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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________
AMENDMENT NO. 1
to
FORM 10-K

____________

(Mark One)

|      |  |                                                                                  
|----- |  | ---------------------------------------------------------------------------------
|[X]   |  | ANNUAL REPORT
UNDER SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934    
|      |  |                                                                                  
|      |  | For the fiscal year ended December 31, 2001.                                     
|      |  |                                                                                  
|[   ] |  | TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________.

Commission File Number 000-26227

SSP SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)

|                                                                                   |  |                                                
|---------------------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization)            |  | 33-0757190
(I.R.S. Employer
Identification No.)
|                                                                                   |  |                                                
|17861 Cartwright Road, Irvine, California
(Address of principal executive offices) |  | 92614
(Zip code)                               

(Registrants telephone number, including area code): (949) 851-1085

Securities Registered Pursuant To Section 12(b) of The Act: None

Securities Registered Pursuant To Section 12(g) of The Act:

Common Stock
(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act or
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes [X]    No [  ]

Indicate by check mark if disclosure of delinquent filers in response to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [  ]




The aggregate market value of the registrants voting stock held by
nonaffiliates was approximately $9,750,000 on April 26, 2002, based upon the
closing sale price of such stock on April 26, 2002.




Number of shares outstanding of each of the registrants classes of common
stock, as of the latest practicable date:




As of April 26, 2002: Common Stock: 20,664,832 Shares




DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference, and
the part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated: (1) any annual report to security holders; (2) any proxy or
information statement; and (3) any prospectus filed pursuant to Rule 424(b) or
(c) of the Securities Act of 1933: None.





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PORTIONS AMENDED




The registrant hereby amends the cover page of its Form 10-K for the
fiscal year ended December 31, 2001 to replace the paragraph on the cover page
titled Documents Incorporated by Reference, amends Items 10 through 13 of
Part III of the Form 10-K to set forth the information that the registrant
intended to incorporate by reference from the registrants definitive proxy
statement relating to the registrants 2002 annual meeting of
shareholders,
and makes various other changes throughout the body of the Form 10-K.
No material changes are being made to the registrant's consolidated financial
statements and financial statement schedule.






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TABLE OF CONTENTS



|           |                                                                                               |  |  |  |  |  |  | 
|---------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I    
|           | Item 1. Business                                                                             
|           | Item 2. Properties                                                                           
|           | Item 3. Legal Proceedings                                                                    
|           | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II   
|           | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|           | Item 6. Selected Financial Data                                                              
|           | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|           | Item 7a. Quantitative and Qualitative Disclosures about Market Risk                          
|           | Item 8. Financial Statements and Supplementary Data                                          
|           | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|PART III  
|           | Item 10. Directors and Executive Officers of the Registrant                                  
|           | Item 11. Executive Compensation                                                              
|           | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|           | Item 13. Certain Relationships and Related Transactions                                      
|           | Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K                    
|SIGNATURES



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PART I







Item 1. Business

Introduction

For purposes of this Annual Report on Form 10-K, references to we, us,
our, SSP and the Company shall mean or refer to SSP Solutions, Inc. In
addition, unless the text indicates otherwise, the term SSP refers to SSP
Solutions, Inc. and its subsidiaries.

This Annual Report on Form 10-K contains certain statements which are not
historical in nature, and are intended to be, and are hereby identified as,
forward-looking statements for purposes of the safe harbor provided by
Section 21E of the Securities Exchange Act of 1934, as amended. Such
forward-looking statements are principally contained in the sections entitled
Business and Managements Discussion and Analysis of Financial Condition and
Results of Operations and include, without limitation, statements relating to
(i) anticipated trends in our financial condition and results of operations
(including expected changes in our gross margin and general, administrative and
selling expenses); (ii) our ability to finance our working capital
requirements; (iii) our business strategy for expanding our presence in the
Internet data security market; and (iv) our ability to distinguish ourselves
from our current and future competitors. These forward-looking statements are
based largely on our current expectations and are subject to a number of risks
and uncertainties. Actual results could differ materially from these
forward-looking statements. Important factors to consider in evaluating such
forward-looking statements include (i) the shortage of reliable market data
regarding the Internet data security market; (ii) changes in external
competitive market factors or in our internal budgeting process which might
impact trends in our results of operations; (iii) unanticipated working capital
or other cash requirements; (iv) changes in our business strategy or an
inability to execute our strategy due to unanticipated changes in the proposed
management and contract support services markets; and (v) various other factors
that may prevent us from competing successfully in the marketplace. In light of
these risks and uncertainties, many of which are described elsewhere in this
document, there can be no assurance that the actual results will not differ
materially from such forward-looking statements contained herein.




When used in this report, the words anticipate, believe, intends,
estimate, plan and expect and similar expressions as they relate to us or
our management are intended to identify such forward-looking statements. We
caution readers that forward-looking statements, including without limitation,
those relating to our future business prospects, revenues, working capital,
liquidity and income, are subject to certain risks and uncertainties that could
cause actual results to differ materially from those indicated in the
forward-looking statements, due to several important facts herein identified,
among others, and other risks and factors identified from time to time in our
reports with the Securities and Exchange Commission (the
Commission.).




Overview

We develop and distribute electronic security solutions and services for
accessing, protecting and distributing digital content via the Internet and
Internet protocol or IP-based networks. We have a 30-year history of
leading-edge technology and data security solutions for government
communications. SSP, which stands for Secure Service Provider, also provides
real-time solutions for electronic commerce and communications. SSP products
embed security and trust throughout the transaction chain, protecting
electronic communications and financial transactions as well as physical and
electronic access. By combining our own technology with a range of partners
technologies and intellectual properties, our products represent an embedded
security architecture simultaneously supporting public key infrastructure
(PKI) and other enterprise security solutions. Our products and services
address the data security issues faced by government, financial services, and
entertainment customers.

We have developed and distribute SSP software, hardware, and embedded
security products. These stand-alone security products include: Internet
application software, cryptographic library software, certificate issuance and
lifecycle management software, PC and smart card readers, and the family of SSP
Universal Secure Access (USA) Smart Cards. In combination with a unique card
reader that includes biometric capability the USA Smart Card can offer
three-factor authentication. A three factor authentication consists of
verifying: (i) who you are (a biometric, such as a thumbprint);
(ii) something
you have (the smart card); (iii) something you know (a pin number). An
authentication occurs when all three items are present simultaneously.

We are developing the SSP Solution Suite, which provides security from
the Core to the Edge of the Internet, across any digital platform. By offering
the SSP Solution Suite with additional stand-alone products and services, we
will provide what we believe to be the highest level of security products and
services commercially available. We have licensed the rights to use a broad
array of technology components and have combined these technology components
with our own proprietary security products. We are uniquely positioned to
deliver a complete range of highly customizable data security solutions across
a broad range of industries and

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agencies. Our business model anticipates revenue from product sales,
software integration, third party integration consulting services and recurring
revenue streams based upon transaction fees or participations. Recurring
revenue is also anticipated from strategic alliances with third party
integration consulting services for the delivery and joint marketing of the SSP
Solution Suite to end users in the data security market.

We have partnered with Electronic Data Systems, (EDS), to provide our
security products and services to secure electronic commerce and communications
over the Internet and other IP based communications networks. EDS is a leading
global services company serving more than 9,000 accounts in 55 countries. After
testing, we understand that EDS has committed resources and capital to promote
our SSP Solution Suite to new and existing customers requiring upgraded
information security for internet-based transactions and information
distribution in the financial, healthcare, education, and entertainment
industries as well as governmental agencies.

EDS has installed the SSP Solution Suite into its
testing/interoperability laboratory and has successfully tested the SSP Core
Technologies components. We plan to pursue additional strategic alliances with
other systems integrators for the delivery and joint marketing of the SSP
Solution Suite to end users in the data security market.

The Acquisition

On August 24, 2001, pursuant to an Agreement and Plan of Reorganization
dated July 3, 2001 with BIZ Interactive Zone, Inc., (BIZ), we completed an
acquisition whereby BIZ became our wholly-owned subsidiary (the Acquisition).
BIZ was a development stage enterprise devoting substantially all of its
efforts to develop and design security solutions for the financial, government,
healthcare, education, and entertainment industries. Simultaneously with the
Acquisition, we changed our name from Litronic Inc. to SSP Solutions, Inc. We
have combined the businesses of Litronic and BIZ into a single operating unit
under the new name. The combined company continues to focus on a complete range
of security solutions for government and commercial customers.

Our wholly-owned subsidiary, Pulsar Data Systems, Inc., (Pulsar),
operates independently as a network solutions company specializing in solutions
requiring the deployment of large-scale networks and secure PCs. Given
increased public awareness and the increasing demand for security in the
government sector, Pulsar can deliver commodity type products coupled with
security solutions to meet the requirements of its government customers.

Industry Background

Consumers, businesses and government agencies are increasingly relying on
the Internet and IP-based networks to conduct electronic commerce and
communications. The increasing proliferation of, and reliance on, shared
electronic data has caused data security to become a paramount concern of
businesses, government agencies, financial and educational institutions,
healthcare providers and consumers. Continued expansion of electronic commerce
and communication will require the implementation of improved security measures
that will irrefutably verify the identity of a party over the communication
channel and ensure that the confidentiality of the information being
transmitted is maintained. The SSP Solution Suite provides a comprehensive
solution for entities and consumers seeking to provide protection for their
transactions and proprietary data.

Todays client operating systems and IP-based networks often lack
fundamental, yet critical, security features such as data privacy and
integrity, identification, authentication, non-repudiation and auditing.

End-to-end data security concerns can be addressed by a variety of means.
Traditionally, enterprises relied heavily on passwords to restrict access to
proprietary information and materials. However, because of the risk of loss or
theft, more advanced protective measures have been developed to include
combinations of passwords and tokens with message encryption and biometric
devices. Regardless of the form of the data security device, the level of
security provided is evaluated based on a set of fundamental principles, which
include the following:



| |  |  | Identification and Authentication. Verifies the identity of the
authorized users to prevent unauthorized access to proprietary
information and resources.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Confidentiality. Involves the encryption of data transmissions so
only the intended recipient can access the information to ensure
privacy.              
|
| |  |  | Data Integrity. Ensures that data is not compromised or manipulated.                                                                                     

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| |  |  | Non-repudiation. Prevents the sender of data transmissions from
disclaiming or repudiating authorship so that the sender cannot deny the
occurrence of the transaction.                                                         
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Audit Control. Retraces information access and facilities use over a
particular time period at a system administration level so an enterprise
can monitor and record authorized and unauthorized user activity.                 
|
| |  |  | Secured System Administration. Maintains and controls corporate
intranets centrally through file encryption, password maintenance, audit
control, certificate and cryptographic key management and device
accessibility control.

The process of implementing Internet and IP-based network solutions
requires specialized skills lacking in most corporate information technology
departments. We provide the technology, products and services necessary for
most companies to implement or manage their data security infrastructure. We
believe that our products offer the highest level of commercially available
security for e-mail, file transport, file protection, remote access,
authentication and authorization in an open multi-platform standards-based
framework. The open architecture of our products makes them compatible with
virtually all commonly used network hardware and enables them to operate
independently of algorithms, platforms, applications and tokens. We believe
that, as the use of the Internet and Internet-based networks continues to grow,
there will be a significant increase in the demand for the data security
products that we offer.

Our Solution

SSP products and solutions are positioned to address the full range of
data security problems. The open architecture and platform independence of our
designs allow our products to operate with virtually any operating system
regardless of the choice of hardware, token (smart cards, PKI cards, PCMCIA
cards) or algorithm. In addition to providing a complete range of hardware and
software products for enterprise-wide data security, we also provide the
software that enables the enterprise to organize and manage its data security
system, from initialization to secure archive and recovery. We continuously
identify technologies that will enhance and improve our products. We expect to
add these technologies to the SSP product range and the SSP Solution Suite
periodically through internal development and licenses with third parties.

A key issue for companies opening their networks to partners, suppliers
and customers is the exposure and vulnerability to numerous security risks
including attacks from hackers and unauthorized access to trade secrets,
corporate confidential information and customer confidential information. As
more businesses, government agencies and financial institutions enable their
operations with Internet access, the need for end-to-end security solutions
becomes necessary. Both companies and customers must be confident and certain
that their online transactions are secure. We believe this need will fuel the
demand for our products and services to provide security for the distribution
of digital content, communications, and the protection of individual users
privacy.

Our data security offerings are illustrated by the following examples:

Case 1: PKI Products



| |  |  | Key Management Infrastructure or (KMI), is the U.S. Department of
Defenses (DoD) comprehensive communications program, designed to
provide a secure infrastructure for both physical and virtual
environments. KMI is designed to be deployed across a broad range of
applications, including financial transactions, e-commerce, healthcare,
personnel records, tactical operations, and command and control
functions. The DoD needs to secure its own internal electronic
communications activities, as well as across federal agencies, allies
and coalition forces, military and civilian personnel, and business
partners in the U.S. and abroad.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |   |  | KMI elements include system hardware and software architecture,
cryptographic tokens and cards, and the management elements of policies and
procedures for issuing and managing the cryptographic keys and cards. PKI
is a major constituent of the program.                                                                                                                                                                                                                                                                                                                                                                                                

Case 2: Integration Consultants



| |  |  | For a business supplier selling inventory to a customer, EDS will be
able to provide the supplier with the capability of verifying the
identity of the customer, authorizing the customer to place the order,
and (if applicable, according to the terms of the customers account),
receiving payment for goods shipped. The transaction will take place
through the Trust Assurance
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | Network (TAN), operated by EDS as the neutral party for registration of
EMBASSY (EMBedded Application Security System) devices. Registration of
EMBASSY devices with the TAN will establish the identities of the parties,
verify ability to pay prior to shipment, and process payments according to
the instruction of the supplier upon product delivery. SSP and EDS will
both earn commissions from the transaction processing and will have the
potential to earn revenue from applet development and content preparation
work.
| |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Case 3: Financial Services






| |  |  | Currently, on-line banking and trading is limited to simple consumer
activity. Large institutions rely on closed, legacy-based systems due to
the lack of security and user authentication. This security is vital for
conducting large real-time financial transactions. SSP has partnered
with ePayLatina, developers of the enhanced transactional secure
software (ETSS) software, to deploy smart cards and smart card readers
throughout the Dominican Republic and parts of Latin America. The
Company anticipates that this bundled package will allow consumers to
conduct ATM and debit transactions, as well as traditional credit card
transactions, over the Internet. The initial deployment agreement by
ePayLatina involves La Nacional de Envios, the leading public payment
system in the Dominican Republic, purchasing 1,500 secure card readers.
SSP will receive revenue from the product sale, as well as a
transactional revenue fee from each transaction that takes place. Our
solution will enable open platform recurring revenue streams and
seamless integration with both businesses and consumers. SSP smart card
readers can be used to facilitate all types of secure transactions,
including direct movement of funds (true electronic funds transfer), for
shopping, on-line payments, on-line trading, mortgage banking and
insurance. SSP will participate in the revenue sharing model and
receives a percentage of each transaction. Similar programs will be in
development for North America and Europe.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Our data security products are designed with an open architecture making
them compatible with virtually all commonly used network hardware and enabling
them to operate independently of algorithms, platforms, applications, or
tokens. Due to our open architecture design, users will be able to either
purchase a complete data security solution or integrate specific components
with their existing security systems and implement additional components as
their needs evolve. Our SSP Solution Suite will offer the highest level of
commercially available data security, a complete, end-to-end range of data
security products with what we believe is the highest level of commercially
available data security.

Business Strategy

Our objective is to become the leading provider of data security solutions
for the digital economy. Key elements of our strategy include:






| |  |  | Expand Our Targeted Customer Base.SSP has experienced a significant
level of governmental sales and has achieved technological credibility.
We intend to develop a strong sales and marketing force initially
targeting government requirements, enterprise secure access, on-line
gaming applications and financial institutions. We intend to build a
strong customer base for the SSP Solution Suite and our stand-alone
components in both the commercial and government sales markets.                                                                                                                                                                                                   
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Strengthen Strategic Relationship with EDS and Develop Relationships
with Other Systems Integrators.Systems integrators design, compile,
install, and manage electronic communication and electronic commerce
systems, using their own components and those of third parties. Our
products will enable systems integrators to create value added solutions
for their customers. We believe that strategic relationships with large
systems integrators represent our greatest opportunity to penetrate the
data security market and provide the security components for large
installations. We intend to aggressively pursue and develop similar
relationships with other systems integrators.
|
| |  |  | Promote Sales of Stand-Alone Components.SSPs open standards will
enable the various SSP products to be sold as components. For example,
by connecting a smart card reader through a USB port, a PC user can
incorporate a secure device for accessing records, paying for products,
or securing the transmission of information. We intend to leverage our
installed base of customers through EDS and other systems integrators
and our brand name recognition to expand the distribution of components
through value added resellers and hardware device manufacturers.                                                                                                                     
|
| |  |  | Establish a Brand Name. Establishing a strong brand name is essential
to attracting and expanding a broad and diverse customer base in both
the commercial and government markets. We intend to build our brand by
leveraging our relationships with well-known systems integrators such as
EDS and through joint marketing efforts with such strategic partners. We
will participate in major industry trade shows, and advertising in both
value-added reseller, VAR, channel-related trade                                                                                                                                                                                                  




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| |   |  | periodicals and end-user focused commercial periodicals. It is our goal to
establish a brand name that is equated with an assurance of security.                                                                                                                                                                                                                                                                                                                                                                            
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Continue to Enhance the SSP Solution Suite .The SSP Solution Suite
will provide end-users with a comprehensive solution for their data
security needs. We continuously seek to identify new components or
technologies to add to the SSP Solution Suite , including, for example,
biometric identification technologies. As we identify appropriate
technologies, we will add new products to the SSP Solution Suite .
These additions will be made either through internal development or
through third party licenses.

Sales and Marketing

SSP markets, sells and distributes both products and services via the
Internet, our direct sales force and indirect sales channels. Our channels
include systems integrators, VARs, original equipment manufacturers, strategic
alliances and international distributors. We intend to devote significant
resources to marketing efforts and business development activities designed to
build our brand name and expand our business distribution channels.

Direct Marketing




As of April 26, 2002, we employed a direct sales, business development and
marketing force of 13 full-time individuals to market our data security
products and services. Our target audiences include: financial, healthcare,
education and entertainment industries and federal, state, local, and foreign
government agencies. Our sales force is responsible for soliciting prospective
customers and providing technical advice and support with respect to our
products and services. Additionally, we use telemarketing efforts to target
commercial accounts and federal government agencies. It is our intention to
achieve greater penetration into markets by using direct sales personnel with
significant market expertise. We will also be employing consultants with
established relationships in the commercial marketplace.




Indirect Marketing

An important component of our sales strategy is the development of
indirect sales channels. These channels include systems integrators,
value-added network service providers, and original equipment manufacturers. We
believe that in addition to the efforts of our direct sales force, a
significant portion of the marketing and distribution of our products will be
attributable to our strategic relationships with third parties and their
established distribution channels. These third parties may provide us with
contacts to prospective customers to which we would not otherwise have access.
As part of our expansion strategy, we will seek to develop relationships with
additional third-party sales channels. We intend to capitalize on and
strengthen our existing relationship with EDS and to pursue additional
strategic alliances with other systems integrators in order to promote our
products and establish a strong brand name.

Advertising

Our advertising efforts include a website, print advertising, public
relations, events, sales tools, telemarketing and corporate marketing
materials. Our website describes our business, products, and services.

Our public relations efforts are designed to target the appropriate press
coverage and consist of press kits, targeted media lists and press releases.
These efforts are designed to complement our sales and marketing efforts.

Trade Shows and Presentations

We attend and exhibit our products and services at selected trade shows in
the U.S. and around the world. We intend to continue attending selected trade
shows and to join with strategic partners in presenting our products and
services to prospective customers.

Distribution

To reach our potential customer base, we are pursuing several distribution
channels, including a direct sales force and strategic relationships with
systems integrators, VARs and other third parties.

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Commercial Sales

We plan to distribute our products to the commercial market through our
direct sales force, through joint distribution arrangements with third parties,
such as EDS and other systems integrators, and through VARs.




Initially, we plan to focus on the distribution of our individual data
security components. By initiating sales relationships with the individual
components of the SSP Solutions Suite, we will be able to expand our sales
distribution to include the complete suite. We do not anticipate sales of our
SSP Solution Suite being delivered until 2003. The target markets for
distribution of our SSP Solution Suite products include the following:









| |  |  | financial services and banking                       
| | - |  | -----------------------------------------------------
|
| |  |  | government                                           
|
| |  |  | entertainment hospitality programs and on-line gaming




Government Sales

We distribute our data security products to the government through our
direct sales force and also through third party private contractors such as
General Dynamics.

The government information technology market is highly structured with
strict procurement rules and procedures. Government projects have large
contracts, a relatively long sales cycle, significant barriers to entry, and
low collection risks. SSP is currently on most government bid lists relevant to
our product offerings. Our products have received the highest level of
government certification. As a result, we have created a highly respected and
positive relationship with many government agencies.




The General Services Administration (GSA), the central procurement
agency for the U.S. government, negotiates schedule contracts. Government
agencies and other authorized purchasers, although not required to do so, may
purchase goods and professional services under GSA schedule contracts using
predetermined price ceilings, terms, and conditions. GSA schedule contracts are
awarded on the basis of a number of factors, the most important of which are
compliance with applicable government regulations and the prices of the
products to be sold. A blanket purchase agreement, or BPA, is a simplified, but
non-mandatory, fixed-price, indefinite delivery-indefinite quantity, contract
for the government to purchase products, at pre-negotiated terms and
conditions. Purchases made under BPAs are often paid using a government-issued
credit card. Federal government agencies are authorized to enter into BPAs with
GSA schedule holders. The GSA-authorized BPAs incorporate many terms and
conditions of GSA schedule contracts, often at lower prices than available on
the GSA schedules.




A significant amount of computer products and services purchased by the
federal government are made under contracts or purchase orders awarded through
formal competitive bids and negotiated procurements. Most bids are awarded
based on a number of factors that determine the best value to the government.
These factors are generally a combination of price, technical expertise, and
past performance on other government contracts. Major procurements can exceed
millions of dollars in total revenue for a reseller, span many years, and
provide a purchasing vehicle for many agencies. In addition, the federal
government purchases networking products through open-market procurements.
These procurements, separate and apart from GSA schedules, include simplified
acquisition procedures, requests for quotes, invitations for bids, and requests
for proposals. Most purchases in the state and local government market are made
through individual competitive procurements. State and local procurements
typically require formal responses and the posting of bid bonds or performance
bonds to ensure complete and proper service by a prospective bidder. Each state
maintains a separate code of procurement regulations. Entities selling products
to the state must understand and comply with these regulations.

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Customers

Our customers represent a wide range of commercial enterprises, including
financial, telecommunications, healthcare and information service companies, as
well as federal, state, local and foreign government agencies.

Our customer base includes:

|                                         |  |                                 
|---------------------------------------- |  | --------------------------------
|Bank of America, N.A                     |  | Lockheed Martin Corporation     
|Booz Allen & Hamilton Inc.               |  | National Institute of Health    
|Department of Budget and Fiscal Planning |  | National Security Agency        
|Defense Finance and Accounting Service   |  | U.S. Army Corps of Engineers    
|EDS                                      |  | U.S. Border Patrol              
|EEOC Financial Management Division       |  | U.S. Department of Justice      
|Federal Bureau of Investigation          |  | U.S. Patent and Trademark Office
|General Services Administration          |  | U.S. Department of State        
|Immigration and Naturalization Service   |  | U.S. Probation Office           
|Leads                                    |  | VeriSign                        

Customer Service and Support




As of April 26,
2002, our customer service and support staff consists of 58
persons, including 48 engineers and technical support personnel, and works
closely with customers and prospective customers to provide comprehensive
service and support for our products and systems.




Products and Services

Internet Data Security Products

Our Internet data security products provide what we believe is the highest
level of commercially available security for secure email, secure file
transport, file protection, remote access, authentication and authorization in
an open multi-platform standards-based framework. Our data security products
are designed with an open architecture so they can operate independently of
algorithms, platforms, applications and tokens.

