**UNITED
STATES**
 **SECURITIES
AND EXCHANGE COMMISSION**
 **Washington,
D.C. 20549**
 **_________________**
 **Form
10-KSB**
 x
    Annual
      Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934:for
      the fiscal year ended December 31,
2004
 o
    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 0-28287
 **_________________**
 
 **BSI2000,
INC.**
 (Exact
Name of Small Business Issuer in its charter)
 
 **Delaware**
    **88-0418749**(State
      of Incorporation)
    (I.R.S.
      Employer Identification No.)**12600
      West Colfax Ave. Suite B410****Lakewood,
      Colorado**
    **80215**(Address
      of Principal Executive Offices)
    (Zip
      Code)
 **(303)
231-9095**
 (Issuer’s
Telephone Number)
  Securities
Registered Under Section 12(b) of the Exchange Act: **Common
Stock, $0.001 par value**
  Securities
Registered Under Section 12(g) of the Exchange Act: **None**
  Check
whether the issuer (1) filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. **Yes**x**No**o
  Check if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. x
  Issuer’s
revenues for the fiscal year ended December 31, 2004 were: **$5,918**
  The
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked price of such common equity, was: **$3,970,926
on March 11, 2005** .
  There
were **99,273,157** shares of
the Issuer’s common stock outstanding on **March
11, 2005** .
  Documents
incorporated by reference: **None**
  Transitional
Small Business Disclosure Format (Check one): **Yes**o**No**x
 
 
 
  **BSI2000,
INC.**
 **FISCAL
YEAR 2004 FORM 10-KSB ANNUAL REPORT**
 **INDEX**
 
 PART
      I
    
    1Item
      1. Description Of Business.
    1Item
      2. Description Of Property.
    6Item
      3. Legal Proceedings.
    6Item
      4. Submission Of Matters To Vote Of Security Holders.
    7PART
      II
    
    8Item 5.
    Market
      For Common Equity And Related Stockholder Matters and Small Business
      Issuer Purchases of Equity Securities.
    8Item
      6.
    Management’s
      Discussion And Analysis Or Plan Of Operation.
    15Item
      7.
    Financial
      Statements.
    28Item
      8.
    Changes
      In And Disagreements With Accountants On Accounting And Financial
      Disclosure.
    28Item
      8A.
    Controls
      And Procedures.
    28Item
      8B.
    Other
      Information.
    28PART
      III
    
    29Item
      9.
    Directors
      And Executive Officers Of The Registrant.
    29Item
      10.
    Executive
      Compensation.
    30Item
      11.
    Security
      Ownership Of Certain Beneficial Owners And Management.
    32Item
      12.
    Certain
      Relationships And Related Transactions.
    33Item
      13.
    Exhibits
      And Reports On Form 8-K.
    34Item
      14.
    Principal
      Accountant Fees And Services.
    37SIGNATURES
    
    38EXHIBIT
      14.1
    
    27EXHIBIT
      31.1
    
    32EXHIBIT
      32.1
    
    33AUDITED
      CONSOLIDATED FINANCIAL STATEMENTS
    F-1
 
 i
  **PART
I**
  **Item
1.  Description Of Business.**
  **Formation**
  On March
31, 2003, Knowledge Foundations, Inc. (“KFI”), now known as BSI2000, Inc.,
closed its reverse triangular merger with BSI2000, Inc., a privately held
Colorado corporation. Immediately prior to the closing, KFI spun-off all of its
assets and liabilities  (except for a $50,000 note payable and related
accrued interest of $6,825) to Dr. Richard Ballard, Jan Pettitt, Michael
Dochterman, Robert A. Dietrich, Joel Vest, all of whom are directors, officers,
and/or principal shareholders of KFI, and certain other KFI shareholders. In
connection with this spin-off, 34,105,900 shares of the common stock of KFI
surrendered by the foregoing parties were cancelled. After this spin-off,
5,027,818 shares of KFI remained outstanding.
  In
closing the reverse merger transaction, KFI issued 45,122,570 shares of its
common stock for all of the outstanding shares of common stock of BSI2000, Inc.
Immediately following the closing, KFI changed its name to BSI2000, Inc. and
BSI2000, Inc., a wholly-owned subsidiary of KFI as a result of the merger,
changed its name to BSI Operating, Inc.
  As a
result of the foregoing transactions, KFI divested itself of its business and
acquired the business of BSI2000, Inc. For financial reporting purposes, the
foregoing transactions have been accounted for as a recapitalization of BSI2000,
Inc. Accordingly the net increase in the BSI2000, Inc. outstanding shares of
41,363,488 shares (from 8,786,900 to 50,150,388 shares of common stock) has
been reflected in the financial statements as shares issued in the
recapitalization of BSI2000, Inc.
  As a
result of the accounting method adopted to record the merger, the historical
financial statements of BSI2000, Inc. have become the historical financial
statements of the continuing entity for financial reporting purposes. The
historical financial statements of KFI are not presented herein.
  **Business**
  BSI2000,
Inc. was incorporated under the name Unified Data Link, Incorporated in July
1993, and changed its name to Bank Systems 2000, Inc. in April 1995. The company
changed its name to BSI2000, Inc. (“BSI”) on May 19, 1995. BSI has a
contract to buy optical cards, card reader heads, and software from LaserCard
Systems Corporation, a division of Drexler Technology under a value-added
reseller volume pricing agreement. See “CURRENT Contracts-LaserCard Systems”
below. BSI develops and markets proprietary applications of optical card
technology, using the LaserCard® products.
  BSI’s
management believes that government agencies and companies in many industries
have interest in developing new identification systems and end-user data
management techniques that integrate carried data that can be updated onsite.
For example, BSI management has presented the BSI technology to the U.S.
Department of Homeland Security, the new Transportation Security Administration,
the U.S. Maritime Administration, the U.S. Coast Guard, several port
authorities, and others that have expressed interest. The U.S. Immigration and
Naturalization Service (the “INS”) purchased a pilot unit from BSI in 2003;
however, no other entities, including the foregoing, have purchased product from
BSI as of the date hereof. BSI management has also presented its technology to
commercial companies resulting in teaming and strategic alliance agreements with
several such companies.
  1
  BSI has
developed technology that integrates special hardware and proprietary,
patent-pending software, to provide turnkey optical card systems for the
national identification and other card markets. BSI develops software
applications for commercial and government customers. We expect to sell secure
encrypted optical cards for distribution to customers’ end-users (e.g.,
employees, patients, immigrants, etc.), as well as reading/writing transaction
processing units that confirm the card carrier’s identity with biometrics and
allow updating of the information on the card, as well as providing a complete
audit trail of the use of the card. Each optical card system is developed
specifically for the customer’s needs. Categories of development for prospective
customers include government agencies, industrial companies, and healthcare
providers.
  The cards
are designed to securely store identification data (i.e., name, address,
photograph, fingerprint, etc.), and other information desired by the
customer (e.g., pension or health and medical data, police records, or
border crossing and employment dates) in an updateable digital form. We believe
that optical cards are essential due to their extreme high data
capacity (equivalent to 1,500 typewritten pages); reliability and high
security; their ability to have data partitioned to separate physical secure
areas on the card; and ease of use and updating.
  The
plastic cards, which are about the same size as credit cards, are produced by
the end-user to a customer employee at a transaction station (e.g., in a
hospital, at a border crossing, etc.). The cards are first “read” at the
station: user identification is visually confirmed by display of a color
photograph (stored in the card) on the monitor, and digitally confirmed by
comparing the user’s fingerprint (also stored in the card) to the optical
reading of the user’s finger print at the transaction station. Then, the
transaction station reads extensive data from the card, and new information can
be added with a computer keyboard. The units run on AC current and are about the
size of a shoebox. In contrast to “smart card” systems in which the card reader
usually runs off a personal computer, all the optical card unit’s computing
power is contained in the unit; the unit cannot be used for any other purpose,
and usually is much easier to operate than smart card systems, which require a
reader unit and a personal computer (not just the keyboard). Also, the card
data is personal to the carrier. The transaction station manager cannot store or
copy the card identification or any other data because the system is inherently
offline (i.e., no online communications with a personal or main frame
computer are needed to access the card).
  Optical
cards provide about 1,000 times the memory, 30 times as fast update speed, and
far more security and reliability than smart chip cards. Optical cards can store
thousands of transaction records, account balances, audit trails, medical and
insurance information, digital photographs, and personal databases. Any
information that can be stored in a computer can be recorded and managed on an
optical card.
  ***Current
Products*** . BSI has
developed three related products, each with biometric verification procedures:
  ***Securus
2000 Access Control And Site Security*** . This
product is designed to meet the most demanding security needs. Any number of
these units can be linked together over an integrated and crypto-secure local
network to cover any number of doors and buildings in a site. The entire system
may be linked over the Internet to a remote control site. Each security officer
has an administrative card to monitor and enable specific actions of controlling
personnel.
  2
  ***Civilitas
2000 Government Id*** . The
Civilitas (the Latin word for citizen) card is for government issue, to
record identification data, and allows up to 16 separate government programs to
be tracked and monitored on a single card, including border crossings, medical
records, social pension eligibility and cash transfers, medical records, police
records, etc. Each partition has its own crypto key. Border crossings also may
be monitored and flagged by advanced heuristic software techniques to
automatically flag suspicious events for closer inspection by personnel. Six
units of a slightly modified version of Civilitas 2000 (the modified
version is named SIGABA 2000) were sold to the INS in 2003.
  ***Technical
Information*** . BSI’s
systems use the optical cards to provide automatic fingerprint and signature
verification, and photographic confirmation, to prevent card use by unauthorized
persons. The data is safe and secure, in contrast to smart chip cards, which can
be unstable due to static electricity and magnetic fields such as used in
airport security.
  The
optical cards may be partitioned into separate physical areas, each used for a
different program: basic identification information may be stored in a common
area; pension payments data in another; medical and health in
another (itself partitioned for sensitive information such as psychiatric,
HIV/AIDS, etc.). Each partitioned data area is protected by its own security
system.
  Permanent
data storage capacity on the card allows a complete audit trail to be maintained
for all transactions. Such audit mechanisms are mandatory in order to
reconstruct events after fraudulent use or system malfunction. Laws in many
countries require such mechanisms to be in place.
  The large
card capacity means that if the end-user wishes, almost all sensitive
information (such as digital fingerprints) can reside only on the card and
not in a central database, an important feature to gain citizen acceptance of
identification cards.
  BSI’s
systems all use a specific variation or application of the standard BSI
developed transaction software and hardware protocol (named “ToolKit
2000”). The ROM-resident real-time process control software, that is embedded in
the processing unit, consists of a combination of the standard BSI C/C++ coded
modules from the following list: Embedded Windows NT multitasking operating
system interface; optical drive interface and control; TCP/IP communications
control for partially online systems; digital input/output module control;
external interface control; printer formatting and control; database systems;
crypto system; magnetic stripe reader control; barcode scanner control;
fingerprint identification and control; signature verification and control; and
components. The optical card reader head and related software is purchased from
LaserCard Systems Corporation.
  BSI
continues to develop (and apply for patent protection covering) software in
the area of strong encryption techniques and high-performance data management
methods for optical card systems. BSI currently has twenty-two patent
applications pending. These methods are required for secure and efficient
optical card systems to be safely used in the field. Other patent applications
cover the use of the technology.
  The
hardware for most applications is fairly straightforward and consists of a metal
or plastic shell, internal bracketry, power supply and switching, control button
and status LEDs, color LCD screen, single board process control computer,
integrated optical card device, sound transducer, thermal printer, and others.
  Devices
integrated into BSI systems include fingerprint scanners, signature verification
pads, and external door lock controls. The device is about the same size and
shape as a shoebox.
  3
  ***Patents*** . BSI’s
business model is to contract with much larger companies to develop or expand
specific vertical markets for their products and sell our products through these
larger companies. In this way competitors must evaluate the cost of overtaking
the larger partner company, which is already dominant in the market, which BSI
believes represents a significant barrier to entry. We believe that a primary
value of BSI’s patents, if awarded, will be to attract larger companies to
contract with BSI, and protect their market share as well as protect BSI’s
technology from copying by its partners and their competitors.
  BSI has
applied to the U.S. Patent & Trademark Office for the following patents
among others: (i) a patent covering the uses or methods of using certain
technology which it has developed, including methods for entering and storing
medical records by using bar codes and optical scanning to rapidly update
records in less than several minutes; (ii) a patent involving a novel
method of recording medical information with automatic analysis of statistical
trends of the data by using card-based heuristic software techniques; (iii)
a patent involving drug testing and personnel access to controlled
areas (for controlling checkout of company or agency tools and equipment);
and (iv) a patent involving the use of biometric data (e.g., digital
fingerprint, signature and photograph) for controlling access to equipment and
other assets. To date, one patent have been issued to BSI. To date, BSI has
filed approximately 25 patent applications in the U.S. and one in South
Africa.
  ***Sales
And Marketing, And Sources Of Revenue*** . BSI’s
sales and marketing strategy and our plan to create sources of revenue has three
primary components:
  1. Contract
with a larger company that is dominant in a sector or country.
  2. Where
possible, negotiate contracts to include ongoing transaction fees, which will be
earned each time an optical card is used (e.g., $0.02 - $0.06 per use).
  3. Negotiate
contracts to include the sale of transaction units, optical cards, replacement
optical cards, and maintenance fees. We anticipate that the transaction units
will be sold through the dominant companies with which we intend to associate.
BSI intends to sell the systems with slim margins, because significantly more
revenue can be obtained through selling the cards and through transaction fees.
In the typical project, as much as 95% of the initial costs comes from the high
margin cards. In some instances we may sell units at or below cost to access the
revenue streams from cards and transactions. BSI intends to sell unique optical
cards directly to customers, which are then distributed to end-users. The cost
of optical cards is almost always the dominant initial expense for the customer.
BSI’s systems require BSI-supplied cards that must be cryptologically
initialized and embossed with our logo. In addition, BSI intends to sell
replacement cards to customers, who are used to replacing cards (e.g., VISA
cards) every two years or so. BSI buys the stock cards from LaserCard Systems
Corporation. BSI also warrants the transaction units for one year, then charges
for maintenance.
  **Current
Contracts**
  It is
important to note that BSI has not yet delivered product in any significant
quantity; however, BSI received a pilot order from the INS and has also put into
place various strategic teaming and alliance agreements with substantial
external partner companies as follows:
  ***L.C.
Sistemia*** . On May
7, 2001, BSI signed a strategic alliance agreement with L.C.
Sistemia (“LCS,” an Italian systems engineering and project management
company with offices in Rome). Pursuant to legislation enacted in 2000 to
implement a secure national identification card system, the Italian government
awarded two contracts. One contract is held by Siemens A.G. to install and
operate card initialization systems (i.e., issuance of secure optical
cards) for ultimately up to 58,000,000 people. The second contract is held by
LCS to supply the optical cards and card transaction units for use in passport
offices, medical clinics, police stations, post offices, and other government
offices.
  4
  Until May
7, 2011, BSI has the exclusive right to develop and market the transaction units
into Italy through LCS, as required to satisfy LCS’ contract with the Italian
government. LCS has agreed not to design, market or sell any other company’s
optical card transaction units to the Italian government. The price for the
units will be BSI’s actual direct cost plus 25%. Development costs and changes
in products will be borne by BSI. BSI will be paid an additional amount equal to
a 1% royalty on all amounts paid for optical cards sold into Italy by LaserCard
Systems Corporation, and this royalty will be paid to BSI by LaserCard Systems
Corporation. As of the date hereof, BSI has not received an initial order for
transaction processing units or an estimate of the amount of the initial order
or the timing thereof.
  BSI has
the right to terminate the agreement with LCS if sales into Italy are less than
target levels. BSI has developed the Civilitas 2000 national identification card
system, which will be used in the LCS portion of the encryption and data
programming of cards for the Italian government system. BSI retains all rights
to this technology, and intends to market similar systems to other governments
in the future.
  ***LaserCard
Systems*** . BSI
signed a one year agreement with LaserCard Systems Corporation on April 28,
2000, which was renewed on June 3, 2004 for a term expiring on June 4, 2005.
LaserCard has the right to sell its products to other resellers and end-users.
To date, BSI has bought a limited amount of products from LaserCard but will
rely upon this vendor for cards and parts to satisfy orders received in the
future.
  **Competition**
  BSI has
two sources of competition. In our opinion, the most serious competition comes
from chip cards which are plastic credit card sized cards that contain embedded
computer chips. Chip cards address markets where only very small amounts of
low-value data is manipulated (e.g., telephone cards). We believe that
applications that require larger amounts of data manipulation (e.g.,
medical cards) or higher security (e.g., bank cards) are better served by
optical cards with their larger memory (1,000x), greater speed (30x
for writing in data), and more robust reliability (i.e., impervious to
static electricity and other environmental damage). However, most consumers are
familiar with chip cards but not with optical cards.
  The other
source of competition is tactical. BSI is aware of only one other competitor,
Zerco Systems, Inc., a small company that markets embedded optical card systems
of any form. BSI believes it can compete effectively against Zerco as Zerco
sells to end-users (and to our knowledge, only those located in the U.S.),
while BSI’s strategy is to sell to larger companies, like L.C. Sistemia, on a
worldwide basis.
  **Manufacturing,
Support And Facilities**
  BSI
outsources hardware manufacturing to one or more contract assembly houses on a
turnkey basis; the manufacturer manages all parts purchasing, inventory control,
quality control, fabrication and assembly, testing, as well as burn-in
operations.
  5
  Fully
tested and finished hardware products will be shipped to BSI’s office in
Lakewood, Colorado where the proprietary control and security software is loaded
and crypto keys installed. After complete checkout, the finished software and
hardware units are packaged, inventoried, and shipped to the end-user.
  We
believe that the primary advantages to this approach include the ability to
control inventory on an agile 30-day (or less) schedule; the ability to
benefit from the parts purchasing power of a large assembler; and the
elimination of direct purchasing and components overhead.
  Except
for the card reader drives and heads BSI buys from LaserCard Systems, all
purchased electronic components for the products are standard and commercially
available from multiple sources. A typical BSI machine has several hundred
inventoried components and subassemblies including a number of custom machined
pieces.
  **Employees**
  As of
March 1, 2005, BSI had 11 full-time and no part-time employees, of which five
are involved in software programming and support, five are involved in the
marketing and deployment of product, and one is involved in BSI’s administrative
and financial operations. None of BSI’s employees is represented by a labor
union, and BSI has never experienced a work stoppage. BSI believe its
relationship with its employees to be good. BSI’s ability to achieve its
financial and operational objectives depends in large part upon BSI’s continuing
ability to attract, integrate, retain and motivate highly qualified sales,
technical and managerial personnel, and upon the continued service of BSI’s
senior management and key sales and technical personnel. See the section of this
report entitled “Executive Compensation.” Competition for such qualified
personnel in BSI’s industry and the geographical locations of BSI’s offices is
intense, particularly in software development and technical
personnel.
  **Research
& Development**
  BSI
expended $542,635 in 2004 for R&D purposes as compared to $446,605 in 2003.
This increase is attributable to R&D components of $36,753, consulting fees
of $64,248 and decreases in travel and entertainment, salaries and wages and
other costs totaling $4,982. These costs were expensed as incurred and increased
as a result of the needs identified relating to potential markets for BSI’s
products in various parts of the world.
  **Item
2.  Description Of Property.** ****
  BSI
leases 2,800 square feet of space at 12600 West Colfax Avenue, B410, Lakewood,
Colorado. The lease, which expires on February 1, 2007, provides for rental
payments of $4,349.04 per month plus payment of BSI’s share of building
operating expenses, such as real estate taxes, insurance and utilities. The
offices house sales and marketing, software and hardware research and
development as well as manufacturing control, limited inventory and other
administrative tasks.
  **Item
3.  Legal Proceedings.**
  BSI is
not a party to any pending legal proceedings outside the ordinary course of its
business other than as set forth below.
  6
  BSI
currently has a claim against it by a consultant over consideration with regard
to a finder’s fee for potential equity financing for Knowledge Foundations,
Inc. (“KFI”). BSI believes that neither the merit or future outcome of such
a claim nor potential damages is readily determinable at this time.
  On
November 19, 2004, **** Excell
HDI (“Excell”) brought a lawsuit against BSI in the District Court of
Jefferson County, Colorado, alleging breach of contract and fraudulent
inducement of contract in connection with a Marketing Services
Agreement (the “MSA”) between the parties where Excell acted as a
consultant to BSI. The suit sought damages of $78,750 and exemplary damages of
another $78,750. BSI filed a Motion to Dismiss and to Compel
Arbitration (the “Motion”) pursuant to the arbitration provision in the
Agreement. The Court granted BSI’s Motion, dismissing Excell’s suit without
prejudice and compelling the parties to arbitrate. Excell has made demand for
arbitration and the parties are negotiating an arbitration agreement. In an
effort to resolve this dispute amicably, BSI had previously tendered $17,500 to
resolve all purported obligations under the MSA, which was rejected by Excell.
At this time, the BSI intends to vigorously contest all claims asserted by
Excell in arbitration and is investigating possible counterclaims against
Excell. BSI does not believe it has material exposure (above the amount
previously tendered) in this matter.
  In 2003,
BSI received requests from the Central Regional Office for United States
Securities and Exchange Commission (the “SEC”) for certain documents
including those concerning arrangements with certain strategic partners,
relationships with the TSA and INS, recent issuances of securities, investor
relations, and information relating to investment opinions distributed by third
parties. BSI responded promptly and fully and will cooperate with any further
requests. The SEC’s letter states that the staff’s inquiry should not be
construed as an indication that any violations of securities laws have occurred
or as an adverse reflection on any individuals, entities, or investments. There
have been no further requests or developments in this matter during 2004.
  **Item
4.  Submission Of Matters To Vote Of Security
Holders.**
  BSI held
a special meeting of shareholders on September 22, 2004. At that meeting, the
shareholders approved an increase in the authorized common stock of BSI from
100,000,000 to 200,000,000. The shareholders also elected directors of BSI at
the meeting.
   7
  **PART
II**
  **Item
5.  Market For Common Equity And Related Stockholder Matters and Small
Business Issuer Purchases of Equity Securities.**
  BSI’s
common stock currently trades on the Over-the-Counter Bulletin Board (the
“OTCBB”) under the trading symbol “BSIO”.
  The
following table sets forth the average high and low bid information for the
common stock for each quarter within the last two fiscal years as reported by
the National Quotation Bureau, and represent interdealer quotations, without
retail markup, markdown or commission, and may not be reflective of actual
transactions.
  **Bid
      Prices****High**
    
