, 301,370 shares of common stock to Kenneth Ducey, Jr. and 904,110 shares of common stock to Asset Growth Company in connection with employment and consulting agreements. The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering. For more information concerning this transaction please refer to Note 11 of our Condensed Consolidated Financial Statements. On November 9, 2004, we entered into a Securities Purchase Agreement with Harborview Master Fund, LP and Southridge Partners, LP pursuant to which we sold warrants to purchase 2,193,750 shares of our common stock and secured convertible promissory notes in the principal amount of $1,755,000, for the aggregate consideration of $1,350,000. We received net proceeds of $1,174,500 from this private placement. The offer and sale of these securities was made in reliance on Section 4(2) of Securities Act of 1933, as amended. For more information concerning this transaction please refer to Note 15 of our Condensed Consolidated Financial Statements. 38 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 3.1 Articles of Incorporation of Quest Net 8-K March 20, 2000 1.3 Corp., filed with the Florida Secretary of State on December 28, 1998 3.2 Articles of Merger filed with the Florida 8-K March 20, 2000 1.2 Secretary of State on March 15, 2000 3.3 Articles of Amendment to the Articles of 8-K April 10, 2001 3.1 Incorporation of Quest Net Corp., filed with the Florida Secretary of State on April 4, 2001 3.4 Articles of Amendment to the Articles of 8-K April 10, 2001 3.3 Incorporation of Quest Net Corp., filed with the Florida Secretary of State on June 21, 2001 3.5 Articles of Amendment to the Articles of SB-2 May 11, 2004 3.5 Incorporation of Markland Technologies, Inc. filed with the Florida Secretary of State on December 21, 2001 3.6 Articles of Amendment to the Articles of 10-KSB October 14, 2003 3.6 Incorporation of Markland Technologies, Inc. filed with the Florida Secretary of State on September 16, 2003 3.7 Certificate of Designations of Rights and 10-KSB October 14, 2003 3.7 Preferences of the Series A Non-Voting Convertible Preferred Stock 3.8 Certificate of Designations of Rights and 8-K December 20, 2002 3.5 Preferences of the Series C Cumulative Convertible Preferred Stock 3.9 Certificate of Designations of Rights and 10-KSB October 14, 2003 3.5 Preferences of the Series D Cumulative Convertible Preferred Stock 3.10 Amended and Restated By-Laws 8-K March 20, 2000 1.4 4.1 Form of common stock certificate of 10-QSB February 14, 2003 4.1 Markland Technologies, Inc. 4.2 Registration Rights Agreement between SB-2 May 11, 2004 4.2 Markland Technologies, Inc., Montana View Corporation, Elite Properties, Ltd., Sparrow Ventures, Inc., dated April 2, 2004 4.3 Form of Common Stock Purchase Warrant dated SB-2 May 11, 2004 4.3 April 2, 2004 4.4 Form of Common Stock Purchase Warrant dated SB-2 May 11, 2004 4.4 April 16, 2004 4.5 Form of Common Stock Purchase Warrant dated SB-2 May 11, 2004 4.5 May 3, 2004 39 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 4.6 Registration Rights Agreement, dated March 10-KSB October 14, 2003 10.10 19, 2003, by and between ASI Technology Corporation and Markland Technologies, Inc. 4.7 Registration Rights Agreement by and 10-KSB October 14, 2003 10.17 between Markland Technologies, Inc. and Brittany Capital Management limited, dated September 10, 2003. Consulting Agreement by and between Markland Technologies, Inc. and George 4.8 Yang, dated September 30, 2003. 8K November 12, 2003 10.3 4.9 Consulting Agreement by and between SB-2 May 11, 2004 4.9 Markland Technologies, Inc. and Commonwealth Acquisitions, Ltd., dated March 24, 2003. 4.10 Consulting Agreement by and between ECON SB-2 May 11, 2004 4.10 Investor Relations, Inc., dated January 18, 2003. 