Software



| |  |  | NetSign® CAC (Common Access Card).NetSign® CAC is a complete smart
card client package that provides network security and desktop
protection for users of the GSA Common Access Card (CAC). With a
NetSign® CAC-enabled system, users can be assured of strong
authentication, confidentiality and non-repudiation at speeds of up to
three times faster than competitors products. NetSign® CAC is a
complete smart card client package that provides network security and
desktop protection for users of the GSA CAC. With a NetSign® CAC-enabled
system, users can be assured of strong authentication, confidentiality
and non-repudiation at speeds substantially faster than competitors
products. NetSign® CAC allows users to digitally sign and encrypt e-mail
and access secure Web sites using via Microsoft and Netscape e-mail and
browser packages. Supported by Windows NT smart card logon, Windows 2000
certificate-based logon and workstation locking using CAC smart cards
issued by the DoD, NetSign® CAC offers a high level of desktop security.
We have collaborated with prime contractors to provide bids on these
programs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | NetSign and NetSign GT (Global Trust).These products are software
adapters that integrate smart cards and digital certificate technology
to enhance security in electronic commerce software systems. They are
used for e-mail, Internet access, file access, and web browsers like
Netscape Communicator and Microsoft Explorer. NetSign and NetSign GT
software products are bundled with a smart card reader/writer and with
smart cards. NetSign GT supports the Identrus bank security model and
Profile Manager GT.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  |  | Profile Manager and Profile Manager GT.Profile Manager is a complete
PKI lifecycle management solution. Profile Manager provides token-based
security systems management from initialization to secure archive and
recovery. For the recovery of token-based information, Profile Manager
provides an optional integration with a secured database of private keys
and other user identification information, and the use of third-party
certificate authorities. Profile Manager integrates with NetSign,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

9



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| |   |  | NetSign GT, and other token-enabled products to provide a complete solution
for a companys security requirements. Profile Manager includes secure
Internet access, digitally signed and encrypted e-mail, desktop file
encryption and secure remote network access. Profile Manager GT supports
the Identrus bank security model and NetSign GT.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Maestro Cryptographic Library.Maestro is a multi-protocol
cryptographic library that enables software developers to incorporate
secure token-based, symmetric-key and asymmetric-key cryptography into
their application software. Maestro is a multi/concurrent access,
cross-platform system that supports multiple types of tokens such as
smart cards, PCMCIA cards and cryptographic algorithms. Coupled with
token reader/writers, Maestro supports devices over commonly used
interfaces, including keyboard, serial, small computer system interface,
or SCSI, parallel port and universal serial bus. Maestro currently
supports two commonly used cryptographic interface protocols. We are
developing additional protocol adapters to expand the functionality of
Maestro. Maestro is compatible with Windows 95, 98, 2000 and NT
operating systems as well as all popular UNIX platforms.
|
| |  |  | EMBASSY Applet Development Kit.The EMBASSY Applet Development Kit,
or ADK, will enable a user to develop applications to use the resources
of the EMBASSY system. A content provider will use the ADK to write an
interface between the application and the EMBASSY device to enable
execution in a secure environment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  |  | Authentication Applet.The authentication applet will contain
instructions for access control, group membership and community support.
The applet will register the users EMBASSY device within the trust
assurance network, which is the neutral third party facilitator for
secure transactions and value exchanges.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

Tokens and Token Readers



| |  |  | SSP USA Smart Card Family.SSP has completed the development of next
generation PKI cards in cooperation with Atmel and the National Security
Agency. Forté, the newest member of the USA family, is a high-speed
32-bit SOC (System On a Chip) microprocessor that is designed with a
high-speed USB interface in addition to the International Standards
Organization (ISO) interface. The USA smart cards will have a larger
storage capacity and faster processing speed than existing smart cards.
Forté offers PCMCIA level performance at a price competitive with PKI
smart cards. We anticipate commercial shipments of the Forté smart card
to begin in 2002.                                                                                        
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Other Security Tokens.In addition to the USA family of smart cards,
we offer off-the-shelf ISO standard smart cards ranging from
storage-only cards to cards containing cryptographic capabilities.
Because our products are open-architecture, open-platform and
open-token, as well as algorithm and application program interface
(API) independent, they work with third-party tokens, such as PCMCIA
cards, smart cards, rings, proximity cards and plastic keys and other
commercially available tokens for use with our reader/writers and
application software.                                                                                                                                                                                       
|
| |  |  | SSP 210 Smart Card Reader.The SSP NetSignia 210 Smart Card Reader is
an ISO 7816 compliant device featuring direct communication between the
host computer and the smart card.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  |  | SSP 250 Biometric Smart Card Reader.The SSP 250 Biometric Smart Card
Reader integrates fingerprint biometrics to secure data transmissions,
protect communications and transaction, and proof of identity in
networked and physical environments. With its embedded fingerprint
verification system, the SSP 250 represents a significant advance in
digital security, bringing the same level of protection, authentication
and non-repudiation to virtual transactions. The SSP 250 also enables
strong levels of physical access and verification of identity, promising powerful security for employee verification, funds transfer,
encrypted communications and granting of physical and electronic access
to personal records, documents or transactions.
|
| |  |  | ARGUS 300.The ARGUS 300 consists of a tamper-resistant ISA or PCI
board and external reader/writer and is connected to the keyboard. The
ARGUS 300 incorporates DES (Data Encryption Standard) encryption
technologies and offers additional security features such as boot
protection, electronic commerce security and protected PIN path directly
through the board rather than through an external device that might be
tampered with by an unauthorized user. The ARGUS 300 is validated for
electronic signature by the National Institute of Standards and
Technology, the U.S. Treasury Department and General Accounting Office.                                                                                                                       
|
| |  |  | PCMCIA Client Reader/Writer.We offer a series of single and
dual-socket PCMCIA card reader/writers for both internal and external
application, that interface via various ports such as SCSI, ISA bus, PCI
bus, universal serial bus and parallel port.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

10



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| |   |  | These reader/writers incorporate our proprietary device drivers, which
provide the interface between the reader/writer and its application
software such as Maestro and third-party application software.                                                                                                                                                                                           
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Argus 2108.We offer a reader/writer that contains sockets for up to
eight PCMCIA cards, is used on the enterprises server side and
incorporates the device drivers and other technologies of our other
PCMCIA readers. The Argus 2108 interfaces with the host server to enable
the host server to provide rapid/simultaneous processing of
cryptographic functions received from numerous clients.

Hardware



| |  |  | G-Server.The G-Server is a transparent, dedicated server that
continuously monitors and verifies web content as it leaves a web
server. Content being sent out of a protected web server is compared to
the digital signatures of the content. When the signature is validated,
the content is sent on with a 2ms delay. If the signature does not
match, a cached copy of the content is sent to ensure that the user
receives only the intended content. The device also alerts
administrators if an intrusion is in process. We are a re-seller of this
product.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | EMBASSY Chip and Hardware Development Kit.EMBASSY is the basis of a
trusted client architecture. The EMBASSY chip provides the secure
execution environment from within which applets are executed. The chips
will be embedded into manufactured edge devices and attached to legacy
systems.                                                                                                                                                                                                                                                                      
|
| |  |  | SSP XBoard.SSP has developed a server accelerator, formerly called
the Cipherserver, designed to maximize the performance of secure web
servers by eliminating the processor bottlenecks incurred by SSL. The
XBoard off-loads the public key functions to on-board processors, frees
up CPU resources, and provides almost instant responses to the customer.                                                                                                                                                                                                     

Services






| |  |  | Trust Assurance Network.The TAN is a
secure hardened network of servers, application developers, and
certifying agents that authorize, validate, and authenticate EMBASSY
devices, applications and each other. Features include: EMBASSY device
registration and synchronization, applet publishing, certification,
installation, revocation, upgrades, inventory and personalization. The
TAN serves as the neutral third party for transactions between providers
and users.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | PKI Professional Services.Designed to complement in-house resources
and meet an organizations security requirements, our professional
services team develop solutions that address the lifecycle of a security
system from planning, installation and training through to deployment
and maintenance.                                                                                                                                                                         




Suppliers

Some of the components incorporated into our Internet data security
products are produced by third party vendors. We also integrate third-party
products and components into the networks we design and develop for our
customers. To maintain quality control and enhance working relationships, we
generally rely on multiple vendors for these products. However, in some cases,
products or services are procured from single sources.

Strategic Alliances

We plan to increase our vertical market penetration and enhance our
product line by continuing to develop strategic alliances with other companies
in the data security and network integration industries. We have developed
strategic alliances with companies in an effort to:






| |  |  | incorporate our components into third party products;                   
| | - |  | ------------------------------------------------------------------------
|
| |  |  | develop additional products and services;                               
|
| |  |  | increase research and development efforts;                              
|
| |  |  | generate more proposals and presentations for products and services; and




11



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| |  |  | license technology.
| | - |  | -------------------




We intend to pursue and develop strategic alliances with systems
integrators for the marketing, sale, and distribution of our products in the
data security market. We currently have a strategic relationship with EDS, one
of the leading systems integrators, to provide us with an installed base of
customers for our products.

Strategic alliances assist in expanding our marketing and technical
capabilities. They are intended to increase the distribution and market
acceptance of our data security products and the SSP Solution Suite .

Strategic alliances are expected to allow us to integrate third-party
products into our product offerings in a cost effective manner and provide our
clients with customized information technology solutions. Strategic alliances
also allow us to incorporate our products into third parties products and
accelerating the adoption of our products into the market. This enhances and
helps to establish the SSP brand name. Our strategic alliances currently
include the following:



| |  |  | EDS. We have a strategic alliance agreement with EDS to market and
sell the SSP Solution Suite                                                                                                                                                                                                                                                                                                            
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Netscape and Microsoft. We provide enhanced e-mail security features
to Netscape and Microsoft browser programs through integration of our
NetSign product lines                                                                                                                                                                                                                                           
|
| |  |  | VeriSign. We have a marketing agreement with VeriSign and act as
VeriSigns recommended PKI card partner                                                                                                                                                                                                                                                                                                   
|
| |  |  | Atmel and the National Security Agency. We have an alliance with
Atmel Corporation and the National Security Agency (NSA). Through this
alliance, we jointly developed Forté, an advanced 32-bit SOC
microprocessor, which will be embedded in our next generation PKI cards.
We signed a teaming agreement with Atmel Corporation to further exploit
the technologies incorporated in the Forté product.
|
| |  |  | RSA Data Security. We have a distribution license agreement with RSA
that allows us to incorporate RSA technology into our products.                                                                                                                                                                                                                                                                       
|
| |  |  | Broadcom. We have licensed master reference designs of certain
Broadcom security chips for inclusion in our products.                                                                                                                                                                                                                                                                                      
|
| |  |  | FingerPrint Cards AB. We have a memorandum of understanding to
jointly develop products to combine fingerprint biometrics and PKI
technology.                                                                                                                                                                                                                                                              

Research and Development

We conduct extensive research and development efforts focusing on the
development of cryptographic PKI software and hardware products. These products
can be readily integrated and adapted to meet the expanding requirements of the
Internet, intranets and extranets. We expect to devote substantial research and
development resources to enhance our data security product line.

Our current research and development efforts include:






| |  |  | enhancing the capabilities of Profile Manager to provide certificate
exchange capabilities with additional third-party certificate
authorities and increased capability for the PKI enterprise manager;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Profile Manager and KMI development  As a core technology provider
under the contract awarded to General Dynamics C4 Systems KMI Team for
the DoD, We will provide smart card and digital certificate management
software and engineering services to implement the secure KMI, a
significant element of the DoD long-term roadmap for an in-depth
information assurance strategy. We have a long history of developing PKI
technology and open, interoperable security products for the government
sector. This contract, known as KMI CI-1, encompasses the first
capability increment of the DoD KMI, and includes the development and
fielding of a system for providing high-assurance digital certificates
to DoD and other government agency users for critical online
identification and authentication in electronic commerce and data
exchange. SSP Profile Manager, a comprehensive smart card and digital
certificate issuance and lifecycle management application, will be used
to satisfy certificate and token management requirements, as the DoD
high-grade digital certificates have strict criteria for the
distribution and use of certificates, protection and recovery of keys,
and stringent auditing requirements.




12



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| |  |  | continuing development of Forté. With Forté being an advanced
security chip that will provide advanced security features, we expect to
be able to embed it in a variety of devices, including PC mother boards;                                 
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | developing a series of USB interface reader/writers, some of which
include fingerprint biometric capability;                                                                                                                                    
|
| |  |  | developing technologies to incorporate a number of biometric
technologies (fingerprint, iris scan, voice recognition, handwriting
recognition) into our PKI products to provide further advanced
identification and authentication protection;  
|
| |  |  | expanding the security features of applications programs such as
NetSign, NetSign® CAC and NetSign GT; and                                                                                                                                      
|
| |  |  | expanding Maestro to offer additional application program interfaces,
including an interface to the GSA CAC protocol, porting of Maestro to a
number of Unix operating system platforms, and adding to the suite of
tokens supported by Maestro.




During the years ended December 31, 1999, 2000 and 2001, research and
development expenses were $3.9 million, $5.8 million and $7.9 million,
respectively.

Intellectual Property

We depend substantially on the proprietary information and technologies
that make our products unique. We rely on a combination of trademark, patent,
copyright and trade secret laws, employee and third-party non-disclosure
agreements, technical measures, and other methods to protect our software
products, proprietary technologies, and intellectual property. We also rely on
standardized license agreements. Since these license agreements are not signed
by the end user, they may not always be enforceable.

We currently have three patents issued by the U.S. Patent and Trademark
Office, one allowed patent application, and five patent applications pending
with the U.S. Patent and Trademark Office. All cover aspects of data security
technology. In addition, we have one foreign pending patent application.
Prosecution of these patent applications and any other patent applications that
we may subsequently determine to file may require the expenditure of
substantial resources. The issuance of a patent from the filing of a patent
application is a lengthy process.

Due to the rapid pace of technological innovation for network security
products, our ability to establish and maintain a position of technological
leadership is dependent more upon the skills of our development personnel than
upon the legal protections afforded our existing and future technology.

Because our products are designed with an open architecture and are
algorithm-independent, they can be utilized with a variety of encryption
algorithms. Some algorithms are in the public domain and can be incorporated
into our products at no charge. To the extent that a customer desires to
incorporate a proprietary algorithm into a security solution, the customer or
we must obtain a license (flat fee, per unit royalty, or combination of these)
from the algorithm owner.




We developed Forté under a task order issued under
a contract with the
NSA. The contract incorporates the standard
licenses for technical data and computer software from the DoD, commonly known
as the data rights clauses. Data rights clauses are only applicable to data or
software actually delivered to the federal government under a contract. If the
data rights clauses, specifically the government purpose rights license, is
applicable to our agreement with the NSA to develop Forté, it would permit the
federal government to create second sources of supply without paying
us any
royalty. The government purpose license clause would not authorize the federal
government to create competitors in the commercial market. We do not believe
the data rights clauses generally, or the government purpose license
specifically, apply to Forté because our contract with the NSA does not provide
for the delivery of Forté to the federal government. The task order does
provide that the NSA will obtain detailed design information about Forté.




Competition

We compete in numerous markets, including:






| |  |  | Internet and intranet electronic security;
| | - |  | ------------------------------------------
|
| |  |  | access control and token authentication;  




13



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| |  |  | smart card-based security applications; and
| | - |  | -------------------------------------------
|
| |  |  | electronic commerce applications.          




The markets for our products and services are intensely competitive and
are characterized by rapidly changing technology and industry standards,
evolving user needs, and the frequent introduction of new products. We believe
that the principal factors affecting competition in our markets include:






| |  |  | product functionality;           
| | - |  | ---------------------------------
|
| |  |  | performance;                     
|
| |  |  | flexibility and features;        
|
| |  |  | use of open standards technology;
|
| |  |  | quality of service and support;  
|
| |  |  | reputation; and                  
|
| |  |  | price.                           




We face significant competition from a number of different sources. Many
of our competitors are more established, benefit from greater name recognition,
and have substantially greater financial, technical, and marketing resources
than we have. Some of our significant data security competitors include IBM,
Motorola, Gem Plus, Network Associates, Secure Computing, RSA Data Security,
Activcard, Rainbow Technologies, nCipher, Sonic Wall, Check Point Software,
Andes Networks, Intel and Entrust.

In addition, there are several smaller and start-up companies with which
we compete from time to time. We also expect competition to increase because of
consolidation in the information security technology.

We believe that no one in the data security industry currently offers a
complete end-to-end solution. Others may begin offering a complete solution
similar to the SSP Solution Suite . We believe, however, that our existing
relationships and the relationships we intend to pursue with systems
integrators provide us with an important competitive advantage in the data
security industry.

Government Regulation

Because we sell our products internationally as well as domestically, we
must comply with federal laws regulating the export and applicable foreign
government laws regulating the import of our products. The U.S. government has
recently relaxed the export restrictions for our NetSign and Profile Manager
products. However, the federal government may rescind these approvals at any
time. Under current regulations these products can be exported without a
license to most countries for use by banks, healthcare and insurance
organizations, and overseas subsidiaries of U.S. companies.

Additionally, we may apply for export approval, on a specific criteria
basis, for future products. Government export regulation for security products
is less stringent for products designed for banking and finance, e-commerce,
health, insurance, and for use by overseas subsidiaries of U.S. companies. It
is possible that we will not receive approval to export future products on a
timely basis, on the basis we request, or at all. As a result of government
regulation of our products, we may be at a disadvantage when competing for
international sales with foreign companies not subject to these restrictions.

Pulsar Product Reselling

Pulsar focuses primarily on the reseller market for the government
information technology segment, specializing in sales of computer and network
products with customized configurations. Examples of these computer and network
products include:



| |  |  | Network Hardware Components. Servers, routers, hubs, and switches
configured to the customers networking requirements.
| | - |  | -----------------------------------------------------------------------------------------------------------------------

14



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| |  |  | Client PC Systems. Desktop PC systems configured to customers
specific requirements.
| | - |  | -------------------------------------------------------------------------------------

Pulsar offers components manufactured by leading vendors including:
Hewlett-Packard Company, International Business Machines Corp., Lucent
Technologies, Inc., Dell Computers, Micron, Toshiba and Sun MicroSystems, Inc.
Pulsar competes primarily on the basis of price and quality of service. Some of
Pulsars competitors include: BTG Inc., InaCom Corporation and Government
Technology Services, Inc. Pulsar employs six sales people who operate out of our
Maryland office.

Employees




As of April 26,
2002, we employed 93 people, of which 91 were full-time
and two were part-time employees, including 48 in research, development and
support, 16 in field operations including sales, MIS and customer management,
and 21 in finance, human resources, business development, legal and
administration. In addition, we employed eight people for our Pulsar operations.
Our employees are not represented by labor unions. We are currently
contemplating a reduction in force of approximately 20% in an effort to match
the appropriate level of personnel resources with the demands and level of
business activity. However, we continuously evaluate our staff and business
requirements, and the precise amount of a reduction in force, if any, is
dependent on a number of factors, including the level of financing we are able
to obtain.










Item 2. Properties




We are headquartered in Irvine, California where we currently lease
approximately 20,702 square feet of office space for our executive offices with
a lease expiring in February 2007. This facility has an annual rent of $429,000
and a lease term of seven years. The facility is leased from KRDS, a related
party. We arranged for the lease of two buildings approximating 63,000 square
feet that were under construction. Our co-chairman Mr. Shah, has a 25%
ownership interest in the entity that owns the two buildings. The leases have
an aggregate monthly rental totaling approximately $115,000, plus common area
costs for seven years. On one building totaling approximately 23,000 square
feet, we sublet one half of the building on terms and conditions matching the
underlying lease. The sub-lease is with a related party company owned by our
co-chairman, Mr. Winkler. While that company made a lease deposit, it has not
made the monthly rent payment and accordingly is currently delinquent on its
rent payments to us. We are in negotiations with the landlord regarding being
released from obligations under the lease for the second building totaling
40,000 square feet. We intend to release the sub-tenant and occupy the 23,000
square foot building based upon having raised $5.0 million. In April 2002, we
and KRDS entered into an agreement whereby, upon 60 days notice, we or the
landlord may cancel the remaining term of the lease of the corporate
headquarters with no liability to us. We have not yet exercised the exit clause but
anticipate moving into one of the buildings in July 2002 and releasing our
sub-tenant from the rental commitment at that time. The net results will be an
increase in cost of approximately $7,000 per month. In addition, Pulsars
offices are located in a 12,700 square foot Lanham, Maryland facility, which we
use as office space for our executive offices and as warehouse space, under a
lease that expires in August 2003 with an annual rent of $146,000.










Item 3. Legal Proceedings

We are involved from time to time in routine litigation that arises in the
ordinary course of business. We are not currently involved in any litigation
that we believe will have a material impact on our results of operations,
financial condition or liquidity, including the following:

On January 16, 1998, G2 Resources Inc. (G2) filed a complaint against
Pulsar in the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County,
Florida. G2 claims that Pulsar breached a contract under which G2 agreed to
provide services related to the monitoring of government contracts available
for bid and the preparation and submission of bids on behalf of Pulsar. The
contract provides that Pulsar pay G2 $500,000 in 30 monthly installments of
$16,666 and an additional fee of 2% of the gross dollar amount generated by
awards. In its complaint, G2 alleged that Pulsar failed to make payments under
the contract and claimed damages in excess of $525,000 plus interest, costs and
attorneys fees. In the course of discovery G2 asserted that its losses/costs
arising out of its claim amounted to approximately $10.3 million. Pulsar has
asserted that G2 failed to perform the services required under the contract and
Pulsar filed a claim for compensatory damages, interest and attorneys fees
against G2. Classical Financial Services, LLC intervened in the case. Classical
claims that G2 assigned its accounts receivable to Classical under a financing
program and that Pulsar breached its obligations to Classical by failing to
make payments under the contract with G2. Pulsar has asserted defenses to
Classicals claim. On April 20, 2001, a court hearing was held and G2s
complaint against Pulsar was dismissed without prejudice on the basis of no
prosecution activity for more than 12 months. On May 22, 2001, G2 filed a new
complaint against Pulsar. We believe that the claims made by G2 and
Classical against Pulsar are without merit and intend to vigorously defend
against these claims. If G2 or Classical were to prevail in this lawsuit, our
business and financial condition could be adversely affected.

15



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During the second quarter of 2001 Microsoft notified us regarding the
alleged sales of unlicensed copies of Microsoft Office. The software in
question was purchased from a major computer hardware manufacturer and was
resold to one of our customers in a package that included both hardware and
software. We are currently investigating the matter, and do not anticipate that
the outcome will have a material impact on our results of operations, financial
condition or liquidity.

We were recently served with a lawsuit filed by Dell Marketing, LLC
pertaining to overdue amounts owed for computer products purchased for re-sale
through Pulsar. The suit asserts claim for payment of approximately $322,000,
which we anticipate paying. We are in negotiations with various vendors
regarding term-out of our obligations, but we cannot guarantee success of these
negotiations. As part of that process, vendors may take legal action to enforce
their claims.







Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to shareholders during the fourth quarter of
2001.




We are preparing to
hold our 2002 annual meeting of shareholders at 2:00
p.m. on June 27, 2002 at the Irvine Residence Inn, 2855 Main
Street, Irvine, California 92614. All holders of record of our outstanding common stock
as of May 8, 2002 will be entitled to vote at the annual meeting.




Our proxy statement circulated to shareholders in connection with our 2001
annual meeting provided that proposals by shareholders that are intended for
inclusion in the proxy statement and proxy to be presented at our next annual
meeting of shareholders must have been received by us by March 27, 2002 in
order to be considered for inclusion in our proxy materials.

As a result of the earlier date established by our board of directors for
our 2002 annual meeting, we hereby notify our shareholders that proposals by
shareholders that are intended for inclusion in its proxy statement and proxy
to be presented at the 2002 annual meeting should have been received by us by
March 27, 2002, as indicated in the proxy statement circulated in connection
with our 2001 annual meeting, in order to have been considered for inclusion in
our proxy materials. No proposals received after that date will be included in
the proxy materials for our 2002 annual meeting. Additionally, for all other
proposals to be timely, a shareholders notice must be delivered to, or mailed
and received at, our principal executive offices no later than May 1, 2002. If
a shareholder fails to so notify us of any such proposal prior to that date,
our management will be allowed to use their discretionary voting authority with
respect to proxies held by management when the proposal is raised at the annual
meeting (without any discussion of the matter in its proxy statement).







PART II







Item 5. Market for Registrants Common Equity and Related Stockholder Matters

Our common stock is listed on The Nasdaq National Market under the symbol
SSPX. The following table sets forth, for the quarters indicated, the high
and low closing sale prices per share of the common stock as reported on The
Nasdaq National Market. The prices shown represent quotations by dealers,
without retail markup, markdown or commissions and may not reflect actual
transactions.




On April 26, 2002, the last reported sale price for our common stock on
The Nasdaq National Market was $1.94. As of April 26, 2002, the approximate
number of holders of record of the common stock was 87. The Company has not
paid dividends and does not anticipate declaring dividends on its common stock
in the foreseeable future.