    **Low****2003**First
      Quarter
    
    
    .6200
    
    
    .1000Second
      Quarter
    
    
    .5800
    
    
    .2600Third
      Quarter
    
    
    .4800
    
    
    .2400Fourth
      Quarter
    
    
    .3500
    
    
    .1600**2004**First
      Quarter
    
    
    .1700
    
    
    .0830Second
      Quarter
    
    
    .134
    
    
    .036Third
      Quarter
    
    
    .105
    
    
    .051Fourth
      Quarter
    
    
    .068
    
    
    .0515
 
 BSI is
authorized to issue 200,000,000 shares of common stock with $ 0.001 par value.
As of March 11, 2005, there were 99,273,157 shares of common stock issued and
outstanding. As of March 11, 2005, BSI had approximately 350 shareholders of
record for its common stock.
  BSI is
authorized to issue 20,000,000 shares of $0.001 par value preferred stock, none
of which is outstanding. The preferred stock is undesignated and may not be
designated or issued by the Board of Directors absent prior stockholder
approval.
  **Dividends**
  BSI has
not declared or paid cash dividends on its Common Stock since its inception and
does not anticipate paying such dividends in the foreseeable future. The payment
of dividends may be made at the discretion of the Board of Directors and will
depend upon, among other factors, on BSI’s operations, its capital requirements,
and its overall financial condition.
  **Recent
Sales of Unregistered Securities**
  During
the past three years ended December 31, 2002, December 31, 2003 and December 31,
2004, BSI sold the following unregistered securities:
  8
  On
December 10, 2004, BSI received net proceeds of $435,723 from a $500,000 secured
promissory note issued to Cornell Capital Partners, LP (“Cornell”). The
note is due on March 11, 2005. The note is secured by substantially all of BSI’s
non-cash assets. The note bears interest at 12% per annum during its term, and
bears a default rate of interest of 24% if the note is not paid when due. BSI
paid cash fees of $64,277 in connection with the issuance of the note. As of
March 1, 2005, Cornell has converted $300,000 of this note into 8,381,359 shares
of BSI’s common stock. In engaging in the foregoing transaction involving
unregistered securities of BSI, BSI relied upon the private offering exemption
provided under Section 4(2) of the Securities Act of 1933, as amended, in that
the transaction involved a private offering of BSI’s unregistered securities,
BSI did not make a public offering or sale of its securities, the investor was
accredited, and the investor represented to BSI that it was acquiring the
securities for investment purposes and for its own account, and not with an eye
toward further distribution.
  On
November 4, 2004, BSI received net proceeds of $178,051 from a $200,000 secured
promissory note issued to Cornell. The note is due on December 4, 2004. The note
is secured by substantially all of BSI’s non-cash assets. The note bears
interest at 12% per annum during its term, and bears a default rate of interest
of 24% if the note is not paid when due. BSI paid cash fees of $21,949 in
connection with the issuance of the note. As of December 31, 2004, Cornell has
converted this note and accrued interest into 3,783,430 shares of BSI’s common
stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On
October 7, 2004, BSI issued a 5% convertible debenture in the amount of $500,000
to Cornell that is due October 7, 2007, on December 10, 2004, BSI issued a 5%
convertible debenture in the amount of $500,000 to Cornell that is due December
10, 2007, and on January 20, 2005, BSI issued a 5% convertible debenture in the
amount of $250,000 to Cornell that is due January 20, 2008. These debentures are
convertible into BSI’s common stock at either the fixed price of 120% of the
Volume Weighted Average price on the closing date (October 7, 2007,
December 10, 2007 and January 20, 2008, respectively) or 80% of the average of
the three lowest daily Volume Weighted Average Price, as reported by Bloomberg,
L.P., of BSI’s common stock for the five trading days immediately preceding the
conversion date. These debentures will automatically convert into BSI’s common
stock on the third anniversary of issuance. BSI has the right to redeem the
debentures with three days advance notice any or all of the outstanding
debenture amount at its sole discretion. The redemption price shall be 120% of
the face amount redeem plus accrued interest. Once the redemption notice has
been given, Cornell may continue to convert the remaining outstanding debenture.
On October 7, 2004, BSI received $500,000 less a 10% fee of $50,000 and $10,000
for legal costs. BSI received $500,000 (net of 10% fee) on December 10,
2004 and $250,000 (net of 10% fee) on January 20, 2005. In engaging in the
foregoing transactions involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transactions involved the private offering of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited, and the investor represented to BSI
that it was acquiring the securities for investment purposes and for its own
account, and not with an eye toward further distribution.
  On
September 13, 2004, BSI issued 990,099 shares of common stock to Cornell for
$50,000 cash. Costs associated with this transaction were $2,500. **** In
engaging in the foregoing transaction involving unregistered securities of BSI,
BSI relied upon the private offering exemption provided under Section 4(2) of
the Securities Act of 1933, as amended, in that the transaction involved a
private offering of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  9
  On July
15, 2004, BSI issued Bernard Nann 250,000 options at a strike price of $0.089
per share, 50,000 of which vested on the date of the grant, and the remaining
200,000 vests 50,000 per year for so long as Mr. Nann remains a director of BSI.
These options were issued as compensation to Mr. Nann for his present and future
services as a director of BSI. All of these options have a 5-year term. In
engaging in the foregoing transaction involving unregistered securities of BSI,
BSI relied upon the private offering exemption provided under Section 4(2) of
the Securities Act of 1933, as amended, in that the transaction involved a
private offering of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On June
18, 2004, BSI received net proceeds of $231,935 from a $250,000 secured
promissory note issued to Cornell. The note is due on October 18, 2004. The note
is secured by substantially all of BSI’s non-cash assets. The note bears
interest at 12% per annum during its term, and bears a default rate of interest
of 24% if the note is not paid when due. BSI paid cash fees of $18,065 in
connection with the issuance of the note. Cornell converted this note and
accrued interest into 4,285,831 shares of BSI’s common stock. In engaging in the
foregoing transaction involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transaction involved a private offering of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited, and the investor represented to BSI
that it was acquiring the securities for investment purposes and for its own
account, and not with an eye toward further distribution.
  On June
8, 2004, BSI received net proceeds of $320,208 from a $350,000 secured
promissory note issued to Cornell. The note is due on September 20, 2004. The
note is secured by substantially all of BSI’s non-cash assets. The note bears
interest at 12% per annum during its term, and bears a default rate of interest
of 24% if the note is not paid when due. BSI paid cash fees of $29,792 in
connection with the issuance of the note. Cornell converted this note and
accrued interest into 6,580,362 shares of BSI’s common stock. In engaging in the
foregoing transaction involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transaction involved a private offering of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited, and the investor represented to BSI
that it was acquiring the securities for investment purposes and for its own
account, and not with an eye toward further distribution.
  On April
14, 2004, BSI received net proceeds of $229,679 from a $250,000 secured
promissory note issued to Cornell. The note is due on June 21, 2004. The note is
secured by substantially all of BSI’s non-cash assets. The note bears no
interest during its term, but bears a default rate of interest of 24% if the
note is not paid when due. BSI paid cash fees of $20,321 in connection with the
issuance of the note. BSI has reserved and placed into escrow 3,000,000 shares
of its common stock as an estimation of the shares necessary to repay the loan.
Cornell converted this note and accrued interest into 3,418,210 shares of BSI’s
common stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  10
  On March
12, 2004, BSI issued Richard Kirk 250,000 options at a strike price of $0.11 per
share, all of which vested on the date of the grant. These options were issued
as compensation to Mr. Kirk for his services as a director of BSI. All of these
options have a 5-year term. In engaging in the foregoing transaction involving
unregistered securities of BSI, BSI relied upon the private offering exemption
provided under Section 4(2) of the Securities Act of 1933, as amended, in that
the transaction involved a private offering of BSI’s unregistered securities,
BSI did not make a public offering or sale of its securities, the investor was
accredited, and the investor represented to BSI that it was acquiring the
securities for investment purposes and for its own account, and not with an eye
toward further distribution.
  On March
3, 2004, BSI received net proceeds of $229,524 from a $250,000 secured
promissory note issued to Cornell. The note is due on June 23, 2004. The note is
secured by substantially all of BSI’s non-cash assets. The note bears interest
of 12% during its term, and bears a default rate of interest of 24% if the note
is not paid when due. BSI paid cash fees of $20,476 in connection with the
issuance of the note. Cornell converted this note into 3,246,474 shares of BSI’s
common stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On
February 4, 2004, BSI received net proceeds of $223,559 from a $250,000 secured
promissory note issued to Cornell. The note is due on May 12, 2004. The note is
secured by substantially all of BSI’s non-cash assets. The note bears no
interest during its term, but bears a default rate of interest of 24% if the
note is not paid when due. BSI paid cash fees of $26,441 in connection with the
issuance of the note. Cornell converted this note into 4,140,867 shares of BSI’s
common stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On
December 19, 2003, BSI received net proceeds of $170,917 from a $200,000 secured
promissory note issued to Cornell. The note is due on April 26, 2004. The note
is secured by substantially all of BSI’s non-cash assets. The note bears no
interest during its term, but bears a default rate of interest of 24% if the
note is not paid when due. Discounts and fees paid to obtain the loan were
$29,083. BSI has reserved and placed in escrow 3.9 million shares of its common
stock as an estimation of the shares necessary to repay the loan. In engaging in
the foregoing transaction involving unregistered securities of BSI, BSI relied
upon the private offering exemption provided under Section 4(2) of the
Securities Act of 1933, as amended, in that the transaction involved a private
offering of BSI’s unregistered securities, BSI did not make a public offering or
sale of its securities, the investor was accredited, and the investor
represented to BSI that it was acquiring the securities for investment purposes
and for its own account, and not with an eye toward further
distribution.
  11
  On
October 31, 2003, BSI entered into an Equity Line of Credit Agreement (the
“Equity Line”) with Cornell. Under the Equity Line, BSI may issue and sell to
Cornell common stock for a total purchase price of up to $15 million.
Subject to certain conditions, BSI will be entitled to commence drawing down on
the Equity Line when the common stock to be issued under the Equity Line is
registered with the SEC and the registration statement is declared effective and
will continue for two years thereafter. The purchase price for the shares will
be equal to 99% of the market price, which is defined as the lowest closing bid
price of the common stock during the five trading days following the notice
date. The amount of each advance is subject to an aggregate maximum advance
amount of $210,000, with no advance occurring within seven trading days of a
prior advance. Cornell received 1,875,000 shares of common stock as a one-time
commitment fee. Cornell is entitled to retain a fee of 4% of each advance. In
addition, BSI entered into a placement agent agreement with Newbridge Securities
Corporation (“Newbridge”), a registered broker-dealer. Pursuant to the
placement agent agreement, BSI paid Newbridge a one-time placement agent fee of
35,714 shares of common stock. In engaging in the foregoing transaction
involving unregistered securities of BSI, BSI relied upon the private offering
exemption provided under Section 4(2) of the Securities Act of 1933, as amended,
in that the transaction involved a private offering of BSI’s unregistered
securities, BSI did not make a public offering or sale of its securities, the
investor was accredited, and the investor represented to BSI that it was
acquiring the securities for investment purposes and for its own account, and
not with an eye toward further distribution.
  On
September 16, 2003, BSI received net proceeds of $455,000 from a $500,000
secured promissory note issued to Cornell. The note is due on the earlier of 90
days from the date thereof or 60 days after BSI’s registration statement on Form
SB-2 is declared effective by the SEC. The note is secured by substantially all
of BSI’s non-cash assets. The note bears no interest during its term, but bears
a default rate of interest of 24% if the note is not paid when due. BSI paid
cash fees of $45,000 in connection with the issuance of the note and also issued
500,000 shares of its common stock to Cornell as additional consideration in the
transaction. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  During
the period August 1, 2003 through October 31, 2003, BSI received proceeds of
$182,500 from the sale of 730,000 shares of its common stock in a private
placement to Pursuit Capital, LLC (“Pursuit Capital”) at $0.25 per share.
In engaging in the foregoing transactions involving unregistered securities of
BSI, BSI relied upon the private offering exemption provided under Section 4(2)
of the Securities Act of 1933, as amended, in that the transactions involved
private offerings of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  During
the period August 1, 2003 through October 31, 2003, BSI received proceeds of
$67,500 from the sale of 270,000 shares of its common stock to Doug Dragoo in a
private placement at $0.25 per share. In engaging in the foregoing transaction
involving unregistered securities of BSI, BSI relied upon the private offering
exemption provided under Section 4(2) of the Securities Act of 1933, as amended,
in that the transaction involved a private offering of BSI’s unregistered
securities, BSI did not make a public offering or sale of its securities, the
investor was accredited, and the investor represented to BSI that it was
acquiring the securities for investment purposes and for its own account, and
not with an eye toward further distribution.
  12
  On July
7, 2003, BSI sold $250,000 of convertible debentures to Cornell. Cornell was the
purchaser of the convertible debentures. These debentures accrue interest at a
rate of 5% per year and mature two years from the issuance date. The debentures
are convertible at the Cornell’s option any time up to maturity at a conversion
price equal to the lower of (i) 120% of the closing bid price of the
common stock as of the closing date or (ii) 80% of the lowest closing bid
price of the common stock for the five trading days immediately preceding the
conversion date. At maturity, BSI has the option to either pay the holder the
outstanding principal balance and accrued interest or to convert the debentures
into shares of common stock at a conversion price equal to the lower of (i)
120% of the closing bid price of the common stock as of the closing date
or (ii) 80% of the lowest closing bid price of the common stock for
the five trading days immediately preceding the conversion date. BSI has the
right to redeem the debentures upon 30 days notice for 120% of the amount
redeemed. In engaging in the foregoing transactions involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transactions
involved private offerings of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On July
7, 2003, BSI entered into an Equity Line of Credit Agreement with Cornell
Capital that was subsequently terminated by the mutual agreement of the parties
on October 30, 2003. On October 31, 2003, BSI entered into a new Equity Line of
Credit Agreement with Cornell Capital. Under this agreement, BSI may issue and
sell to Cornell Capital common stock for a total purchase price of up to $15
million. Subject to certain conditions, BSI became entitled to commence drawing
down on the Equity Line of Credit effective on December 9, 2003, the date the
registration statement filed with the SEC was declared effective, and for two
years thereafter. The purchase price for the shares will be equal to 99% of, or
a 1% discount to, the market price, which is defined as the lowest closing bid
price of the common stock during the five trading days following the notice
date. The amount of each advance is subject to an aggregate maximum advance
amount of $210,000, with no advance occurring within seven trading days of a
prior advance. Cornell Capital received 1,875,000 shares of BSI common stock as
a one-time commitment fee. Cornell Capital is entitled to retain a fee of 4% of
each advance. In addition, BSI entered into a placement agent agreement with
Newbridge Securities Corporation, a registered broker-dealer. Pursuant to the
placement agent agreement, BSI paid Newbridge Securities a one-time placement
agent fee of 35,714 shares of common stock.
  During
the first quarter of 2003, BSI received proceeds of $134,500 from the sale of
134,500 shares of its common stock in a private placement. In engaging in the
foregoing transactions involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transactions involved private offerings of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited or unaccredited but sophisticated, and
the investors represented to BSI that they were acquiring the securities for
investment purposes and for their own account, and not with an eye toward
further distribution.
  During
the period December 2002 through February 2003, 1,072,386 shares at $1.00 for
$771,282 cash and $301,104 cancellation of debt (total $1,020,886) were
issued to 11 accredited and 20 non-accredited investors. In engaging in the
foregoing transactions involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transactions involved private offerings of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investors were accredited or unaccredited but sophisticated, and
the investors represented to BSI that they were acquiring the securities for
investment purposes and for their own accounts, and not with an eye toward
further distribution. With regard to the unaccredited investors, all information
required to be delivered to them concerning BSI, including audited financial
statements, was in fact delivered to them.
  13
  During
November 2002, 80,000 shares at $0.625 for $50,000 were issued to eight
employees as stock bonuses. No consideration was paid for these shares. In
engaging in the foregoing transactions involving unregistered securities of BSI,
BSI relied upon the private offering exemption provided under Section 4(2) of
the Securities Act of 1933, as amended, in that the transactions involved
private offerings of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investors were accredited or
unaccredited but sophisticated, and the investors represented to BSI that they
were acquiring the securities for investment purposes and for their own
accounts, and not with an eye toward further distribution. With regard to the
unaccredited investors, all information required to be delivered to them
concerning BSI, including audited financial statements, was in fact delivered to
them.
  During
July 2002, 800,000 shares at $0.625 were issued to Pursuit Capital, an
accredited investor, in consideration of Pursuit’s forgiving the $500,000
principal amount of the loan owed to Pursuit by BSI. In engaging in the
foregoing transaction involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transaction involved a private offering of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited, and the investor represented to BSI
that it was acquiring the securities for investment purposes and for its own
account, and not with an eye toward further distribution.
  During
the period June through July 2002, BSI issued 529,191 shares at $0.625 for
$330,745 to 14 accredited investors and five unaccredited. In engaging in the
foregoing transactions involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transactions involved private offerings of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investors were accredited or unaccredited but sophisticated, and
the investors represented to BSI that they were acquiring the securities for
investment purposes and for their own accounts, and not with an eye toward
further distribution. With regard to the unaccredited investors, all information
required to be delivered to them concerning BSI, including audited financial
statements, was in fact delivered to them.
  During
July 2002, BSI issued 300,000 shares to two individuals, Bernie Ciazza and John
Sloan (150,000 shares each) for introducing BSI to investors. In engaging
in the foregoing transactions involving unregistered securities of BSI, BSI
relied upon the private offering exemption provided under Section 4(2) of the
Securities Act of 1933, as amended, in that the transactions involved private
offerings of BSI’s unregistered securities, BSI did not make a public offering
or sale of its securities, the investors were unaccredited but sophisticated,
and the investors represented to BSI that they were acquiring the securities for
investment purposes and for their own accounts, and not with an eye toward
further distribution. With regard to both investors, all information required to
be delivered to them concerning BSI, including audited financial statements, was
in fact delivered to them.
  During
February 2002, BSI issued warrants to purchase 800,000 shares of its common
stock exercisable at $0.625 per share, issued to Pursuit Capital in a negotiated
transaction. The warrants were issued in exchange for Pursuit’s $500,000 loan to
BSI. In engaging in the foregoing transaction involving unregistered securities
of BSI, BSI relied upon the private offering exemption provided under Section
4(2) of the Securities Act of 1933, as amended, in that the transaction involved
a private offering of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  14
  During
January 2002, BSI issued 500,000 shares of its common stock to a business
consultant, D. David Breen, as a signing bonus for entering into his consulting
agreement with BSI. In engaging in the foregoing transaction involving
unregistered securities of BSI, BSI relied upon the private offering exemption