4.11 Consulting Agreement by and between SB-2 May 11, 2004 4.11 Markland Technologies, Inc. and Marketshare Recovery, Inc., dated October 29, 2003 4.12 Consulting Agreement by and between 10-QSB February 23, 2004 10.4 Markland Technologies, Inc. and Emerging Concepts, Inc., dated July 7, 2003 4.13 Research Agreement by and between Markland SB-2 May 11, 2004 4.13 Technologies, Inc. and The Research Works, Inc., dated October 29, 2003 4.14 Employment Agreement by and between SB-2 May 11, 2004 4.14 Markland Technologies, Inc. and Jo-Ann Nichols, dated October 27, 2003. 4.15 Registration Rights Agreement by and 8-K September 23, 2004 99.3 between Markland Technologies, Inc. and the investors named therein, dated September 21, 2004 4.16 Form of Common Stock Purchase Warrant 8-K September 23, 2004 99.5 issued by Markland Technologies, Inc. on September 21, 2004 4.17 Lock-up Agreement by and among Markland 8-K September 23, 2004 99.7 Technologies, Inc., Robert Tarini, and Kenneth Ducey, Jr. 4.18 Lock-up Agreement by and between Markland 8-K September 23, 2004 99.6 Technologies, Inc. and James, LLC. 4.19 Waiver Agreement by and among Markland 8-K September 23, 2004 99.8 Technologies, Inc. and the parties named therein, dated September 21, 2004 10.1 Securities Purchase Agreement, between SB-2 May 11, 2004 10.1 Markland Technologies, Inc., Montana View Corporation, Elite Properties, Ltd., and Sparrow Ventures, Inc., dated April 2, 2004 10.2 Securities Purchase Agreement by and among SB-2 May 11, 2004 10.2 Markland Technologies, Inc. and the Investors named therein, dated April 16, 2004. 40 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.3 Securities Purchase Agreement by and SB-2 May 11, 2004 10.3 between Markland Technologies, Inc. and the Investors named therein, dated May 3, 2004. 10.4 Agreement and Plan of Merger by and among 8K November 12, 2003 10.1 Markland Technologies, Inc. and STR Acquisition Corp., Security Technology, Inc., Science and Technology Research, Inc., and George Yang, dated September 30, 2003. 10.5 Promissory Note made by Markland 8K November 12, 2003 10.4 Technologies, Inc., in favor of George Yang, dated September 30, 2003. 10.6 Security Agreement by and between Markland SB-2 May 11, 2004 10.6 Technologies, Inc. and George Yang, dated September 30, 2003. Guaranty by Markland Technologies, Inc. in favor of George Yang, dated September 30, 10.7 2003. SB-2 May 11, 2004 10.7 10.8 Amendment and Payment Extension Agreement SB-2 May 11, 2004 10.8 by and between Markland Technologies, Inc. and George Yang, dated March 17, 2004. 10.9 Loan Agreement by and between Security 8K November 12, 2003 10.2 Technology, Inc. and Bay View Capital LLC, dated September 30, 2003. 10.10 Promissory Note by and among Markland 8K November 12, 2003 10.5 Technologies, Inc., Security Technology, Inc., and Bay View Capital LLC, dated September 30, 2003. 10.11 Security Agreement by and between Security SB-2 May 11, 2004 10.11 Technology, Inc. and Bay View Capital LLC, dated September 30, 2003. 10.12 Security Agreement by and between Markland SB-2 May 11, 2004 10.12 Technologies, Inc. and Bay View Capital LLC. 10.13 Sublicense Agreement by and between SB-2 May 11, 2004 10.13 Markland Technologies, Inc. and ASI Technology Corporation, dated March 19, 2004. 10.14 ASI Technology Corporation SBIR Phase II SB-2/1A June 16, 2004 10.14 Proposal, dated October 8, 2001. 10.15 ASI Technology Corporation Contract SB-2/1A June 16, 2004 10.15 with Air Force Office of Scientific Research, dated August 1, 2002. 10.16 ASI Technology Corporation Contract with SB-2/1A June 16, 2004 10.16 Naval Surface Warfare Center, dated January 31, 2003. 