High and low prices for the last eight fiscal quarters are as follows:

|                                        |  |      |       |     |  |   |      | 
|--------------------------------------- |  | ---- | ----- | --- |  | - | ---- | 
|                                        |  | High |       | Low
|                                        |  |      |       |    
|Fiscal quarter ended June 30, 2000      |  | $    | 17.38 |     |  | $ | 6.69 | 
|Fiscal quarter ended September 30, 2000 |  | $    | 9.50  |     |  | $ | 2.94 | 
|Fiscal quarter ended December 31, 2000  |  | $    | 7.81  |     |  | $ | 2.34 | 
|Fiscal quarter ended March 31, 2001     |  | $    | 6.59  |     |  | $ | 2.50 | 
|Fiscal quarter ended June 30, 2001      |  | $    | 4.60  |     |  | $ | 2.46 | 
|Fiscal quarter ended September 30, 2001 |  | $    | 3.99  |     |  | $ | 2.01 | 
|Fiscal quarter ended December 31, 2001  |  | $    | 6.60  |     |  | $ | 3.44 | 
|Fiscal quarter ended March 31, 2002     |  | $    | 4.40  |     |  | $ | 2.31 | 

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On August 24, 2001, we completed the Acquisition in which Litronic Merger
Corp., a Delaware corporation and one of our wholly-owned subsidiaries,
was merged with and into BIZ. BIZ survived the Acquisition as our wholly-owned
subsidiary. Upon consummation of the Acquisition, the
outstanding shares of BIZ common stock were automatically converted into an
aggregate of 10,875,128 shares of our common stock.




Effective as of
October 17, 2001, we issued a fully-vested one-year non-qualified
option to purchase up to 1,461 shares of common stock at an exercise
price of $4.74 per share in lieu of paying cash to retire a trade
debt of approximately $6,925.

Effective as of October 31, 2001, we entered into
an agreement that terminated our engagement of an exclusive financial
advisor and placement agent. Under the termination agreement, we
issued an aggregate of 8,100 shares of common stock with piggyback
registration rights to three individuals and one entity designated
by the placement agent in lieu of payment of an aggregate of $36,000
due to the placement agent as a retainer
and as reimbursement of expenses.

On December 18, 2001, we issued and sold to four individuals including our
co-chairmen and co-chief executive officer, subordinated convertible promissory
notes (Notes) in the aggregate principal amount of $2.5 million. These notes
are convertible at the election of the holder, at any time, into the number of
shares of our common stock determined by dividing the outstanding principal
amount of the Notes being converted by the conversion price in effect at that
time. The initial conversion price provided for in the Notes is $3.60 per share
and is subject to adjustment as provided for in the Notes.

In addition, upon the closing of a qualified financing as defined in the
Notes, the then outstanding principal and any accrued and unpaid interest on
the Notes will automatically convert into such number of shares of the type of
equity securities sold in that qualified financing as is determined by dividing
the amount of principal and interest remaining on the Notes being converted by
the lesser of (a) the price at which the equity securities are being sold in
the qualified financing or (b) the conversion price provided in the Notes being
converted in effect at the time.




In issuing the securities described in the paragraphs above, we relied on
the exemption from registration under the Securities Act of 1933, as amended,
found under Rule 506 of Regulation D promulgated under the Act. The BIZ
shareholders who received shares of our common stock upon consummation of the
Acquisition and the purchasers of the Notes were all accredited investors as
defined in Rule 501(a) of Regulation D of the Act. There was no general
solicitation of general advertising by us or by any agent acting on our behalf,
in connection with either the offer or sale of the shares of our common stock
in the Acquisition or the Notes. In addition, in connection with the issuance
of the common stock in connection with the Acquisition and the Notes, we filed
with the Commission notices on Form D.




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Item 6. Selected Financial Data




The selected data presented below under the captions Selected Statements
of Operations Data and Selected Balance Sheet Data for, and as of the end of
each of the years in the five-year period ended December 31, 2001, are derived
from the consolidated financial statements of SSP Solutions, Inc. and
subsidiaries, which consolidated financial statements have been audited by KPMG
LLP, independent certified public accountants. The consolidated financial
statements as of December 31, 2001, and 2000, and for each of the years in the
three-year period ended December 31, 2001, and the report thereon, are included
elsewhere in this Annual Report on Form 10-K.




Selected Statements of Operations Data:

|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |        |        | 
|----------------------------------------------------------------------- | ---------------------------------------------- | -------------- | --------- | ------------------------ | ------ | ---- | --------- | ----------------------------------------------- | ----- | ---- | --------- | ------- | ------ | - | --------- | ------ | ------ | - | ---------- | ------ | ------ | 
|                                                                        |                                                |                |           | Years Ended December 31,
|                                                                        |                                                |                |           |                         
|                                                                        |                                                |                |           | 1997                     |        | 1998 |           | 1999(1)                                         |       | 2000 |           | 2001(2)
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |        
|                                                                        |                                                |                |           |                          |        |      |           | (In thousands, except share and per share data) |       |      |           |        
|Revenues:                                                               |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|                                                                        | Product                                        |                | $         | 8,627                    |        |      | $         | 5,214                                           |       |      | $         | 29,587  |        |   | $         | 37,421 |        |   | $          | 21,145 |       
|                                                                        | License and service                            |                |           | 1,539                    |        |      |           | 1,041                                           |       |      |           | 1,270   |        |   |           | 1,935  |        |   |            | 1,575  |       
|                                                                        | Research and development                       |                |           |                         |        |      |           | 398                                             |       |      |           | 798     |        |   |           |       |        |   |            |       |       
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|                                                                        |                                                | Total revenues |           |                          | 10,166 |      |           |                                                 | 6,653 |      |           |         | 31,655 |   |           |        | 39,356 |   |            |        | 22,720 | 
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|Costs and expenses:                                                     |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|                                                                        | Cost of sales  product                        |                |           | 3,211                    |        |      |           | 2,821                                           |       |      |           | 25,478  |        |   |           | 30,481 |        |   |            | 17,457 |       
|                                                                        | Cost of sales  license and service            |                |           | 643                      |        |      |           | 950                                             |       |      |           | 590     |        |   |           | 679    |        |   |            | 537    |       
|                                                                        | Selling, general, and administrative           |                |           | 3,487                    |        |      |           | 2,631                                           |       |      |           | 7,194   |        |   |           | 9,559  |        |   |            | 10,645 |       
|                                                                        | Research and development                       |                |           | 1,172                    |        |      |           | 1,334                                           |       |      |           | 3,906   |        |   |           | 5,800  |        |   |            | 7,850  |       
|                                                                        | Impairment of goodwill and other intangibles   |                |           |                         |        |      |           |                                                |       |      |           |        |        |   |           | 31,415 |        |   |            | 36,299 |       
|                                                                        | Amortization of goodwill and other intangibles |                |           |                         |        |      |           |                                                |       |      |           | 1,448   |        |   |           | 2,828  |        |   |            | 746    |       
|                                                                        | In-process research and development            |                |           |                         |        |      |           |                                                |       |      |           |        |        |   |           |       |        |   |            | 1,600  |       
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|Operating income (loss)                                                 |                                                |                | 1,653     |                          |        |      | (1,083    | )                                               |       |      | (6,961    | )       |        |   | (41,406   | )      |        |   | (52,414    | )     
|Other (income) expense, net                                             |                                                |                | 42        |                          |        |      | 418       |                                                 |       |      | 168       |         |        |   | (7        | )      |        |   | 693        |       
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|Earnings (loss) from continuing operations
before income taxes          |                                                |                | 1,611     |                          |        |      | (1,501    | )                                               |       |      | (7,129    | )       |        |   | (41,399   | )      |        |   | (53,107    | )     
|Provision for (benefit from) income taxes                               |                                                |                | 22        |                          |        |      | (95       | )                                               |       |      | (43       | )       |        |   | 6         |        |        |   | 53         |       
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       
|Earning (loss) from continuing operations                               |                                                | $              | 1,589     |                          |        | $    | (1,406    | )                                               |       | $    | (7,086    | )       |        | $ | (41,405   | )      |        | $ | (53,160    | )     
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |        |       
|Net earnings (loss)                                                     |                                                | $              | 15,334    |                          |        | $    | (1,406    | )                                               |       | $    | (7,086    | )       |        | $ | (41,405   | )      |        | $ | (53,160    | )     
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |        |       
|Earnings (loss) from continuing operations per
share: basic and diluted |                                                | $              | .41       |                          |        | $    | (.36      | )                                               |       | $    | (1.00     | )       |        | $ | (4.20     | )      |        | $ | (3.91      | )     
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |        |       
|Net earnings (loss) per share: basic and diluted                        |                                                | $              | 3.96      |                          |        | $    | (.36      | )                                               |       | $    | (1.00     | )       |        | $ | (4.20     | )      |        | $ | (3.91      | )     
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |        |       
|Shares used in per share computations: basic
and diluted                |                                                |                | 3,870,693 |                          |        |      | 3,870,693 |                                                 |       |      | 7,055,882 |         |        |   | 9,862,472 |        |        |   | 13,585,202 |       
|                                                                        |                                                |                |           |                          |        |      |           |                                                 |       |      |           |         |        |   |           |        |        |   |            |       



---




|(1) |  | On June 14, 1999, we completed the acquisition of Pulsar. All outstanding
shares of Pulsar were exchanged for 2,169,938 shares of our common stock.
The acquisition of Pulsar was accounted for using the purchase method of accounting,
and accordingly, the results of operations of Pulsar have been included in
our consolidated financial statements from June 14, 1999. We have
determined that the integration of Pulsar will not be completed as
planned. Based on the results of an independent valuation, we recorded an
impairment charge of $31.4 million related to unamortized intangible
assets acquired in connection with our acquisition of Pulsar.                               
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | On August 24, 2001, we completed the Acquisition. All outstanding
shares of BIZ were exchange for 10,875,128 shares of our common stock. The
Acquisition was accounted for using the purchase method of accounting, and
accordingly, the results of operations of BIZ have been included in our
consolidated financial statements from August 24, 2001. We have determined
that the other intangible assets and a portion of the goodwill related to
the Acquisition would not be realized. As a result, we analyzed the
recoverablility of the other intangibles and goodwill relating to the
Acquisition. Based on the results of our analysis, we recorded an
impairment charge of $27.8 million.




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Selected Balance Sheet Data:




|                                          |  |                |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        |  
|----------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | -
|                                          |  | December 31,  
|                                          |  |               
|                                          |  | 1997           |        | 1998 |  | 1999 |        | 2000 |  | 2001
|                                          |  |                |        |      |  |      |        |      |  |     
|                                          |  | (In Thousands)
|Cash and cash equivalents                 |  | $              | 490    |      |  | $    | 898    |      |  | $    | 6,441  |  |  | $ | 4,120  |  |  | $ | 3,257  |  
|Working capital (deficit)                 |  |                | 385    |      |  |      | 758    |      |  |      | 12,592 |  |  |   | 4,858  |  |  |   | (5,779 | )
|Total assets                              |  |                | 2,347  |      |  |      | 2,791  |      |  |      | 51,104 |  |  |   | 11,768 |  |  |   | 37,423 |  
|Current installments of long-term debt    |  |                |       |      |  |      | 580    |      |  |      | 481    |  |  |   | 1,986  |  |  |   | 1,695  |  
|Long-term debt, less current installments |  |                | 3,506  |      |  |      | 5,200  |      |  |      |       |  |  |   | 19     |  |  |   | 2,500  |  
|Total liabilities                         |  |                | 5,148  |      |  |      | 6,998  |      |  |      | 3,171  |  |  |   | 5,220  |  |  |   | 19,845 |  
|Total shareholders equity (deficit)      |  |                | (2,801 | )    |  |      | (4,207 | )    |  |      | 47,933 |  |  |   | 6,548  |  |  |   | 17,578 |  




During the year ended December 31, 1997, Litronic paid a cash dividend of
$9.5 million to its shareholders. No other dividends have been paid during the
periods presented. Our loan agreements restrict our ability to pay cash
dividends.







Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations

General

We provide professional Internet data security services and develop and
market software and microprocessor-based products needed to secure electronic
commerce and communications over the Internet and other communications networks
based on Internet protocols. Our primary technology offerings use PKI, which is
the standard technology for securing Internet-based commerce and
communications. In addition, Pulsar, a wholly owned subsidiary, is an
established computer and networking product reseller that focuses on resales to
government agencies, large corporate accounts and state and local governments.
We acquired Pulsar in June 1999 in exchange for 2,169,938 shares of our common
stock.

Before 1990, we were solely a provider of electronic interconnect products
to government and commercial entities. In 1990, we formed our data security
division, which is the basis of our operations today. The data security
division was engaged primarily in research and development until 1993 when it
began to generate meaningful revenue. In September 1997, we sold our Intercon
division, which consisted of the assets relating to our interconnect
operations, for cash to Allied Signal Inc., an unrelated, publicly traded
company.

Results of Operations  Comparison of Years Ended December 31, 1999, 2000 and 2001

We acquired Pulsar in June 1999, and our results of operations for the
fiscal year ended December 31, 1999, include the results of Pulsars operations
since June 14, 1999. In August 2001, we acquired BIZ and our results of
operations for the fiscal year ended December 31, 2001, include the results of
BIZs operations since August 25, 2001. Therefore, revenue and expenses are not
comparable from period to period.

Total Revenue

Total revenue increased 24% from $31.7 million during the year ended
December 31, 1999 to $39.4 million during the year ended December 31, 2000 and
decreased 42% from $39.4 million during 2000 to $22.7 million during the year
ended December 31, 2001. The increase from 1999 to 2000 consisted of a $5.5
million increase in network solutions market revenue primarily attributable to
a full year of sales in 2000 as compared to a partial year in 1999, a $3.0
million increase in data security products and services revenue primarily
attributable to an increase in sales of existing data security products and
services, and a $798,000 decrease in research and development revenue
attributable to the completion in 1999 of the contract that was responsible for
generating research and development revenue. The decrease from 2000 to 2001
consisted of an $822,000 increase in data security products and services
revenue primarily attributable to an increase in sales volume of existing data
security products and services, and a $17.5 million decrease in network
solutions market revenue primarily attributable to our inability to accept and
fulfill a large number of customer orders due to reduced accounts receivable
financing availability and as our primary vendors being unwilling to sell
additional product to us on open account because of significant past due
amounts for goods we had previously purchased from them.

During 1999, 31% and 12% of revenue was generated from sales to the United
States Immigration and Naturalization Service and the United States Department
of State, respectively. During 2000, 42% of revenue was generated from sales to
the United States Immigration and Naturalization Service. During 2001, 20% of
revenue was generated from sales to the United States Immigration and

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Naturalization Service. Sales to federal government agencies accounted for
approximately 78%, 79% and 67% of sales during 1999, 2000 and 2001,
respectively.

Product Revenue

Product revenue increased 26% from $29.6 million during 1999 to $37.4
million during 2000 and decreased 43% from 2000 to $21.1 million during 2001.
The increase from 1999 to 2000 consisted of a $5.6 million increase in network
deployment products revenue and a $2.2 million increase in data security
products revenue. The decrease from 2000 to 2001 consisted of a $17.2 million
decrease in network deployment products revenue and a $918,000 increase in data
security products revenue.

License and Service Revenue

License and service revenue increased 52% from $1.3 million during 1999 to
$1.9 million during 2000 and decreased 19% from $1.9 million during 2000 to
$1.6 million during 2001. The increase from 1999 to 2000 was primarily
attributable to an increase of $444,000 related to an ongoing government
support contract that began in August 1999 and to the recognition of $137,000
of revenue, out of a total of $550,000 contract, which requires us to provide
customer support for three years. The balance of this $550,000 contract has
been recorded as deferred revenue and will be recognized over the remainder of
the support period. The decrease from 2000 to 2001 was primarily attributable
to a $264,000 decrease in electric security systems revenues. The electric
security systems product line was discontinued in July 2000, and no revenues
were recognized in 2001.

Research and Development Revenue

Research and development revenue represents amounts earned under a
contract with the NSA for the design of a microprocessor meeting minimum
specifications established by the NSA. We have contracted with others to
perform aspects of the project. All related project costs were expensed as
research and development was incurred. Regardless of the results of the
development efforts, the amounts received from the NSA are nonrefundable. The
related research and development costs were not separately identifiable.
Therefore, the corresponding costs of the entire development effort were
included in research and development expenses. Research and development revenue
was $798,000 during 1999. The contract that resulted in research and
development revenue was completed in 1999 and no further research and
development revenue is anticipated under this contract.

Product Gross Margin

Product gross margin increased as a percentage of net product revenue from
14% during 1999 to 19% during 2000 and decreased to 17% during 2001. The
increase from 1999 to 2000 was primarily attributable to the proportionately
higher increase in revenue related to data security products as compared to
network deployment products. The decrease from 2000 to 2001 was primarily
attributable to a reduction in margins related to network deployment products
that resulted from having to pay higher prices for product from secondary
suppliers because our primary vendors were unwilling to sell to us on open
account. In addition, data security products margins also decreased mainly due
to significant reduction in the average selling price of one of our key
products. During 2000 network deployment products represented 85% of product
revenue as compared to data security products that represented 15% of product
revenue. During 2001 network deployment products represented 68% of product
revenue as compared to data security products that represented 32% of product
revenue. Margins from the sale of data security products are significantly
greater than the margins from the sale of network deployment products. In
addition, data security products margins also decreased mainly due to
significant reduction in the average selling price of one of our key products.

License and Service Gross Margin

License and service gross margin increased as a percentage of license and
service revenue from 54% during 1999 to 65% during 2000 and increased to 66%
during 2001. The increase from 1999 to 2000 was primarily attributable to
discontinuing the ESS product line. Gross margins associated with the ESS
product line were significantly less than the gross margins associated with
data security services. The ESS product line was discontinued in July 2000.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 33% from $7.2
million during 1999 to $9.6 million during 2000 and increased 11% from 2000 to
$10.6 million during 2001. The increase from 1999 to 2000 was primarily
attributable to twelve months of Pulsar related selling, general and
administrative expenses in 2000 as compared to approximately six months in
1999. The increase

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from 2000 to 2001 was primarily attributable to the addition of personnel
expenses associated with the Acquisition of approximately $1.2 million, a
net loss on a lease for new operating facilities of approximately $2.2 million,
partially offset by a reduction in compensation expense of approximately
$900,000 and other net reductions totaling approximately $1.3 million. The net
loss on a lease was the result of a lease entered into in October 2001 for new
operating facilities. After entering into the lease we determined that we would
not need all of the space contracted for and therefore we recorded a loss on
the lease net of estimated sublease income. Compensation expense reductions
included $807,000 related to Pulsar were primarily for reductions in salary and
commission expenses due to decreased revenues and the need to adjust cost
structures accordingly. Reductions not related to Pulsar were primarily
attributable to reductions in salary, travel, professional fees, printing and
office expenses. Expense reductions not related to Pulsar were done in an
effort to reduce current cash expenditures. As a percentage of revenue,
selling, general and administrative expenses increased from 23% during 1999 to
24% during 2000 and increased to 47% during 2001. The percentage increase from
1999 to 2000 was primarily attributable to the revenues generated by Pulsar
during 1999 and the percentage increase from 2000 to 2001 was partially the
result of the overall increase in expenses but was primarily attributable to
the significant decrease in revenues.




Research and Development Expenses




Research and Development Expenses increased 48% from $3.9 million during
1999 to $5.8 million during 2000 and increased 35% from 2000 to $7.9 million
during 2001. The increase from 1999 to 2000 was primarily attributable to
significant increased staffing related to product development, including
development efforts related to the Forté microprocessor, Maestro, Profile
Manager, NetSign and token reader/writers. The increase from 2000 to 2001 was
primarily attributable to continued development related to those same projects
that were responsible for the staffing increases in 2000 and the addition of
personnel expense from the Acquisition. As a percentage of revenue,
expenses increased from 12% during 1999 to 15% during 2000 and increased to 35%
during 2001. The percentage increase from 1999 to 2000 was primarily
attributable to increased staffing. The percentage increase from 2000 to 2001
was primarily attributable to the continued expansion of our research and
development efforts combined with the significant decrease in revenues.




Impairment of Goodwill and Other Intangibles

In June 1999, we acquired Pulsar. All of the outstanding shares of Pulsar
were exchanged for 2,169,938 shares of our common stock. The acquisition was
accounted for using the purchase method of accounting. In the fourth quarter of
2000 we determined the integration of Pulsar would not be completed as planned
and the anticipated operating synergies would not be realized. As a result, in
accordance with Statement of Financial Accounting Standards No. (SFAS) 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of, we analyzed the recoverability of the goodwill and other
intangibles relating to the acquisition of Pulsar. In order to evaluate the
recoverability of the remaining goodwill and other intangible assets, we
engaged the services of an independent valuation firm to perform a valuation.
In the fourth quarter of 2000, based on the results of the independent
valuation, we recorded an impairment charge of $31.4 million related to
unamortized intangible assets acquired in the purchase of Pulsar. Based on the
independent valuation, we believed that after the impairment charge of $31.4
million, no further impairment existed at December 31, 2000. As of December 31,
2001, the remaining unamortized intangible assets of $691,000 acquired in the
purchase of Pulsar will be amortized over the remainder of their 10-year life.

In August 2001, we acquired BIZ. All of the outstanding shares of BIZ were
exchanged for 10,875,128 shares of our common stock. The Acquisition was
accounted for using the purchase method of accounting. As part of the
Acquisition we acquired $9.0 million of identifiable intangible assets. In the
fourth quarter of 2001 we determined that the other intangible assets and a
portion of goodwill related to the Acquisition would not be realized. As a
result, we analyzed the recoverability of the intangible assets relating to the
Acquisition. Based on the results of our analysis, we recorded an impairment
charge of $36.2 million related to unamortized identifiable intangible assets
and goodwill acquired in the Acquisition. Based on our analysis, we believe
that after the impairment charge of $36.2 million, no further impairment
existed at December 31, 2001. The remaining identifiable intangible asset
acquired in the Acquisition of BIZ is goodwill which will no longer be
amortized in accordance with SFAS 142.

Acquired In-Process Research and Development

During the year ended December 31, 2001, we recorded an in-process
research and development (IPR&D) charges of $1.6 million related to the
Acquisition. The portion of the purchase price allocated to IPR&D for the
Acquisition was approximately 2.5% of the total purchase price of $64.7
million. An independent third party investment banking firm, was retained to
estimate the fair value of purchased IPR&D. At the Acquisition date, BIZ was in
the process of developing technology that would deliver security features to
customers, and develop a new platform for delivering its product. The IPR&D had
not yet reached technological feasibility,

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had no alternative uses, and may not have achieved commercial viability.
At the valuation date, the new technology had not reached a completed prototype
stage, although some beta testing on portions of the technology had begun. At
the valuation date, the IPR&D was ranged between 6% and 17% complete, based on
costs incurred on the IPR&D through the Acquisition date versus the total costs
estimated to complete the project. The IPR&D project was valued using the
Income Forecast Method. This method took into consideration earnings remaining
after deducting from cash flows related to the in-process technology, the
market rates of return on contributory assets, including assembled workforce,
merchant agreements working capital and fixed assets. The cash flows were then
discounted to present value at an appropriate rate. The discount rate was
determined by an analysis of the risks associated with each of the identified
intangible assets. The resulting net cash flows to which discount rates of 45%
to 50% were applied were based on managements estimates of revenues, operating
expenses and income taxes from such acquired in-process technology.

Amortization of Goodwill and Other Intangibles

Amortization expense increased 95% from $1.4 million during 1999 to $2.8
million during 2000 and decreased 74% from 2000 to $746,000 during 2001. The
increase from 1999 to 2000 was primarily attributable to a full year of
amortization expense related to unamortized intangible assets in 2000 compared
to six months during 1999 when we acquired Pulsar. The decrease from 2000 to
2001 was primarily attributable to the reduction of goodwill and other
intangibles that resulted from the $31.4 million impairment charge recorded in
the fourth quarter of 2000. Amortization expense in 2001 was comprised of
$23,000 related to Pulsar intangibles and $495,000 related to BIZ identifiable
intangible assets.

Other (Income) Expense, Net

Other (income) expense, net, decreased 104% from $168,000 during 1999 to
($7,000) during 2000 and increased 2429% from 2000 to $693,000 during 2001. The
decrease from 1999 to 2000 was primarily attributable to an increase in
interest income of $75,000, a reduction in interest expense of $27,000 and a
one time non-operating credit of $72,000. The increase from 2000 to 2001 was
primarily attributable to a decrease in interest income of $188,000, a decrease
in interest expense of $90,000 and a realized loss on trading securities of
$530,000.

Income Taxes

For 1999 the income tax benefit of $43,000 was primarily attributable to
prior year tax refunds received that exceeded amounts recorded as receivable in
prior years. For 2000 the income tax expense of $6,000 was primarily
attributable to minimum California franchise taxes. For 2001 the income tax
expense was attributable to the reversal of previously recognized tax credits
because it was determined that they would not be realized.

Backlog

At December 31, 1999, 2000 and 2001 total backlog was $366,000, $1.3
million and $1.1 million respectively. Orders are subject to cancellation in
certain circumstances, and backlog may therefore not be indicative of future
operating results. The increase in the backlog at December 31, 2000, was
attributable to an increase of $409,000 related to data security products and
$525,000 related to network deployment products. The backlog of data security
products at December 31, 2000, consisted primarily of unfilled orders for the
Argus 300. Materials required to assemble the Argus 300 were not received until
January 2001. Once the necessary materials were received, the Argus 300 readers
were assembled and shipped during the first quarter of 2001. The backlog of
network deployment products at December 31, 2000, was the result of orders that
were received too close to the end of the year to be shipped before the end of
the year. The backlog at December 31, 2001, was made up of $218,000 related to
data security products and $910,000 related to network deployment products. The
$910,000 related to network deployment products was caused by our inability to
obtain product from our vendors to fulfill customer orders. If we are not able
to obtain the product necessary to fulfill these orders they will have to be
cancelled.