provided under Section 4(2) of the Securities Act of 1933, as amended, in that
the transaction involved a private offerings of BSI’s unregistered securities,
BSI did not make a public offering or sale of its securities, the investor was
unaccredited but sophisticated, and the investor represented to BSI that it was
acquiring the securities for investment purposes and for his own account, and
not with an eye toward further distribution. All information required to be
delivered to this investor concerning BSI, including audited financial
statements, was in fact delivered to them.
  **Item
6.** **Management’s
Discussion And Analysis Or Plan Of Operation.**
  **General**
  The
following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements, and the Notes thereto included
herein.
  **Forward-Looking
Statements**
  This Form
10-KSB contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act, as amended. Such statements include BSI’s beliefs, expectations,
hopes, goals and plans regarding the future, including but not limited to
statements regarding BSI’s strategy, competition, development plans, financing,
revenue and operations. Forward-looking statements often can be identified by
the use of terms such as “may,” “will,” “expect,” “anticipate,” “estimate,” or
“continue,” or the negative thereof. Such forward-looking statements speak only
as of the date made. Any forward-looking statements represent management’s best
judgment as to what may occur in the future. However, forward-looking statements
are subject to risks, uncertainties, and important factors beyond the control of
BSI that could cause actual results and events to differ materially from
historical results of operations and events and those presently anticipated or
projected. BSI disclaims any obligation subsequently to revise any
forward-looking statements to reflect events or circumstances after the date of
such statement or to reflect the occurrence of anticipated or unanticipated
events.
  **Going
Concern**
  The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and liquidation of liabilities in
the ordinary course of business. BSI has experienced losses since
inception.
  The
extended period over which losses have been experienced is, in the opinion of
BSI, principally attributable to two factors: lack of capital and long sales
lead times. Lack of capital has prevented BSI from quickly developing and
aggressively marketing its products. In addition, most of BSI’s potential
customers are large corporations or governments. Adopting BSI’s products will in
many cases require changing the way business is done. These circumstances can
result in two years or more elapsing from initial sales contact to delivery of
product.
  15
  In order
to fund activities until positive operating cash flow is achieved, management
recognizes that BSI must generate revenue from its operations and must raise
capital from the sale of its securities. BSI anticipates that the capital raised
under the Equity Line of Credit with Cornell Capital Partners, LP will be
sufficient to fund BSI’s activities until positive cash flow is achieved.
However, no assurances can be given that BSI will be successful in these
activities. Should any of these events not occur, the accompanying financial
statements will be materially affected and this in-turn could result in the
suspension and/or termination of BSI’s operations.
  **Critical
Accounting Policies And Estimates**
  Management’s
discussion and analysis of BSI’s financial condition and results of operations
are based upon BSI’s consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires that BSI make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. At each balance sheet date, management evaluates its estimates,
including but not limited to, those related to inventories, accrued liabilities,
and the valuation allowance offsetting deferred income taxes. BSI bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. The estimates
and critical accounting policies that are most important in fully understanding
and evaluating BSI’s financial condition and results of operations include those
listed below, as well as its valuation of equity securities used in transactions
and for compensation, and its revenue recognition methods.
  **Principles
of Consolidation**
  The
accompanying consolidated financial statements include the accounts of BSI2000,
Inc. and its subsidiary, BSI Operating, Inc. All intercompany accounts and
transactions have been eliminated in consolidation.
  **Cash
And Equivalents**
  BSI
considers all highly liquid instruments purchased with an original maturity of
three months or less to be cash equivalents. BSI continually monitors its
positions with, and the credit quality of, the financial institutions with which
it invests.
  **Inventories**
  Inventory
consists of raw materials and is stated at the lower of cost or market,
determined using the first-in, first-out method (“FIFO”).
  **Property
and Equipment**
  Property
and equipment is stated at cost. Depreciation is provided utilizing the
straight-line method over the estimated useful lives for owned assets of
five-to-seven years. Leasehold improvements are amortized over a five and
one-half year period.
  **Use
of Estimates**
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
  16
  **Revenue
Recognition**
  BSI
recognizes revenue in compliance with the SEC Staff Accounting
Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements”.
Revenue is recognized when an order has been placed by the customer, the product
has been shipped and collectibility is reasonably assured. Prices of the
products are determined prior to entering into a purchase agreement. From
inception through December 31, 2004, revenues earned represented sales to
distributors of demonstrations units of BSI’s products. Transaction-based
revenue is recognized as transactions are completed and are billed monthly based
on service agreement rates in effect. Distribution rights revenue is recognized
ratable over the life of each underlying distribution agreement.
  **Intangible
Assets**
  Intangibles
include trademarks and patents, which are recorded at cost. To date, BSI has
been awarded one patent by the United States Patent and Trademark
Office (the “USPTO”), and has 22 additional provisional and non-provisional
applications for patents pending with the USPTO. Once accepted, BSI will begin
amortization over the life of each patent.
  **Income
Taxes**
  BSI
recognizes deferred tax liabilities and assets based on the differences between
the tax basis of assets and liabilities and their reported amounts in the
financial statements that will result in taxable or deductible amounts in future
years.
  **Advertising
Costs**
  BSI
expenses advertising costs as incurred.
  **Software
And Research And Development Costs**
  Expenditures
made for research and development are charged to expense as incurred. Costs
incurred to date for the development of BSI’s products have been charged to
expense as incurred. Future costs may be capitalized to the extent they meet the
requirements of the Financial Accounting Standards Board’s (“FASB’s”)
Statement of Financial Account Standards (“SFAS”) No. 86 “Accounting for
the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed.”
  **Basic
And Diluted Earnings Per Common Share**
  Basic
earnings per share are computed by dividing net income by the number of weighted
average common shares outstanding during the year. Diluted earnings per share is
computed by dividing net income by the number of weighted average common shares
outstanding during the year, including potential common shares, which consisted
of warrants, options and convertible debt.
  **SEC
Inquiry**
  In 2003,
BSI received requests from the SEC’s Central Regional Office for certain
documents, including those concerning arrangements with certain strategic
partners, relationships with the TSA and INS, recent issuances of securities,
investor relations, and information relating to investment opinions distributed
by third parties.  The SEC’s letter states that the staff’s inquiry should
not be construed as an indication that any violations of securities laws have
occurred or as an adverse reflection on any individuals, entities, or
investments. BSI responded promptly and fully to the request and will cooperate
with any further requests. BSI did not receive any additional requests in
2004.
  17
  **Financial
Condition**
  BSI had
net losses of $1,568,978 and $973,635 for the years ended December 31, 2003 and
December 31, 2002, respectively. For the year ended December 31, 2004, BSI had a
net loss of $2,169,238, an increase of $600,260 or 38% from 2003. **** As of
December 31, 2004, BSI had cash and cash equivalents of $893,387 as compared to
$125,550 at December 31, 2003, or an increase of 612%; and current liabilities
of $688,808 as compared to $908,330 at December 31, 2003, or a decrease of 24%.
BSI does not have sufficient cash or other current assets to meet BSI’s current
liabilities. In order to meet those obligations, BSI will need to raise cash
from the sale of securities or from borrowings. BSI estimates that its cash
reserves on December 31, 2004 will sustain BSI until May 2005. **** Our
independent auditors have added an explanatory paragraph to their audit opinions
issued in connection with the years 2004, 2003, 2002 and 2001 financial
statements, which states that BSI’s ability to continue as a going concern
depends upon its ability to resolve liquidity problems, principally by obtaining
capital, commencing sales and generating sufficient revenues to become
profitable. BSI’s ability to obtain additional funding will determine BSI’s
ability to continue as a going concern.
  **Results
of Operations**
  The
following discussion should be read in conjunction with BSI’s financial
statements and the related notes and the other financial information appearing
elsewhere in this report.
  **Comparison
Of The Year Ended December 31, 2004 To The Year Ended December 31,
2003**
  ***Overall
Results Of Operations***
  For the
year ended December 31, 2004 BSI incurred an overall loss of $2,169,238 or $0.03
per share, which was a material increase from the loss of $1,568,978 or $0.04
per share for the comparable period in the prior year.
  ***Revenue***
  BSI had
revenues of $5,918 and $34,440 during the one-year periods ended December 31,
2004 and 2003, respectively, or a decease of $28,522 or 83%. Such revenues were
from the sale of demonstration units and software development kits to potential
distributors of BSI’s products, and distributions fees.
  ***Operating
Expenses***
  Operating
expenses for the year ended December 31, 2004, were $1,958,515 and represent an
increase of $476,542 or nearly a 32% increase in operating expenses of
$1,481,973 for the comparative period ended December 31, 2003.
  The
largest component of operating expenses for the periods ended December 31, 2004
and 2003 related to general and administrative expenses. For the period ended
December 31, 2004, general and administrative expense were $1,048,073, an
increase of $287,803 or nearly 37% in general and administrative expenses of
$760,270 for the comparative period ended December 31, 2003. This increase is
attributable to a decrease in fees of $43,625 incurred in connection with the
merger with KFI, salaries, payroll taxes and related benefits of $155,890,
shareholder relations expense included in selling in P/Y of $8,832, a decrease
in legal fees of $58,237, increase in accounting and auditing fees of $35,420,
general office expenses of $30,921, increase in consulting fee of $150,275, and
increases in other expenses directly related to increased levels of
activity.
  18
  BSI had
selling expenses for the year ended December 31, 2004 of $367,807, as compared
to $275,098 for the comparative period ended December 31, 2003, a decrease of
$92,709 or 34%. The increases in selling expenses are primarily attributable to
salary expense of $37,381, a decrease in consulting fees of $19,551, travel and
entertainment expenses of $47,119, a decrease in material development and trade
show costs of $3,240, and an increase in demonstration unit costs of
$30,565.
  BSI had
research and development expenses of $542,635 for the year ended December 31,
2004, as compared to $446,605 for the period ended December 31, 2003, or an
increase of $96,030 or 22%. **** This
increase is attributable to R&D components of $36,753, consulting fees of
$64,248 and decreases in travel and entertainment, salaries and wages and other
costs totaling $4,982. These costs were expensed as incurred and increased as a
result of the needs identified relating to potential markets for BSI’s products
in various parts of the world.
  ***Other
Expenses***
  As to the
other expenses, BSI had other expense of $216,641 for the year ended December
31, 2004, as compared to other expense of $53,459 for the year ended December
31, 2003, which represents an increase of $163,182 or 305%. BSI had interest
expense of $53,864 and $8,152 for the years ended December 31, 2004 and 2004,
respectively, which represents a $45,712 or 561% increase. BSI had interest
income of $3 and $1,636 for the years ended December 31, 2004 and 2003,
respectively, or a decrease of $1,633 or 99%. **** BSI
incurred financing costs of $163,030 and $46,943 during 2004 and 2003,
respectively, or an increase of $116,087 or 247%, related to the Equity Line of
Credit with Cornell Capital, which were partially paid in lieu of
interest.
  **Liquidity
and Capital Resources**
  As of
December 31, 2004, BSI had cash of $893,387 as compared to $125,550 at December
31, 2003, an increase of 612% and current liabilities of $688,808, as compared
to $908,330, or a decrease of 24%; and cash used by operations was $2,139,380 in
2004 as compared to $1,339,634 at December 31, 2003, or an increase of $799,746
or 60%. BSI does not have sufficient cash an cash equivalents or other current
assets to meet BSI’s current liabilities. In order to meet those obligations,
BSI will need to raise cash from the sale of securities or from borrowings. Our
independent auditors have added an explanatory paragraph to their audit opinions
issued in connection with the years 2004, 2003, 2002 and 2001 financial
statements, which states that BSI’s ability to continue as a going concern
depends upon BSI’s ability to resolve liquidity problems, principally by
obtaining capital, commencing sales and generating sufficient revenues to become
profitable. Our ability to obtain additional funding will determine BSI’s
ability to continue as a going concern. BSI estimates that is cash reserves as
of December 31, 2004 will sustain BSI until May 2005.
  During
the period December 2002 through February 2003, 1,072,386 shares at $1.00 for
$771,282 cash and $301,104 cancellation of debt (total $1,020,886) were
issued to 11 accredited and 20 non-accredited investors. In engaging in the
foregoing transactions involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transactions involved private offerings of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investors were accredited or unaccredited but sophisticated, and
the investors represented to BSI that they were acquiring the securities for
investment purposes and for their own accounts, and not with an eye toward
further distribution. With regard to the unaccredited investors, all information
required to be delivered to them concerning BSI, including audited financial
statements, was in fact delivered to them.
  19
  During
the first quarter of 2003, BSI received proceeds of $134,500 from the sale of
134,500 shares of its common stock in a private placement. In engaging in the
foregoing transactions involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transactions involved private offerings of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited or unaccredited but sophisticated, and
the investors represented to BSI that they were acquiring the securities for
investment purposes and for their own account, and not with an eye toward
further distribution.
  On July
7, 2003, BSI sold $250,000 of convertible debentures to Cornell. Cornell was the
purchaser of the convertible debentures. These debentures accrue interest at a
rate of 5% per year and mature two years from the issuance date. The debentures
are convertible at the Cornell’s option any time up to maturity at a conversion
price equal to the lower of (i) 120% of the closing bid price of the
common stock as of the closing date or (ii) 80% of the lowest closing bid
price of the common stock for the five trading days immediately preceding the
conversion date. At maturity, BSI has the option to either pay the holder the
outstanding principal balance and accrued interest or to convert the debentures
into shares of common stock at a conversion price equal to the lower of (i)
120% of the closing bid price of the common stock as of the closing date
or (ii) 80% of the lowest closing bid price of the common stock for
the five trading days immediately preceding the conversion date. BSI has the
right to redeem the debentures upon 30 days notice for 120% of the amount
redeemed. In engaging in the foregoing transactions involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transactions
involved private offerings of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On July
7, 2003, BSI entered into an Equity Line of Credit Agreement with Cornell
Capital that was subsequently terminated by the mutual agreement of the parties
on October 30, 2003. On October 31, 2003, BSI entered into a new Equity
Line of Credit Agreement with Cornell Capital. Under this agreement, BSI may
issue and sell to Cornell Capital common stock for a total purchase price of up
to $15 million. Subject to certain conditions, BSI became entitled to commence
drawing down on the Equity Line of Credit effective on December 9, 2003, the
date the registration statement filed with the SEC was declared effective, and
for two years thereafter. The purchase price for the shares will be equal to 99%
of, or a 1% discount to, the market price, which is defined as the lowest
closing bid price of the common stock during the five trading days following the
notice date. The amount of each advance is subject to an aggregate maximum
advance amount of $210,000, with no advance occurring within seven trading days
of a prior advance. Cornell Capital received 1,875,000 shares of BSI common
stock as a one-time commitment fee. Cornell Capital is entitled to retain a fee
of 4% of each advance. In addition, BSI entered into a placement agent agreement
with Newbridge Securities Corporation, a registered broker-dealer. Pursuant to
the placement agent agreement, BSI paid Newbridge Securities a one-time
placement agent fee of 35,714 shares of common stock.
  20
  During
the period August 1, 2003 through October 31, 2003, BSI received proceeds of
$182,500 from the sale of 730,000 shares of its common stock in a private
placement to Pursuit Capital, LLC (“Pursuit Capital”) at $0.25 per share.
In engaging in the foregoing transactions involving unregistered securities of
BSI, BSI relied upon the private offering exemption provided under Section 4(2)
of the Securities Act of 1933, as amended, in that the transactions involved
private offerings of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  During
the period August 1, 2003 through October 31, 2003, BSI received proceeds of
$67,500 from the sale of 270,000 shares of its common stock to Doug Dragoo in a
private placement at $0.25 per share. In engaging in the foregoing transaction
involving unregistered securities of BSI, BSI relied upon the private offering
exemption provided under Section 4(2) of the Securities Act of 1933, as amended,
in that the transaction involved a private offering of BSI’s unregistered
securities, BSI did not make a public offering or sale of its securities, the
investor was accredited, and the investor represented to BSI that it was
acquiring the securities for investment purposes and for its own account, and
not with an eye toward further distribution.
  On
September 16, 2003, BSI received net proceeds of $455,000 from a $500,000
secured promissory note issued to Cornell. The note is due on the earlier of 90
days from the date thereof or 60 days after BSI’s registration statement on Form
SB-2 is declared effective by the SEC. The note is secured by substantially all
of BSI’s non-cash assets. The note bears no interest during its term, but bears
a default rate of interest of 24% if the note is not paid when due. BSI paid
cash fees of $45,000 in connection with the issuance of the note and also issued
500,000 shares of its common stock to Cornell as additional consideration in the
transaction. Subsequent to December 31, 2003 and through March 29, 2003, Cornell
Capital converted $500,000 of debt into 4,776,988 shares of common stock of BSI
and $19,890 of accrued interest into 211,734 shares of common stock. In engaging
in the foregoing transaction involving unregistered securities of BSI, BSI
relied upon the private offering exemption provided under Section 4(2) of the
Securities Act of 1933, as amended, in that the transaction involved a private
offering of BSI’s unregistered securities, BSI did not make a public offering or
sale of its securities, the investor was accredited, and the investor
represented to BSI that it was acquiring the securities for investment purposes
and for its own account, and not with an eye toward further
distribution.
  On
October 31, 2003, BSI entered into an Equity Line of Credit Agreement (the
“Equity Line”) with Cornell. Under the Equity Line, BSI may issue and sell to
Cornell common stock for a total purchase price of up to $15 million.
Subject to certain conditions, BSI will be entitled to commence drawing down on
the Equity Line when the common stock to be issued under the Equity Line is
registered with the SEC and the registration statement is declared effective and
will continue for two years thereafter. The purchase price for the shares will
be equal to 99% of the market price, which is defined as the lowest closing bid
price of the common stock during the five trading days following the notice
date. The amount of each advance is subject to an aggregate maximum advance
amount of $210,000, with no advance occurring within seven trading days of a
prior advance. Cornell received 1,875,000 shares of common stock as a one-time
commitment fee. Cornell is entitled to retain a fee of 4% of each advance. In
addition, BSI entered into a placement agent agreement with Newbridge Securities
Corporation (“Newbridge”), a registered broker-dealer. Pursuant to the
placement agent agreement, BSI paid Newbridge a one-time placement agent fee of
35,714 shares of common stock. In engaging in the foregoing transaction
involving unregistered securities of BSI, BSI relied upon the private offering
exemption provided under Section 4(2) of the Securities Act of 1933, as amended,
in that the transaction involved a private offering of BSI’s unregistered
securities, BSI did not make a public offering or sale of its securities, the
investor was accredited, and the investor represented to BSI that it was
acquiring the securities for investment purposes and for its own account, and
not with an eye toward further distribution.
  21
  On
December 19, 2003, BSI received net proceeds of $170,917 from a $200,000 secured
promissory note issued to Cornell. The note is due on April 26, 2004. The note
is secured by substantially all of BSI’s non-cash assets. The note bears no