41 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.17 Stock Purchase Agreement by and among Ocean 8-K January 28, 2003 10.1 Data Equipment Corporation, Ergo Systems, Markland Technologies, and Security Technology, Inc., dated December 9, 2002. 10.18 Exchange Agreement, dated December 9, 2002, 8-K December 20, 2002 10.4 by and among Markland Technologies, Inc., Market LLC, and James LLC. 10.19 Exchange Agreement, dated December 9, 2002, 8-K December 20, 2002 10.5 by and among Eurotech, Ltd., Crypto.com Inc., Markland Technologies, Inc., Security Technology, Inc. ipPartners, Inc., Market LLC, and James LLC. 10.20 First Amendment to Exchange Agreement, 10-QSB February 14, 2003 10.6 dated December 9, 2002, by and among Eurotech, Ltd., Crypto.com Inc., Markland Technologies, Inc., Security Technology, Inc. ipPartners, Inc., Market LLC, and James LLC. 10.21 Restated and Amended Convertible Revolving 10-QSB February 14, 2003 10.2 Credit Note Agreement, dated December 10, 2002, by and between Markland Technologies, Inc. and Market LLC. 10.22 Letter from Sherb & Co., LLP to the 8-K March 17, 2003 16.1 Commission, dated March 12, 2003, concerning change in certifying accountant. 10.23 Technology Purchase Agreement between 8-K April 4, 2003 10.1 Markland Technologies, Inc. and ASI Technology Corporation, dated March 19, 2003. 10.24 Exchange Agreement, dated March 27, 2003, 8-K April 4, 2003 10.2 by and between Eurotech, Ltd. and Markland Technologies, Inc. 10.25 Registration Rights Agreement, dated March 10-KSB October 14, 2003 10.12 27, 2003, by and between Eurotech, Ltd. and Markland Technologies, Inc. 10.26 Amended and Restated Exchange Agreement, 8-K July 30, 2003 10.1 dated July 24, 2003, by and between Markland Technologies, Inc. and Syqwest, Inc. 10.27 Preferred Securities Purchase Agreement by 10-KSB October 14, 2003 10.14 and between Markland Technologies, Inc. and James LLC, dated February 2, 2003, relating to the issuance of 170 shares of Series C 5% Convertible Preferred Stock. 10.28 Preferred Securities Purchase Agreement by 10-KSB October 14, 2003 10.15 and between Markland Technologies, Inc., and James LLC, dated April 1, 2003, relating to the issuance of Series D Convertible Preferred Stock. 10.29 Private Equity Credit Agreement by and 10-KSB October 14, 2003 10.16 between Markland Technologies, Inc. and Brittany Capital Management Limited, dated September 10, 2003. 42 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.30 Employment and consulting agreements, dated 10-KSB October 14, 2003 10.18 December 5, 2002, for Delmar Kintner, Kenneth Ducey, Robert Tarini, and Verdi Consulting. 10.31 Nonexclusive License Agreement by and between SB-2 May 11, 2004 10.31 Science & Technology Research , Inc. and the Secretary of the Navy, dated 11/4/03. 10.32 International Distribution Agreement SB-2 May 11, 2004 10.32 between Markland Technologies, Inc. and Tradeways. 10.33 Science & Technology Research contract SB-2 May 11, 2004 10.33 Naval Surface Warfare Center, dated January 31, 2003. 10.34 Subcontract Agreement by and between ERGO SB-2 May 11, 2004 10.34 Systems, Inc. and Computer Sciences Corporation ,dated December 8, 2003. 10.35 Lease for Property in Fredericksburg, SB-2/1A June 16, 2004 10.35 Virginia. 10.36 Co-Operative Research and Development SB-2/1A June 16, 2004 10.35 Agreement between Markland Technologies, Inc. and the U.S. Air Force. 10.37 Employment Agreement by and between 10-QSB May 24, 2004 10.32 Markland Technologies, Inc. and Robert Tarini, dated May 12, 2004 . 10.38 Employment Agreement by and between 10-QSB May 24, 2004 10.33 Markland Technologies, Inc. and Kenneth Ducey, Jr., dated May 12, 2004. 10.39 Strategic Operations Contractor Agreement 10-QSB May 24, 2004 10.34 by and between Markland Technologies, Inc. and Asset Growth Company, dated May 12, 2004. 