Critical Accounting Policies

Managements Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities at the date of our financial statements.

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We based our estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. We believe the
following critical accounting policies, among others, affect significant
judgments and estimates used in the preparation of our consolidated financial
statements. For a detailed discussion of the application of these and other
accounting policies, see notes to the consolidated financial statements.



| |  |  | Revenue Recognition.We recognize revenue from product sales,
including hardware (with embedded software) and software, upon shipment
unless contract terms call for a later date. Revenue from network
deployment products is recognized upon transfer of title, generally upon
delivery. We record an allowance to cover estimated warranty costs in
cost of sales. Customers do not have the right of return except for
product defects, and product sales are not contingent upon customer
testing, approval and/or acceptance. The costs of providing post
contract customer support are not significant. Revenue under service and
development contracts is recorded as services are rendered. Revenue from
time and material, network deployment service contracts is recognized on
the basis of man-hours incurred plus other reimbursable contract costs
incurred during the period.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Allowance for Doubtful Accounts.We maintain an allowance for
doubtful accounts for estimated losses resulting from the inability of
our customers to make payments for services. We analyze accounts
receivable, customer credit-worthiness, current economic trends and
changes in our customer payment terms when evaluating the adequacy of
the allowance for doubtful accounts. If the financial condition of our
customers deteriorates, resulting in an impairment of their ability to
make payments, additional allowances may be required.                                                                                                                                                                                                                                                                                                                                          
|
| |  |  | Valuation of Goodwill and Other Intangible Assets. We assess the
impairment of goodwill and other intangible assets whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important which could trigger an
impairment review include significant underperformance relative to
expected historical or projected future operating results, significant
changes in the manner of our use of the acquired assets or the strategy
for our overall business, and significant negative industry or economic
trends. The net carrying value of goodwill and other intangible assets
not recoverable is reduced to fair value.                                                                                                                                                                                                    




During the fourth quarter of 2001, we determined that certain identifiable
technology and developed technology acquired in connection with the Acquisition were no longer going to be pursued. Additionally, we anticipate a
delay or indefinite reduction in projected revenues from the Acquisition.
Accordingly, we performed an impairment analysis.







As the result of that analysis, we recorded an impairment charge of $36.2
million in the fourth quarter of 2001 related to $2.6 million in identifiable
technology, $5.8 million in developed technology and $27.8 million in goodwill
acquired in connection with the Acquisition. After this impairment
charge, goodwill is the only remaining intangible asset.




Changes in assumptions and estimates included within the analysis could
result in significantly different results than those identified above and those
recorded in the consolidated financial statements.

Liquidity and Capital Resources

At December 31, 2001, we had deficit working capital of $5.8 million and
we incurred a loss from operations of $52.4 million and used cash in operating
activities of $2.5 million for the year then ended. We expect to continue to
incur substantial additional losses in the current year. Given our December 31,
2001 cash balance of $3.3 million and our projected operating cash
requirements, we anticipate that our existing capital resources will not be
adequate to satisfy our cash flow requirements through the December 31, 2002.
We will require additional funding. Our cash flow estimates are based upon
achieving certain levels of sales, reductions in operating expenses and
liquidity available under the accounts receivable line. Should sales be less
than forecast, expenses be higher than forecast or the liquidity not be
available under our accounts receivable line or through additional financings
of debt and/or equity, we will not have adequate resources to fund its
operations. During the past year, we have incurred defaults under both our line
of credit secured by accounts receivable and the long-term convertible notes.
We secured waivers for our accounts receivable line through March 31, 2002 and
for the long-term convertible notes through December 31, 2002. However, there
is no guarantee the lenders will continue to waive defaults in the future,
should they occur, and the lenders may declare amounts owed by us due and
payable. Subsequent to March 31, 2002, we remained in default under the line of
credit. We do not expect future fixed obligations through December 31, 2002 to
be paid by cash generated from operating activities. We intend to satisfy fixed
obligations from, but not

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limited to the following: (i) additional financings; (ii) use of our
accounts receivable line; (iii) extending vendor payments; and (iv) issuing
stock as payment on obligations.

During the twelve months ended December 31, 2001, cash used in operations
was $2.5 million primarily attributable to a net loss of $53.2 million, which
included an impairment charge of $36.2 million related to unamortized goodwill
and other intangibles assets. The net loss was primarily offset by the $36.2
million noncash impairment charge of goodwill and other intangibles, $1.5
million of noncash depreciation and amortization, $1.6 million increase of In
process research and development, a $6.3 million increase in accounts payable,
$2.4 million increase in accrued liabilities, and a $2.2 million increase in
accrued rent.

During the twelve months ended December 31, 2000, cash used in operations
was $3.6 million primarily attributable to a net loss of $41.4 million, which
included an impairment charge of $31.4 million related to unamortized goodwill
and other intangible assets. The net loss was primarily offset by the $31.4
million noncash impairment charge of goodwill and other intangibles, $3.5
million of noncash depreciation and amortization and a reduction in accounts
receivable of $2.7 million.




During the twelve months ended December 31, 2001, cash provided by
investing activities was $140,000 versus $251,000 cash used in 2000. The
increase was attributable to the net cash paid for the Acquisition of
$675,000 offset by a decrease of $118,000 related to the purchase of property
and equipment during the year ended December 31, 2001. However, during the year
ended December 31, 2000, the decrease of $863,000 related to property and
equipment purchased was partially offset by $612,000 of previously restricted
cash related to our revolving credit line that was reclassified as unrestricted
cash. Finally, during the year ended December 31, 2001, we received proceeds of
$933,000 from the sale of trading securities versus $0 in 2000.




During the twelve months ended December 31, 2001, cash provided by
financing activities was $1.5 million, the same as 2000. The cash provided by
financing activities in 2001 was primarily the result of borrowings of $14.2
million under bank agreements. These borrowings were offset by repayments of
$14.1 million under these bank agreements. Furthermore, $2.5 million was
provided by the issuance of long-term convertible debt. The cash provided by
financing activities in 2000 was primarily the result of borrowings of $23.7
million under bank and other borrowing agreements. These borrowings were offset
by repayments of $22.4 million under bank and other borrowing agreements.

We have experienced net losses and negative cash flows for the last
several years, and as of December 31, 2001, had a deficit accumulated deficit
of $99.5 million. We have financed our operations principally through the
issuance of Common Stock total proceeds net of issuance costs from our public
offering of approximately $35.3 million.




In June 1999, we entered into a three-year lending agreement with Guaranty
Business Credit Corporation permitting borrowings under a $20.0
million secured revolving line of credit facility that commenced on June 14,
1999. The agreement provided for an annual interest rate of prime plus .625%;
and a pledge of substantially all of our personal and real property as
collateral. Although the credit facility was for borrowings up to $20.0
million, under the terms of the agreement the amount of borrowing available to
us was subject to a maximum borrowing limitation based on eligible collateral.







On April 18, 2001, the terms of our revolving line of credit were amended.
Under the terms of the amended agreement the maximum borrowings were $5.0
million, eligible collateral excluded inventory and the advance rate was 35%.
In addition, certain of the financial covenants and requirements were adjusted.
The amended $5.0 million revolving credit facility also contained various
covenants and restrictions. Under the terms of the amended agreement, we were
required to obtain the lenders consent for any merger, acquisition or
consolidation. The lender was not willing to give its consent to our
Acquisition and discontinued making advances under the terms of the
amended agreement effective with the Acquisition. The lender applied all
collections subsequent to the Acquisition to outstanding borrowings until such
borrowings and related interest charges were paid in full. All amounts due to
the lender were paid in full on October 2, 2001. Once all amounts were paid in
full the lender released its security interest in our assets.







On July 31, 2001, Chase Manhattan Bank (Chase) advanced to our
co-chairman, Mr. Winkler, $1.0 million which Mr. Winkler advanced to BIZ for
the re-purchase of preferred stock held by an investor in BIZ. Mr. Winkler
executed a $1.0 million demand note with Chase and BIZ executed a $1.0 million
demand note due September 15, 2001 with J.A.W. Financial, L.P. (JAW), an
entity controlled by Mr. Winkler. The demand note contained an interest charge
of prime plus 1% through the maturity date and prime plus 3% after the maturity
date. On October 11, 2001, we made a principal payment of $30,000, paid accrued
interest, and executed a new promissory note to JAW for $970,000. The terms of
the promissory note call for interest of prime plus 3% payable monthly,
together with five monthly payments of principal in the amount of $160,000 and
one final payment on April 15, 2002 in the amount of $170,000. The promissory
note provides Chase a security interest in the shares in Wave Systems
Corp. (Wave) owned by us and, subject to




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Chases loan security guidelines, including the rights to proceeds from
any sales of those shares. The loan was paid in full on March 8, 2002.




During October and November 2001 we and our wholly owned subsidiary,
Pulsar, entered into financing agreements with Wells Fargo Business Credit,
Inc. (WFBC), which provides for the factoring of accounts receivable. The
agreements contain no limit on the dollar volume of receivable financing, but
does provide for WFBCs approval of credit limits for non-government customers.
The discount rate charged is 1.25% of the gross receivable, which may be
increased by .0625% per day for accounts that do not pay within 30 days of the
receivable purchase. At the time of purchase, terms call for WFBC to advance
85% of the gross receivable, with the balance remitted after collection of the
invoice less the discount and any other charges. We were in violation of the
covenant to pay debts and obligations as they come due and delays in
misdirected payments. We requested a waiver of these defaults and received a
waiver through March 31, 2002 and January 31, 2002, respectively. We are in
default and anticipate being in default of this provision in the future unless
we raise sufficient working capital. The balances due WFBC are guaranteed by
Mr. Shah and Mr. Winkler, our co-chairmen and co-chief executive officers.







In December 2001, our co-chairmen, each purchased a three year $375,000
subordinated convertible 8% note, in a total private placement of $2.5 million
of such notes. These notes were intended to convert into a subsequent
financing, which is described below. In connection with the issuance of the
subordinated convertible notes we incurred approximately $25,000 of issuance
costs, which primarily consisted of legal and other professional fees, and
which are to be paid upon completion of the subsequent financing described
below. All subordinated convertible notes mature December 17, 2004; bear
interest at a rate of 8% per annum, which will be paid quarterly in cash or
rolled into the subsequent financing described below; upon a financing of $5.0
million or more in equity or convertible securities in a private placement to
institutional investors, the subordinated convertible notes are convertible
into such financing on the same terms and conditions; at the election of the
holders, subordinated convertible notes are convertible into common stock at a
conversion price of $3.60 per share, subject to adjustment under certain
conditions. In April 2002, the subordinated convertible notes of our
co-chairmen were amended to provide that their notes can only be converted upon
a financing of $5.0 million or more in equity or convertible securities in a
private placement to institutional investors at a conversion price that
represents a 25% or less discount to the trading price of the Companys stock
and extended their term to December 31, 2005. After December 11, 2003, we may
call for mandatory conversion of the subordinated convertible notes prior to
maturity if the Companys common shares trade at or above an average price of
300% of the conversion price for 20 consecutive trading days and
average volume of 200,000 shares per day for 20 consecutive trading
days. As of December 31, 2001, we were in violation of certain provisions of
the subordinated convertible notes pertaining to: (i) payment of debts and
obligations as they come due; (ii) violation of provisions within the WFBC
agreements; and (iii) payment of interest on these notes due March 31, 2002. We
requested and received a waiver for these violations through January 1, 2003,
see notes to consolidated financial statements. On April 16, 2002, simultaneous
with the filing of our Annual Report on Form 10-K we closed a financing whereby, with the
exception of Mr. Winkler and Mr. Shah, the noteholders converted their
subordinated convertible notes into 10% secured convertible promissory notes
convertible at $1.00 per share, with detachable warrants.




Over the past three years, we have spent substantial sums on research and
development (R&D) activities. During that time period, we incurred
substantial losses from continuing operations. As a result of these and other
changes, we currently have a deficit in working capital and an accumulated
deficit. While we believe the R&D expenditures created significant future
revenue producing opportunities, some of the related products are just entering
production. We are currently involved in sales pursuits relative to these
products that, if successful, will generate significant revenues. However,
unless we receive orders for these new products and receive significant
financing, we can no longer support the current level of research and
development activity. While we have reduced our staffing levels, if sales fail
to materialize, we will need to further reduce expenses through additional
reductions in staff.

Reduced accounts receivable financing availability caused us to
re-evaluate the operations of our networking business and our primary vendors
being unwilling to sell additional product to us on open account because of
significant past due amounts for goods we had previously purchased from them.
This caused a substantial reduction in the sales and related cost of sales
during the year, which in turn reduced cashflow. The reduced cashflow impaired
our ability to meet vendor commitments as they became due.




In October 2000, we signed a development agreement with Wave for the
integration of EMBASSY based systems with set-top box master reference designs
of Broadcom Corporation. Wave owns approximately 15% of our issued and
outstanding common stock. The development agreement was amended in May 2001.
Under this agreement, as amended, we are required to pay Wave $278,000 per
month beginning June 1, 2001 through December 1, 2002 for work to be performed,
for a total of $5.0 million. Should we not make the required monthly payments,
Wave may request payment in the form of common stock. As of December 31, 2001,
we owed $1.4 million to Wave for which they have tendered monthly notices of
default. Under the terms of the agreement, if the default notices are not cured
within 30 days of written notice, the unpaid installment converts the
obligation for delinquent installments from a cash obligation into a stock
acquisition right, (SAR). A SAR gives Wave the right to acquire a number of
fully paid, nonassessable shares of our common stock determined by dividing the
fair market value (the average closing price of our common stock for the ten
trading-day period prior to the date of exercise) of a share of our common
stock on the date of exercise of the SAR into the aggregate portion of the
installment payments declared to be in default and such default was not cured.
To date, Wave has made no request for issuance of stock. The $1.4
million
obligation is carried as an accrued liability of December 31, 2001. Further, to
conserve cash we do not intend to pay in cash the monthly billings due under
the agreement. In February 2002, based upon a verbal agreement the work under
the agreement was suspended along with the related billings. The suspension
does not decrease the obligation to purchase development services in the
future. We have reserved 1,150,000 shares of common stock for issuance under
the agreement. In addition, should we not purchase $5.0 million of goods or
services from Wave by June 30, 2003, our exclusivity related to certain
customers will, at Waves option, become non-exclusive.




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In November 2000, we executed an Alliance Agreement with EDS for the marketing of our products to EDS customers
(Alliance). The Alliance calls for a joint working relationship between the
two companies, is non-exclusive and has a term of ten (10) years. In February
2001, we and EDS executed an engagement letter for EDS to provide certain
information technology and consulting services for both our organizational
structure and for a specific customer project. Under these engagements, EDS
billed $1.2 million, of which $458,000 remained unpaid as of December 31, 2001. On August
27, 2001, EDS and we executed a letter of intent and temporary working
agreement whereby EDS supplied software and hardware for re-sale to Pulsar
customers (Pulsar Agreement). Under the Pulsar Agreement, as of December 31,
2001, $1.5 million remained outstanding and unpaid to EDS for purchases of hardware
and software. We and EDS executed a Master Services Agreement dated as of
November 14, 2001 (MSA) whereby beginning December 1, 2001 and ending
December 31, 2006, we and EDS established a strategic teaming relationship to
implement, sell and deliver a set of secure transaction processing offerings
based upon a TAN. The MSA task order 001 Task
Order requires that we pay a monthly fee of $44,000 for account, test and lab
management services beginning January 1, 2002. The obligations for these
services can be terminated beginning January 1, 2003 by giving ninety (90) days
prior written notice and payment of $400,000, or beginning January 1, 2004 by
giving ninety (90) days prior written notice and payment of
$200,000. Further, the
Task Order provides for EDS to provide TAN hosting and implementation in
exchange for an implementation fee of $45,000 payable October 1, 2002. Once
installation of the production environment TAN is complete, EDS agrees to host
the TAN in exchange for a monthly service fee of $59,000 for thirty-six (36) months
and $60,000 per month for the remaining months of the MSA. We may delay
implementation of the TAN by paying a fee of $200,000 prior to January 31, 2003. We
may terminate the Task Order without cause by paying $400,000 after January 1, 2004
and providing ninety (90) days prior written notice. In the event we are unable
to obtain intellectual property rights or licensing consents that may be
required, if any, prior to January 1, 2003, and the parties determine there are
no software alternatives, then after giving ninety (90) days prior written
notice we may terminate the Task Order by paying $450,000.

We arranged for the lease of two buildings approximating 63,000 square
feet that were under construction. Our co-chairman Mr. Shah, has a 25%
ownership interest in the entity that owns the two buildings. The leases have
an aggregate monthly rental totaling approximately $115,000, plus common area
costs for seven years. On one building totaling approximately 23,000 square
feet, we sublet one half of the building on terms and conditions matching the
underlying lease. The sublease is with a related party company owned by our
co-chairman, Mr. Winkler. While that company made a lease deposit, it has not
made the monthly rent payment and accordingly is currently delinquent on its
rent payments to us. We are in negotiations with the landlord regarding being
released from obligations under the lease for the second building totaling
40,000 square feet. We intend to release the sub-tenant and occupy the 23,000
square foot building based upon having raised $5.0 million of convertible notes
(see below). We have accrued $2.2 million as an estimate for anticipated costs
relative to the disposition of the 40,000 square foot building net of
anticipated offsetting sublease income, which may be partially recovered
depending on future events that cannot be estimated.

Our significant fixed commitments with respect to leases and inventory
purchases as of April 15, 2002 are as follows:

|                                   |  |                                          |            |      |  |             |           |             |  |              |           |  |  |   |            |  |  |   |           | 
|---------------------------------- |  | ---------------------------------------- | ---------- | ---- |  | ----------- | --------- | ----------- |  | ------------ | --------- |  |  | - | ---------- |  |  | - | --------- | 
|                                   |  | Payments for the Year Ended December 31,
|                                   |  |                                         
|                                   |  | TOTAL                                    |            | 2002 |  | 2003 & 2004 |           | 2005 & 2006 |  | 2007 & after
|                                   |  |                                          |            |      |  |             |           |             |  |             
|Contractual Obligations            |  |                                          |            |      |  |             |           |             |  |              |           |  |  |   |            |  |  |   |           | 
|Convertible Notes                  |  | $                                        | 7,152,800  |      |  | $           | 0         |             |  | $            | 1,750,000 |  |  | $ | 5,402,800  |  |  | $ | 0         | 
|Operating Leases                   |  |                                          | 12,324,969 |      |  |             | 2,036,613 |             |  |              | 3,786,373 |  |  |   | 3,696,409  |  |  |   | 2,805,574 | 
|Unconditional Purchase Obligations |  |                                          | 8,873,338  |      |  |             | 4,510,498 |             |  |              | 2,303,160 |  |  |   | 2,059,680  |  |  |   | 0         | 
|                                   |  |                                          |            |      |  |             |           |             |  |              |           |  |  |   |            |  |  |   |           | 
|Total Contractual Cash Obligations |  | $                                        | 28,351,107 |      |  | $           | 6,547,111 |             |  | $            | 7,839,533 |  |  | $ | 11,158,889 |  |  | $ | 2,805,574 | 
|                                   |  |                                          |            |      |  |             |           |             |  |              |           |  |  |   |            |  |  |   |           | 

With our deficit working capital position, we will not be able to meet
existing obligations as they become due. We will use receivables and
investments to generate liquidity and are in negotiations with vendors for
extended terms on current obligations. To

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remedy the working capital deficiency, we are in discussions with
financing sources and simultaneous to the filing of this form 10-K, raised $5.0
million through convertible notes, non-convertible notes and
pre-payment of an existing note.

We currently have a need for a substantial amount of capital to meet our
liquidity requirements. The amount of capital that we will need in the future
will depend on many factors including, but not limited, to:



| |  |  | the ability to extend terms of payment to vendors;                                                                                                      
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the market acceptance of products and services;                                                                                                         
|
| |  |  | the levels of promotion and advertising that will be required to
launch new products and services and attain a competitive position in
the market place;
|
| |  |  | research and development plans;                                                                                                                         
|
| |  |  | levels of inventory and accounts receivable;                                                                                                            
|
| |  |  | technological advances;                                                                                                                                 
|
| |  |  | competitors responses to our products and services;                                                                                                    
|
| |  |  | relationships with partners, suppliers and customers;                                                                                                   
|
| |  |  | projected capital expenditures;                                                                                                                         
|
| |  |  | downturn in economy;                                                                                                                                    
|
| |  |  | defaults on financing that will impact the availability of borrowings; and                                                                              
|
| |  |  | reductions in the valuation of investment.                                                                                                              

As of December 31, 2001, we had available net operating loss carryforwards
for Federal income tax purposes of approximately $25.0 million. Because of the
change in ownership provisions of the Tax Reform Act of 1986, our net
operating loss carryforwards may be subject to an annual limitation on the
utilization of these carryforwards against taxable income in future periods if
a cumulative change in ownership of more than 50% occurs within
any three-year period. We have made no determination concerning whether there
has been such a cumulative change in ownership. However, we believe that it is
likely that such a change in ownership occurred prior to or following the
completion of the Acquisition in August 2001.

Our current financial condition is the result of several factors including
the following:



| |  |  | Our operating results were below expectations.                                                                                                                                                                                                                      
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Sales of products through channels acquired in the Acquisition are taking longer than originally anticipated to develop.                                                                                                                                            
|
| |  |  | Market demand for our Xboard product (formerly known as CipherServer
Product line) did not materialize as anticipated and therefore our sales
were below forecast.                                                                                                  
|
| |  |  | Reduced credit line availability affected the sales volume of our Pulsar subsidiary.                                                                                                                                                                                
|
| |  |  | Research and development
expenses from the Acquisition increased our costs.                                                                                                                                                                                         
|
| |  |  | The events of September 11, 2001 affected the operations and delayed
the decisions of the U.S. government. This caused sales we had
anticipated to be substantially delayed. The events may also affect
potential investors and related terms of investment capital.

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In addition to our current deficit working capital situation, current
operating plans show a shortfall of cash during 2002. We intend to mitigate our
position through one or more of the following:



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Should we not receive adequate financing, we could be forced to merge with
another company or cease operations.

While we have a history of selling products in the government markets, new
products just entering production after years of development have no sales
history. Additionally, we are entering commercial markets with our products and
are still developing

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acceptance of its offerings. Considerable uncertainty currently exists
with respect to the adequacy of current funds to support our activities beyond
December 31, 2002. This uncertainty will continue until a positive cash flow
from operations is achieved. Additionally, we are uncertain as to the
availability of financing from other sources to fund any cash deficiencies.




In order to reduce
this uncertainty, we continue to evaluate
additional financing options and may therefore elect to raise capital, from
time to time, through equity or debt financings in order to capitalize on
business opportunities and market conditions and to insure the continued
marketing of current product offerings together with development of new
technology, products and services. There can be no assurance that we can raise
additional financing in the future.







Based upon forecast sales and expense levels, we currently anticipate that
existing cash, cash equivalents, investments, term out arrangements with
vendors, the proceeds of a $5.0 million financing on April 16, 2002 described
below and the current availability under our WFBC factoring agreements will be
sufficient to satisfy our contemplated cash requirements for the next twelve
months. However, our forecast is based upon certain assumptions, which may
differ than actual future outcomes. We have incurred defaults under its
financing agreements in the past. If we incur a default in the future under our
accounts receivable line of credit or other financing instruments, we may not
be able to draw funds thereby affecting our ability to fund operations. At this
time we are currently in default and anticipate that we will continue to be in
default unless we are able to raise sufficient capital to pay debts and
obligations as they become due. Additionally, without a substantial increase in
sales or a reduction in expenses, we will continue to incur operating losses.
Simultaneous with the filing of our Annual Report on Form 10-K, we closed the
round of secured convertible promissory notes financing described above to provide $5.0 million in
additional working capital and are in discussions with several sources of
regarding up to an additional $5.0 million on the same terms and conditions.




Recent Accounting Pronouncements

On July 20, 2001, FASB issued Statements No. 141, Business Combinations
(SFAS 141) and No. 142 Goodwill and Other Intangible Assets (SFAS 142).
SFAS 141 requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. Poolings initiated prior to June 30,
2001 are grandfathered. SFAS 142 replaces the requirement to amortize
intangible assets with indefinite lives and goodwill with a requirement for an
impairment test. SFAS 142 also requires an evaluation of intangible assets and
their useful lives and a transitional impairment test for goodwill and certain
intangible assets. After the transition, the impairment tests must be performed
annually. A company must adopt SFAS 142 at the beginning of the fiscal year.
Thus, as a calendar year-end company, we must adopt SFAS. 142 no later than
January 1, 2002. we are currently examining the impact of this pronouncement on
its results of operations and financial position. While we believe there will
be a material impact, the amount has not yet been determined.