interest during its term, but bears a default rate of interest of 24% if the
note is not paid when due. Discounts and fees paid to obtain the loan were
$29,083. BSI has reserved and placed in escrow 3.9 million shares of its common
stock as an estimation of the shares necessary to repay the loan. In engaging in
the foregoing transaction involving unregistered securities of BSI, BSI relied
upon the private offering exemption provided under Section 4(2) of the
Securities Act of 1933, as amended, in that the transaction involved a private
offering of BSI’s unregistered securities, BSI did not make a public offering or
sale of its securities, the investor was accredited, and the investor
represented to BSI that it was acquiring the securities for investment purposes
and for its own account, and not with an eye toward further
distribution.
  On
February 4, 2004, BSI received net proceeds of $223,559 from a $250,000 secured
promissory note issued to Cornell. The note is due on May 12, 2004. The note is
secured by substantially all of BSI’s non-cash assets. The note bears no
interest during its term, but bears a default rate of interest of 24% if the
note is not paid when due. BSI paid cash fees of $26,441 in connection with the
issuance of the note. Cornell converted this note into 4,140,867 shares of BSI’s
common stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On March
3, 2004, BSI received net proceeds of $229,524 from a $250,000 secured
promissory note issued to Cornell. The note is due on June 23, 2004. The note is
secured by substantially all of BSI’s non-cash assets. The note bears interest
of 12% during its term, and bears a default rate of interest of 24% if the note
is not paid when due. BSI paid cash fees of $20,476 in connection with the
issuance of the note. Cornell converted this note into 3,246,474 shares of BSI’s
common stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On March
12, 2004, BSI issued Richard Kirk 250,000 options at a strike price of $0.11 per
share, all of which vested on the date of the grant. These options were issued
as compensation to Mr. Kirk for his services as a director of BSI. All of these
options have a 5-year term. In engaging in the foregoing transaction involving
unregistered securities of BSI, BSI relied upon the private offering exemption
provided under Section 4(2) of the Securities Act of 1933, as amended, in that
the transaction involved a private offering of BSI’s unregistered securities,
BSI did not make a public offering or sale of its securities, the investor was
accredited, and the investor represented to BSI that it was acquiring the
securities for investment purposes and for its own account, and not with an eye
toward further distribution.
  22
  On April
14, 2004, BSI received net proceeds of $229,679 from a $250,000 secured
promissory note issued to Cornell. The note is due on June 21, 2004. The note is
secured by substantially all of BSI’s non-cash assets. The note bears no
interest during its term, but bears a default rate of interest of 24% if the
note is not paid when due. BSI paid cash fees of $20,321 in connection with the
issuance of the note. BSI has reserved and placed into escrow 3,000,000 shares
of its common stock as an estimation of the shares necessary to repay the loan.
Cornell converted this note and accrued interest into 3,418,210 shares of BSI’s
common stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On June
8, 2004, BSI received net proceeds of $320,208 from a $350,000 secured
promissory note issued to Cornell. The note is due on September 20, 2004. The
note is secured by substantially all of BSI’s non-cash assets. The note bears
interest at 12% per annum during its term, and bears a default rate of interest
of 24% if the note is not paid when due. BSI paid cash fees of $29,792 in
connection with the issuance of the note. Cornell converted this note and
accrued interest into 6,580,362 shares of BSI’s common stock. In engaging in the
foregoing transaction involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transaction involved a private offering of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited, and the investor represented to BSI
that it was acquiring the securities for investment purposes and for its own
account, and not with an eye toward further distribution.
  On June
18, 2004, BSI received net proceeds of $231,935 from a $250,000 secured
promissory note issued to Cornell. The note is due on October 18, 2004. The note
is secured by substantially all of BSI’s non-cash assets. The note bears
interest at 12% per annum during its term, and bears a default rate of interest
of 24% if the note is not paid when due. BSI paid cash fees of $18,065 in
connection with the issuance of the note. Cornell converted this note and
accrued interest into 4,285,831 shares of BSI’s common stock. In engaging in the
foregoing transaction involving unregistered securities of BSI, BSI relied upon
the private offering exemption provided under Section 4(2) of the Securities Act
of 1933, as amended, in that the transaction involved a private offering of
BSI’s unregistered securities, BSI did not make a public offering or sale of its
securities, the investor was accredited, and the investor represented to BSI
that it was acquiring the securities for investment purposes and for its own
account, and not with an eye toward further distribution.
  On July
15, 2004, BSI issued Bernard Nann 250,000 options at a strike price of $0.089
per share, 50,000 of which vested on the date of the grant, and the remaining
200,000 vests 50,000 per year for so long as Mr. Nann remains a director of BSI.
These options were issued as compensation to Mr. Nann for his present and future
services as a director of BSI. All of these options have a 5-year term. In
engaging in the foregoing transaction involving unregistered securities of BSI,
BSI relied upon the private offering exemption provided under Section 4(2) of
the Securities Act of 1933, as amended, in that the transaction involved a
private offering of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On
September 13, 2004, BSI issued 990,099 shares of common stock to Cornell for
$50,000 cash. Costs associated with this transaction were $2,500. **** In
engaging in the foregoing transaction involving unregistered securities of BSI,
BSI relied upon the private offering exemption provided under Section 4(2) of
the Securities Act of 1933, as amended, in that the transaction involved a
private offering of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  23
  On
October 7, 2004, BSI issued a 5% convertible debenture in the amount of $500,000
to Cornell that is due October 7, 2007, on December 10, 2004, BSI issued a 5%
convertible debenture in the amount of $500,000 to Cornell that is due December
10, 2007, and on January 20, 2005, BSI issued a 5% convertible debenture in the
amount of $250,000 to Cornell that is due January 20, 2008. These debentures are
convertible into BSI’s common stock at either the fixed price of 120% of the
Volume Weighted Average price on the closing date (October 7, 2007,
December 10, 2007 and January 20, 2008, respectively) or 80% of the average of
the three lowest daily Volume Weighted Average Price, as reported by Bloomberg,
L.P., of BSI’s common stock for the five trading days immediately preceding the
conversion date. These debentures will automatically convert into BSI’s common
stock on the third anniversary of issuance. BSI has the right to redeem the
debentures with three days advance notice any or all of the outstanding
debenture amount at its sole discretion. The redemption price shall be 120% of
the face amount redeem plus accrued interest. Once the redemption notice has
been given, Cornell may continue to convert the remaining outstanding debenture.
Also on October 7, 2004, BSI received $500,000 less a 10% fee of $50,000 and
$10,000 for legal costs. BSI received $500,000 (net of 10% fee) on December
10, 2004 and $250,000 (net of 10% fee) on January 20, 2005. In engaging in
the foregoing transactions involving unregistered securities of BSI, BSI relied
upon the private offering exemption provided under Section 4(2) of the
Securities Act of 1933, as amended, in that the transactions involved the
private offering of BSI’s unregistered securities, BSI did not make a public
offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On
November 4, 2004, BSI received net proceeds of $178,051 from a $200,000 secured
promissory note issued to Cornell. The note is due on December 4, 2004. The note
is secured by substantially all of BSI’s non-cash assets. The note bears
interest at 12% per annum during its term, and bears a default rate of interest
of 24% if the note is not paid when due. BSI paid cash fees of $21,949 in
connection with the issuance of the note. As of December 31, 2004, Cornell has
converted this note and accrued interest into 3,783,430 shares of BSI’s common
stock. In engaging in the foregoing transaction involving unregistered
securities of BSI, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transaction
involved a private offering of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the investor was accredited, and the
investor represented to BSI that it was acquiring the securities for investment
purposes and for its own account, and not with an eye toward further
distribution.
  On
December 10, 2004, BSI received net proceeds of $435,723 from a $500,000 secured
promissory note issued to Cornell Capital Partners, LP (“Cornell”). The
note is due on March 11, 2005. The note is secured by substantially all of BSI’s
non-cash assets. The note bears interest at 12% per annum during its term, and
bears a default rate of interest of 24% if the note is not paid when due. BSI
paid cash fees of $64,277 in connection with the issuance of the note. As of
March 11, 2005, Cornell has converted $300,000 of this note into 8,381,359
shares of BSI’s common stock. In engaging in the foregoing transaction involving
unregistered securities of BSI, BSI relied upon the private offering exemption
provided under Section 4(2) of the Securities Act of 1933, as amended, in that
the transaction involved a private offering of BSI’s unregistered securities,
BSI did not make a public offering or sale of its securities, the investor was
accredited, and the investor represented to BSI that it was acquiring the
securities for investment purposes and for its own account, and not with an eye
toward further distribution.
  24
  The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and liquidation of liabilities in
the ordinary course of business. BSI has experienced losses since inception. The
extended period over which losses have been experienced is, in the opinion of
BSI, principally attributable to two factors: lack of capital and long sales
lead times. Lack of capital has prevented BSI from quickly developing and
aggressively marketing its products. In addition, most of BSI’s potential
customers are large corporations or governments. Adopting BSI’s products will in
many cases require changing the way business is done. These circumstances can
result in two years or more elapsing from initial sales contact to delivery of
product. In order to fund activities until positive operating cash flow is
achieved, management recognizes that BSI must generate revenue from its
operations and must raise capital from the sale of its securities. However, no
assurances can be given that BSI will be successful in these activities. Should
any of these events not occur, the accompanying financial statements will be
materially affected, which in-turn could result in the suspension or termination
of BSI’s operations.
  **Capital
Resources**
  Pursuant
to the Equity Line of Credit, BSI may issue and sell to Cornell Capital common
stock for a total purchase price of up to $15 million. Subject to certain
conditions, BSI became entitled to commence drawing down on the Equity Line of
Credit when the common stock to be issued under the Equity Line of Credit was
registered with the SEC and the registration statement is declared
effective (December 9, 2003) and for two years thereafter. The purchase
price for the shares will be equal to 99% of, or a 1% discount to, the market
price, which is defined as the lowest closing bid price of the common stock
during the five trading days following the notice date. The amount of each
advance is subject to an aggregate maximum advance amount of $210,000, with no
advance occurring within seven trading days of a prior advance. Cornell Capital
received 1,875,000 shares of BSI common stock as a one-time commitment fee.
Cornell Capital is entitled to retain a fee of 4% of each advance. In addition,
BSI entered into a placement agent agreement with Newbridge Securities. Pursuant
to the placement agent agreement, BSI paid to Newbridge Securities a one-time
placement agent fee of 35,714 shares of common stock.
  BSI
cannot predict the actual number of shares of common stock that will be issued
pursuant to the Equity Line of Credit, in part, because the purchase price of
the shares will fluctuate based on prevailing market conditions and BSI have not
determined the total amount of advances BSI intend to draw. Pursuant to BSI’s
Articles of Incorporation, BSI is authorized to issue up to 200,000,000 shares
of common stock, of which 99,273,157 are outstanding as of March 11, 2005. At a
recent price of $0.04 per share, BSI would be required to issue at
$0.0396 (99% of $0.04), 378,787,878 shares of common stock in order to
fully utilize the $15 million available under the Equity Line. **** At BSI’s
current stock price, BSI would be required to authorize and register additional
shares of BSI’s common stock to fully utilize the amount available under the
Equity Line of Credit. At BSI’s current price of $0.04, BSI would need to
authorize approximately 180,000,000 additional shares to fully utilize the
Equity Line of Credit. BSI would have to receive the affirmative vote of a
majority of BSI’s outstanding shares to approve any increase in authorized
shares. Our inability to obtain such approval would prohibit us from increasing
BSI’s authorized shares of common stock and from issuing any additional shares
under the Equity Line of Credit or to otherwise raise capital from the sale of
capital stock.
  25
  **Plan
Of Operations**
  BSI
continues to rely on funding by Cornell Capital while it pursues potential sales
of its Employee Tracking System and Access Control and Site Security products to
commercial customers located in the United States, South Africa and
Germany.
  If a
contract is awarded, BSI will need to increase the size of its staff to
approximately 15 to 25 employees and consultants and will need to establish and
enhance its production capabilities. These activities will require additional
financing.
  If a
contract is not awarded, BSI may be required to significantly reduce its
administrative costs, salaries and research and development activities until
such time as a new plan of action can be developed. The new plan, if required,
may include locating additional sources of funding or merger and acquisition
activities.
  **Off-Balance
Sheet Arrangements**
  None.
  **Property,
Plant and Equipment**
  No
material changes from December 31, 2003.
  **Current
Accounting Pronouncements**
  In April
2002, the FASB issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44 and
64, Amendment of FASB Statement No. 13, and Technical Corrections.” This
statement provides guidance on the classification of gains and losses from the
extinguishment of debt and on the accounting for certain specified lease
transactions. BSI adopted SFAS No. 145 January 1, 2003. Adoption of SFAS No. 145
did not have a material impact on BSI.
  In June
2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with
Exit or Disposal Activities,” (effective January 1, 2003) which
replaces Emerging Issues Task Force (EITF) Issue No. 94-3
“Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring).”
SFAS No. 146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred and states
that an entity’s commitment to an exit plan, by itself, does not create a
present obligation that meets the definition of a liability. SFAS No. 146
also establishes that fair value is the objective for initial measurement of the
liability. BSI adopted this statement on January 1, 2003; adoption did not have
an effect on results of operations and financial position.
  In
October 2002, the FASB issued SFAS No. 147 “Acquisitions of Certain Financial
Institutions.” SFAS No. 147 amends FASB Statements No. 72 and 144 and FASB
Interpretations No. 9. Adoption of this statement did not have a material effect
on BSI.
  In
November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45, "Guarantor’s Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" (the
Interpretation), which addresses the disclosure to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees.
The Interpretation also requires the recognition of a liability by a guarantor
at the inception of certain guarantees. The Interpretation requires the
guarantor to recognize a liability for the non-contingent component of the
guarantee, this is the obligation to stand ready to perform in the event that
specified triggering events or conditions occur. The initial measurement of this
liability is the fair value of the guarantee at inception. The recognition of
the liability is required even if it is not probable that payments will be
required under the guarantee or if the guarantee was issued with a premium
payment or as part of a transaction with multiple elements. BSI adopted the
disclosure provisions of the Interpretation beginning with its fiscal 2003
consolidated financial statements, and will apply the recognition and
measurement provisions for all guarantees entered into or modified after
December 31, 2002. However, BSI is not a guarantor of indebtedness of
others.
  26
  In
December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based
Compensation - Transition and Disclosure.” This statement amends FASB Statement
No. 123 “Accounting for Stock-Based Compensation,” to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. This statement also amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The provisions of this statement relating to alternative transition
methods and annual disclosure requirements are effective for the year ended
December 31, 2002. The transitional provisions did not have an impact on BSI’s
financial statements as it has elected to retain the intrinsic value method. The
provisions relating to annual and interim disclosures have changed the manner in
which BSI discloses information regarding stock-based compensation.
  In
January 2003, the Financial Accounting Standards Board issued Interpretation No.
46, “Consolidation of Variable Interest Entities” (FIN No. 46)”. This
interpretation clarifies existing accounting principles related to the
preparation of consolidated financial statements when the equity investors in an
entity do not have the characteristics of a controlling financial interest or
when the equity at risk is not sufficient for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN No. 46 requires a company to evaluate all existing arrangements to identify
situations where a company has a “variable interest” (commonly evidenced by
a guarantee arrangement or other commitment to provide financial support) in a
“variable interest entity” (commonly a thinly capitalized entity) and
further determine when such variable interests require a company to consolidate
the variable interest entities’ financial statement with its own. BSI is
required to perform this assessment by December 31, 2003 and consolidate any
variable interest entities for which it will absorb a majority of the entities’
expected losses or receive a majority of the expected residual gains. Management
has not yet performed this assessment, however it does not have any variable
interest entities as of December 31, 2004.
  In April
2003, FASB issued SFAS No. 149, “Accounting for Derivative Instruments and
Hedging Activities,” which is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. This statement amends and clarifies financial accounting and reporting for
derivative instruments including certain instruments embedded in other contracts
and for hedging activities under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” BSI has not entered into any contracts of
this type.
  In May
2003, FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity,” which 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
September 15, 2003. SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. The adoption of this standard is not expected to
have a material impact on BSI’s financial statements.
  27
  In
December 2004, the FASB issued SFAS No. 123 (revised), *Share-Based
Payment,* which
supersedes Accounting Principles Board (“APB”) No. 25, *Accounting
for Stock Issued to Employees,* and its
related implementation guidance. Under SFAS No. 123 (revised), all
share-based payments would be treated as other forms of compensation by
recognizing the costs, generally measured as the fair value at the date of
grant, in the income statement. BSI will adopt, as required, SFAS No.
123 (revised) for its fiscal year beginning January 1, 2006. Management
expects that the impact of the adoption of SFAS No. 123 (revised) will be
that the share-based payment expense amounts historically disclosed as required
by SFAS No. 123 will now be recognized as an expense on the statement of
operations.
  **Item
7.** **Financial
Statements.**
  Attached
hereto and filed as a part of this Form 10-KSB are BSI’s Consolidated Financial
Statements.
  **Item
8.** **Changes
In And Disagreements With Accountants On Accounting And Financial
Disclosure.**
  Effective
February 17, 2003, BSI’s Board of Directors dismissed Corbin & Wertz as the
independent auditor and engaged Ehrhardt Keefe Steiner & Hottman PC. Neither
of the principal accountant’s reports for the past two years contained any
adverse opinion or disclaimer, nor were they modified as to uncertainty, audit
scope or accounting principles; however, the report for the past two years has
been modified to include an emphasis paragraph indicating that substantial doubt
existed about BSI’s ability to continue as a going concern. The decision to
change accountants was approved by BSI’s Board of Directors. There were no
disagreements with former or current independent auditors.
  **Item
8A.** **Controls
And Procedures.**
  **Evaluation
Of Disclosure Controls And Procedures**
  BSI’s
Chief Executive Officer and Interim Chief Financial Officer, after evaluating
the effectiveness of BSI’s disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended) as of the end of the period covered by this report, has concluded that
as of such date, BSI’s disclosure controls and procedures were adequate and
effective to ensure that material information relating to BSI and its
consolidated subsidiary that is required to be disclosed by BSI in reports that
BSI files or submits under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in SEC rules and accumulated and communicated to BSI’s management, including
BSI’s Chief Executive Officer and Interim Chief Financial Officer, to allow
timely decisions regarding required disclosure.
  **Changes
In Internal Controls Over Financial Reporting**
  There was
no change in BSI’s internal controls over financial reporting that occurred
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, BSI’s control over financial
reporting.
  **Item
8B.** **Other
Information.**
  None.
 