10.40 Consulting Agreement by and between 10-QSB May 24, 2004 10.35 Markland Technologies, Inc. and Chad A. Verdi, dated May 12, 2004. 10.41 Amendment to Employment Agreement between SB-2/1A June 16, 2004 10.41 Markland Technologies Inc. and Robert Tarini dated June 16, 2004. 10.42 Amendment to the Employment SB-2/1A June 16, 2004 10.42 Agreement between Markland Technologies Inc. and Kenneth P. Ducey, dated June 16, 2004. 10.43 Amendment to the Consulting Agreement SB-2/1A June 16, 2004 10.43 between Markland Technologies Inc. and Verdi Consulting, dated June 16, 2004. 10.44 Amendment to the Strategic Operations SB-2/1A June 16, 2004 10.44 Contractor Agreement by and between Markland Technologies, Inc. and Asset Growth Company, dated June 16, 2004. 43 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.45 Purchase Agreement between Markland 8-K September 23, 2004 99.1 Technologies, Inc. and the investors named therein, dated September 21, 2004. 10.46 Security Agreement between Markland 8-K September 23, 2004 99.2 Technologies, Inc. and the investors named therein, dated September 21, 2004. 10.47 Form of Secured Convertible Promissory Note 8-K September 23, 2004 99.4 issued by Markland Technologies, Inc., on September 21, 2004. 10.48 Night Vision Electronic Sensors Directorate 10-KSB October 13, 2004 10.48 (NVESD) Omnibus Contract between E-OIR Measurement Inc., a subsidiary of EOIR and United States Army Night Vision and Electronic Sensors Directorate. 10.49 Securities Purchase Agreement between SB-2 November 10, 2004 10.50 Markland Technologies, Inc., Harborview Master Fund L.P. and Southridge Partners LP dated November 9, 2004. 10.50 Form of Convertible Note issued to SB-2 November 10, 2004 10.51 Harborview Master Fund L.P. and Southridge Partners LP. 10.51 Form of Warrant issued to Harborview Master SB-2 November 10, 2004 10.52 Fund L.P. and Southridge Partners LP. 10.52 Subordination Agreement between DKR SB-2 November 10, 2004 10.53 Soundshore Oasis Holding Fund, LLC DKR Soundshore Strategic Holding Fund, LLC, Harborview Master Fund L.P., Southridge Partners LP, and Markland Technologies, Inc., dated November 9, 2004. 10.53 Conditional Waiver and Consent between DKR SB-2 November 10, 2004 10.54 Soundshore Oasis Holding Fund, LLC DKR Soundshore Strategic Holding Fund, LLC, Harborview Master Fund L.P., Southridge Partners LP, and Markland Technologies, Inc., dated November 9, 2004. 10.54 Stock Purchase Agreement by and between 8-K June 30, 2004 2.1 Markland and EOIR, dated June 30, 2004 10.55 Forms of Promissory Note. 8-K June 30, 2004 2.2 10.56 Security Agreement by and between EOIR and 8-K June 30, 2004 2.3 sellers of EOIR stock, dated June 30, 2004. 10.57 2004 Stock Option Plan, adopted June 30, 8-K June 30, 2004 2.4 2004. 10.58 Preferred Securities Purchase Agreement. 8-K June 30, 2004 2.5 10.59 Pledge and Security Agreement. 8-K June 30, 2004 2.6 10.60 Forms of Stock Option. 8-K June 30, 2004 2.7 44 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.61 Agreement and General Release, dated X November 1, 2004, between Markland Technologies, Inc. and Gregory A. Williams. X 31.1 Certification by CEO of Periodic Report X Pursuant to Rule 13a-14(a) or Rule 15d-14(a) 31.2 Certification by CFO of Periodic Report X Pursuant to Rule 13a-14(a) or Rule 15d-14(a) 32.1 Certification by CEO and CFO of Periodic X Report Pursuant to 18 U.S.C. Section 1350