FASB recently issued SFAS 143, Accounting for Asset Retirement Obligations
(SFAS 143) which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS 143 requires an enterprise to record the fair
value of an asset retirement obligation as a liability in the period in which
it incurs a legal obligation associated with the retirement of a tangible
long-lived asset. SFAS 143 also requires the enterprise to record the contra to
the initial obligation as an increase to the carrying amount of the related
long-lived asset and to depreciate that cost over the remaining useful life of
the asset. The liability is changed at the end of each period to reflect the
passage of time and changes in the estimated future cash flows underlying the
initial fair value measurement. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. We are currently examining the impact of this
pronouncement on the results of its operations and financial position, but
currently believe the impact will not be material.

On October 3, 2001, FASB issued SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS 144), which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets
and supersedes SFAS 121. SFAS 144, retains many of the fundamental provisions
of SFAS 121. SFAS 144 also supersedes the accounting and reporting provisions
of Accounting Principle Board Opinion 30, Reporting the Results of Operations-
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB
30), for the disposal of a segment of a business. However, it retains the
requirement in APB 30 to report separately discontinued operations and extends
that reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to owners) or is classified as held for
sale. SFAS 144 is effective for fiscal years beginning after December 15, 2001
and interim periods within those fiscal years. We are currently examining the
impact of this pronouncement on its results of operations and financial
position, but currently believe the impact will not be material.

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Risk Factors

Risks Related to our Business

We have a history of losses and may incur future losses

We may not become profitable or significantly increase our revenue. We
incurred net loss of $41.4 million for the twelve month period ended December
31, 2000 and net operating losses of $43.9 million and net loss of $53.2
million for the twelve month period ended December 31, 2001. To achieve
profitability, we will need to generate and sustain sufficient revenues while
maintaining reasonable cost and expense levels. We expect to continue to incur
significant operating expenses primarily to support research and development
and expansion of our sales and marketing efforts. These expenditures may not
result in increased revenues or customer growth. We do not know when or if we
will become profitable. We may not be able to sustain or increase profitability
on a quarterly or annual basis.

Our stock price is extremely volatile

The trading price of our common stock is highly volatile as a result of
factors specific to us or applicable to our market and industry in general.
These factors, include:



| |  |  | variations in our annual or quarterly financial results or those of our competitors;                                                                                                 
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | company issued earnings announcements that vary from consensus analyst estimates;                                                                                                    
|
| |  |  | changes by financial research analysts in their recommendations or estimates of our earnings;                                                                                        
|
| |  |  | conditions in the economy in general or in the information technology service sector in particular;                                                                                  
|
| |  |  | announcements of technological innovations or new products or services by us or our competitors; and                                                                                 
|
| |  |  | unfavorable publicity or changes in applicable laws and regulations,
or their judicial or administrative interpretations, affecting us or the
information technology service sectors.

In addition, the stock market has recently been subject to extreme price
and volume fluctuations. This volatility has significantly affected the market
prices of securities issued by many companies for reasons unrelated to the
operating performance of these companies. In the past, following periods of
volatility in the market price of a companys securities, some companies have
been sued by their stockholders. If we were sued, it could result in
substantial costs and a diversion of managements attention and resources,
which could adversely affect our business.



| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have not generated any sales to date of our SSP Solution Suite, which
makes it difficult to evaluate our current business performance and future
prospects




To date, we have not had any sales of our SSP Solution Suite and have not
established a sales and marketing force to promote this product. Although we have had some success selling our security solutions to
government agencies, we are just beginning to enter the complex and competitive
commercial market for digital commerce and communication security solutions. We
believe that many potential customers in our target markets are not fully aware
of the need for security products and services in the digital economy.
Historically, only enterprises having substantial resources developed or
purchased security solutions for Internet or other means of delivering digital
content. Also, there is a perception that security in delivering digital
content is costly and difficult to implement. Therefore, we will not succeed
unless we can educate our target markets about the need for security in
delivering digital content and convince potential customers of our ability to
provide this security in a cost-effective and easy-to-use manner.

Even if we convince our target markets about the importance of and need
for such security, we do not know if this will result in the sale of our
products. We may be
unable to establish sales and marketing operations to levels necessary for us
to grow this portion of our business, especially if we are unsuccessful at
selling this product into vertical markets. We may not be able to support the
promotional programs required by selling simultaneously into several markets.
If we are unable to develop an efficient sales system, or if our
products or components do not achieve wide market acceptance, then our operating results
will suffer.




Late payments may have damaged relationships with our vendors




Should we not be able to utilize our accounts receivable financing line,
we will not have adequate cash available to pay vendors. We have incurred
defaults on our line in the past, are currently in default and anticipate we
will continue to be in default on the line unless we are able to raise
sufficient capital to pay debts and obligations as they become due. Should our
financial source not waive the defaults, the financial source may not advance
additional funds. Slow and delinquent payments may cause vendors not to sell products to us,
or only with advance payment. Should this occur, we will not have components
and services available for our products.




The average selling price of our products may decrease, which may reduce
gross margins

The average selling prices for our products may decline as a result of
competitive pricing pressures, promotional programs and customers who negotiate
price reductions in exchange for longer term purchase commitments. The pricing
of products depends on the

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specific features and functions of the products, purchase volumes and the
level of sales and service support required. We expect competition to increase
in the future. As we experience pricing pressure, we anticipate that the
average selling prices and gross margins for our products will decrease over
product life cycles. These same competitive pressures may require us to write
down the carrying value of inventory on hand, if any.



| |                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We derive a substantial portion of our revenue from a small number of
customers and, therefore, the loss of even one of these customers could
significantly and negatively impact our operating results

We depend on a limited number of customers for a substantial portion of
our revenue and many of our contracts with our significant customers are
short-term contracts. The non-renewal of any significant contract upon
expiration, or a substantial reduction in sales to any of our significant
customers, would adversely affect our business unless we were able to replace
the revenue we received from these customers. During the twelve month period
ended December 31, 2000, we derived 42% of our consolidated revenue from one
customer and during the twelve month period ended December 31, 2001, we derived
20% of our consolidated net revenue from one customer.







Our auditors opinion could adversely affect our stock price

KPMGs audit report is a going concern opinion due to our need to obtain
financing to satisfy forecasted cash requirements and the uncertainty over our
ability to continue as a going concern. This may affect our stock price and
prevent us from obtaining funding.



| |                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reliance on third party technologies for the development of the SSP
Solution Suite products and our reliance on third parties for manufacturing
may delay product launch, impair our ability to develop and deliver products
or hurt our ability to compete in the market

We have licensed the rights to use a broad array of technology components
from third parties to develop the SSP Solution Suite and we face many risks
associated with our reliance on third parties as follows:



| |  |  | a third party may develop or enable others to develop a similar
solution to digital communication security issues as the SSP Solution
Suite thereby eroding our market share; and                                                                                                     
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | dependence on the patent protection of third parties may not afford
us any control over the protection of the technologies we rely on, and,
thus, if the patent protection of any of these third parties were
compromised, our ability to compete in the market would also be
impaired.

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| |                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our inability to maintain and develop new relationships with partners and
suppliers could impact our ability to obtain or sell our products including
the SSP Solution Suite and result in a failure to generate revenues

We plan to obtain certain of our products, have products built to
specifications and sell products through alliance and supplier agreements.
While we will have direct sales channels, we currently anticipate that many of
our products will be sold through alliance and supplier partners. If alliance
or supplier agreements are cancelled, modified or delayed, if alliance or
supplier partners decide not to purchase our products or purchase only limited
quantities of our products, or if we are unable to enter into additional
alliance or supplier agreements, our ability to produce and sell our products
and, therefore, our ability to generate revenues, could be adversely affected.

Failure to license new technologies could impair our new product development

Our SSP Solution Suite is a collection of technologies, some of which are
licensed from our alliance and supplier partners. As a result, our ability to
license new technologies from third parties is and will continue to be critical
to our ability to offer a complete suite of products that meets customer needs
and technological requirements. Some of our licenses do not run for the length
of the patent for the technology. We may not be able to renew our existing
licenses on favorable terms, or at all. If we lose the rights to a patented
technology, we may need to stop selling certain of our products or redesign our
products or lose a competitive advantage. Potential competitors could license
technologies that we fail to license and potentially erode our market share for
certain products.

If PKI technology is compromised, our business would be adversely affected

Many of our products are based on PKI technology. The security afforded by
this technology depends on the integrity of a users private key, which depends
in part, on the application of algorithms, or advanced mathematical factoring
equations. The occurrence of any of the following could result in a decline in
demand for our data security products:



| |  |  | Any significant advance in techniques for attacking PKI systems,
including the development of an easy factoring method or faster, more
powerful computers;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | publicity of the successful decoding of cryptographic messages or the misappropriation of private keys; and                                               
|
| |  |  | government regulation limiting the use, scope or strength of PKI.                                                                                         












| |                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------
| | Should our stated shareholders equity fall below $10 million or our stock
price trade below $1.00 we may be de-listed by The Nasdaq National Market







The listing
requirements of The Nasdaq National Market require a company to maintain a minimum
net shareholders equity and a minimum trading price. At December 31, 2001 our
shareholders equity was $17.6 million and the closing sale
price of a share of our common stock was $3.62. Should our shareholders equity be
decreased by further losses or should our stock price fall below
$1.00, Nasdaq may take steps to de-list our stock from The Nasdaq
National Market.






| |                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Recently issued securities contain
full ratchet anti-dilution provisions which could cause large
numbers of shares of our common stock to be issued in the future




Convertible notes
issued by us in December 2001 and April 2002 contain full
ratchet anti-dilution provisions, and we are currently seeking
to raise additional capital on similar terms. This means that if we
issue common stock or securities convertible into or exercisable for
common stock at an effective price less than the conversion price,
the conversion price of the notes is automatically reduced to the
effective price of the newly issued securities. While we have no
current plans to do so, future market conditions and cash needs may
require us to issue securities at a lower price. If we do so, the
new, lower effective conversion price of the convertible notes would
cause even more shares of our common stock to be issuable, creating
the possibility of significant dilution of our earnings per share.






| |                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | If use of the Internet and other communication networks based on Internet
protocols does not continue to grow, demand for our products may not increase

Increased demand for our products depends in large part on the continued
growth of the Internet and Internet protocol-based networks and the widespread
acceptance and use of these mediums for electronic commerce and communications.
Because electronic commerce and communications over these networks are
evolving, we cannot predict the size of the market and its sustainable growth
rate. A number of factors may affect market size and growth rate, including:



| |  |  | the use of electronic commerce and communications may not increase,
or may increase more slowly than we expect;
| | - |  | ---------------------------------------------------------------------------------------------------------------

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| |  |  | the Internet infrastructure and communications services to support
electronic commerce may not be able to continue to support the demands
placed on it by continued growth; and                                                         
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the growth and reliability of electronic commerce and communications
could be harmed by delays in development or adoption of new standards
and protocols to handle increased levels of activity or by increased
governmental regulation.

We face intense competition from a number of sources

The markets for our products and services are intensely competitive and,
as a result, we face significant competition from a number of different
sources. We may be unable to compete successfully as many of our competitors
are more established, benefit from greater name recognition and have
substantially greater financial, technical and marketing resources than we
have. In addition, there are several smaller and start-up companies with which
we compete from time to time. We also expect competition to increase as a
result of consolidation in the information security technology and product
reseller industries.



| |                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Third parties could obtain access to our proprietary information or
independently develop similar technologies because of the limited protection
for our intellectual property

Our business, financial condition and operating results could be adversely
affected if we are unable to protect our intellectual property rights.
Notwithstanding the precautions we take, third parties may copy or obtain and
use our proprietary technologies, ideas, know-how and other proprietary
information without authorization or independently develop technologies similar
or superior to our technologies. In addition, the confidentiality and
non-competition agreements between us and our employees, distributors and
clients may not provide meaningful protection of our proprietary technologies
or other intellectual property in the event of unauthorized use or disclosure.
Policing unauthorized use of our technologies and other intellectual property
is difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. Furthermore, the laws of other jurisdictions may afford
little or no effective protection of our intellectual property rights.

If we are unable to raise additional capital to fund our future operations,
our business will be harmed




If we are unable to obtain additional capital to fund operations when
needed, our product development efforts would be adversely affected, causing
our business, operating results, financial condition and prospects to be
materially harmed. If we undertake or accelerate significant research and
development projects for new products, we may require additional outside
financing. We expect that, to meet our long-term needs, we will need to raise
substantial additional funds through the sale of equity securities or the
incurrence of additional debt or through collaborative arrangements. Any
additional equity financing may be dilutive to stockholders, and debt
financing, if available, may involve restrictive covenants. Collaborative
arrangements, if necessary to raise additional funds, may require us to
relinquish rights to certain technologies, products or marketing territories.
We have forecast operations for the year 2002 and project a need for cash
in excess of $10.0 million. While we closed a financing of $5.0
million simultaneously with the initial filing of our annual report on Form 10-K, this will not be adequate
if we cannot access our accounts receivable credit line, receive extended terms
from vendors, or raise additional capital. Additionally, if our sales are less
than forecast or expenses higher than forecast, our cash needs may be higher
than our current forecast. Our failure to raise capital when needed could have a significant negative
effect on our business, operating results, financial condition and prospects.













If we do not respond to rapid technological changes, our product and service
offerings could become obsolete




If we are unable to modify existing products and develop new products that
are responsive to changing technology and standards and meet customer needs in
a timely and cost effective manner, our business could be adversely affected.
The markets we serve are characterized by rapidly changing technology, emerging
industry standards and frequent introduction of new products. The introduction
of products embodying new technologies and the emergence of new industry
standards may render our products obsolete or less marketable. The process of
developing our products and services is extremely complex and requires
significant continuing development efforts.

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| |                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to establish and maintain strategic relationships, our ability to
develop and market our products would be adversely affected

The loss of any of our existing strategic relationships, or the inability
to create new strategic relationships in the future, could adversely affect our
ability to develop and market our products. We depend upon our partners to
develop and market products and to fund and perform their obligations as
contemplated by our agreements with them. We do not control the time and
resources devoted by our partners to these activities. These relationships may
not continue or may require us to spend significant financial, personnel and
administrative resources from time to time. We may not have the resources
available to satisfy our commitments, which may adversely affect our strategic
relationships. Further, our products and services may compete with the products
and services of our strategic partners. This competition may adversely affect
our relationships with our strategic partners, which could adversely affect our
business.

We may face claims of infringement of proprietary rights

There is a risk that our products infringe the proprietary rights of third
parties. In addition, whether or not our products infringe on proprietary
rights of third parties, infringement or invalidity claims may be asserted or
prosecuted against us and we could incur significant expense in defending them.
If any claims or actions are asserted against us, we may be required to modify
our products or seek licenses for these intellectual property rights. We may
not be able to modify our products or obtain licenses on commercially
reasonable terms, in a timely manner or at all. Our failure to do so could
adversely affect our business.

A security breach of our internal systems or those of our customers could
harm our business




Since we provide security for Internet and other digital
communication networks, we may become a greater target for attacks by computer
hackers. We will not succeed unless the marketplace is confident that we
provide effective security protection for Internet and other digital
communication networks. Networks protected by our products may be vulnerable to
electronic break-ins. Because the techniques used by computer hackers to access
or sabotage networks change frequently and generally are not recognized until
launched against a target, we may be unable to anticipate these techniques.
Although we have not experienced any act of sabotage or unauthorized access by
a third party of our internal network to date, if an actual or perceived breach
of security for Internet and other digital communication networks occurs in our
internal systems or those of our end-user customers, regardless of whether we
caused the breach, it could adversely affect the market perception of our
products and services. This could cause us to lose customers, resellers,
alliance partners or other business partners.






| |                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our business may be the target of cyber terrorist activities, or our revenues
may be affected by the affect of cyber terrorist activities on our customers
and/or employees

The full effects of the events on September 11, 2001 have not been
determined. The ripple effects throughout the economy may have an affect on our
potential commercial customers, or their ability to purchase our products and
services. Additionally, because we provide security products to the United
States government, we may be targeted by cyber terrorist groups for the
follow-up activities threatened against the United States based targets.

Doing business with the U.S. government entails many risks, which could
adversely affect us

Sales to U.S. government agencies accounted for 72% of our consolidated
revenue for the twelve month period ended December 31, 2001. Our sales to these
agencies are subject to risks, including:



| |  |  | early termination of our contracts;                                                                                                                  
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | disallowance of costs upon audit; and                                                                                                                
|
| |  |  | the necessity to participate in competitive bidding and proposal
processes, which is costly, time consuming and may result in
unprofitable contracts.

In addition, the government may be in a position to obtain greater rights
with respect to our intellectual property than we would grant to other
entities. Government agencies also have the power, based on financial
difficulties or investigations of its contractors, to deem contractors
unsuitable for new contract awards. Because we engage in the government
contracting business, we have been and will be subject to audits and may be
subject to investigation by governmental entities. Failure to comply with the
terms of any of our

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governmental contracts could result in substantial civil and criminal
fines and penalties, as well as our suspension from future government contracts
for a significant period of time, any of which could adversely affect our
business.

Our quarterly operating results may fluctuate significantly

Our quarterly operating results may fluctuate significantly as a result of
a variety of factors, many of which are outside our control. These factors
include:



| |  |  | the length of our customer commitments;                                                                         
| | - |  | ----------------------------------------------------------------------------------------------------------------
|
| |  |  | patterns of information technology spending by customers;                                                       
|
| |  |  | the timing, size, mix and customer acceptance of our product and service offerings and those of our competitors;
|
| |  |  | the timing and magnitude of required capital expenditures; and                                                  
|
| |  |  | the need to use outside contractors to complete some assignments.                                               



| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Delays in deliveries from our suppliers or defects in goods or components
supplied by our vendors could cause revenues to decline and adversely affect
our operating results




We rely on a limited number of vendors for certain components for the
products we are developing that will comprise the SSP Solution
Suite. If we
are unable to purchase these components, this may delay or prevent product
shipments and result in a loss of sales. In addition, if any components have
undetected flaws, this could lead to unanticipated costs to repair or replace
these parts. This could cause a loss of revenue, which would adversely affect
our results of operations. We may not be able to replace any of our supply
sources on economically advantageous terms. Further, if we experience price
increases for the components for our products, we will experience declines in
our gross margins.






| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | A default under our secured credit arrangements could result in a foreclosure
of our assets by our creditors

All of our assets are pledged as collateral to secure portions of our
debt. This means that if we default on our secured debt obligations, our
indebtedness could become immediately due and payable and the lenders could
foreclose on our assets.

Our inability to find alternative suppliers of components may adversely
affect our business

Some of the components incorporated into our products are produced by
other vendors. We currently purchase some of these components from a single
supplier, thus presenting a risk that they may not be available on commercially
reasonable terms in the future or at all. Our inability to develop alternative
sources, if necessary, may require us to re-design certain products, which
could result in delays or reductions in product shipments that could adversely
affect our business.

We depend on key management personnel




Our success will depend largely on the continuing efforts of our executive
officers and senior management. Our business may be adversely affected if the
services of any of our key personnel become unavailable to us. There is a risk
that these individuals will not continue to serve for any particular period of
time. While we have obtained a $3 million key person life insurance policy on the life of
Kris Shah, our co-chairman and co-chief executive officer, this amount may not be sufficient to offset the loss of his service.
We have not yet obtained any such policies on the lives of our other key
executives.









| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There is significant competition in our
industry for highly skilled employees,
and our failure to attract and retain technical personnel would adversely
affect our business




We may not be able to attract or retain highly skilled employees. Our
inability to hire or retain highly qualified individuals may impede our ability
to develop, install, implement and service our software and hardware systems,
customers and potential customers or efficiently conduct our operations, all of
which may adversely affect our business. The data security and networking
solution industries are characterized by a high level of employee mobility, and
the market for highly qualified individuals in the computer-related fields is
intense. This competition means there are fewer highly qualified employees
available to hire and the costs of hiring

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and retaining these individuals are high. Even if we are able to hire
these individuals, we may be unable to retain them. Furthermore, there is
increasing pressure to provide technical employees with stock options and other
equity interests, which may dilute earnings per share.












| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | We may be exposed to potential liability for actual or perceived failure to
provide required products or services







Products as complex as those we offer may contain undetected errors or
result in failures when first introduced or when new versions are released.
Despite our product testing efforts and testing by current and potential
customers, it is possible that errors will be found in new products or
enhancements after commencement of commercial shipments. The occurrence of
product defects or errors could result in adverse publicity, delay in product
introduction, diversion of resources to remedy defects, loss of or a delay in
market acceptance or claims by customers against us, or could cause us to incur
additional costs, any of which could adversely affect our business.










Because our customers rely on our products for critical security
applications, we may be exposed to potential liability claims for damage caused
to an enterprise as a result of an actual or perceived failure of our products.
An actual or perceived breach of enterprise network or data security systems of
one of our customers, regardless of whether the breach is attributable to our
products or solutions, could adversely affect our business reputation.

Furthermore, our failure or inability to meet a customers expectations in
the performance of our services, or to do so in the time frame required by the
customer, regardless of our responsibility for the failure, could:

     result in a claim for substantial damages against us by the customer;

     discourage customers from engaging us for these services; and

     damage our business reputation.

In addition, as a professional services provider, a portion of our
business involves employing people and placing them in the workplace of other
businesses. Therefore, we are also exposed to liability for actions taken by
our employees while on assignment.

Our efforts to expand international operations are subject to a number of
risks

We are currently seeking to increase our international sales. Our
inability to maintain or to obtain federal or foreign regulatory approvals
relating to the import or export of our products on a timely basis could
adversely affect our ability to expand our international business.
Additionally, our international operations could be subject to a number of
risks, any of which could adversely affect our future international sales,
including:



| |  |  | increased collection risks;                                   
| | - |  | --------------------------------------------------------------
|
| |  |  | trade restrictions;                                           
|
| |  |  | export duties and tariffs;                                    
|
| |  |  | uncertain political, regulatory and economic developments; and
|
| |  |  | inability to protect our intellectual property rights.        



| |                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our ability to produce the Forté PKI card on a timely and cost-effective
basis depends on the availability of a computer chip from a third-party
supplier, with whom we do not expect to maintain a supply agreement

Any inability to receive adequate supplies of Atmel Corporations
specially designed Forté microprocessor would adversely affect our ability to
sell the Forté PKI card. We do not anticipate maintaining a supply agreement
with Atmel for the Forté microprocessor. If Atmel were unable to
deliver the Forté microprocessor for a lengthy period of time or terminated its
relationship

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with us, we would be unable to produce the Forté PKI card until we could
design a replacement computer chip for the Forté microprocessor. We anticipate
this would take substantial time and resources to complete.






| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There are lawsuits pending against us and our wholly-owned subsidiary,
Pulsar, which, if resolved against either us or Pulsar, could adversely
affect our business







During the second
quarter of 2001 Microsoft notified us regarding
the alleged sales of unlicensed copies of Microsoft Office. The software in
question was purchased from a major computer hardware manufacturer and was
resold to one of our customers in a package that included both hardware and
software. We are currently investigating the matter, and do not anticipate that
the outcome will have a material impact on our results of operations, financial
condition or liquidity.




In addition, there is a lawsuit pending against Pulsar which, if resolved
against Pulsar, could materially and adversely affect our financial condition.
This suit was brought by G2 Resources, Inc. alleging breach of contract by
Pulsar. This suit was dismissed but G2 Resources has refiled the suit. Dell
Marketing LLC has filed suit to collect approximately $322,000 owed for
equipment purchased for re-sale through Pulsar.



| |                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------
| | We have anti-takeover defenses that could delay or prevent an acquisition and
could adversely affect the price of our common stock

Our certificate of incorporation and bylaws contain provisions that may
deter a takeover or a change in control or prevent an acquisition not approved
by our board of directors, or that may adversely affect the price of our common
stock.






| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | Governmental regulations affecting
security of Internet and other digital
communication networks could limit the market for our products and services




The United States and other foreign governments have imposed controls,
export license requirements and restrictions on the import or export of some
technologies, including encryption technology. Any additional governmental
regulation of imports or exports or failure to obtain required export approval
of our encryption technologies could delay or prevent the acceptance and use of
encryption products and public networks for secure communications and could
limit the market for our products and services. In addition, some foreign
competitors are subject to less rigorous controls on exporting their encryption
technologies and, as a result, they may be able to compete more effectively
than us in the United States and in international security markets for Internet
and other digital communication networks. In addition, certain governmental
agencies, such as the Federal Communications Commission, periodically issue
regulations governing the conduct of business in telecommunications markets
that may negatively affect the telecommunications industry and us.



| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | A small number of shareholders, who include certain of our officers and
directors, have the ability to control shareholder votes




Kris Shah, Marvin Winkler, their affiliates and certain family members
own, in the aggregate, approximately 60.0% of our outstanding common stock.
These shareholders, if acting together, have the ability to elect our directors
and to determine the outcome of corporate actions requiring shareholder
approval, irrespective of how our other shareholders may vote. This
concentration of ownership may also have the effect of delaying or preventing a
change in control of our company.