 28
  **PART
III**
  **Item
9.**  **Directors And Executive Officers Of The Registrant.**
  As of
December 31, 2004, the directors and executive officers of BSI, their age,
positions in BSI, the dates of their initial election or appointment as
directors or executive officers, and the expiration of the terms are as
follows:
  **Name
      of Director/****Executive
      Officer**
    
    **Age**
    
    **Position**
    
    **Period
      Served (****1)**Jack
      Harper
    
    
    52
    
    
    Chairman
      and President
    
    
    1995
      to presentRichard
      A. Kirk
    
    
    74
    
    
    Director
      and Secretary
    
    
    1995
      to presentJohn
      D. Woods
    
    
    65
    
    
    Director
    
    
    2005
      to present
  
 (1)
    Period
      served includes the period served in same capacity with BSI, Inc., a
      private Colorado corporation.
  None of
BSI’s directors or executive officers is a director of any company that files
reports with the SEC.
  **Family
Relationships**
  To our
knowledge, there are no family relationships between or among the directors,
executive officers or any other person.
  **Legal
Proceedings**
  None of
BSI’s directors have been involved in legal proceedings.
  **Audit
Committee Financial Expert**
  BSI does
not have an audit committee, nor an audit committee financial expert.
  **Election
of Directors**
  BSI’s
directors are elected at the annual meeting of stockholders and hold office
until their successors are elected. BSI’s officers are appointed by the Board of
Directors and serve at the pleasure of the Board of Directors and are subject to
employment agreements, if any, approved and ratified by the Board of Directors.
  **Background
of Directors**
  ***Jack
Harper, President, Chief Executive Officer, And Chairman of the
Board***
  Mr.
Harper has been President and Chairman of the Board of BSI since late 1995.
Previously, from 1989 until 1994, Mr. Harper was President of Technology Fusion,
Inc., a company that specialized in low-cost add-in video hardware products for
the Apple Macintosh. Mr. Harper received an MBA from the University of Denver in
2000, having completed all studies in 1992; in 1975, Mr. Harper received a B.S.
in Electrical Engineering and a B.A. in Mathematics with a Minor in Russian
Language from the University of Houston.
  29
  ***Richard
A. Kirk, Secretary And Director***
  Mr. Kirk
has been a Director of BSI since August of 1995 and acting Secretary since July
of 1999. He was Chairman of the Board of Access Long Distance, a long distance
provider that was sold in 2001. Mr. Kirk worked for United Bank of
Denver/Norwest Bank/Wells Fargo from 1958 through 1990, ultimately serving as
Chairman, President and Chief Executive Officer. In 1986, Mr. Kirk was elected
Vice Chairman of the United Banks of Colorado, Inc. (now Wells Fargo). In
1992, he retired from the Norwest Bank Denver but continues as Chairman Emeritus
and serves on its Advisory Board. He is a graduate of the Haverford College; the
Advanced Management Program of the Harvard Business School; and the Stonier
Graduate School of Banking at Rutgers University. Mr. Kirk serves on boards of
several nonprofit institutions and is an appointed Commissioner of the Denver
Water Board.
  ***John
D. Woods, Director***
  John D.
Woods is a founding shareholder of Community Bankshares Inc. and has served as
Chairman of the Board since its incorporation in February 1989. He divides his
business time on affairs of the holding company and also as Chairman and part
owner of Market Reach, Ltd., London, England.
  He has
spent 40 years in the banking industry, starting at the Northern Trust Company,
Chicago, Illinois in 1956. During the course of his career, he has served as
President and COO of Winters National Bank, Dayton, Ohio (an 42.5 billion
bank now part of Bank One), and Chairman and CEO of Omaha National Bank and its
successor , FirstTier Financial, Inc (a $4.7 billion banking organization
now part of US Bank, Minneapolis, Minnesota). Mr. Woods received his B.A. degree
from the University of Colorado in Boulder, Colorado.
  **Section
16(a) Beneficial Ownership Reporting Compliance**
  Section
16(a) of the Securities Exchange Act of 1934, as amended, and the rules
promulgated thereunder require BSI’s officers and directors, and persons who
beneficially own more than 10% of a registered class of BSI equity securities,
to file reports of ownership and changes in ownership with the SEC and to
furnish BSI with copies thereof.
  Based on
its reviews of the copies of the Section 16(a) forms received by it, or written
representations from certain reporting persons, BSI believes that, during the
last fiscal year, all Section 16(a) filing requirements applicable to its
officers, directors and greater than 10% beneficial owners were complied with
and filed timely
  **Code
of Ethics**
  On April
12, 2004, the Board of Directors of BSI adopted a written Code of Ethics
designed to deter wrongdoing and promote honest and ethical conduct, full, fair
and accurate disclosure, compliance with laws, prompt internal reporting and
accountability to adherence to the Code of Ethics. The Code of Ethics is
attached hereto as an exhibit to this report.
  **Item
10.** **Executive
Compensation.**
  The
following table sets forth, for the fiscal year ended December 31, 2004, 2003,
2002 and 2001 certain information regarding the compensation earned by BSI’s
President (the “Named Executive Officer”), with respect to services
rendered by him to BSI. No other officer of BSI has been paid or earned
compensation in excess of $100,000 in any such fiscal year.
  30
  **Summary
Compensation Table**
 **Annual
      Compensation**
    
    **Long-Term
      Compensation****Name
      and Principal Position**
    
    **Year**
    
    **Salary**
    
    **Bonus**
    
    **Other
      Annual Compensation**
    
    **Restricted
      Stock Awards**
    
    **Securities
      Underlying Options / SARs**
    
    **All
      Other Compensation**Jack
      Harper,
    
    
    2004
    
    $
    125,000
    
    
    35,000
    
    
    --
    
    
    --
    
    
    --
    
    
    --Chairman
      and
    
    
    2003
    
    $
    90,000
    
    
    --
    
    
    --
    
    
    --
    
    
    --
    
    
    --President
    
    
    2002
    
    $
    80,000
    
    
    --
    
    
    --
    
    
    --
    
    
    --
    
    
    --
 
 
 (1)
    Mr.
      Harper was issued 2,500,000 shares in consideration for $2,500 and the
      forgiveness of accrued wages.
  (2)
    The
      2004 bonus to Mr. Harper was in recognition of his financial support
      during the early days of BSI that resulted in personal
    debt.
   **Option
/ SAR Grants**
  BSI
granted 3,097,500 stock options to directors, employees and consultants during
the fiscal year ended December 31, 2004. No stock appreciation
rights (“SARs”) were granted to these individuals during any
year.
  On
October 24, 1996, BSI adopted a Stock Option Plan whereby the Board of Directors
can issue both incentive and nonqualified options to directors, employees and
consultants. Currently, there are no outstanding stock options issued under the
plan.
  **Compensation
Of Directors**
  During
the year 2003, BSI did not pay its directors any remuneration; however, BSI
periodically reimburses its directors for out-of-pocket expenses they incur in
fulfillment of their duties as directors of BSI. In 2004, BSI paid the following
remuneration to its directors: (i) on March 12, 2004, BSI issued Mr. Kirk
250,000 options at a strike price of $0.11 per share, all of which vested on the
date of the grant; and (ii) on July 15, 2004, BSI issued Mr. Nann 250,000
options at a strike price of $0.089 per share, 50,000 of which vested on the
date of the grant, and the remaining 200,000 vests 50,000 per year for so long
as he remains a member of the Board of Directors. All of the options issued to
Messrs. Kirk and Nann have a five year term.
  **Employment
Contracts, Termination of Employment, and Change-in-Control
Arrangements**
  BSI
presently has an oral employment contract with Jack Harper. The employment
agreement provides for an annual salary of $125,000 per year, as well as group
life, health, dental and disability insurance. The employment agreement is for
an indefinite period, but is terminable at will.
  31
  **Committees
of the Board of Directors**
  Currently,
BSI does not have an executive, audit or any standing committees of the Board of
Directors.
  **Item
11.** **Security
Ownership Of Certain Beneficial Owners And Management.**
  The
following table sets forth information with respect of the beneficial ownership
as of March 1, 2005 for each officer and director of BSI and for each
person who is known to BSI to be the beneficial owner of more than 5% of BSI’s
common stock.
  **Security
      Ownership of Certain Beneficial Owners and
    Management****Title
      of Class**
    
    **Name
      and**
      **Address
      of Beneficial Owner**
    
    **Amount
      and Nature of Beneficial Ownership**
    
    **Percentage
      of Class****(1)**Common
    
    Jack
      Harper
    
    10,403,102
    
    10.70
    %12600
      West Colfax Ave. Suite B410Lakewood,
      Colorado 80215Common
    
    Richard
      Kirk
    
    4,601,340
    
    4.73
    %12600
      West Colfax Ave. Suite B410Lakewood,
      Colorado 80215Common
    
    Bernhard
      Nann
      12600
      West Colfax Ave. Suite B410
      Lakewood,
      CO 80215
    
    50,000
    
    
    ***All
      Officers And Directors**
      **As
      A Group (3) Persons**
    
    
    
    15,054,442
    
    15.48
    %Common
    
    Cornell
      Capital Partners, L.P.
      101
      Hudson Street, Suite 3606
      Jersey
      City, NJ 07302
    
    0
    
    8.68
    %
 
 *
    Less
      than 1%.
  (1)
    Applicable
      percentage of ownership is based on 99,273,157 shares of common stock
      outstanding as of March 11, 2005 for each stockholder. Beneficial
      ownership is determined in accordance within the rules of the SEC and
      generally includes voting of investment power with respect to securities.
      Shares of common stock subject to securities exercisable or convertible
      into shares of common stock that are currently exercisable or exercisable
      within 60 days of March 1, 2005 are deemed to be beneficially owned by the
      person holding such options for the purpose of computing the percentage of
      ownership of such persons, but are not treated as outstanding for the
      purpose of computing the percentage ownership of any other
      person.
  **Securities
Authorized For Issuance Under Equity Compensation Plan**
  The
following table sets forth the securities that have been authorized under equity
compensation plans as of December 31, 2004.
  **Number**
      **Of
      Securities**
      **To
      Be Issued**
      **Upon
      Exercise**
      **Of
      Outstanding Options, Warrants And Rights**
    
    **Weighted-Average**
      **Exercise
      Price**
      **Of
      Outstanding Options,**
      **Warrants
      And Rights**
    
    **Number**
      **Of
      Securities**
      **Remaining
      Available**
      **For
      Future Issuance**
      **Under
      Equity Compensation Plans**
      **(Excluding
      Securities Reflected**
      **In
      Column (a))****(a)**
    
    **(b)**
    
    **(c)**Equity
      compensation plans approved by security holders
    
    
    --
    
    
    --
    
    
    --Equity
      compensation plans not approved by security holders
    
    
    --
    
    
    --
    
    
    --TOTAL
    
    
    --
    
    
    --
    
    
    --
   32
 **Item
12.** **Certain
Relationships And Related Transactions.**
  During
the past two years, BSI has not entered into a transaction with a value in
excess of $60,000 with a director, officer or beneficial owner of 5% or more of
BSI’s common stock, except as disclosed in the following
paragraphs.
  *Stock
Issued to an Officer and Employee* . On
September 11, 2001, BSI issued 2,500,000 shares of common stock to Jack Harper,
President and a Director of BSI, for $2,500.00 at $0.001 per share and
forgiveness of $59,643 accrued wages. Also in 2001, BSI issued 212,045 shares of
common stock to Robert B. Lumen for $212.05 at $0.001 per share. When the
foregoing shares were issued, BSI was insolvent with negative working capital,
and unable to pay salaries to employees. In engaging in the foregoing
transactions, BSI relied upon the private offering exemption provided under
Section 4(2) of the Securities Act of 1933, as amended, in that the transactions
involved private offerings of BSI’s unregistered securities, BSI did not make a
public offering or sale of its securities, the employees were either accredited
or unaccredited but sophisticated investors, and the employees represented to
BSI that they were acquiring the securities for investment purposes and for
their own accounts, and not with an eye toward further distribution. With regard
to the unaccredited investor, Mr. Lumen, all information required to be
delivered to him concerning BSI, including audited financial statements, was in
fact delivered to him.
  *Loans
by Director* . From
March 30, 2000 through December 31, 2001, Richard A. Kirk, director of BSI, had
loaned $259,000 to BSI, all with annual interest at 10% (accrued interest
at March 31, 2002 was $19,935). Of the total debt, $64,000 plus interest is
currently due, and $195,000 is due when BSI has received cumulative funding of
$3 million. In December 2002, BSI issued 301,104 restricted shares of common
stock to Mr. Kirk, for his cancellation of $301,104 of debt (principal and
all interest) owed to him by BSI. In engaging in the foregoing transaction, BSI
relied upon the private offering exemption provided under Section 4(2) of the
Securities Act of 1933, as amended, in that the transaction involved a private
offering of BSI’s restricted securities, BSI did not make a public offering or
sale of its securities, Mr. Kirk was an accredited investor, and he represented
to BSI that he was acquiring the securities for investment purposes and for his
own account, and not with an eye toward further distribution.
  33
  **Item
13.** **Exhibits
And Reports On Form 8-K.**
  **(a)**  **Exhibits**
  **Exhibit
      No.**
    **Description**
    
    **Location**2.1
    Agreement
      and Plan of Merger, dated August 7, 2000, between Calipso and Knowledge
      Foundations, Inc.
    