(b) REPORTS ON FORM 8-K On July 13, 2004, the Company filed a Current Report on Form 8-K reporting Item 4 and containing certain information regarding the Company's change of independent registered public accounting firm. On July 15, 2004, the Company filed a Current Report on Form 8-K/A reporting Item 4 and containing certain information regarding the Company's change of independent registered public accounting firm. On August 11, 2004, the Company filed a Current Report on Form 8-K reporting Items 5, 7, and 12 and containing financial information for the month ended July 31, 2004 and forward-looking statements, all as presented in a press release of August 10, 2004 On September 13, 2004, the Company filed a Current Report on Form 8-K/A reporting Item 7 and containing certain audited and pro-forma financial information relating to its acquisition of EOIR Technologies, Inc. on June 29, 2004. On September 23, 2004, the Company filed a Current Report on Form 8-K reporting Items 1.01, 2.01, and 3.02 and containing certain information in connection with the Company's private placement of securities on September 21, 2004. On September 23, 2004, the Company filed a Current Report on Form 8-K, reporting Items 8.01 and 9.01 and containing certain information in connection with the Company's private placement of securities on September 21, 2004, and forward-looking statements, all as presented in a press release of September 23, 2004. 45 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MARKLAND TECHNOLOGIES, INC. Date: November 15, 2004 By: /S/ ROBERT TARINI ------------------------------- Robert Tarini Chairman, Director, and Chief Executive Officer 46 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 3.1 Articles of Incorporation of Quest Net 8-K March 20, 2000 1.3 Corp., filed with the Florida Secretary of State on December 28, 1998 3.2 Articles of Merger filed with the Florida 8-K March 20, 2000 1.2 Secretary of State on March 15, 2000 3.3 Articles of Amendment to the Articles of 8-K April 10, 2001 3.1 Incorporation of Quest Net Corp., filed with the Florida Secretary of State on April 4, 2001 3.4 Articles of Amendment to the Articles of 8-K April 10, 2001 3.3 Incorporation of Quest Net Corp., filed with the Florida Secretary of State on June 21, 2001 3.5 Articles of Amendment to the Articles of SB-2 May 11, 2004 3.5 Incorporation of Markland Technologies, Inc. filed with the Florida Secretary of State on December 21, 2001 3.6 Articles of Amendment to the Articles of 10-KSB October 14, 2003 3.6 Incorporation of Markland Technologies, Inc. filed with the Florida Secretary of State on September 16, 2003 3.7 Certificate of Designations of Rights and 10-KSB October 14, 2003 3.7 Preferences of the Series A Non-Voting Convertible Preferred Stock 3.8 Certificate of Designations of Rights and 8-K December 20, 2002 3.5 Preferences of the Series C Cumulative Convertible Preferred Stock 3.9 Certificate of Designations of Rights and 10-KSB October 14, 2003 3.5 Preferences of the Series D Cumulative Convertible Preferred Stock 3.10 Amended and Restated By-Laws 8-K March 20, 2000 1.4 4.1 Form of common stock certificate of 10-QSB February 14, 2003 4.1 Markland Technologies, Inc. 4.2 Registration Rights Agreement between SB-2 May 11, 2004 4.2 Markland Technologies, Inc., Montana View Corporation, Elite Properties, Ltd., Sparrow Ventures, Inc., dated April 2, 2004 4.3 Form of Common Stock Purchase Warrant dated SB-2 May 11, 2004 4.3 April 2, 2004 4.4 Form of Common Stock Purchase Warrant dated SB-2 May 11, 2004 4.4 April 16, 2004 4.5 Form of Common Stock Purchase Warrant dated SB-2 May 11, 2004 4.5 May 3, 2004 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 4.6 Registration Rights Agreement, dated March 10-KSB October 14, 2003 10.10 19, 2003, by and between ASI Technology Corporation and Markland Technologies, Inc. 4.7 Registration Rights Agreement by and 10-KSB October 14, 2003 10.17 between Markland Technologies, Inc. and Brittany Capital Management limited, dated September 10, 2003. Consulting Agreement by and between Markland Technologies, Inc. and George 4.8 Yang, dated September 30, 2003. 