Risks Related to the Acquisition

The anticipated benefits of the Acquisition may not be realized

The anticipated benefits of the Acquisition may not be realized due to a
number of factors. For example:



| |  |  | The anticipated management synergies and operational efficiencies of
the Acquisition may not be realized.                    
| | - |  | -----------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The anticipated increase in sales resulting from the combined efforts
and combined distribution channels may not be realized.

37



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##### Table of Contents






We may not successfully integrate our business with BIZ, which could harm
future earnings




As a result of the Acquisition, we face challenges in integrating our
products and services with those of BIZ and this may continue for some time.
The integration might not be smooth or successful. The integration of certain
operations requires the dedication of management resources, which may
temporarily distract managements attention from the day-to-day business of the
combined company. The business of the combined company may also be disrupted by
employee uncertainty and lack of focus during the integration. If this occurs,
the anticipated advantages from the Acquisition could be undermined and our
business, financial condition and results of operations could be adversely
impacted.






| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our inability to integrate our
management team with BIZs management team may
adversely affect our ability to realize the expected benefits of the
Acquisition







The success of the recent Acquisition depends, in part, on our ability to
unite the members of our respective management teams. Combining management from
BIZ and our company has resulted in changes that affect all employees and
operations. Differences in corporate cultures, strategies and management
philosophies may strain employee relations. Additionally, if we encounter
difficulties in integrating our management teams, our ability to realize the
expected benefits from the Acquisition, including management synergies,
operational efficiencies and increased sales, could be adversely affected.




Unanticipated costs relating to the recent acquisition could reduce our
future earnings

We believe that we reasonably estimated the likely costs of integrating
our operations with the operations of BIZ and the incremental costs of
operating as a combined company. It is possible, however, that unexpected
transaction costs, such as taxes, fees or professional expenses, or unexpected
future operating expenses, such as increased personnel costs, as well as other
types of unanticipated developments, could adversely impact our business and
profitability.

Acquisition-related accounting charges may delay or reduce our profitability

We have accounted for the Acquisition as a purchase. Under the
purchase method of accounting, the purchase price is allocated to the
fair value of the identifiable tangible and intangible assets and liabilities
that we acquired from BIZ. The excess of the purchase price over BIZs tangible
net assets results in intangible assets for us that will have to be amortized
over their useful lives with the exception of goodwill based on the adoption of
SFAS 142 in the first quarter of 2002. In addition, we incurred an in-process
research and development charge of $1.6 million in connection with our Acquisition. As a result, we will incur accounting charges from the
Acquisition that may delay and reduce our profitability. We also incurred
charges of $36.3 million to record the impairment in value of assets acquired.



| |                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Recently issued FASB statements require us to evaluate the fair values of
intangible assets and goodwill that we acquired in the Acquisition that could
result in significant charges to our earnings and may adversely affect the
market price of our common stock

In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement 141, Business Combinations, and Statement 142, Goodwill and Other
Intangible Assets. The changes included in these statements require companies
to perform impairment tests on goodwill and certain intangibles using a fair
value approach rather than allowing companies to amortize goodwill and certain
intangibles over their estimated useful lives. We are now required to evaluate
periodically whether intangible assets and goodwill that we acquired in the
Acquisition have fair values that meet or exceed the amounts recorded on our
balance sheet. We cannot predict whether or when there will be an impairment
charge, or the amount of such charge, if any. However, if the charge is
significant, it could cause the market price of our common stock to decline. In
addition, adoption of the SFAS 142 will eliminate recurring amortization
charges that would remove certain intangible assets and goodwill from our
balance sheet, and such amounts will remain permanently on our balance sheet
unless future evaluations require us to record impairment charges.







Item 7a. Quantitative and Qualitative Disclosures about Market Risk




We own Class A common stock of Wave, which is classified as
trading securities. The stock is listed on The Nasdaq National Market. The
increase or decrease in value of the stock is included in our statement of
operations together with the gain or loss on sales of the stock.




38



---



##### Table of Contents









Item 8. Financial Statements and Supplementary Data

Reference is made to the financial statements included in this Report at
pages F-1 through F-30.







Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

Not Applicable.







PART III







Item 10. Directors and Executive Officers of the Registrant

Set forth below is information regarding our executive officers, directors
and director nominee.

|                        |  |     |    |          |  |                                                                                                            
|----------------------- |  | --- | -- | -------- |  | -----------------------------------------------------------------------------------------------------------
|Name                    |  | Age |    | Position
|                        |  |     |    |         
|Kris Shah               |  |     | 62 |          |  | Co-Chairman of the Board of Directors, Director,
Co-Chief Executive Officer, Secretary and Director
Nominee
|Marvin J. Winkler       |  |     | 47 |          |  | Co-Chairman of the Board of Directors, Director and
Co-Chief Executive Officer                             
|Richard M. Depew        |  |     | 41 |          |  | President and Chief Operating Officer                                                                      
|Thomas E. Schiff        |  |     | 51 |          |  | Chief Financial Officer and Executive Vice President                                                       
|Robert J. Gray          |  |     | 65 |          |  | Vice President, Product Development and Embedded
Systems and Chief Technical Officer                       
|Gregg Amber (1)(2)      |  |     | 45 |          |  | Director                                                                                                   
|Bruce J. Block (1)      |  |     | 54 |          |  | Director                                                                                                   
|Matthew Medeiros (1)(2) |  |     | 46 |          |  | Director                                                                                                   



---

|(1) |  | Member of audit committee       
|--- |  | --------------------------------
|(2) |  | Member of compensation committee

Kris Shah is our co-chairman of the board of directors, director, co-chief
executive officer and secretary. Mr. Shah has been our chairman of the board of
directors, director and chief executive officer since he founded our Company in
1970 and began sharing these positions with Mr. Winkler in August 2001
following the merger with BIZ. Mr. Shah has served as our secretary since May
2001. In addition, from September 2000 until August 2001, Mr. Shah served as
our president. Mr. Shahs career has involved every major aspect of circuit
design and chip packaging technology, including research and development,
manufacturing, engineering, marketing and strategic planning. Before forming
our Company, Mr. Shah held management level positions at Hughes Aircraft Co.,
Fiberite Inc. and Bell Industries, Inc. Mr. Shah holds B.S. and M.S. degrees in
mechanical engineering from the University of Southern California.




Marvin J. Winkler is our co-chairman of the board of directors, director
and co-chief executive officer, positions he has held since August 2001
following the merger with BIZ. Prior to that and since April 2000, Mr. Winkler
served as the chief executive officer, chairman of the board of directors and
director of BIZ. Mr. Winkler founded BIZ to address the secure processing and
applications required to ensure secure high-speed knowledge and financial
transactions across the Internet. He also established the industrys first
Core-To-Edge solution set of hardware, software and firmware products and
applications for security in electronic commerce. In June 1999, Mr. Winkler
partnered with principals of Broadcom Corporation to co-found Broadband
Interactive Group (BIG) to demonstrate the applications for interactive television in
a convergent broadband media industry. In November 2001 BIG made an assignment for the benefit of its creditors. In August 1996, Mr. Winkler acquired
Gotcha International, L.P., an apparel manufacturer, and has served as its
president and chief executive officer since that time.




Richard M. Depew was appointed as our president and chief operating
officer in August 2001. From July 1998 until he began serving in these
positions, Mr. Depew served as executive vice president of Certicom Inc. and as
president of its wholly-owned subsidiary Certicom International, a wireless
security company. From December 1995 until he joined Certicom, Mr. Depew served
as our vice president and general manager of information security. Mr. Depew
holds a BSEF (equivalent, engineer first class) in electronics engineering
technology from the United States Coast Guard and holds a certificate from the
Southern Methodist University M.B.A. program in entrepreneurial studies.

39



---



##### Table of Contents



Thomas E. Schiff has served as our executive vice president and chief
financial officer since the merger with BIZ in August 2001. Prior to that, Mr.
Schiff served as the executive vice president, chief financial officer,
treasurer, secretary and a member of the board of directors of BIZ since its
inception in April 2000. From December 1998 to June 2001, he was an executive
vice president and chief financial officer for SW Gotcha Acquisition Ltd and
Gotcha International, L.P. From March 1996 to December 1998, Mr. Schiff was
executive vice president and chief financial officer of Pacific Eyes & Ts. Mr.
Schiff was formerly a certified public accountant for the San Francisco office
of Peat, Marwick, Mitchell. He holds a degree in economics from Stanford
University and an M.B.A. degree from the Stanford Graduate School of Business.

Robert J. Gray is our vice president, product development and embedded
systems and chief technical officer. Mr. Gray joined our Company in May 1990.
Mr. Gray served as president of Cyphernet, Inc., a division of Codercard, Inc.,
a data security company, from January 1985 to May 1990. Mr. Gray has also
served as president of Genisco Computers Corp., a manufacturer of computer
graphics and imaging hardware for the computer aided design, image processing
and simulation markets. After obtaining his education in meteorology,
oceanography and computer sciences from various military schools including the
Naval Postgraduate School in Monterey, California, Mr. Gray served as an
officer in the U.S. Navy for 22 years, specializing in meteorology and computer
sciences.

Gregg Amber has been serving as one of our directors since April 2000.
From March 2000 until May 2001, Mr. Amber also served as our secretary. Mr.
Amber is currently a partner with the law firm of Rutan & Tucker, LLP. From
December 1999 until July 2000, Mr. Amber was the senior vice president,
secretary and general counsel for ZLand.com, Inc. From March 1998 through
November 1999, Mr. Amber was a partner with the law firm of Rutan & Tucker,
LLP. Prior to that time, and since June 1995, he was a partner with the law
firm of Snell & Wilmer LLP. Mr. Amber holds a B.A. degree in political science
and mathematics from Principia College and a J.D. degree from Stanford Law
School.




Bruce J. Block has been serving as one of our directors since August 2001.
Since May 2000, Mr. Block has been serving as the senior vice president,
technology of the Recording Institute of America (RIAA). In this position, he
manages the technology oversight program, specific technology initiatives and
efforts in the area of standards development. From July 1996 until May 2000,
Mr. Block was the chief technology officer and vice president, business
development of musicmaker.com, a web-based electronic commerce media company.
Prior to joining musicmaker.com, Mr. Block founded and served as the president
and chief executive officer of Spaceworks, Inc., a business-to-business,
electronic commerce company. Mr. Block holds a B.S. degree from the City
College of New York, an M.B.A. degree from American University and a
Certificate in Health Care Administration from Boston University.




Matthew Medeiros has been serving as one of our directors since June 1999.
Since February 1998, Mr. Medeiros has been serving as chairman of the board of
directors, director and chief executive officer of Philips Flat Display
Systems. Before joining Philips Flat Display Systems, Mr. Medeiros served as
vice president and general manager for the optical polymers group, and as vice
president of business development for the electronic materials division of
Allied Signal Inc. from January 1996 to February 1998. Mr. Medeiros has also
previously served in executive positions with Radius, Inc., NeXT Computer and
Apple Computer, Inc. in which positions he developed an extensive background in
personal computer manufacturing, operations and materials management. Mr.
Medeiros holds a B.S. degree in business administration, management science and
finance from the University of San Francisco.

There are no family relationships among our officers and directors.

Section 16(a) Beneficial Ownership Reporting Compliance




Section 16(a) of the Exchange Act and the regulations thereunder, require
the directors, executive officers and persons who beneficially own more than 10% of a
registered class of our equity securities to file with the Commission, initial
reports of ownership and reports of changes in ownership of our common stock
and other equity securities, and to furnish us with copies of all Section 16(a)
forms that they file.







During the fiscal year ended December 31, 2001, the following directors,
executive officers and persons beneficially owning more than 10% of our outstanding equity
securities failed to file on a timely basis, reports under Section 16(a):









| |  |  | Bruce J. Block and Thomas E. Schiff each failed to file, on a timely
basis, a Form 4 to report options to purchase shares of our common stock
received in connection with the merger with BIZ.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Richard M. Depew failed to file, on a timely basis, a Form 3 to
report his initial beneficial ownership of our equity securities upon
becoming an executive officer of our company.           




40



---



##### Table of Contents





| |  |  | JAW Financial, L.P., a limited partnership owning more than 10% of
our outstanding equity securities failed to file, on a timely basis, a
Form 3 to report its initial beneficial ownership of our equity
securities. JAW Lending, Inc., as general partner of JAW Financial, L.P.
also failed to file on a timely basis, a Form 3 to report its initial
beneficial ownership of our equity securities.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Wave failed to file a
Form 3 to report its initial beneficial ownership of our equity
securities received in connection with the Acquisition. Wave also
failed to file five Form 4s to report five transactions.                                                                                                                                                                                       
|




Each of the
transactions described above have been subsequently reported except
that Wave is in the process of preparing and filing its delinquent
forms.










Item 11. Executive Compensation

|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                        |   |  |  |   |   |  |  |   |   | 
|--------------------------------------------------------------------- | ------------------------------------------------ | ------ | ---- | ------ |  | ----- | ------------------- | ------------ |  | ------ | -------------------------- | ------------ | ------ | ------- | ----- | ------------ | ---------- | ---- | ---------- | --------- |  |  | ---------------------- | - |  |  | - | - |  |  | - | - | 
|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        | Summary Compensation Table |              |        |         |       |              |            |      |            |           |  |  |                       
|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                       
|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  | Long-Term Compensation |   |  |  |  
|                                                                      |                                                  |        |      |        |  |       | Annual Compensation |              |  |        |                            |              | Awards |         |       |              |           
|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |           
|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         | Other |              | Restricted |      | Securities |           |  |  |                        |   |  |  |  
|Name and                                                              |                                                  | Fiscal |      |        |  |       |                     |              |  |        |                            | Annual       |        | Stock   |       | Underlying   |            | LTIP |            | All Other
|Principal Positions                                                   |                                                  | Year   |      | Salary |  | Bonus |                     | Compensation |  | Awards |                            | Options/SARs |        | Payouts |       | Compensation
|                                                                      |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |             
|Kris Shah,                                                            |                                                  |        | 2001 |        |  | $     | 236,908             |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  |                       |   |  |  |  |   |  |  | * |  
|Co-Chairman of the                                                    |                                                  |        | 2000 |        |  | $     | 181,375             |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  |                       |   |  |  |  |   |  |  | * |  
|                                                                      | Board, Director,                                 |        |      | 1999   |  |       | $                   | 201,176      |  |        |                            |             |        |         |       |             |            |      |            |          |  |  |                        |  |  |  |   |  |  |  |   | * | 
|                                                                      | Co-Chief Executive
Officer and Secretary         |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                        |   |  |  |   |   |  |  |   |   | 
|Marvin J. Winkler,                                                    |                                                  |        | 2001 |        |  | $     | 34,615              |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  |                       |   |  |  |  |   |  |  | * |  
|Co-Chairman of the
Board, Director and
Co-Chief Executive
Officer (1) |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                        |   |  |  |   |   |  |  |   |  
|Richard M. Depew,                                                     |                                                  |        | 2001 |        |  | $     | 60,333              |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  | 220,000                |   |  |  |  |   |  |  | * |  
|President and Chief
Operating Officer (1)                             |                                                  |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                        |   |  |  |   |   |  |  |   |  
|Thomas E. Schiff,                                                     |                                                  |        | 2001 |        |  | $     | 48,096              |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  | 47,512                 |   |  |  |  |   |  |  | * |  
|                                                                      | Chief Financial
Officer (1)                      |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                        |   |  |  |   |   |  |  |   |   | 
|Robert J. Gray,                                                       |                                                  |        | 2001 |        |  | $     | 126,258             |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  | 10,000                 |   |  |  |  |   |  |  | * |  
|Vice President,                                                       |                                                  |        | 2000 |        |  | $     | 119,583             |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  | 10,000                 |   |  |  |  |   |  |  | * |  
|Product Development                                                   |                                                  |        | 1999 |        |  | $     | 101,329             |              |  |        |                           |              |        |         |      |              |            |      |           |           |  |  |                       |   |  |  |  |   |  |  | * |  
|                                                                      | and Embedded
Systems and Chief
Technical Officer |        |      |        |  |       |                     |              |  |        |                            |              |        |         |       |              |            |      |            |           |  |  |                        |   |  |  |   |   |  |  |   |   | 



---

|*   |  | The executive officers also received other fringe benefits from us in
their capacities as executive officers; however, those benefits were less
than $50,000.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | Messrs. Winkler, Depew
and Schiff joined our Company in August 2001. Their current annual
salaries are $187,000, $181,000 and $139,400, respectively.        
|   

41



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##### Table of Contents



Option Grants In Last Fiscal Year




The following table provides information regarding options granted in the
fiscal year ended December 31, 2001 to the executive officers named in the
summary compensation table. We did not grant any stock appreciation rights in
the year ended December 31, 2001. This information includes hypothetical
potential gains from stock options granted in fiscal 2001. These hypothetical
gains are based entirely on assumed annual growth rates of 5% and 10% in the
value of our common stock price over the 10-year life of the stock options
granted in 2001. These assumed rates of growth were selected by the Commission for illustrative purposes only and are not intended to
predict future stock prices, which will depend upon market conditions and our
future performance and prospects.







|                     |  |       |         |                 |  |                   |         |            |  |            |      |    |  |    |      |                 |  |                  |         |                  |  |  |        |  |  |  |         |  |  |  |           | 
|-------------------- |  | ----- | ------- | --------------- |  | ----------------- | ------- | ---------- |  | ---------- | ---- | -- |  | -- | ---- | --------------- |  | ---------------- | ------- | ---------------- |  |  | ------ |  |  |  | ------- |  |  |  | --------- | 
|                     |  |       |         |                 |  | Individual Grants |         |            |  |            |      |    |  |    |      |                 |  |                  |         |                  |  |  |        |  |  |  |         |  |  | 
|                     |  |       |         |                 |  |                   |         |            |  |            |      |    |  |    |      |                 |  |                  |         | Potential       
|                     |  |       |         |                 |  |                   |         |            |  | Percentage |      |    |  |    |      |                 |  |                  |         | Realizable Value
|                     |  |       |         |                 |  |                   |         |            |  | of Total   |      |    |  |    |      |                 |  |                  |         | at Assumed Rates
|                     |  |       |         |                 |  |                   |         |            |  | Options    |      |    |  |    |      |                 |  |                  |         | of Stock Price  
|                     |  |       |         |                 |  | Number of         |         | Granted to |  |            |      |    |  |    |      |                 |  | Appreciation for
|                     |  |       |         |                 |  | Securities        |         | Employees  |  | Exercise   |      |    |  |    |      | Option Term (2)
|                     |  | Grant |         | Underlying      |  | in Fiscal         |         | Price Per  |  | Expiration |      |   
|Name                 |  | Date  |         | Options Granted |  | Year (1)          |         | Share      |  | Date       |      | 0% |  | 5% |      | 10%            
|                     |  |       |         |                 |  |                   |         |            |  |            |      |    |  |    |      |                
|Kris Shah            |  |       |        |                 |  |                   |        |            |  |            |     |    |  |    |     |                 |  |                  |        |                  |  |  |       |  |  |  |        |  |  |  |          | 
|Marvin J. Winkler    |  |       |        |                 |  |                   |        |            |  |            |     |    |  |    |     |                 |  |                  |        |                  |  |  |       |  |  |  |        |  |  |  |          | 
|Richard M. Depew (3) |  |       | 8/16/01 |                 |  |                   | 220,000 |            |  |            | 44.8 | %  |  | $  | 3.14 |                 |  |                  | 8/16/11 |                  |  |  |       |  |  |  | 434,500 |  |  |  | 1,100,880 | 
|Thomas E. Schiff (4) |  |       | 5/29/01 |                 |  |                   | 47,512  |            |  |            | 9.7  | %  |  | $  | 2.11 |                 |  |                  | 5/29/11 |                  |  |  | 87,422 |  |  |  | 205,252 |  |  |  | 386,748   | 
|Robert J. Gray (5)   |  |       | 1/2/01  |                 |  |                   | 10,000  |            |  |            | 2.0  | %  |  | $  | 2.50 |                 |  |                  | 1/2/11  |                  |  |  |       |  |  |  | 15,720  |  |  |  | 39,840    | 






---

|   
|---
|(1)
|   
|(2)
|   
|(3)
|   
|(4)
|(5)

Aggregated Option Exercises in Last Fiscal Year And Fiscal Year-End Option Values

The following table provides information regarding stock options exercised
in the fiscal year ended December 31, 2001 by the executive officers named in
the summary compensation table, as well as the number of exercisable and
unexercisable in-the-money stock options and their values at fiscal year end.
An option is in-the-money if the fair market value for the underlying
securities exceeds the exercise price of the option.




|                  |  |             |   |          |  |             |   |                   |  |                        |        |                         |  |  |         |  |  |   |         |  |  |   |         | 
|----------------- |  | ----------- | - | -------- |  | ----------- | - | ----------------- |  | ---------------------- | ------ | ----------------------- |  |  | ------- |  |  | - | ------- |  |  | - | ------- | 
|                  |  |             |   |          |  |             |   |                   |  | Number of              |        |                         |  |  |         |  |  |  
|                  |  |             |   |          |  |             |   |                   |  | Securities Underlying  |        | Value of Unexercised   
|                  |  |             |   |          |  |             |   |                   |  | Unexercised Options at |        | In-the-Money Options at
|                  |  | Shares      |   |          |  |             |   | December 31, 2001 |  | December 31, 2001(1)  
|                  |  | Acquired    |   | Value    |  |             |   |                  
|Name              |  | on Exercise |   | Realized |  | Exercisable |   | Unexercisable     |  | Exercisable            |        | Unexercisable          
|                  |  |             |   |          |  |             |   |                   |  |                        |        |                        
|Kris Shah         |  |             |  |          |  |             |  |                   |  |                        |       |                         |  |  |        |  |  |   |        |  |  |   |        | 
|Marvin J. Winkler |  |             |  |          |  |             |  |                   |  |                        |       |                         |  |  |        |  |  |   |        |  |  |   |        | 
|Richard M. Depew  |  |             |  |          |  |             |  |                   |  |                        | 20,000 |                         |  |  | 200,000 |  |  | $ | 9,600   |  |  | $ | 96,000  | 
|Thomas E. Schiff  |  |             |  |          |  |             |  |                   |  |                        | 95,025 |                         |  |  | 142,536 |  |  | $ | 143,488 |  |  | $ | 215,229 | 
|Robert J. Gray    |  |             |  |          |  |             |  |                   |  |                        | 2,000  |                         |  |  | 18,000  |  |  |   |        |  |  | $ | 11,200  | 




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|(1) |  | Based on the last reported sale price of underlying securities ($3.62) on
December 31, 2001 as reported by The Nasdaq National Market, minus the
exercise price of the options.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Directors Compensation

Directors receive no cash compensation for serving on our board of
directors or any committee although directors are reimbursed for expenses
incurred in attending board and committee meetings. No compensation is paid for
attending meetings of committees of our board of directors on which directors
serve. We may periodically award options or warrants to our directors under our
existing stock option plans and otherwise.

During fiscal year 2001, Bruce J. Block was granted an option to purchase
up to 19,005 shares of our common stock at an exercise price of $2.11 per
share, which shares vested 25% on April 30, 2001, with the remainder vesting
1/48 per month for 36 months.

Employment Agreements

Kris Shah has entered into a two-year employment agreement with us,
effective as of June 9, 1999. This agreement provides that, after the initial
term, it will automatically renew for successive one-year terms unless it is
terminated by us or by Mr. Shah through written notice given to the other party
90 days before the expiration of the then current term. Our board of directors
may adjust Mr. Shahs salary. Mr. Shah is also entitled to receive an annual
bonus award of $100,000 if we have earnings in excess of $2,500,000 or more and
an additional $37,500 for each additional $1,000,000 of earnings in excess of
$2,500,000. In making the calculation for the bonus, we will measure earnings
before interest and taxes and will add back the amortization of goodwill and
other intangibles.