    Incorporated
      by reference to Exhibit 2(1) to Form 8-K filed on September 27, 2000 to2.2
    Merger
      Agreement, dated April 23, 2002, between BSI2000, Inc., Knowledge
      Foundations, Inc. and KFI, Inc.
    
    Incorporated
      by reference to Exhibit 99.2 to Form 8-K filed on May 9,
    20022.3
    First
      Amendment to Merger Agreement dated August 8, 2002, between BSI2000, Inc.,
      KFI, Inc. and Knowledge Foundations, Inc.
    
    Incorporated
      by reference to Form S-4 filed on August 13, 20022.4
    Separation
      and Distribution Agreement by and among Knowledge Foundations, Inc., Cyber
      Knowledge, Inc. and CKI Group
    
    Incorporated
      by reference to Form S-4 filed on August 13, 20022.5
    Second
      Amendment to Merger Agreement dated November 20, 2002 between BSI2000,
      Inc., KFI, Inc. and Knowledge Foundations, Inc.
    
    Incorporated
      by reference to Form S-4/A1 filed on November 27, 20023.1
    Certificate
      of Incorporation of Knowledge Foundations, Inc. filed on May 31,
      1994
    
    Incorporated
      by reference to Form 10-SB filed on November 24, 19993.2
    Certificate
      of Amendment of Certificate of Incorporation re: 36:1 forward
      split
    
    Incorporated
      by reference to Exhibit 3(i)(a) to Form 8-K filed on September 27,
      20003.3
    Certificate
      of Amendment of Certificate of Incorporation re: 35:1 forward
      split
    
    Incorporated
      by reference to Exhibit 3(i)(b) to Form 8-K filed on September 27,
      20003.4
    Certificate
      of Amendment of Certificate of Incorporation re: increase in authorized
      shares
    
    Incorporated
      by reference to Exhibit 3(i)(c) to Form 8-K filed on September 27,
      20003.5
    Certificate
      of Amendment of Certificate of incorporation re: name
    change
    
    Incorporated
      by reference to Exhibit 3.3 to Form 8-K filed on April 8, 20033.6
    Bylaws
      of Knowledge Foundations, Inc.
    
    Incorporated
      by reference to Form 10-SB filed on November 24, 1999
   34
  **Exhibit
      No.**
    **Description**
    
    **Location**
 3.7
    Certificate
      of Merger, dated August 17, 2000, filed with the Secretary of State of
      Delaware
    
    Incorporated
      by reference to Exhibit 3(i) to Form 8-K filed on September 27,
      200010.1
    Stock
      Repurchase Agreement dated September 18, 2002 between Calipso and Wrights
      & Bleers and Ocean Way Investments, Ltd.
    
    Incorporated
      by reference to Exhibit 4(a) to Form 8-K filed on September 27,
      200010.2
    Lock
      Up Agreement dated September 18, 2000 between Calipso and Wright &
      Bleers and Ocean Way Investments, Ltd.
    
    Incorporated
      by reference to Exhibit 4(b) to Form 8-K filed on September 27,
      200010.3
    License
      and Royalty Agreement dated April 6, 2000 between Richard L. Ballard and
      Janet J. Pettitt and Knowledge Foundations Inc.
    
    Incorporated
      by reference to Exhibit 10(1) to Form 8-K filed on September 27,
      200010.4
    Employment
      Contract of Michael W. Dochterman dated May 1, 2000
    
    Incorporated
      by reference to Exhibit 10(2) to Form 8-K filed on September 27,
      200010.5
    Employment
      Contract of Robert A. Dietrich dated May 1, 2000
    
    Incorporated
      by reference to Exhibit 10(3) to Form 8-K filed on September 27,
      200010.6
    Strategic
      Alliance Agreement dated May 4, 2000 between BSI2000, Inc. and Drug
      Intervention Services of America, Inc.
    
    Incorporated
      by reference to Exhibit 10.4 to Form S-4 filed on August 13,
      200210.7
    Office
      Lease by and between BSI2000, Inc. and Golden Hill Partnership, dated as
      of January 24, 2001.
    
    Incorporated
      by reference to Exhibit 10.7 to Form SB-2 filed on November 4,
      2003.10.8
    Strategic
      Alliance Agreement dated May 7, 2001 between BSI2000, Inc. and L.C.
      Sistemia
    
    Incorporated
      by reference to Exhibit 10.5 to Form S-4 filed on August 13,
      200210.9
    Agreement
      to replace options with common stock dated September 11, 2001 between
      BSI2000, Inc. and Jack Harper and Bryan Luman
    
    Incorporated
      by reference to Exhibit 10.8 to Form S-4 filed on August 13,
      200210.10
    Certificate
      of LaserCard Systems Corporation Issued to BSI2000, Inc. dated April 28,
      2002
    
    Incorporated
      by reference to Exhibit 10.10 to Form SB-2 filed on November 4,
      2003.
   35
  **Exhibit
      No.**
    **Description**
    
    **Location**
 10.11
    Strategic
      Alliance Agreement between Titan Secure Systems and BSI2000, Inc. dated
      July 25, 2002
    
    Incorporated
      by reference to Exhibit 10.9 to Form S-4/A1 filed on November 27,
      200210.12
    Teaming
      Agreement between Science Applications International Corporation and
      BSI2000, Inc. dated August 20, 2002
    
    Incorporated
      by reference to Exhibit 10.10 to Form S-4/A1 filed on November 27,
      200210.13
    Solicitation/Contract/Order
      for Commercial Items dated September 2, 2002, issued by U.S. Immigration
      and Naturalization Service with BSI2000, Inc. as Contractor/Offeror 21
    
    Incorporated
      by reference to Exhibit 10.11 to Form S-4/A1 filed on November 27, 200210.14
    Form
      of Lock-Up Agreement between certain shareholders of BSI2000, Inc. and
      Knowledge Foundations, Inc.
    
    Incorporated
      by reference to Exhibit 4(c) to Form S-4/A3 filed on January 29, 200310.15
    Securities
      Purchase Agreement dated July 7, 2003 among the Registrant and the
      Buyers
    
    Incorporated
      by reference to Exhibit 10.15 to Form SB-2 filed on November 4,
      200310.16
    Escrow
      Agreement dated July 7, 2003 among the Registrant, the Buyers, and Law
      Offices of Eric S. Hutner & Associates
    
    Incorporated
      by reference to Exhibit 10.16 to Form SB-2 filed on November 4,
      200310.17
    Debenture
      Agreement Dated July 7, 2003 between the Registrant and Cornell Capital
      Partners LP
    
    Incorporated
      by reference to Exhibit 10.17 to Form SB-2 filed on November 4,
      200310.18
    Investor
      Registration Rights Agreement dated July 7, 2003 between the Registrant
      and the Investors
    
    Incorporated
      by reference to Exhibit 10.18 to Form SB-2 filed on November 4,
      200310.19
    Equity
      Line of Credit Agreement dated October 31, 2003 between the Registrant and
      Cornell Capital Partners LP
    
    Incorporated
      by reference to Exhibit 10.19 to Form SB-2 filed on November 4,
      200310.20
    Registration
      Rights Agreement dated October 31, 2003 between the Registrant and Cornell
      Capital Partners, LP
    
    Incorporated
      by reference to Exhibit 10.20 to Form SB-2 filed on November 4,
      200310.21
    Escrow
      Agreement dated October 31, 2003 among the Registrant, Cornell Capital
      Partners, LP, Law Offices of Eric S. Hutner &
    Associates
    
    Incorporated
      by reference to Exhibit 10.21 to Form SB-2 filed on November 4,
      2003
   36
  **Exhibit
      No.**
    **Description**
    
    **Location**
 10.22
    Placement
      Agent Agreement dated July 7, 2003 among the Registrant, Newbridge
      Securities Corporation and Cornell Capital Partners LP
    
    Incorporated
      by reference to Exhibit 10.22 to Form SB-2 filed on November 4,
      200314.1
    Code
      of Ethics
    
    Provided
      herewith23.1
    Consent
      of Independent Registered Public Accounting Firm
    
    Provided
      herewith31.1
    Certification
      by Chief Executive Officer and Chief Financial Officer pursuant to 15
      U.S.C. Section 7241, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.
    
    Provided
      herewith.32.1
    Certification
      by Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002
    
    Provided
      herewith
 
 **(b)**  **Reports
on Form 8-K**
  The
Registrant filed no reports on Form 8-K during the fourth quarter of fiscal year
2004.
  **Item
14.** **Principal
Accountant Fees And Services.**
  BSI
incurred fees to Ehrhardt Keefe Steiner & Hottman PC of $54,943 for auditing
work, services related to the SEC Registration Statement on Form SB-2, review of
various other SEC filings, and quarterly reviews on SEC Forms 10-QSB, as
well as $3,200 for income tax preparation services. Ehrhardt Keefe Steiner &
Hottman PC has provided no other services to BSI other than the
foregoing.
  
 37
  **SIGNATURES**
  In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, as
amended, the Registrant caused this report to be signed on behalf by the
undersigned, thereunto duly authorized.
  **BSI2000,
      INC.**Date: April __,
2005
    By:
    */s/ Jack
      Harper*Jack Harper,President
      (Principal Executive Officer and Principal Accounting Officer)
      and Director
 
 In
accordance with the Securities Exchange Act of 1934, as amended, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
  Date: April __,
2005
    
    */s/* *Jack
      Harper*Jack Harper, President and
      Director
 Date: April __,
2005
    
    */s/* *Richard
      Kirk*Richard Kirk,
Director
 Date: April __,
2005
    
    */s/* *John D.
      Woods*John D. Woods,
  Director
  38
   
 
 
 
 
 **(A
Development Stage Company)**
 
 **Consolidated
Financial Statements**
 **and**
 **Independent
Auditors’ Report**
 
 
 
 
 
 
 
   
  **Table
of Contents**
 
 PageReport
      of Independent Registered Public Accounting Firm
    F-1Consolidated
      Financial StatementsConsolidated
      Balance Sheet
    F-2Consolidated
      Statements of Operations
    F-3Consolidated
      Statement of Changes in Stockholders’
Equity (Deficit)
    F-4Consolidated
      Statements of Cash Flows
    F-5Notes
      to Consolidated Financial Statements
    F-7
 
   
  **REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  Board of
Directors and Stockholders
 BSI 2000,
Inc.
 Denver,
Colorado
 
 We have
audited the accompanying consolidated balance sheet of BSI 2000, Inc. and
subsidiary (A Development Stage Company) (the Company) as of December
31, 2004, and the related consolidated statements of operations, stockholders’
equity (deficit) and cash flows for the years ended December 31, 2004
and 2003 and for the cumulative period from Inception (July 30, 1993)
through December 31, 2004. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
 
 We
conducted our audits in accordance with auditing standards of The Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of BSI 2000, Inc. and
subsidiary as of December 31, 2004, and the results of their operations and
their cash flows for the years ended December 31, 2004 and 2003 and for the
cumulative period from Inception (July 30, 1993) through December 31, 2004
in conformity with accounting principles generally accepted in the United States
of America.
 
 The
accompanying consolidated financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has experienced circumstances,
which raise substantial doubt about its ability to continue as a going concern.
Management’s plans regarding those matters also are described in Note 2. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
 
 Ehrhardt
Keefe Steiner & Hottman PC
 March 11,
2005
 Denver,
Colorado
 
 
  F-1
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Consolidated
Balance Sheet**
 **December
31, 2004**
 
 **Assets**
 Current
      assetsCash
      and cash equivalents
    
    $
    893,387Inventories
    
    
    50,370Other
    
    
    3,432Total
      current assets
    
    
    947,189Property
      and equipment, net
    
    
    44,125Intangible
      assets, net
    
    
    182,966Other
      long-term assets
    
    
    4,232Total
      assets
    
    $
    1,178,512
 
 **Liabilities
and Stockholders’ Deficit**
 Current
      liabilitiesAccounts
      payable
    
    $
    184,269Accrued
      liabilities
    
    
    27,331Deferred
      revenue, current portion
    
    
    6,375Convertible
      notes payable, current portion
    
    
    470,833Total
      current liabilities
    
    
    688,808Deferred
      revenue, long-term portion
    
    
    13,208Convertible
      notes payable, less current portion
    
    
    896,389Commitments
      and contingenciesStockholders’
      deficitPreferred
      stock, $.001 par value, 20,000,000 shares authorized, no shares issued and
      outstanding
    
    
    --Common
      stock, $.001 par value, 200,000,000 shares authorized, 90,891,798 shares
      issued and outstanding
    
    
    90,892Additional
      paid-in capital
    
    
    6,938,742Accumulated
      deficit
    
    
    (7,449,527
    )Total
      stockholders’ deficit
    
    
    (419,893
    )Total
      liabilities and stockholders’ deficit
    
    $
    1,178,512
 
 See notes
to consolidated financial statements.
 
  F-2
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Consolidated
Statements of Operations**
 
 For
      the Years Ended
    
    Inception (July 30,
      1993) throughDecember
      31,
    
    December
      31,2004
    
    2003
    
    2004Revenues
    
    $
    5,918
    
    $
    34,440
    
    $
    101,648Cost
      of goods sold
    
    
    --
    
    
    67,986
    
    
    67,986Gross (loss)
      profit
    
    
    5,918
    
    
    (33,546
    )
    
    33,662Operating
      expensesSelling
      expenses
    
    
    367,807
    
    
    275,098
    
    
    1,406,780General
      and administrative
    
    
    1,048,073
    
    
    760,270
    
    
    3,632,515Stock
      based compensation expense
    
    
    --
    
    
    --
    
    
    253,741Research
      and development
    
    
    542,635
    
    
    446,605
    
    
    1,903,524Total
      operating expenses
    
    
    1,958,515
    
    
    1,481,973
    
    
    7,196,560Other (expense)
      incomeInterest
      expense
    
    
    (53,864
    )
    
    (8,152
    )
    
    (183,229
    )Interest
      income
    
    
    3
    
    
    1,636
    
    
    23,047Financing
      costs
    
    
    (163,030
    )
    
    (46,943
    )
    
    (209,973
    )Other
    
    
    250
    
    
    --
    
    
    83,526Total
      other (expense) income
    
    
    (216,641
    )
    
    (53,459
    )
    
    (286,629
    )Net
      loss
    
    $
    (2,169,238
    )
    $
    (1,568,978
    )
    $
    (7,449,527
    )Basic
      and diluted weighted average common shares outstanding
    
    
    72,506,696
    
    
    41,412,101
    
    
    13,384,466Basic
      and diluted loss per common share
    
    $
    (0.03
    )
    $
    (0.04
    )
    $
    (0.56
    )
 
 See notes
to consolidated financial statements.
 
 
  F-3
  
 **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Consolidated
Statement of Changes in Stockholders’
Equity (Deficit)**
 **For
the Years Ended December 31, 2004 and 2003 and**
 **For
the Period from Inception (July 30, 1993) to December 31,
2004**
 
 Common
      Stock
    
    Additional
    
    Accumulated
      Deficit During the
    
    TotalShares
    
    Amount
    
    Paid-in-Capital
    
    Development
      Stage
    
    Stockholders’
      Equity (Deficit)Balance
      at Inception - July 30, 1993
    
    
    --
    
    $
    --
    
    $
    --
    
    $
    --
    
    $
    --Stock
      issued to founders for cash during the period ended December 31,
      1993
    
    
    19,580
    
    
    85,000
    
    
    --
    
    
    --
    
    
    85,000Stock
      issued for cash during the year ended December 31, 1993
    
    
    2,701
    
    
    57,500
    
    
    --
    
    
    --
    
    
    57,500Stock
      issued to founders for services during the period ended December 31,
      1993
    
    
    33,812
    
    
    146,793
    
    
    --
    
    
    --
    
    
    146,793Stock
      issued for cash during the year ended December 31, 1994
    
    
    12,904
    
    
    65,000
    
    
    --
    
    
    --
    
    
    65,000Stock
      issued for cash during the year ended December 31, 1995
    
    
    224,672
    
    
    118,763
    
    
    --
    
    
    --
    
    
    118,763Stock
      issued for cash during the year ended December 31, 1996
    
    
    616,989
    
    
    227,872
    
    
    --
    
    
    --
    
    
    227,872Stock
      issued for cash during the year ended December 31, 1997
    
    
    225,766
    
    
    144,612
    
    
    --
    
    
    --
    
    
    144,612Stock
      issued for cash during the year ended December 31, 1998
    
    
    831,118
    
    
    788,309
    
    
    --
    
    
    --
    
    
    788,309Stock
      issued for cash during the year ended December 31, 1999
    
    
    583,767
    
    
    364,854
    
    
    --
    
    
    --
    
    
    364,854Stock
      issued for cash during the year ended December 31, 2000
    
    
    195,369
    
    
    122,106
    
    
    --
    
    
    --
    
    
    122,106Net
      loss from Inception
    
    
    --
    
    
    --
    
    
    --
    
    
    (2,398,997
    )
    
    (2,398,997
    )Balance
      - December 31, 2000
    
    
    2,746,678
    
    
    2,120,809
    
    
    --
    
    
    (2,398,997
    )
    
    (278,188
    )Stock
      issued for cash
    
    
    46,600
    
    
    29,125
    
    
    --
    
    
    --
    
    
    29,125Stock
      issued to officer for services
    
    
    2,500,000
    
    
    56,736
    
    
    --
    
    
    --
    
    
    56,736Stock
      issued for services to an employee
    
    
    212,045
    
    
    212
    
    
    --
    
    
    --
    
    
    212Net
      income
    
    
    --
    
    
    --
    
    
    --
    
    
    (338,679
    )
    
    (338,679
    )Balance
      - December 31, 2001
    
    
    5,505,323
    
    
    2,206,882
    
    
    --
    
    
    (2,737,676
    )
    
    (530,794
    )Stock
      issued for debt conversion
    
    
    1,159,426
    
    
    865,375
    
    
    --
    
    
    --
    
    
    865,375Stock
      issued for cash
    
    
    1,082,651
    
    
    889,200
    
    
    --
    
    
    --
    
    
    889,200Stock
      issued for services to finders of private placement offering in June 2002
      at $.01 per share, net of expense
    
    
    300,000
    
    
    --
    
    
    --
    
    
    --
    
    
    --Stock
      issued for services
    
    
    25,000
    
    
    25,500
    
    
    --
    
    
    --
    
    
    25,500Stock
      based compensation expense
    
    
    580,000
    
    
    50,000
    
    
    --
    
    
    --
    
    
    50,000Net
      loss
    
    
    --
    
    
    --
    
    
    --
    
    
    (973,635
    )
    
    (973,635
    )Balance
      - December 31, 2002
    
    
    8,652,400
    
    
    4,036,957
    
    
    --
    
    
    (3,711,311
    )
    
    325,646Stock
      issued for cash
    
    
    1,134,500
    
    
    135,500
    
    
    249,000
    
    
    --
    
    
    384,500Stock
      issued for equity line of credit commitment and placement
    fees
    
    
    1,910,714
    
    
    1,911
    
    
    (1,911
    )
    
    --
    
    
    --Stock
      issued for convertible note payable fees
    
    
    500,000
    
    
    500
    
    
    (500
    )
    
    --
    
    
    --Issuance
      of stock in connection with reverse acquisition
    
    
    41,363,488
    
    
    (4,121,307
    )
    
    4,121,307
    
    
    --
    
    
    --Stock
      issued for debt conversion
    
    
    390,625
    
    
    391
    
    
    49,609
    
    
    --
    
    
    50,000Net
      loss
    
    
    --
    
    
    --
    
    
    --
    
    
    (1,568,978
    )
    
    (1,568,978
    )Balance
      December 31, 2003
    
    
    53,951,727
    
    
    53,952
    
    
    4,417,505
    
    
    (5,280,289
    )
    
    (808,832
    )Stock
      issued for debt conversion
    
    
    35,949,972
    
    
    35,950
    
    
    2,454,579
    
    
    --
    
    
    2,490,529Stock
      issued for cash
    
    
    990,099
    
    
    990
    
    
    46,510
    
    
    --
    
    
    47,500Warrants
      issued to consultants
    
    
    --
    
    
    --
    
    
    20,148
    
    
    --
    
    
    20,148Net
      loss
    
    
    --
    
    
    --
    
    
    --
    
    
    (2,169,238
    )
    
    (2,169,238
    )Balance
      December 31, 2004
    
    
    90,891,798
    
    $
    90,892
    
    $
    6,938,742
    
    $
    (7,449,527
    )
    $
    (419,893
    )
 See notes
to consolidated financial statements.
 