8K November 12, 2003 10.3 4.9 Consulting Agreement by and between SB-2 May 11, 2004 4.9 Markland Technologies, Inc. and Commonwealth Acquisitions, Ltd., dated March 24, 2003. 4.10 Consulting Agreement by and between ECON SB-2 May 11, 2004 4.10 Investor Relations, Inc., dated January 18, 2003. 4.11 Consulting Agreement by and between SB-2 May 11, 2004 4.11 Markland Technologies, Inc. and Marketshare Recovery, Inc., dated October 29, 2003 4.12 Consulting Agreement by and between 10-QSB February 23, 2004 10.4 Markland Technologies, Inc. and Emerging Concepts, Inc., dated July 7, 2003 4.13 Research Agreement by and between Markland SB-2 May 11, 2004 4.13 Technologies, Inc. and The Research Works, Inc., dated October 29, 2003 4.14 Employment Agreement by and between SB-2 May 11, 2004 4.14 Markland Technologies, Inc. and Jo-Ann Nichols, dated October 27, 2003. 4.15 Registration Rights Agreement by and 8-K September 23, 2004 99.3 between Markland Technologies, Inc. and the investors named therein, dated September 21, 2004 4.16 Form of Common Stock Purchase Warrant 8-K September 23, 2004 99.5 issued by Markland Technologies, Inc. on September 21, 2004 4.17 Lock-up Agreement by and among Markland 8-K September 23, 2004 99.7 Technologies, Inc., Robert Tarini, and Kenneth Ducey, Jr. 4.18 Lock-up Agreement by and between Markland 8-K September 23, 2004 99.6 Technologies, Inc. and James, LLC. 4.19 Waiver Agreement by and among Markland 8-K September 23, 2004 99.8 Technologies, Inc. and the parties named therein, dated September 21, 2004 10.1 Securities Purchase Agreement, between SB-2 May 11, 2004 10.1 Markland Technologies, Inc., Montana View Corporation, Elite Properties, Ltd., and Sparrow Ventures, Inc., dated April 2, 2004 10.2 Securities Purchase Agreement by and among SB-2 May 11, 2004 10.2 Markland Technologies, Inc. and the Investors named therein, dated April 16, 2004. INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.3 Securities Purchase Agreement by and SB-2 May 11, 2004 10.3 between Markland Technologies, Inc. and the Investors named therein, dated May 3, 2004. 10.4 Agreement and Plan of Merger by and among 8K November 12, 2003 10.1 Markland Technologies, Inc. and STR Acquisition Corp., Security Technology, Inc., Science and Technology Research, Inc., and George Yang, dated September 30, 2003. 10.5 Promissory Note made by Markland 8K November 12, 2003 10.4 Technologies, Inc., in favor of George Yang, dated September 30, 2003. 10.6 Security Agreement by and between Markland SB-2 May 11, 2004 10.6 Technologies, Inc. and George Yang, dated September 30, 2003. Guaranty by Markland Technologies, Inc. in favor of George Yang, dated September 30, 10.7 2003. SB-2 May 11, 2004 10.7 10.8 Amendment and Payment Extension Agreement SB-2 May 11, 2004 10.8 by and between Markland Technologies, Inc. and George Yang, dated March 17, 2004. 10.9 Loan Agreement by and between Security 8K November 12, 2003 10.2 Technology, Inc. and Bay View Capital LLC, dated September 30, 2003. 10.10 Promissory Note by and among Markland 8K November 12, 2003 10.5 Technologies, Inc., Security Technology, Inc., and Bay View Capital LLC, dated September 30, 2003. 10.11 Security Agreement by and between Security SB-2 May 11, 2004 10.11 Technology, Inc. and Bay View Capital LLC, dated September 30, 2003. 10.12 Security Agreement by and between Markland SB-2 May 11, 2004 10.12 Technologies, Inc. and Bay View Capital LLC. 10.13 Sublicense Agreement by and between SB-2 May 11, 2004 10.13 Markland Technologies, Inc. and ASI Technology Corporation, dated March 19, 2004. 10.14 ASI Technology Corporation SBIR Phase II SB-2/1A June 16, 2004 10.14 Proposal, dated October 8, 2001. 10.15 ASI Technology Corporation Contract SB-2/1A June 16, 2004 10.15 with Air Force Office of Scientific Research, dated August 1, 2002. 10.16 ASI Technology Corporation Contract with SB-2/1A June 16, 2004 10.16 Naval Surface Warfare Center, dated January 31, 2003. INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.17 Stock Purchase Agreement by and among Ocean 8-K January 28, 2003 10.1 Data Equipment Corporation, Ergo Systems, Markland Technologies, and Security Technology, Inc., dated December 9, 2002. 10.18 Exchange Agreement, dated December 9, 2002, 8-K December 20, 2002 10.4 by and among Markland Technologies, Inc., Market LLC, and James LLC. 10.19 Exchange Agreement, dated December 9, 2002, 8-K December 20, 2002 10.5 by and among Eurotech, Ltd., Crypto.com Inc., Markland Technologies, Inc., Security Technology, Inc. ipPartners, Inc., Market LLC, and James LLC. 10.20 First Amendment to Exchange Agreement, 10-QSB February 14, 2003 10.6 dated December 9, 2002, by and among Eurotech, Ltd., Crypto.com Inc., Markland Technologies, Inc., Security Technology, Inc. ipPartners, Inc., Market LLC, and James LLC. 10.21 Restated and Amended Convertible Revolving 10-QSB February 14, 2003 10.2 Credit Note Agreement, dated December 10, 2002, by and between Markland Technologies, Inc. and Market LLC. 10.22 Letter from Sherb & Co., LLP to the 8-K March 17, 2003 16.1 Commission, dated March 12, 2003, concerning change in certifying accountant. 10.23 Technology Purchase Agreement between 8-K April 4, 2003 10.1 Markland Technologies, Inc. and ASI Technology Corporation, dated March 19, 2003. 10.24 Exchange Agreement, dated March 27, 2003, 8-K April 4, 2003 10.2 by and between Eurotech, Ltd. and Markland Technologies, Inc. 10.25 Registration Rights Agreement, dated March 10-KSB October 14, 2003 10.12 27, 2003, by and between Eurotech, Ltd. and Markland Technologies, Inc. 10.26 Amended and Restated Exchange Agreement, 8-K July 30, 2003 10.1 dated July 24, 2003, by and between Markland Technologies, Inc. and Syqwest, Inc. 10.27 Preferred Securities Purchase Agreement by 10-KSB October 14, 2003 10.14 and between Markland Technologies, Inc. and James LLC, dated February 2, 2003, relating to the issuance of 170 shares of Series C 5% Convertible Preferred Stock. 10.28 Preferred Securities Purchase Agreement by 10-KSB October 14, 2003 10.15 and between Markland Technologies, Inc., and James LLC, dated April 1, 2003, relating to the issuance of Series D Convertible Preferred Stock. 10.29 Private Equity Credit Agreement by and 10-KSB October 14, 2003 10.16 between Markland Technologies, Inc. and Brittany Capital Management Limited, dated September 10, 2003. INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.30 Employment and consulting agreements, dated 10-KSB October 14, 2003 10.18 December 5, 2002, for Delmar Kintner, Kenneth Ducey, Robert Tarini, and Verdi Consulting. 10.31 Nonexclusive License Agreement by and between SB-2 May 11, 2004 10.31 Science & Technology Research , Inc. and the Secretary of the Navy, dated 11/4/03. 10.32 International Distribution Agreement SB-2 May 11, 2004 10.32 between Markland Technologies, Inc. and Tradeways. 10.33 Science & Technology Research contract SB-2 May 11, 2004 10.33 Naval Surface Warfare Center, dated January 31, 2003. 10.34 Subcontract Agreement by and between ERGO SB-2 May 11, 2004 10.34 Systems, Inc. and Computer Sciences Corporation ,dated December 8, 2003. 10.35 Lease for Property in Fredericksburg, SB-2/1A June 16, 2004 10.35 Virginia. 10.36 Co-Operative Research and Development SB-2/1A June 16, 2004 10.35 Agreement between Markland Technologies, Inc. and the U.S. Air Force. 10.37 Employment Agreement by and between 10-QSB May 24, 2004 10.32 Markland Technologies, Inc. and Robert Tarini, dated May 12, 2004 . 10.38 Employment Agreement by and between 10-QSB May 24, 2004 10.33 Markland Technologies, Inc. and Kenneth Ducey, Jr., dated May 12, 2004. 