  F-4
  
 **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Consolidated
Statements of Cash Flows**
 For
      the Years Ended
    
    Inception (July 30,
      1993) toDecember
      31,
    
    December
      31,2004
    
    2003
    
    2004Cash
      flows from operating activitiesNet
      loss
    
    $
    (2,169,238
    )
    $
    (1,568,978
    )
    $
    (7,449,527
    )Adjustments
      to reconcile net loss to net cash used in operating
    activitiesDepreciation
      and amortization expense
    
    
    19,152
    
    
    27,128
    
    
    123,313Gain
      on forgiveness of debt
    
    
    --
    
    
    --
    
    
    (65,485
    )Gain
      on disposal of fixed assets
    
    
    (250
    )
    
    
    
    
    (250
    )Stock
      based compensation
    
    
    20,148
    
    
    --
    
    
    273,889Changes
      in assets and liabilitiesInventories
    
    
    (15,009
    )
    
    (8,237
    )
    
    (50,370
    )Other
      current assets
    
    
    (3,432
    )
    
    4,257
    
    
    (3,432
    )Other
      long-term assets
    
    
    --
    
    
    --
    
    
    (4,232
    )Accounts
      payable
    
    
    (11,868
    )
    
    186,890
    
    
    238,332Deferred
      revenue
    
    
    19,583
    
    
    --
    
    
    19,583Accrued
      liabilities
    
    
    1,533
    
    
    19,306
    
    
    80,88029,857
    
    
    229,344
    
    
    612,228Net
      cash used in operating activities
    
    
    (2,139,381
    )
    
    (1,339,634
    )
    
    (6,837,299
    )Cash
      flows from investing activitiesRedemption
      of certificates of deposit
    
    
    --
    
    
    --
    
    
    35,000Purchase
      of certificate of deposit
    
    
    --
    
    
    --
    
    
    (35,000
    )Proceeds
      from fixed asset disposals
    
    
    250
    
    
    
    
    
    250Purchase
      of fixed assets
    
    
    (10,755
    )
    
    (10,533
    )
    
    (118,882
    )Patent
      application
    
    
    (120,585
    )
    
    (54,343
    )
    
    (183,168
    )Net
      cash used in investing activities
    
    
    (131,090
    )
    
    (64,876
    )
    
    (301,800
    )Cash
      flows from financing activitiesProceeds
      from issuance of common stock
    
    
    47,500
    
    
    384,500
    
    
    3,324,341Proceeds
      from long-term debt
    
    
    --
    
    
    --
    
    
    919,500Net
      proceeds from convertible notes payable
    
    
    2,990,808
    
    
    916,943
    
    
    3,907,751Repayment
      on long-term debt
    
    
    --
    
    
    --
    
    
    (81,516
    )Repayment
      on capital lease obligation
    
    
    --
    
    
    --
    
    
    (37,590
    )Net
      cash provided by financing activities
    
    
    3,038,308
    
    
    1,301,443
    
    
    8,032,486Net (decrease)
      increase in cash and cash equivalents
    
    
    767,837
    
    
    (103,067
    )
    
    893,387Cash
      and cash equivalents - beginning of year
    
    
    125,550
    
    
    228,617
    
    
    --Cash
      and cash equivalents - end of year
    
    $
    893,387
    
    $
    125,550
    
    $
    893,387
 
 (Continued
on following page.)
 
 See notes
to consolidated financial statements.
 
  F-5
  
 **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Consolidated
Statements of Cash Flows**
 
 (Continued
from previous page.)
  Supplemental
disclosure of cash flow information:
  Cash paid
for interest during the years ended December 31, 2004 and 2003 was $0 and $0,
respectively. Cash paid for interest expense from Inception (July 30, 1993)
through December 31, 2004 was $68,164.
  Supplemental
disclosure of non-cash activity:
  During
the year ended December 31, 2004, the Company issued 250,000 warrants to a
consultant valued at $20,148.
  During
the year ended December 31, 2004, the Company converted $2,490,529 of notes
payable and accrued interest into 35,949,972 shares of common
stock.
  During
the year ended December 31, 2003, the Company converted $50,000 of notes payable
into 390,625 shares of common stock.
  Effective
March 31, 2003, the Company entered into a merger agreement, which has been
accounted for as a reverse acquisition. No assets were acquired. As a result of
the merger, there was an increase of 41,363,488 shares of common stock
outstanding in the surviving company.
  As part
of the merger, the Company assumed an existing liability of $56,825, which has
been funded through a note receivable from shareholders of the Company.
  During
the year ended December 31, 2002, the Company converted $812,326 of notes
payable and $53,049 of accrued interest into 1,159,426 shares of common
stock.
  During
the year ended December 31, 2002, the Company converted $25,500 of accounts
payable and accrued liabilities into 25,000 shares of common stock.
  During
the year ended December 31, 2001, the Company converted accrued wages totaling
$56,736 into 2,500,000 shares of common stock.
  During
the year ended December 31, 1999, the Company converted $29,063 from accounts
payable to notes payable.
  In
September 1998, the Company obtained fixed assets totaling $37,590 through a
capital lease. In addition, the Company financed leasehold improvements in the
amount of $16,000 through a note payable.
  
  F-6
  
 **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
1 - Description of Business and Summary of Significant Accounting
Policies**
  BSI 2000,
Inc. was formed on July 30, 1993 and is a value-added reseller (“VAR”) of
LaserCard’s® optical cards and optical card readers. As a VAR, BSI 2000, Inc.
develops proprietary hardware and software adapting LaserCard’s® optical card
technology for specific applications. BSI 2000 Inc.’s products are designed as
turnkey solutions for identified commercial and governmental card-based
information needs.
  BSI 2000,
Inc. is a development stage company that has not had any significant revenue
since inception. There is no assurance that the Company will generate
significant revenue or earn a profit in the future.
  **Principles
of Consolidation**
  The
accompanying consolidated financial statements include the accounts of BSI 2000,
Inc. and its subsidiary, BSI Operating, Inc. (the Company). All
intercompany accounts and transactions have been eliminated in
consolidation.
  **Cash
and Cash Equivalents**
  The
Company considers all highly liquid instruments purchased with an original
maturity of three months or less to be cash equivalents. The Company continually
monitors its positions with, and the credit quality of, the financial
institutions with which it invests. As of the balance sheet date, and
periodically throughout the year, the Company’s cash and cash equivalents exceed
federally insured limits.
  **Inventories**
  Inventories
consist of raw materials and are stated at the lower of cost or market,
determined using the first-in, first-out method (FIFO).
  **Property
and Equipment**
  Property
and equipment is stated at cost. Depreciation is provided utilizing the
straight-line method over the estimated useful lives for owned assets of 5 to 7
years. Leasehold improvements are amortized over a 5 1/2 year
period.
  **Use
of Estimates**
  The
preparation of financial statements 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, disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
estimates.
   F-7
  
 **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
1 - Description of Business and Summary of Significant Accounting
Policies (continued)**
  **Revenue
Recognition**
  The
Company recognizes revenue in compliance with SAB 104, “Revenue Recognition in
Financial Statements.” Revenue is recognized when an order has been placed by
the customer, the product has been shipped and collectibility is reasonably
assured. Prices of the products are determined prior to entering into a purchase
agreement. From inception through December 31, 2004, revenues earned represented
sales to distributors of demonstration units of the Company’s
products.
  Transaction
based revenue is recognized as transactions are completed and are billed monthly
based on service agreement rates in effect.
  Distribution
rights revenue is recognized ratable over the life of each underlying
distribution agreement.
  **Intangible
Assets**
  Intangibles
include trademarks and patents, which are recorded at cost. These patents are
awaiting approval from the U.S. Patent office. Once accepted, the Company will
begin amortization over the life of the patent. If patents are not awarded, the
related costs will be expensed.
  **Income
Taxes**
  The
Company recognizes deferred tax liabilities and assets based on the differences
between the tax basis of assets and liabilities and their reported amounts in
the financial statements that will result in taxable or deductible amounts in
future years.
  **Advertising
Costs**
  The
Company expenses advertising costs as incurred.
  **Software
and Research and Development Costs**
  Expenditures
made for research and development are charged to expense as
incurred.
  Costs
incurred to date for the development of the Company’s products have been charged
to expense as incurred. Future costs may be capitalized to the extent they meet
the requirements of SFAS No. 86 “Accounting for the Costs of Computer Software
to be Sold, Leased, or Otherwise Marketed.”
  
 F-8
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Basic
and Diluted Earnings Per Common Share**
  Basic
earnings per share are computed by dividing net income by the number of weighted
average common shares outstanding during the year. Diluted earnings per share is
computed by dividing net income by the number of weighted average common shares
outstanding during the year, including potential common shares, which consisted
of warrants, options and convertible debt.
  **Stock-Based
Compensation**
  During
the year ended December 31, 2004, the Company has issued options to employees to
purchase 3,387,500 shares of common stock at an exercise prices ranging from
$.04 to $0.11. Of the 3,387,500 options issued during 2004, 1,127,500 were
vested at the date of grant with the remainder vesting in 2005 through
2007.
  The
Company accounts for stock-based compensation in accordance with Accounting
Principles Board Opinion (“APB”) No. 25 and has adopted the disclosure-only
provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.”
Accordingly, no compensation cost has been recognized for awards under the stock
option plan as the exercise prices equaled or exceeded their fair value of the
underlying stock as determined by the Board of Directors. Had compensation cost
for the Company’s options issued to employees been determined based on the fair
value at the grant date for awards consistent with the provisions of SFAS No.
123, as amended by SFAS No. 148, the Company’s net loss would have been changed
to the pro forma amount indicated below at December 31, 2004:
  Net
      loss - as reported
    
    $
    (2,169,238
    )Deduct
      recorded employee compensation expense
    
    
    --Add
      fair value of employee compensation expense
    
    
    (86,899
    )Net
      loss - pro forma
    
    $
    (2,256,137
    )Net
      loss per share-pro forma
    
    $
    (0.03
    )
 
 The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used at December 31, 2004:
  Approximate
      risk free rate
    
    
    4.25
    %Average
      expected life
    
    
    5
      yearsDividend
      yield
    
    
    0
    %Weighted
      Average Volatility
    
    
    85.28
    %Estimated
      fair value of total options granted
    
    $
    230,575
 
 
 
  F-9
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 During
February 2004, the Company granted warrants to purchase 250,000 shares of common
stock to a consulting firm. The warrants are exercisable at $.12 per share for a
period of five years, and were fully vested on May 31, 2004. The warrants have
been valued at $20,148 using the Black Scholes option pricing model with the
following weighted-average assumptions used at December 31, 2004:
  Approximate
      risk free rate
    
    
    4.25
    %Average
      expected life
    
    
    5
      yearsDividend
      yield
    
    
    0
    %Volatility
    
    
    80.85
    %Estimated
      fair value of total options granted
    
    $
    20,148
 
 The value
of the warrants has been included in general and administrative expenses as of
December 31, 2004.
  
 
 
  F-10
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
1 - Description of Business and Summary of Significant Accounting
Policies (continued)**
  **Recently
Issued Accounting Pronouncements**
  In April
2002, the FASB issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44 and
64, Amendment of FASB Statement No. 13, and Technical Corrections.” This
statement provides guidance on the classification of gains and losses from the
extinguishment of debt and on the accounting for certain specified lease
transactions. The Company adopted SFAS No. 145 January 1, 2003. Adoption of SFAS
No. 145 did not have a material impact on the Company.
  In June
2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with
Exit or Disposal Activities,” (effective January 1, 2003) which
replaces Emerging Issues Task Force (EITF) Issue No. 94-3
“Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring).”
SFAS No. 146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred and states
that an entity’s commitment to an exit plan, by itself, does not create a
present obligation that meets the definition of a liability. SFAS No. 146
also establishes that fair value is the objective for initial measurement of the
liability. The Company adopted this statement on January 1, 2003; adoption did
not have an effect on results of operations and financial position.
  In
October 2002, the FASB issued SFAS No. 147 “Acquisitions of Certain Financial
Institutions.” SFAS No. 147 amends FASB Statements No. 72 and 144 and FASB
Interpretations No. 9. Adoption of SFAS No. 147 did not have a material impact
on the Company.
  In
November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others (the
Interpretation), which addresses the disclosure to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees.
The Interpretation also requires the recognition of a liability by a guarantor
at the inception of certain guarantees. The Interpretation requires the
guarantor to recognize a liability for the non-contingent component of the
guarantee, this is the obligation to stand ready to perform in the event that
specified triggering events or conditions occur. The initial measurement of this
liability is the fair value of the guarantee at inception. The recognition of
the liability is required even if it is not probable that payments will be
required under the guarantee or if the guarantee was issued with a premium
payment or as part of a transaction with multiple elements. The Company adopted
the disclosure provisions of the Interpretation beginning with its fiscal 2003
consolidated financial statements, and will apply the recognition and
measurement provisions for all guarantees entered into or modified after
December 31, 2002. However, the Company is not a guarantor of indebtedness of
others.
    F-11
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 In
December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based
Compensation — Transition and Disclosure.” This statement amends FASB Statement
No. 123 “Accounting for Stock-Based Compensation,” to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. This statement also amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The provisions of this statement relating to alternative transition
methods and annual disclosure requirements are effective for the year ended
December 31, 2002. The transitional provisions did not have an impact on the
Company’s financial statements as it has elected to retain the intrinsic value
method. The provisions relating to annual and interim disclosures have changed
the manner in which the Company discloses information regarding stock-based
compensation.
  In
January 2003, the Financial Accounting Standards Board issued Interpretation No.
46, “Consolidation of Variable Interest Entities” (FIN No. 46)”. This
interpretation clarifies existing accounting principles related to the
preparation of consolidated financial statements when the equity investors in an
entity do not have the characteristics of a controlling financial interest or
when the equity at risk is not sufficient for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN No. 46 requires a company to evaluate all existing arrangements to identify
situations where a company has a “variable interest” (commonly evidenced by
a guarantee arrangement or other commitment to provide financial support) in a
“variable interest entity” (commonly a thinly capitalized entity) and
further determine when such variable interests require a company to consolidate
the variable interest entities’ financial statement with its own. The Company is
required to perform this assessment by December 31, 2003 and consolidate any
variable interest entities for which it will absorb a majority of the entities’
expected losses or receive a majority of the expected residual gains. Management
has not yet performed this assessment, however it does not have any variable
interest entities as of December 31, 2004.
  In April
2003, FASB issued SFAS No. 149, “Accounting for Derivative Instruments and
Hedging Activities,” which is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. This statement amends and clarifies financial accounting and reporting for
derivative instruments including certain instruments embedded in other contracts
and for hedging activities under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” The Company has not entered into any
transactions of this type.
  In May
2003, FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity,” which 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
September 15, 2003. SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. The adoption of this standard is not expected to
have a material impact on the Company’s financial statements.
  
 F-12
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 In
December 2004, the FASB issued SFAS No. 123 (revised), *Share-Based
Payment,* which
supersedes Accounting Principles Board (“APB”) No. 25, *Accounting
for Stock Issued to Employees,* and its
related implementation guidance. Under SFAS No. 123 (revised), all
share-based payments would be treated as other forms of compensation by
recognizing the costs, generally measured as the fair value at the date of
grant, in the income statement. The Company will adopt, as required, SFAS No.
123 (revised) for its fiscal year beginning January 1, 2006. Management
expects that the impact of the adoption of SFAS No. 123 (revised) will be
that the share-based payment expense amounts historically disclosed as required
by SFAS No. 123 will now be recognized as an expense on the statement of
operations.
  