10.39 Strategic Operations Contractor Agreement 10-QSB May 24, 2004 10.34 by and between Markland Technologies, Inc. and Asset Growth Company, dated May 12, 2004. 10.40 Consulting Agreement by and between 10-QSB May 24, 2004 10.35 Markland Technologies, Inc. and Chad A. Verdi, dated May 12, 2004. 10.41 Amendment to Employment Agreement between SB-2/1A June 16, 2004 10.41 Markland Technologies Inc. and Robert Tarini dated June 16, 2004. 10.42 Amendment to the Employment SB-2/1A June 16, 2004 10.42 Agreement between Markland Technologies Inc. and Kenneth P. Ducey, dated June 16, 2004. 10.43 Amendment to the Consulting Agreement SB-2/1A June 16, 2004 10.43 between Markland Technologies Inc. and Verdi Consulting, dated June 16, 2004. 10.44 Amendment to the Strategic Operations SB-2/1A June 16, 2004 10.44 Contractor Agreement by and between Markland Technologies, Inc. and Asset Growth Company, dated June 16, 2004. INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.45 Purchase Agreement between Markland 8-K September 23, 2004 99.1 Technologies, Inc. and the investors named therein, dated September 21, 2004. 10.46 Security Agreement between Markland 8-K September 23, 2004 99.2 Technologies, Inc. and the investors named therein, dated September 21, 2004. 10.47 Form of Secured Convertible Promissory Note 8-K September 23, 2004 99.4 issued by Markland Technologies, Inc., on September 21, 2004. 10.48 Night Vision Electronic Sensors Directorate 10-KSB October 13, 2004 10.48 (NVESD) Omnibus Contract between E-OIR Measurement Inc., a subsidiary of EOIR and United States Army Night Vision and Electronic Sensors Directorate. 10.49 Securities Purchase Agreement between SB-2 November 10, 2004 10.50 Markland Technologies, Inc., Harborview Master Fund L.P. and Southridge Partners LP dated November 9, 2004. 10.50 Form of Convertible Note issued to SB-2 November 10, 2004 10.51 Harborview Master Fund L.P. and Southridge Partners LP. 10.51 Form of Warrant issued to Harborview Master SB-2 November 10, 2004 10.52 Fund L.P. and Southridge Partners LP. 10.52 Subordination Agreement between DKR SB-2 November 10, 2004 10.53 Soundshore Oasis Holding Fund, LLC DKR Soundshore Strategic Holding Fund, LLC, Harborview Master Fund L.P., Southridge Partners LP, and Markland Technologies, Inc., dated November 9, 2004. 10.53 Conditional Waiver and Consent between DKR SB-2 November 10, 2004 10.54 Soundshore Oasis Holding Fund, LLC DKR Soundshore Strategic Holding Fund, LLC, Harborview Master Fund L.P., Southridge Partners LP, and Markland Technologies, Inc., dated November 9, 2004. 10.54 Stock Purchase Agreement by and between 8-K June 30, 2004 2.1 Markland and EOIR, dated June 30, 2004 10.55 Forms of Promissory Note. 8-K June 30, 2004 2.2 10.56 Security Agreement by and between EOIR and 8-K June 30, 2004 2.3 sellers of EOIR stock, dated June 30, 2004. 10.57 2004 Stock Option Plan, adopted June 30, 8-K June 30, 2004 2.4 2004. 10.58 Preferred Securities Purchase Agreement. 8-K June 30, 2004 2.5 10.59 Pledge and Security Agreement. 8-K June 30, 2004 2.6 10.60 Forms of Stock Option. 8-K June 30, 2004 2.7 INCORPORATED BY REFERENCE FILED WITH ---------------------------------------- THIS FORM EXHIBIT EXHIBIT NO. DESCRIPTION 10-KSB FORM FILING DATE NO. ----------- ----------- ------ ---- ----------- --- 10.61 Agreement and General Release, dated X November 1, 2004, between Markland Technologies, Inc. and Gregory A. Williams. X 31.1 Certification by CEO of Periodic Report X Pursuant to Rule 13a-14(a) or Rule 15d-14(a) 31.2 Certification by CFO of Periodic Report X Pursuant to Rule 13a-14(a) or Rule 15d-14(a) 32.1 Certification by CEO and CFO of Periodic X Report Pursuant to 18 U.S.C. Section 1350