 
 
  F-13
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
2 - Going Concern**
  The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and liquidation of liabilities in
the ordinary course of business. The Company has experienced losses since
inception (July 30, 1993) through December 31, 2004 of $7,449,527. The
Company has working capital of $258,381 and stockholder’s deficit of $419,893 as
of December 31, 2004 and used cash of $2,139,381 in its 2004
operations.
  The
extended period over which losses have been experienced is principally
attributable to two factors, lack of capital and the type of potential
customers. Lack of capital has prevented the Company from quickly developing and
aggressively marketing its products. In addition, most of the Company’s
potential customers are large corporations or governments. Adopting the
Company’s products will in many cases require changing the way business is
done.
  The
Company has made advances in the sales process with several potentially large
customers. Although there are no assurances that the Company will be successful,
in order to fund activities until positive operating cash flow can be achieved,
the Company has implemented the plan described below.
  During
the first quarter of 2003, the Company signed an agreement to merge with a small
public company (Note 3). The transaction was a reverse acquisition with the
Company as the accounting acquirer. The Company became a wholly owned subsidiary
of the public company, the Company’s shareholders became the majority
shareholders of the public company, and the public company will changed its name
to “BSI2000, Inc.”
  On
October 31, 2003, the Company entered into an Equity Line of Credit Agreement
with Cornell Capital Partners, LP (Cornell). Under this agreement, the
Company may issue and sell to Cornell common stock for a total purchase price of
up to $15 million (Note 5).
  On
October 8, 2004 through January 20, 2005 the company issued a $1,250,000
convertible debenture to Cornell Capital Partners, LP. (See note
5).
  The
Company expects that the capital raised in the transactions described above will
be sufficient to fund the Company’s activities until positive operating cash
flow is achieved
  
  F-14
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
3 - Reverse Acquisition**
  On March
31, 2003 the reverse triangular merger between the Company and Knowledge
Foundation, Inc. closed. As a result of the closing BSI2000, Inc. became a 100%
owned subsidiary of Knowledge Foundations, Inc. Also as result of the closing
Knowledge Foundations, Inc.’s name changed to BSI2000, Inc. (“new BSI”) and
BSI2000, Inc.’s name changed to BSI Operating, Inc. (“old
BSI”).
  Immediately
prior to the closing all of Knowledge Foundation, Inc.’s assets and all but
$56,825 of its liabilities (see below) were spun-off to certain of its
shareholders in exchange for 34,105,900 shares of common stock, which were then
canceled. After the spin-off 5,027,818 shares of Knowledge Foundations, Inc.
common stock (“new BSI stock”) remained outstanding.
  
 
 
  F-15
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
3 - Reverse Acquisition (continued)**
  Knowledge
Foundations, Inc. (“new BSI”) acquired BSI2000, Inc. (“old BSI”) by
issuing 45,122,570 of its common shares (“new BSI stock”) to stockholders
of BSI2000, Inc. (“old BSI”) in exchange for 100% of the outstanding
8,786,900 common shares of BSI2000, Inc. (“old BSI stock”).
  For
financial reporting purposes the transaction has been accounted for as a
re-capitalization of the Company. Accordingly the net increase in the
outstanding shares of 41,363,488 resulting from the above transactions has been
reflected in the financial statements as shares issued in connection with the
re-capitalization of the Company. In recording the re-capitalization transaction
$4,121,307 has been reclassified from common stock to additional paid in
capital.
  As a
result of the accounting method adopted to record the merger, for financial
reporting purposes the historical financial statements of the Company, and only
the historical financial statements of the Company, have become the historical
financial statements of the continuing entity. Historical financial statements
of Knowledge Foundation, Inc. are not presented.
  The terms
of the merger agreement between the Company and Knowledge Foundations, Inc.
provided that the liabilities of Knowledge Foundation, Inc. at the closing would
not exceed $15,000. However, at the closing Knowledge Foundations, Inc. had a
note payable and accrued interest outstanding in the amount of $56,825. In order
to off set this liability certain shareholders of Knowledge Foundations Inc.
executed a note payable to the Company in the amount of $56,825. The Knowledge
Foundation, Inc. note and accrued interest have been recorded as a reduction of
additional paid in capital. The note receivable from the Knowledge Foundation,
Inc. stockholders has been recorded as an increase to additional paid in
capital.
  **Note
4 - Furniture and Fixtures**
  Property
and equipment consist of the following at December 31, 2004:
  Leasehold
      improvements
    
    $
    18,744Software
    
    
    7,919Equipment
    
    
    103,091Furniture
    
    
    36,588166,342Less
      accumulated depreciation
    
    
    (122,217
    )$
    44,125
 
 
  F-16
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
5 - Convertible Debt**
  On
October 31, 2003, the Company entered into an Equity Line of Credit Agreement
with Cornell. Under this agreement, the Company may issue and sell to Cornell
common stock for a total purchase price of up to $15.0 million. Subject to
certain conditions, the Company is entitled to commence drawing down on the
Equity Line of Credit effective on December 9, 2003, the effective date of the
registration statement filed with The Securities and Exchange commission, and
will continue for two years thereafter. The purchase price for the shares will
be equal to 99% of, or a 1% discount to, the market price, which is defined as
the lowest closing bid price of the common stock during the five trading days
following the notice date. The amount of each advance is subject to an aggregate
maximum advance amount of $210,000, with no advance occurring within seven
trading days of a prior advance. Cornell received 1,875,000 shares of the
Company’s common stock as a one-time commitment fee and is entitled to retain a
fee of 4.0% of each advance. In addition, the Company entered into a placement
agent agreement with Newbridge Securities Corporation, a registered
broker-dealer. Pursuant to the placement agent agreement, the Company paid a
one-time placement agent fee of 35,714 shares of common stock equal to
approximately $10,000 based on the Company’s stock price on July 7, 2003, the
date the Company agreed to engage the placement agent.
  On
October 7, 2004, the Company issued a 5% convertible debenture in the amount of
$500,000 to Cornell Capital Partners, LP (“Cornell”) that is due October 7,
2007. On December 10, 2004, the Company issued a 5% convertible debenture in the
amount of $500,000 to Cornell Capital Partners, LP (“Cornell”) that is due
December 10, 2007. On January 19, 2005, the Company issued a 5% convertible
debenture in the amount of $250,000 to Cornell Capital Partners,
LP (“Cornell”) that is due January 19, 2008. The debentures are convertible
into the Company’s common stock at either the fixed price of 120% of the Volume
Weighted Average price on the closing date (October 7, 2007, December 10,
2007 and January 20, 2008, respectively) or 80% of the average of the
three (3) lowest daily Volume Weighted Average Price, as reported by
Bloomberg, L.P., of the Company’s common stock for the five (5) trading
days immediately preceding the conversion date (date on which the Company
receives a notice of conversion from Cornell). The debentures will automatically
convert into the Company’s common stock on the third anniversary of issuance.
The Company has the right to redeem the debentures with three (3) days
advance notice any or all of the outstanding debenture amount at its sole
discretion.
  The
redemption price shall be 120% of the face amount redeem plus accrued interest.
Once the redemption notice has been given, Cornell may continue to convert the
remaining outstanding debenture.
  The
Company received $500,000 on October 7, 2004, less a 10% fee of $50,000 and
$10,000 for legal costs. The Company received $500,000 (net of 10% fee) on
December 10, 2004 and $250,000 (net of 10% fee) on January 20,
2005.
  
 F-17
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
5 - Convertible Debt (continued)**
  In the
event that the Company exercises it right of redemption as described above for
either all or a portion of the outstanding debenture, Cornell shall receive for
every $100,000 invested a warrant to purchase 50,000 shares of the Company’s
common stock. The warrant will have “piggy-back” registration rights and will
survive for two years from closing. The exercise price of the warrant shall be
120% of the volume weighted average price on the closing date.
  Convertible
notes payable consist of the following at December 31, 2004:
  Secured
      promissory note issued to Cornell, due on March 11, 2005 and secured by
      substantially all of Company’s non-cash assets. The note bears interest at
      12% during its term, and bears a default rate of interest of 24% if the
      note is not paid when due. Discounts and fees paid to obtain the loan were
      $37,500, of which $29,167 is unamortized at December 31, 2004. Subsequent
      to December 31, 2004 and through March 11, 2005, Cornell converted
      $300,000 of the debt into 8,381,359 shares of common stock of the
      Company.
    
    $
    500,000
 
 
 
  F-18
  
 **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
5 - Convertible Debt (continued)**
  Convertible
      secured promissory note issued to Cornell, bearing interest at 5% and due
      on October 7, 2007. The debenture is convertible at Cornell’s option at
      any time up to maturity at a conversion price equal to the lower
      of (i) 120% of the closing bid price of the common stock as of the
      closing date or (ii) 80% of the lowest closing bid price of the
      common stock for the five trading days immediately preceding the
      conversion date. At maturity, the Company has the option to either pay the
      holder the outstanding principal balance and accrued interest or to
      convert the debentures into shares of common stock at a conversion price
      previously described. The Company has the right to redeem the debentures
      upon thirty days notice for 120% of the amount redeemed. Discounts and
      fees paid to obtain the loan were $60,000, of which $55,000 is unamortized
      at December 31, 2004. Subsequent to December 31, 2004, Cornell converted
      $0 of the debt into 0 shares of common stock of the
    Company.
    
    
    500,000Convertible
      secured promissory note issued to Cornell, bearing interest at 5% and due
      on December 10, 2007. The debenture is convertible at Cornell’s option at
      any time up to maturity at a conversion price equal to the lower
      of (i) 120% of the closing bid price of the common stock as of the
      closing date or (ii) 80% of the lowest closing bid price of the
      common stock for the five trading days immediately preceding the
      conversion date. At maturity, the Company has the option to either pay the
      holder the outstanding principal balance and accrued interest or to
      convert the debentures into shares of common stock at a conversion price
      previously described. The Company has the right to redeem the debentures
      upon thirty days notice for 120% of the amount redeemed. Discounts and
      fees paid to obtain the loan were $50,000, of which $48,611 is unamortized
      at December 31, 2004. Subsequent to December 31, 2004, Cornell converted
      $0 of the debt into 0 shares of common stock of the
    Company.
    
    
    500,000Fees
      and discounts
    
    
    (132,778
    )1,367,222Less
      current portion
    
    
    (470,833
    )$
    896,389
 
 
 
  F-19
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
6 - Commitments and Contingencies**
  **Litigation**
  In the
normal course of business, the Company is party to litigation from time to time.
The Company maintains insurance to cover certain actions and believes that
resolution of such litigation will not have a material adverse effect on the
Company.
  
 
 
  F-20
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
6 - Commitments and Contingencies (continued)**
  **Consulting
Agreement**
  In
September 2003, the Company entered into a consulting agreement for a term of
six months. Under the term of the agreement, the Company paid a monthly fee of
$3,500 for services performed. As of December 31, 2004, this agreement had been
terminated.
  In
February 2004, the Company entered into a consulting agreement through July 31,
2004. The Company is obligated to pay $7,000 per month plus expenses for
services performed. The Company granted five-year warrants to purchase 250,000
shares of the Company’s common stock at the closing price on February 1, 2004.
Since August 1, 2004, this agreement has continued on a month to month
basis.
  **Note
7 - Stockholders’ Equity**
  **Stock
Issued to Founders**
  During
the period from Inception (July 30, 1993) through December 31, 1993, the
Company issued shares of common stock to the founders for prior services at
$4.34 per share, which was the value consistent with the cash sales of stock
immediately preceding the issuance.
  **Stock
Issued to an Officer and Employee**
  On
September 11, 2001, BSI issued 2,500,000 shares of common stock to Jack Harper,
president and director, for $2,500 ($0.001 per share) and forgiveness of
accrued wages. Also in 2001, BSI issued 212,045 shares of common stock to Robert
B. Lumen for $212 ($0.001 per share). When these shares were issued, BSI
was insolvent with negative working capital, and unable to pay salaries to
employees.
  **Private
Offerings**
  On
September 13, 2004, the Company issued 990,099 shares of common stock under the
Equity Line of Credit Agreement to Cornell Capital for $50,000 cash. Costs
associated with this transaction were $2,500.
  During
2003, the Company sold 134,500 and 1,000,000 shares of common stock in private
placement offerings at $1.00 and $.25 per share, respectively
  During
2002, the Company sold 937,886 and 515,869 shares of common stock in private
placement offerings at $1.00 and $.625 per share, respectively. The shares
issued under the private placement for $1.00 per share include 371,104 shares
issued in satisfaction of long-term debt.
  
 
 
  F-21
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
7 - Stockholders’ Equity (continued)**
  **Stock
Options**
  During
the period ended December 31, 2004, the Company has issued options to employees
to purchase 4,310,000 shares of common stock at an exercise prices ranging from
$.04 to $0.11. Of the 4,310,000 options issued during 2004, 1,142,500 were
vested at the date of grant with the remainder vesting in 2005 through 2007.
  The
following table presents the activity for options outstanding:
  WeightedIncentive
    
    AverageStock
    
    ExerciseOptions
    
    PriceOutstanding
      - December 31, 2003
    
    
    --
    
    $
    --Granted
    
    
    4,310,000
    
    
    .104Forfeited/canceled
    
    
    (1,212,500
    )
    
    (.110
    )Exercised
    
    
    --
    
    
    --Outstanding
      - December 31, 2004
    
    
    3,097,500
    
    $
    .101
 
 The
Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (as
amended by SFAS No. 148 “Accounting for Stock Based Compensation - Transition
and Disclosure”). Accordingly, no compensation cost has been recognized for the
stock option plans. Had compensation cost for the Company’s option plan been
determined based on the fair value at the grant date for awards consistent with
the provisions of SFAS No. 123, the Corporation’s net loss and basic loss per
common share would have been changed to the pro forma amounts indicated
below:
  For
      the Years Ended
    
    Inception (July 30,
      1993) throughDecember
      31,
    
    December
      31,2004
    
    2003
    
    2004Net
      loss - as reported
    
    $
    (2,169,238
    )
    $
    (1,568,978
    )
    $
    (7,449,527
    )Net
      loss - pro forma
    
    $
    (2,256,137
    )
    $
    (1,568,978
    )
    $
    (7,536,426
    )Basic
      loss per common share - as reported
    
    $
    (0.03
    )
    $
    (0.04
    )
    $
    (0.56
    )Basic
      loss per common share - pro forma
    
    $
    (0.03
    )
    $
    (0.04
    )
    $
    (0.56
    )
 
  F-22
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
7 - Stockholders’ Equity (continued)**
  **Stock
Options (continued)**
  The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used: expected life of 5 years, 85.28% weighted average volatility,
risk free rate interest rate of 4.25% and a 0% dividend yield.
  **Warrants**
  During
February 2004, the Company granted warrants to purchase 250,000 shares of common
stock to a consulting firm. The warrants are exercisable at $.12 per share for a
period of five years, and were fully vested on May 31, 2004. The warrants have
been valued at $20,148 using the Black Scholes option pricing model with the
following weighted-average assumptions used at December 31, 2004:
  Approximate
      risk free rate
    
    
    4.25
    %Average
      expected life
    
    
    5
      yearsDividend
      yield
    
    
    0
    %Volatility
    
    
    80.85
    %Estimated
      fair value of total options granted
    
    $
    20,148
 
 The
Company issued warrants to purchase 2,250,000 shares common stock to a
consulting firms that are exercisable at $.061 per share for a period of five
years. These warrants vest according to specific performance criteria that were
not met as of December 31, 2004. Accordingly, no expense has been recorded in
these financial statements with respect to these warrants.
  The
following table presents the activity for warrants outstanding:
  WeightedAverageNumber
      of
    
    ExerciseWarrants
    
    PriceOutstanding
      - December 31, 2003
    
    
    --
    
    $
    --Issued
    
    
    2,500,000
    
    
    .067Outstanding
      - December 31, 2004
    
    
    2,500,000
    
    $
    .067
 
 During
September 2004, the Board of Directors approved an amendment of the articles of
incorporation to increase the authorized number of common shares from
100,000,000 to 200,000,000.
  
  F-23
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
7 - Stockholders’ Equity (continued)**
  **Earnings
Per Share**
  The
following table sets forth the computation for basic and diluted earnings per
share:
  Inception
      (July
      30, 1993)
      throughDecember
      31,
    
    December
      31,
    
    December
      31,2004
    
    2003
    
    2004Numerator
      for basic earnings per share
    
    $
    (2,150,895
    )
    $
    (1,568,978
    )
    $
    (7,431,184
    )Numerator
      for diluted income per common share
    
    $
    (2,150,895
    )
    $
    (1,568,978
    )
    $
    (7,431,184
    )Denominator
      for basic earnings per share - weighted average shares
    
    
    72,506,696
    
    
    41,412,101
    
    
    13,384,466Denominator
      for diluted earnings per share - adjusted weighted average
      shares
    
    
    72,506,696
    
    
    41,412,101
    
    
    13,384,466Diluted
      income per common share
    
    $
    (0.03
    )
    $
    (0.04
    )
    $
    (0.56
    )
 
 **Note
8 - Income Taxes**
  The
Company did not provide a current or deferred federal or state income tax
provision or benefit for any of the periods presented because it has experienced
recurring operating losses. The Company has provided a full valuation allowance
on the deferred tax asset, consisting primarily of the net operating loss,
because of uncertainty regarding its realization.
  
 
 
  F-24
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
8 - Income Taxes (continued)**
  At
December 31, 2004, the Company had federal net operating losses of approximately
$6.3 million. Utilization of the net operating loss, which expires at various
times starting in 2009, may be subject to certain limitations under Section 382
of the Internal Revenue Code of 1986, as amended, and other limitations under
state tax laws.
  Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company’s deferred tax assets are approximately as follows:
  For
      the Years EndedDecember
      31,2004
    
    2003Net
      operating loss
    
    $
    2,205,000
    
    $
    1,439,000Total
      deferred tax assets
    
    
    2,205,000
    
    
    1,439,000Valuation
      allowance
    
    
    (2,205,000
    )
    
    (1,439,000
    )Net
      deferred tax asset
    
    $
    --
    
    $
    --
 
 The
following is a reconciliation of the statutory federal income tax rate applied
to pre-tax accounting net income compared to the income taxes in the statements
of income:
  For
      the Years Ended
    
    Inception
      (July
      30, 1993)
      throughDecember
      31,
    
    December
      31,2004
    
    2003
    
    2004Federal
      tax benefit at statutory rates
    
    $
    762,000
    
    $
    550,000
    
    $
    2,201,000State
      tax benefit at statutory rates
    
    
    72,000
    
    
    47,000
    
    
    195,000Valuation
      allowance
    
    
    (834,000
    )
    
    (597,000
    )
    
    (2,396,000
    )Reported
      income tax benefit
    
    $
    --
    
    $
    --
    
    $
    --
 
 
 
  F-25
  **BSI
2000, INC.**
 **(A
Development Stage Company)**
 **Notes
to Consolidated Financial Statements**
 
 **Note
9 - Subsequent Event (Unaudited)**
  Subsequent
to December 31, 2004, the Company issued one additional convertible debenture to
Cornell for $250,000 and converted outstanding debt of $300,000 into 8,381,359
shares of common stock of the Company.
  
 
 
 F-26