Mr. Shahs employment agreement provides that, in addition to being
terminated through the notice feature described above, employment may be
terminated as follows:



| |  |  | by Mr. Shah if he has good reason to terminate the agreement. Good reason exists if:
| | - |  | ------------------------------------------------------------------------------------

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| |  |  | by us if we determine that due cause for termination exists. Due cause exists if we find that Mr. Shah:
| | - |  | -------------------------------------------------------------------------------------------------------

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| |  |  | Additionally, we can terminate the terms of the agreement upon Mr. Shahs:
| | - |  | --------------------------------------------------------------------------

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| |  |  | disability for more than 180 days after we give 30 days notice
of our intention to terminate the employment agreement; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------
|
| |  |  | retirement.                                                                                                               

We may be obligated to make payments to Mr. Shah upon termination of
employment depending on the circumstances surrounding the termination. If the
employment agreement is terminated by Mr. Shah after giving notice, by us for
cause, or by Mr. Shah in breach of the agreement, we will not be obligated to
pay any compensation after the termination date, except:



| |  |  | employee benefits;                                                         
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | unpaid base salary that Mr. Shah has earned but which we have not paid; and
|
| |  |  | vested stock options.                                                      

If the employment agreement is terminated by Mr. Shah for good reason or
by us through a constructive termination, we will be obligated to pay Mr. Shah:



| |  |  | his annual salary for the greater of the balance of the term of the employment agreement or for a period of two years;
| | - |  | ----------------------------------------------------------------------------------------------------------------------
|
| |  |  | a pro rata bonus for the fiscal year in which the termination occurs;                                                 
|
| |  |  | continuing medical and life employee benefits for six months after the termination; and                               
|
| |  |  | vested stock options.                                                                                                 

Mr. Shahs employment agreement also contains non-compete, confidentiality
and non-disclosure clauses designed to protect our intellectual property.
Additionally, the agreement contains a provision designed to preclude Mr. Shah
from claiming rights to any products or technologies he developed while in our
employ or for a two-year period following his termination.




Richard M. Depew has entered into an employment agreement with us,
effective as of August 16, 2001 and terminating on August 31, 2003 pursuant to
which Mr. Depew agreed to act as our president and chief operating officer. In
exchange for his services as our president and chief operating officer, Mr.
Depew is entitled to an annual base salary of $175,000 and to an incentive
bonus payable each year, equal to the product of $100,000 multiplied by a
percentage calculated by our board of directors which percentage shall be based
upon our Companys stock price, total revenues and net income before taxes. Mr.
Depew was also granted an option to purchase up to 220,000 shares of common
stock under our Amended and Restated 1999 Stock Option Plan at an exercise
price equal to $3.14 per share, the closing price of a share of our common on
August 16, 2001. 20,000 of these shares vested on August 16, 2001 and the
remaining shares vest 20% annually over five years commencing one
year from grant date.






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Mr. Depews employment agreement provides that, other than by expiration
of the term of the agreement, employment may be terminated as follows:

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| |  |  | by Mr. Depew, at any time upon proper notice to us;                                                        
| | - |  | -----------------------------------------------------------------------------------------------------------
|
| |  |  | by us if our co-chairmen of determine that the termination is for due cause. Due cause exists if Mr. Depew:

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We may have the following obligations to Mr. Depew upon termination of
employment if the employment agreement is terminated by us, other than for due
cause, due to Mr. Depews disability or death or Mr. Depew having reached the
age of 65, or by Mr. Depew, with good reason:



| |  |  | to pay his base salary in effect as of the date of termination
through the end of the month during which such termination occurs plus
credit for any vacation earned but not taken;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | to pay 50% of his annual base salary;                                                                                                                                              
|
| |  |  | to pay a prorated bonus for the calendar year during which termination occurs;                                                                                                     
|
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| |  |  | to pay his automobile
allowance for the six month period after the date of termination; and                                                                                        
|

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|
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|

If the employment relationship is terminated by Mr. Depew, with proper
notice, or by us, for due cause or because Mr. Depew refuses to continue his
employment and fails to give proper notice, we will not be obligated to pay any
compensation after the termination date, except:



| |  |  | those benefits that are provided by retirement and benefit plans and
programs specifically adopted and approved by us for Mr. Depew that are
earned and vested by the date of termination;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Mr. Depews pro rata annual salary through the date of termination;                                                                                                                       
|
| |  |  | any stock options which have vested as of the date of termination; and                                                                                                                    
|
| |  |  | accrued vacation as required by California law.                                                                                                                                           

If Mr. Depews employment relationship is terminated due to his incapacity
or death, we are obligated to provide those benefits that are provided by
retirement and benefits plans and programs specifically adopted and approved by
us for Mr. Depew that are earned and vested at the date of termination, and a
prorated bonus for the calendar year in which incapacity or death occurs.









The employment agreement with Mr. Depew also contains non-competition and
nonsolicitation clauses as well as representations and warranties from Mr.
Depew that in performing his duties as our president and chief operating
officer, he has not and will not violate any agreements of confidentiality to
which he has entered into with any third parties. These clauses and
representations and warranties are designed to protect our intellectual
property.

Compensation Committee Interlocks and Insider Participation in Compensation
Decisions















Item 12. Security Ownership of Certain Beneficial Owners and Management

As of April 26, 2002, a total of 20,664,832 shares of our common stock
were outstanding. The following table sets forth information as of that date
regarding the beneficial ownership of our common stock by:



| |  |  | each of our directors;                                                                                                           
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | each of our executive officers named in the summary compensation table;                                                          
|
| |  |  | all of our directors and executive officers as a group; and                                                                      
|
| |  |  | each person known by us to beneficially own 5% or more of the
outstanding shares of our common stock as of the date of the table.

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Except as indicated below, the address for each named beneficial owner is
the same as ours. The inclusion of shares in this table as beneficially owned
is not an admission of beneficial ownership. Percentages shown as an asterisk
represent less than 1.00%.




|                                                            |  |                      |                      |  |  |  |       |  
|----------------------------------------------------------- |  | -------------------- | -------------------- |  |  |  | ----- | -
|                                                            |  | Beneficial Ownership
|                                                            |  | of Common Stock     
|                                                            |  |                     
|                                                            |  | Number               | Percentage of Common
|Name of Beneficial Owner                                    |  | of Shares            | Stock               
|                                                            |  |                      |                     
|Kris Shah                                                   |  |                      | 5,447,484            |  |  |  | 26.23 | %
|Marvin J. Winkler                                           |  |                      | 7,231,037            |  |  |  | 34.82 | %
|Richard M. Depew                                            |  |                      | 21,000               |  |  |  | *     |  
|Thomas E. Schiff                                            |  |                      | 126,899              |  |  |  | *     |  
|Robert J. Gray                                              |  |                      | 86,413               |  |  |  | *     |  
|Matthew Medeiros                                            |  |                      | 19,500               |  |  |  | *     |  
|Gregg Amber                                                 |  |                      | 23,295               |  |  |  | *     |  
|Bruce J. Block                                              |  |                      | 9,899                |  |  |  | *     |  
|Wave Systems Corp.                                          |  |                      | 4,509,048            |  |  |  | 20.41 | %
|Richard P. Kiphart                                          |  |                      | 1,087,393            |  |  |  | 4.99  | %
|Kingsport Capital Partners, LLC                             |  |                      | 1,087,393            |  |  |  | 4.99  | %
|All directors and executive officers
as a group (8 persons) |  |                      | 12,965,527           |  |  |  | 61.53 | %







Beneficial ownership is determined in accordance with Rule 13d-3
promulgated by the Commission, and generally includes
voting or investment power with respect to securities. Except as indicated
below, we believe each holder possesses sole voting and investment power with
respect to all of the shares of common stock owned by that holder, subject to
community property laws where applicable. In computing the number of shares
beneficially owned by a holder and the percentage ownership of that holder,
shares of common stock subject to options or warrants or underlying notes held
by that holder that are currently exercisable or convertible or are exercisable
or convertible within 60 days after the date of the table are deemed
outstanding. Those shares, however, are not deemed outstanding for the purpose
of computing the percentage ownership of any other person or group.




The shares beneficially owned by Kris Shah include:



| |  |  | 435,301 shares held by the Chandra L. Shah Trust, of which Mr. Shah is the trustee;                                                      
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | 435,301 shares held by the Leena Shah Trust, of which Mr. Shah is the trustee;                                                           
|
| |  |  | 4,472,716 shares held by the Kris and Geraldine Shah Family Trust, of
which Mr. Shah and his wife are the trustees and beneficiaries; and
|
| |  |  | 104,166 shares underlying convertible notes.                                                                                             

The shares beneficially owned by Marvin J. Winkler include:



| |  |  | 6,770,528 shares held by JAW Financial, L.P., of which Mr. Winkler owns 100% of the equity interests;                     
| | - |  | --------------------------------------------------------------------------------------------------------------------------
|
| |  |  | 356,343 shares held by the Winkler Childrens Trust 1998, the
beneficiaries of which are Mr. Winklers minor children; and
|
| |  |  | 104,166 shares underlying convertible notes.                                                                              

The shares beneficially owned by all of our directors and executive
officers as a group include the shares listed above as beneficially owned by
Mr. Shah and Mr. Winkler and 208,332 shares underlying options that are
beneficially owned as follows:



| |  |  | Richard M. Depew  20,000 shares underlying options; 
| | - |  | -----------------------------------------------------
|
| |  |  | Thomas E. Schiff  126,699 shares underlying options;

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| |  |  | Robert J. Gray  6,000 shares underlying options;   
| | - |  | ----------------------------------------------------
|
| |  |  | Matthew Medeiros  19,500 shares underlying options;
|
| |  |  | Gregg Amber  18,000 shares underlying options; and 
|
| |  |  | Bruce Block  9,899 shares underlying options.      




The shares beneficially owned by Wave Systems Corp. include 1,425,965
shares of common stock that are or may become issuable under a stock
acquisition right described under the heading Certain Relationships and
Related Transactions. Power to vote or dispose of the shares beneficially
owned by Wave Systems Corp. is held by Steven Sprague as
President. The address for Mr. Sprague is c/o Wave
Systems Corp., 480 Pleasant Street, Lee, Massachusetts 01238.







As described under the heading Certain Relationships and Related
Transactions, each of Richard P. Kiphart and Kingsport Capital Partners, LLC beneficially owns shares of common stock
underlying notes and warrants that we issued in a private placement transaction
on April 16, 2002. The shares shown in the table below as beneficially owned by
Mr. Kiphart represent shares issuable upon
conversion of notes and upon exercise of warrants held of record by Mr. Kiphart. The shares shown in the table below as
beneficially owned by Kingsport Capital Partners, LLC represent shares issuable
upon conversion of notes and upon exercise of warrants held of record by
three funds of which Kingsport Capital
Partners, LLC is the general partner. Power to vote or dispose of the shares beneficially owned by
Kingsport Capital Partners, LLC is held by Stewart Flink and Richard
Levy. The address for Mr. Flink and Mr. Levy is c/o Kingsport Capital
Partners, LLC, 95 Revere Drive, Suite F, Northbrook, Illinois 60062.







The notes and
warrants beneficially owned by Mr. Kiphart and Kingsport
Capital Partners, LLC prohibit conversion of
the notes or exercise of the warrants to the extent that conversion of a note
or exercise of a warrant would result in the holder, together with its
affiliates, beneficially owning in excess of 4.999% of our outstanding shares
of common stock. A beneficial owner of one of those notes or warrants may waive
the 4.999% limitations after 61 days prior written notice to us or immediately
upon written notice to us if we are or may become subject to a change in
control as defined in the notes and warrants. Also, these limitations do not
preclude a holder from converting or exercising a note or warrant and selling
shares underlying the note or warrant in stages over time where each stage does
not cause the holder and its affiliates to beneficially own shares in excess of
the limitation amounts.







At the initial conversion and exercise prices, the notes and warrants
beneficially owned by each of Mr. Kiphart and Kingsport Capital Partners, LLC would be convertible for or exercisable into more
than 5% of our outstanding shares of common stock if those beneficial owners
were to waive beneficial ownership limitations. However, as of the date of the
table, neither of those beneficial owners had made such a waiver. In light of the
limitations contained in the notes and warrants, the numbers of shares shown in
the table as beneficially owned by Mr. Kiphart and Kingsport Capital Partners, LLC
have been limited to 4.999% of the shares of
our common stock outstanding as of the date of the table.










Item 13. Certain Relationships and Related Transactions




On January 2,
2000, we entered into a lease agreement for our principal executive offices
with KRDS, Inc. Kris Shah, our co-chief executive
officer, co-chairman of the board and secretary, is the
majority stockholder and a director of KRDS, Inc. The lease has a seven-year
term and expires on February 28, 2007, and we have an option to renew the lease
for a five-year period which we may exercise by providing notice to KRDS, Inc.
not less than six months prior to the expiration of the initial seven-year
term; however, on April 11, 2002, KRDS, Inc. and we agreed that the lease may
be canceled by either party on 60 days written notice with no further
obligation on the part of either party. The building is approximately 20,702
square feet, our monthly payment is $34,259 and we paid a security deposit of
$31,674.







Mr. Shah owned 1,400,000 shares of common stock of BIZ that were converted
into 665,174 shares of our common stock upon consummation of the merger with
BIZ on August 24, 2001. Prior to the Acquisition, Mr. Shah purchased shares of BIZ common
stock. Part of the consideration consisted of a promissory note from Mr. Shah
with a stated interest rate of 5% per annum, with a maturity date of July 24, 2005. On April
12, 2002, in a transaction approved by our board of directors, Mr. Shah prepaid
the note by paying $347,224. We recorded a discount of $152,776




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that was charged against income in the second quarter of 2002. The discount was computed
based upon a present value calculation using a discount rate of 20%.




In October 2000, we signed a development agreement with Wave for the
integration of EMBASSY based systems with set-top box master reference designs
of Broadcom Corporation. Wave owns approximately 15% of our issued and
outstanding common stock. The development agreement was amended in May 2001.
Under this agreement, as amended, we are required to pay Wave $278,000 per
month beginning June 1, 2001 through December 1, 2002 for work to be performed,
for a total of $5.0 million. Should we not make the required monthly payments,
Wave may request payment in the form of common stock. As of December 31, 2001,
we owed $1.4 million to Wave for which they have tendered monthly notices of
default. Under the terms of the agreement, if the default notices are not cured
within 30 days of written notice, the unpaid installment converts the
obligation for delinquent installments from a cash obligation into a SAR. A SAR gives Wave the right to acquire a number of
fully paid, nonassessable shares of our common stock determined by dividing the
fair market value (the average closing price of our common stock for the ten
trading-day period prior to the date of exercise) of a share of our common
stock on the date of exercise of the SAR into the aggregate portion of the
installment payments declared to be in default and such default was not cured.
To date, Wave has made no request for issuance of stock. The $1.4
million
obligation is carried as an accrued liability of December 31, 2001. Further, to
conserve cash we do not intend to pay in cash the monthly billings due under
the agreement. In February 2002, based upon a verbal agreement the work under
the agreement was suspended along with the related billings. The suspension
does not decrease the obligation to purchase development services in the
future. We have reserved 1,150,000 shares of common stock for issuance under
the agreement. In addition, should we not purchase $5.0 million of goods or
services from Wave by June 30, 2003, our exclusivity related to certain
customers will, at Waves option, become non-exclusive.







We arranged for the lease of two buildings totaling approximately 63,000
square feet that were to be constructed. The buildings were completed January
2002, but are too large for our current needs. Mr. Shah has a 25% ownership
interest in the entity that owns the two buildings. The leases have an
aggregate monthly rental totaling approximately $115,000, plus common area
costs for seven years. We sublet one-half of a 23,000 square foot building on
terms and conditions matching the underlying lease, to a company owned by our
co-chief executive officer and co-chairman of the board,
Marvin Winkler. While that company made a lease deposit, it has not made the
monthly rent payments and accordingly is currently delinquent on its rent
payments to us. We are in negotiations with the landlord regarding being
released from obligations under the lease for the 40,000 square foot building.
We intend to release the related party sub-tenant and occupy the 23,000 square
foot building. We have accrued $2.2 million as an estimate for anticipated costs
relative to the disposition of the 40,000 square foot building net of
anticipated offsetting sublease income, which may be partially recovered
depending on future events that cannot be estimated.







On July 31,
2001, Chase Manhattan Bank, ("Chase") advanced $1.0 million to
Mr. Winkler, who then advanced that amount to BIZ for the re-purchase of
preferred stock held by an investor in BIZ. Mr. Winkler executed a $1.0 million
demand note with Chase and BIZ executed a $1.0 million demand note due September
15, 2001 with J.A.W. Financial, L.P., or JAW, an entity controlled by Mr.
Winkler. The demand note contained an interest charge of prime plus 1% through
the maturity date and prime plus 3% after the maturity date. On October 11,
2001, we made a principal payment of $30,000, paid accrued interest, and
executed a new promissory note to JAW for $970,000. The terms of the promissory
note called for interest at prime plus 3% payable monthly, together with five
monthly payments of principal in the amount of $160,000 and one final payment
on April 15, 2002 in the amount of $170,000. The promissory note provided Chase
a security interest in the shares in Wave owned by us and, subject to Chases
loan security guidelines, the rights to proceeds from any sales of those
shares. On March 8, 2002, the promissory note was paid in full ahead of
scheduled maturity.




On April 16, 2002, we issued to Messrs. Shah and Winkler non-convertible
unsecured promissory notes due December 31, 2005 in the principal amounts of
$152,776 and $500,000, respectively, in connection with loans to us made by
each of them. These notes bear interest at an annual rate of 10%.




On December 18, 2001, we issued and sold convertible promissory notes to
four individuals, in the aggregate principal amount of $2.5 million. Messrs. Shah
and Winkler, each purchased a note in the principal amount of $375,000 in this
transaction. These notes bear interest at 8% per annum, are convertible into
our common stock at $3.60 per share (subject to certain possible adjustments)
and are due and payable on December 31, 2005.







Mr. Amber served
as a director of our company during the fiscal year ended
December 31, 2001, and also served as our secretary until May 2001. Mr. Amber
is currently a partner of the law firm of Rutan & Tucker LLP, which during the
fiscal year ended December 31, 2001 acted as our outside legal counsel and was
paid $572,398 in fees and costs. This amount represented less than 5% of
Rutan & Tucker, LLPs revenues during 2001.




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Under a Securities Purchase, Registration Rights and Security Agreement
dated as of April 16, 2002, we issued an aggregate of
approximately $5.8 million of secured
convertible promissory notes due December 31, 2005 and warrants to purchase an
aggregate of 3,477,666 shares of our common stock to six accredited investors
in a private offering. We issued the notes and warrants in exchange for
$4.0 million in cash and the exchange of approximately $1.8 million of our
outstanding 8% subordinated convertible notes dated December 17, 2001.




The notes issued on April 16, 2002 are secured by all of our assets and
mature on December 31, 2005. The notes bear interest at an annual rate of 10%.
Interest is payable quarterly in cash beginning on July 1, 2002 or, at our
discretion, in shares of common stock at a price based upon the average of the
closing sale prices of our common stock for the 30-day period ending on the day
prior to the interest due date. The principal balance of each note is
convertible into shares of our common stock at the election of the holder at
the initial conversion price of $1.00 per share. The outstanding principal
balances of the notes and, at our option, any accrued and unpaid interest,
automatically will convert into shares of common stock at the then-applicable
conversion price if:



| |  |  | the closing sale price of a share of our common stock equals or exceeds $3.00 for 20 consecutive trading days;                                                                                                                                         
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the average daily trading volume during the 20 trading day period equals or exceeds 100,000 shares; and                                                                                                                                                
|
| |  |  | the registration statement that we are required to file to cover the
resale of shares of common stock underlying the notes and warrants is
declared effective by the Commission and remains effective throughout
each day of the 20 trading day period.

The warrants are three-year warrants that have an initial exercise price
of $1.30 per share and contain a cashless exercise provision. The notes and
warrants contain anti-dilution and protective provisions that provide for
adjustments to their conversion and exercise prices upon issuances of
securities below the then-applicable conversion or exercise price and upon the
occurrence of certain other events such as a distribution of assets.




At the initial conversion and exercise prices, the notes and warrants
beneficially owned by each of Richard P. Kiphart and Kingsport Capital Partners, LLC would be convertible
for or exercisable into more than 5% of our outstanding shares of common stock.
However, the notes and warrants prohibit conversion of the notes or exercise of
the warrants to the extent that conversion of a note or warrant would result in
the holder, together with its affiliates, beneficially owning in excess of
4.999% of our outstanding shares of common stock. A holder of one of those
notes or warrants may waive the 4.999% limitations after 61 days prior written
notice to us or immediately upon written notice to us if we are or may become
subject to a change in control as defined in the notes and warrants. As of
April 26, 2002, neither of the holders had waived the beneficial ownership
limitations. However, the beneficial ownership limitations do not preclude a
holder from converting or exercising a note or warrant and selling shares
underlying the note or warrant in stages over time where each stage does not
cause the holder and its affiliates to beneficially own shares in excess of the
limitation amounts.




In addition to the 4.999% beneficial ownership limitations that apply to
the beneficial owners of the notes and warrants, unless our shareholders
otherwise consent, we are not obligated to issue shares of common stock upon
conversion of all of the notes or upon exercise of all of the warrants to the
extent the aggregate number of shares to be issued exceeds 19.9999% of the
20,664,832 shares of our common stock that were issued and outstanding as of
April 16, 2002. However, shareholders having a majority of the voting power of
SSP have indicated their intention to consent, at our 2002 annual meeting of
shareholders, to conversion of the notes and exercise of the warrants into a
number of shares that exceeds 19.9999% of the shares of our common stock that
were issued and outstanding as of April 16, 2002.

The interest of the particular director, executive officer or security
holder in each matter described above was disclosed to our board of directors
before our board of directors approved the matter.







Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K



|(a)(1) |  | Financial statements The financial statements listed in the accompanying
index to consolidated financial statements and financial statement
schedules are filed or incorporated by reference as part of this annual
report.
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|(2)    |  | Financial statement schedules The financial statement schedule listed
in the accompanying index to consolidated financial statements and
financial statement schedules, is filed as part of this annual report.            
|      
|(3)    |  | Exhibits                                                                                                                                                                                                                   

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|    |  | The exhibits listed in the accompanying index to exhibits are filed or
incorporated by reference as part of this annual report.                                                                                                                           
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Reports on Form 8-K                                                                                                                                                                                                                                       
|   
|    |  | On November 6, 2001 we filed an amendment on Form 8-K/A to our current
report on Form 8-K that was previously filed on September 7, 2001. The
purpose of this amendment was to file the pro forma financial information
required by Item 7(b) of Form 8-K.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

|                      |  |                     |  |                                                                      
|--------------------- |  | ------------------- |  | ---------------------------------------------------------------------
|Dated: April 30, 2002 |  | SSP Solutions, Inc.
|                     
|                      |  | By:                 |  | /s/      MARVIN J. WINKLERMarvin J. WinklerCo-Chief Executive Officer
|                     
|                      |  | By:                 |  | /s/        KRIS SHAHKris ShahCo-Chief Executive Officer              

Pursuant to the requirements of the Securities Act of 1934, this report is
made by the following persons on behalf of the Registrant and in the capacities
indicted.

|                                         |  |                                                                                                                     |  |                   
|---------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ------------------
|Name                                     |  | Title                                                                                                               |  | Date              
|                                         |  |                                                                                                                     |  |                   
|                                         |  |                                                                                                                     |  |                   
|/s/ MARVIN J. WINKLER

Marvin J. Winkler |  | Co-Chairman of the Board of Directors,
Director and Co-Chief Executive Officer
(Principal Executive Officer)        |  | April 30, 2002    
|                                         |  |                                                                                                                     |  |                   
|/s/ KRIS SHAH

Kris Shah                 |  | Co-Chairman of the Board of Directors,
Director and Co-Chief Executive Officer
(Principal Executive Officer)        |  | April 30, 2002    
|                                         |  |                                                                                                                     |  |                   
|/s/ THOMAS E. SCHIFF

Thomas E. Schiff   |  | Executive Vice President and Chief
Financial Officer
(Principal Financial Officer and Principal
Accounting Officer) |  | April 30, 2002    
|                                         |  |                                                                                                                     |  |                   
|/s/ GREGG AMBER

Gregg Amber             |  | Director                                                                                                            |  | April 30, 2002    
|                                         |  |                                                                                                                     |  |                   
|Matthew Medeiros                         |  | Director                                                                                                            |  | April ______, 2002
|                                        
|Bruce Block                              |  | Director                                                                                                            |  | April ______, 2002

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SSP SOLUTIONS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

|                                                                                                     |  |  |      | 
|---------------------------------------------------------------------------------------------------- |  |  | ---- | 
|                                                                                                     |  |  | Page | 
|Independent Auditors Report                                                                         |  |  | F-2  | 
|Consolidated Balance Sheets as of December 31, 2000 and 2001                                         |  |  | F-3  | 
|Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001           |  |  | F-4  | 
|Consolidated
Statements of Shareholders Equity for the years ended December 31, 1999, 2000 and 2001 |  |  | F-5  | 
|Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001           |  |  | F-6  | 
|Notes to Consolidated Financial Statements                                                           |  |  | F-7  | 
|Schedule II  Valuation and qualifying accounts                                                      |  |  | S-1  | 

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INDEPENDENT AUDITORS REPORT

The Board of Directors
SSP Solutions, Inc.:

We have audited the accompanying consolidated financial statements of SSP
Solutions, Inc. and subsidiaries (formerly Litronic Inc.) as of December 31,
2000 and 2001 and for each of the years in the three-year period ended December
31, 2001 as listed in the accompanying index. In connection with our audit of
the financial statements, we also have audited the financial statement schedule
as listed in the accompanying index. These consolidated financial statements
and financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above,
present fairly, in all material respects, the financial position of SSP
Solutions, Inc. and subsidiaries as of December 31, 2000 and 2001 and the
results of its operations and its cash flows for each of the years in the
three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 3 to the consolidated financial statements, the Company has incurred
significant operating losses, has used cash in operating activities, has an
accumulated deficit and deficit working capital. These matters raise
substantial doubt about its ability to continue as a going concern.
Managements plans in regard to these matters are also described in Note 3. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

/s/ KPMG LLP

Costa Mesa, California
April 16, 2002

F-2



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SSP SOLUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |        |        |        |        | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | -------------------------- | ----------------- | -------------------- | ----- | ------------ | ------- | ------ | ------ | ------ | ------ | 
|                                                                                                                                                                 |                           |                            |                   |                      |       | December 31,
|                                                                                                                                                                 |                           |                            |                   |                      |       |             
|                                                                                                                                                                 |                           |                            |                   |                      |       | 2000         |         | 2001  
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|ASSETS                                                                                                                                                           |                           |                            |                   |                      |       |              |         |       
|Current assets:                                                                                                                                                  |                           |                            |                   |                      |       |              |         |       
|Cash and cash equivalents                                                                                                                                        |                           | $                          | 4,120             |                      |       | $            | 3,257   |       
|Investment in trading securities                                                                                                                                 |                           |                            |                  |                      |       |              | 1,360   |       
|Accounts receivable (net of allowance for doubtful accounts of $268 and $254 as of December
31, 2000 and 2001, respectively)                                     |                           |                            | 4,137             |                      |       |              | 4,358   |       
|Inventories                                                                                                                                                      |                           |                            | 695               |                      |       |              | 436     |       
|Prepaid expenses                                                                                                                                                 |                           |                            | 542               |                      |       |              | 601     |       
|Other current assets                                                                                                                                             |                           |                            | 325               |                      |       |              | 401     |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|                                                                                                                                                                 |                           |                            |                   | Total current assets |       |              | 9,819   |        |        |        | 10,413 | 
|Property and equipment, net                                                                                                                                      |                           |                            | 823               |                      |       |              | 361     |       
|Other assets                                                                                                                                                     |                           |                            | 343               |                      |       |              | 28      |       
|Goodwill and other intangibles, net                                                                                                                              |                           |                            | 783               |                      |       |              | 26,621  |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|                                                                                                                                                                 |                           | $                          | 11,768            |                      |       | $            | 37,423  |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                             |                           |                            |                   |                      |       |              |         |       
|Current liabilities:                                                                                                                                             |                           |                            |                   |                      |       |              |         |       
|Current installments of long-term debt                                                                                                                           |                           | $                          | 1,986             |                      |       | $            | 1,695   |       
|Accounts payable                                                                                                                                                 |                           |                            | 1,337             |                      |       |              | 9,495   |       
|Accrued liabilities                                                                                                                                              |                           |                            | 1,366             |                      |       |              | 3,343   |       
|Notes payable to related party                                                                                                                                   |                           |                            |                  |                      |       |              | 392     |       
|Deferred revenue                                                                                                                                                 |                           |                            | 217               |                      |       |              | 203     |       
|Accrued rent                                                                                                                                                     |                           |                            | 55                |                      |       |              | 1,064   |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|                                                                                                                                                                 | Total current liabilities |                            |                   | 4,961                |       |              |         | 16,192 |       
|Long-term debt, less current installments                                                                                                                        |                           |                            | 19                |                      |       |              | 2,500   |       
|Deferred revenue                                                                                                                                                 |                           |                            | 240               |                      |       |              | 46      |       
|Accrued rent, less current                                                                                                                                       |                           |                            |                  |                      |       |              | 1,107   |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|                                                                                                                                                                 |                           |                            | Total liabilities |                      |       | 5,220        |         |        |        | 19,845 |       
|Shareholders equity:                                                                                                                                            |                           |                            |                   |                      |       |              |         |       
|Preferred stock, $0.01 par value; Authorized 5,000,000 shares; no shares issued or outstanding                                                                   |                           |                            |                  |                      |       |              |        |       
|Common stock, $0.01 par value; Authorized 100,000,000 shares; issued and outstanding
9,743,573 and 20,630,754 shares at December 31, 2000 and 2001, respectively |                           |                            | 97                |                      |       |              | 206     |       
|Additional paid-in capital                                                                                                                                       |                           |                            | 52,834            |                      |       |              | 118,608 |       
|Note receivable from shareholder                                                                                                                                 |                           |                            |                  |                      |       |              | (500    | )     
|Deferred compensation                                                                                                                                            |                           |                            |                  |                      |       |              | (1,193  | )     
|Accumulated deficit                                                                                                                                              |                           |                            | (46,383           | )                    |       |              | (99,543 | )     
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|                                                                                                                                                                 |                           | Total shareholders equity |                   |                      | 6,548 |              |         |        | 17,578 |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       
|Commitments and contingencies (notes 13 and 18)                                                                                                                  |                           |                            |                   |                      |       |              |         |       
|Subsequent events ( note 19)                                                                                                                                     |                           | $                          | 11,768            |                      |       | $            | 37,423  |       
|                                                                                                                                                                 |                           |                            |                   |                      |       |              |         |       

See accompanying notes to consolidated financial statements

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SSP SOLUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except share and per share data)

|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |        |        | 
|------------------------------------------------------- | ---------------------------------------------- | -------------- | --------- | ------------------------ | ------ | ---- | --------- | ------ | ------ | - | ---------- | ------ | ------ | 
|                                                        |                                                |                |           | Years Ended December 31,
|                                                        |                                                |                |           |                         
|                                                        |                                                |                |           | 1999                     |        | 2000 |           | 2001  
|                                                        |                                                |                |           |                          |        |      |           |       
|Revenues:                                               |                                                |                |           |                          |        |      |           |        |        |   |            |       
|                                                        | Product                                        |                | $         | 29,587                   |        |      | $         | 37,421 |        |   | $          | 21,145 |       
|                                                        | License and service                            |                |           | 1,270                    |        |      |           | 1,935  |        |   |            | 1,575  |       
|                                                        | Research and development                       |                |           | 798                      |        |      |           |       |        |   |            |       |       
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|                                                        |                                                | Total revenues |           |                          | 31,655 |      |           |        | 39,356 |   |            |        | 22,720 | 
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|Costs and expenses:                                     |                                                |                |           |                          |        |      |           |        |        |   |            |       
|                                                        | Cost of sales  product                        |                |           | 25,478                   |        |      |           | 30,481 |        |   |            | 17,457 |       
|                                                        | Cost of sales  license and service            |                |           | 590                      |        |      |           | 679    |        |   |            | 537    |       
|                                                        | Selling, general and administrative            |                |           | 7,194                    |        |      |           | 9,559  |        |   |            | 10,645 |       
|                                                        | Research and development                       |                |           | 3,906                    |        |      |           | 5,800  |        |   |            | 7,850  |       
|                                                        | Impairment of goodwill and other intangibles   |                |           |                         |        |      |           | 31,415 |        |   |            | 36,299 |       
|                                                        | Amortization of goodwill and other intangibles |                |           | 1,448                    |        |      |           | 2,828  |        |   |            | 746    |       
|                                                        | In-process research and development            |                |           |                         |        |      |           |       |        |   |            | 1,600  |       
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|Operating loss                                          |                                                |                | (6,961    | )                        |        |      | (41,406   | )      |        |   | (52,414    | )     
|Other (income) expense, net                             |                                                |                | 168       |                          |        |      | (7        | )      |        |   | 693        |       
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|Loss before income taxes                                |                                                |                | (7,129    | )                        |        |      | (41,399   | )      |        |   | (53,107    | )     
|Provision for (benefit from) income taxes               |                                                |                | (43       | )                        |        |      | 6         |        |        |   | 53         |       
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|Net loss                                                |                                                | $              | (7,086    | )                        |        | $    | (41,405   | )      |        | $ | (53,160    | )     
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|Net loss per sharebasic and diluted                    |                                                | $              | (1.00     | )                        |        | $    | (4.20     | )      |        | $ | (3.91      | )     
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       
|Shares used in per share computationsbasic and diluted |                                                |                | 7,055,882 |                          |        |      | 9,862,472 |        |        |   | 13,585,202 |       
|                                                        |                                                |                |           |                          |        |      |           |        |        |   |            |       

See accompanying notes to consolidated financial statements

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SSP SOLUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY(In thousands)

|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  |           |      |               |  |   |        |   |  |   |         |       |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---------- |  | ---------- | --- | ----------- |  | ------------ | ------- | ------- |  | --------- | ---- | ------------- |  | - | ------ | - |  | - | ------- | ----- |  | - | ------- | -
|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  | Note      |      |               |  |   |        |   |  |   |         | Total
|                                                                                                                                                                            |  | Common Stock |        | Additional |  | Receivable |     |             |  |              |         |         |  |           |      | Shareholders'
|                                                                                                                                                                            |  |              |        | Paid in    |  | from       |     | Deferred    |  | Accumulated  |         | Equity 
|                                                                                                                                                                            |  | Shares       |        | Amount     |  | Capital    |     | Shareholder |  | Compensation |         | Deficit |  | (Deficit)
|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  |          
|Balance, December 31, 1998                                                                                                                                                  |  |              | 3,871  |            |  | $          | 39  |             |  | $            |        |         |  | $         |     |               |  | $ |       |   |  | $ | (4,246  | )     |  | $ | (4,207  | )
|Proceeds from sale of
common stock, net of
issuance costs of $5,426                                                                                                         |  |              | 3,700  |            |  |            | 37  |             |  |              | 35,237  |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 35,274  |  
|Common stock issued in
connection with the
acquisition of Pulsar                                                                                                            |  |              | 2,170  |            |  |            | 22  |             |  |              | 23,848  |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 23,870  |  
|Change from Subchapter S
Corporation to C
Corporation                                                                                                                       |  |              |       |            |  |            |    |             |  |              | (6,354  | )       |  |           |     |               |  |   |       |   |  |   | 6,354   |       |  |   |        |  
|Stock options exercised                                                                                                                                                     |  |              | 116    |            |  |            | 1   |             |  |              | 81      |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 82      |  
|Net loss                                                                                                                                                                    |  |              |       |            |  |            |    |             |  |              |        |         |  |           |     |               |  |   |       |   |  |   | (7,086  | )     |  |   | (7,086  | )
|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  |           |      |               |  |   |        |   |  |   |         |       |  |   |         |  
|Balance, December 31, 1999                                                                                                                                                  |  |              | 9,857  |            |  |            | 99  |             |  |              | 52,812  |         |  |           |     |               |  |   |       |   |  |   | (4,978  | )     |  |   | 47,933  |  
|Stock options exercised                                                                                                                                                     |  |              | 28     |            |  |            |    |             |  |              | 20      |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 20      |  
|Treasury stock retired                                                                                                                                                      |  |              | (141   | )          |  |            | (2  | )           |  |              | 2       |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   |        |  
|Net loss                                                                                                                                                                    |  |              |       |            |  |            |    |             |  |              |        |         |  |           |     |               |  |   |       |   |  |   | (41,405 | )     |  |   | (41,405 | )
|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  |           |      |               |  |   |        |   |  |   |         |       |  |   |         |  
|Balance, December 31, 2000                                                                                                                                                  |  |              | 9,744  |            |  |            | 97  |             |  |              | 52,834  |         |  |           |     |               |  |   |       |   |  |   | (46,383 | )     |  |   | 6,548   |  
|Common shares issued,
warrants, and options
assumed deferred stock
compensation, and note
receivable from
shareholder for
acquisition of Biz
Interactive Zone, Inc.
(BIZ) |  |              | 10,875 |            |  |            | 109 |             |  |              | 65,807  |         |  |           | (500 | )             |  |   | (1,471 | ) |  |   |        |       |  |   | 63,945  |  
|Deferred compensation
related to issuance of
stock options                                                                                                                  |  |              |       |            |  |            |    |             |  |              | 122     |         |  |           |     |               |  |   | (122   | ) |  |   |        |       |  |   |        |  
|Reversal of deferred
compensation related to
terminated employees                                                                                                           |  |              |       |            |  |            |    |             |  |              | (201    | )       |  |           |     |               |  |   | 201    |   |  |   |        |       |  |   |        |  
|Amortization of deferred
stock compensation                                                                                                                                 |  |              |       |            |  |            |    |             |  |              |        |         |  |           |     |               |  |   | 199    |   |  |   |        |       |  |   | 199     |  
|Common stock issued for
services                                                                                                                                            |  |              | 8      |            |  |            |    |             |  |              | 36      |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 36      |  
|Stock options exercised                                                                                                                                                     |  |              | 4      |            |  |            |    |             |  |              | 3       |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 3       |  
|Stock options issued for
services                                                                                                                                           |  |              |       |            |  |            |    |             |  |              | 7       |         |  |           |     |               |  |   |       |   |  |   |        |       |  |   | 7       |  
|Net loss                                                                                                                                                                    |  |              |       |            |  |            |    |             |  |              |        |         |  |           |     |               |  |   |       |   |  |   | (53,160 | )     |  |   | (53,160 | )
|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  |           |      |               |  |   |        |   |  |   |         |       |  |   |         |  
|Balance, December 31, 2001                                                                                                                                                  |  |              | 20,631 |            |  |            | 206 |             |  |              | 118,608 |         |  |           | (500 | )             |  |   | (1,193 | ) |  |   | (99,543 | )     |  |   | 17,578  |  
|                                                                                                                                                                            |  |              |        |            |  |            |     |             |  |              |         |         |  |           |      |               |  |   |        |   |  |   |         |       |  |   |         |  

See accompanying notes to consolidated financial statements.

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SSP SOLUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)

|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |         |        |     | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------- | ---------------------------------------------------------- | ------------ | ------- | ------------------------ | --- | ------ | ------- | ---- | -- | ------ | ------- | ------ | --- | 
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         | Years Ended December 31,
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                         
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         | 1999                     |     | 2000   |         | 2001
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |     
|Cash flows from operating activities:                                                                                                                                                                                                  |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Net loss                                                                           |                                                            | $            | (7,086  | )                        |     | $      | (41,405 | )    |    | $      | (53,160 | )     
|Adjustments to reconcile net loss to net cash used in operating activities:                                                                                                                                                            |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Provision for losses on receivables                                                |                                                            |              | 327     |                          |     |        | 286     |      |    |        | 401     |       
|                                                                                                                                                                                                                                       | Impairment of goodwill and other intangibles                                       |                                                            |              |        |                          |     |        | 31,415  |      |    |        | 36,299  |       
|                                                                                                                                                                                                                                       | Depreciation and amortization                                                      |                                                            |              | 1,803   |                          |     |        | 3,514   |      |    |        | 1,450   |       
|                                                                                                                                                                                                                                       | In process research and development                                                |                                                            |              |        |                          |     |        |        |      |    |        | 1,600   |       
|                                                                                                                                                                                                                                       | Deferred compensation                                                              |                                                            |              |        |                          |     |        |        |      |    |        | 199     |       
|                                                                                                                                                                                                                                       | Realized loss on trading securities                                                |                                                            |              |        |                          |     |        |        |      |    |        | 530     |       
|                                                                                                                                                                                                                                       | Stock and options issued for services                                              |                                                            |              |        |                          |     |        |        |      |    |        | 43      |       
|Changes in assets and liabilities net of effects of the acquisition:                                                                                                                                                                   |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Accounts receivable                                                                |                                                            |              | (1,823  | )                        |     |        | 2,718   |      |    |        | (622    | )     
|                                                                                                                                                                                                                                       | Inventories                                                                        |                                                            |              | (64     | )                        |     |        | 101     |      |    |        | 259     |       
|                                                                                                                                                                                                                                       | Prepaid expenses                                                                   |                                                            |              | (303    | )                        |     |        | (182    | )    |    |        | (59     | )     
|                                                                                                                                                                                                                                       | Other current assets                                                               |                                                            |              | (8      | )                        |     |        | 18      |      |    |        | (536    | )     
|                                                                                                                                                                                                                                       | Notes receivable  related party                                                   |                                                            |              | (70     | )                        |     |        | 70      |      |    |        |        |       
|                                                                                                                                                                                                                                       | Other assets                                                                       |                                                            |              | 332     |                          |     |        | (343    | )    |    |        | 410     |       
|                                                                                                                                                                                                                                       | Accounts payable                                                                   |                                                            |              | (3,964  | )                        |     |        | 142     |      |    |        | 6,275   |       
|                                                                                                                                                                                                                                       | Accrued liabilities                                                                |                                                            |              | (556    | )                        |     |        | (376    | )    |    |        | 2,448   |       
|                                                                                                                                                                                                                                       | Accrued rent                                                                       |                                                            |              |        |                          |     |        |        |      |    |        | 2,171   |       
|                                                                                                                                                                                                                                       | Deferred revenue                                                                   |                                                            |              | (77     | )                        |     |        | 428     |      |    |        | (208    | )     
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Net cash used in operating activities                                                                                                                                                                                                  |                                                                                    |                                                            | (11,489      | )       |                          |     | (3,614 | )       |      |    | (2,500 | )      
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Cash flows from investing activities:                                                                                                                                                                                                  |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Purchases of property and equipment                                                |                                                            |              | (282    | )                        |     |        | (863    | )    |    |        | (118    | )     
|                                                                                                                                                                                                                                       | Restricted cash relating to line of credit                                         |                                                            |              | (612    | )                        |     |        | 612     |      |    |        |        |       
|                                                                                                                                                                                                                                       | Proceeds from the sale of trading securities                                       |                                                            |              |        |                          |     |        |        |      |    |        | 933     |       
|                                                                                                                                                                                                                                       | Net cash paid for acquisition of BIZ                                               |                                                            |              |        |                          |     |        |        |      |    |        | (675    | )     
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Net cash provided by (used in) investing activities                                                                                                                                                                                    |                                                                                    |                                                            | (894         | )       |                          |     | (251   | )       |      |    | 140    |        
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Cash flows from financing activities:                                                                                                                                                                                                  |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Stock options exercised                                                            |                                                            |              | 82      |                          |     |        | 20      |      |    |        | 3       |       
|                                                                                                                                                                                                                                       | Borrowings on revolving note payable to bank                                       |                                                            |              |        |                          |     |        | 23,666  |      |    |        | 14,155  |       
|                                                                                                                                                                                                                                       | Proceeds from insurance financing                                                  |                                                            |              | 497     |                          |     |        | 748     |      |    |        | 205     |       
|                                                                                                                                                                                                                                       | Proceeds from sale of common stock, net of issuance costs of $5,426                |                                                            |              | 35,274  |                          |     |        |        |      |    |        |        |       
|                                                                                                                                                                                                                                       | Proceeds from revolving note payable to bank                                       |                                                            |              | 23,837  |                          |     |        |        |      |    |        |        |       
|                                                                                                                                                                                                                                       | Proceeds from line of credit                                                       |                                                            |              | 1,129   |                          |     |        |        |      |    |        |        |       
|                                                                                                                                                                                                                                       | Proceeds from convertible debt                                                     |                                                            |              |        |                          |     |        |        |      |    |        | 2,500   |       
|                                                                                                                                                                                                                                       | Proceeds from long-term debt                                                       |                                                            |              | 1,500   |                          |     |        |        |      |    |        |        |       
|                                                                                                                                                                                                                                       | Principal payments on revolving line of credit and long-term notes payable to bank |                                                            |              | (44,064 | )                        |     |        | (22,469 | )    |    |        | (14,142 | )     
|                                                                                                                                                                                                                                       | Proceeds from note payable to related party                                        |                                                            |              |        |                          |     |        |        |      |    |        | (696    | )     
|                                                                                                                                                                                                                                       | Repayment on insurance financing                                                   |                                                            |              | (329    | )                        |     |        | (421    | )    |    |        | (528    | )     
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Net cash provided by financing activities                                          |                                                            |              | 17,926  |                          |     |        | 1,544   |      |    |        | 1,497   |       
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Net increase (decrease) in cash                                                    |                                                            |              | 5,543   |                          |     |        | (2,321  | )    |    |        | (863    | )     
|Cash and cash equivalents at beginning of year                                                                                                                                                                                         |                                                                                    |                                                            | 898          |         |                          |     | 6,441  |         |      |    | 4,120  |        
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Cash and cash equivalents at end of year                                                                                                                                                                                               |                                                                                    | $                                                          | 6,441        |         |                          | $   | 4,120  |         |      | $  | 3,257  |        
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Supplemental disclosures of cash flow information:                                                                                                                                                                                     |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|                                                                                                                                                                                                                                       | Cash paid during the year for:                                                     |                                                            |              |         |                          |     |        |         |      |    |        |         |       
|                                                                                                                                                                                                                                       |                                                                                    |                                                            | Interest     |         |                          | 162 |        |         |      | 63 |        |         |        | 197 | 
|                                                                                                                                                                                                                                       |                                                                                    |                                                            | Income taxes |         |                          | 3   |        |         |      | 6  |        |         |        | 2   | 
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Supplemental disclosure of non-cash investing and financing activities:                                                                                                                                                                |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|The Company issued 2,169,938 and 10,875,128 shares of common in connection with the
acquisitions of Pulsar and BIZ, respectively. In connection with the acquisitions,
net assets purchased were as follows (note 4) Acquisition costs |                                                                                    | $                                                          | (122         | )       |                          |     |       |         |      |    | (750   | )      
|                                                                                                                                                                                                                                       |                                                                                    | Fair value of net assets acquired less liabilities assumed |              |         | (12,151                  | )   |        |         | (331 | )  |        |         | 184    |    
|                                                                                                                                                                                                                                       |                                                                                    | Goodwill and other intangible assets                       |              |         | 36,143                   |     |        |         |     |    |        |         | 62,882 |    
|                                                                                                                                                                                                                                       |                                                                                    | In-process research and development                        |              |         |                         |     |        |         |     |    |        |         | 1,600  |    
|                                                                                                                                                                                                                                       |                                                                                    | Deferred compensation                                      |              |         |                         |     |        |         |     |    |        |         | 29     |    
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        
|Market value of common stock issued                                                                                                                                                                                                    |                                                                                    | $                                                          | 23,870       |         |                          |     | (331   | )       |      |    | 63,945 |        
|                                                                                                                                                                                                                                       |                                                                                    |                                                            |              |         |                          |     |        |         |      |    |        |        

See accompanying notes to consolidated financial statementsF-6



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SSP SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)

(1) General Information

General

SSP Solutions, Inc. (formally Litronic, Inc.) (SSP or the Company)
designs and produces high-grade information security solutions. In addition,
the Company also provides engineering and other services to various government
agencies on a time and material basis.

Through its wholly-owned subsidiary Pulsar Data Systems, Inc. (Pulsar),
the Company engages in the sale of computer hardware, software, peripheral
equipment, and support services to governmental agencies and commercial
enterprises throughout the United States.

Biz Interactive Zone, Inc. (BIZ), a wholly-owned subsidiary of the
Company, was a development stage enterprise when the Company acquired it in
August 2001. BIZ had been devoting substantially all of its efforts to develop,
design, and market security solutions for the financial, government,
healthcare, education, and entertainment industries (note 4). The combined
Company will continue to focus on a complete range of solutions for physical
access, electronic commerce, and communications, from the core to the edge.

Public Offering and Reorganization

In June 1999, SSP completed an initial public offering of common stock of
SSP Solutions, Inc., a newly formed corporation with no operations (the
Offering). The Company offered 3,700,000 shares of common stock at a purchase
price of $11 per share, resulting in gross proceeds of $40,700. These proceeds
were offset by issuance costs of $5,426, resulting in net proceeds of $35,274.
Litronic Industries, Inc. also initiated certain events (the Reorganization)
in connection with the Offering that resulted in it becoming a wholly owned
subsidiary of SSP Solutions, Inc. on June 8, 1999. The Reorganization was
accomplished through a stock-for-stock exchange between SSP Solutions, Inc. and
Litronic Industries, Inc. and was accounted for as an as if pooling of
interests for entities under common control. Concurrent with the
Reorganization, Litronic Industries, Inc. terminated its Subchapter S status
and is subject to federal and state income taxes. Pursuant to the change from a
Subchapter S to a C corporation, the cumulative loss from inception to June 9,
1999, as a Subchapter S corporation of $6,354 was transferred from accumulated
deficit to additional paid in capital.

All of the outstanding shares of Litronic Industries, Inc. were exchanged
for 3,870,693 shares of the Companys common stock. Consequently, as of June 8,
1999, the consolidated group included the operations of SSP and its wholly
owned subsidiary, Litronic Industries, Inc. The prior period financial
statements have been restated to reflect the exchange of these shares.

Pulsar Acquisition

The Company also entered into a stock acquisition agreement with Pulsar,
which was effected simultaneously with the Offering. All of the outstanding
shares of Pulsar were exchanged for 2,169,938 shares of the Companys common
stock. The acquisition was accounted for using the purchase method of
accounting, and accordingly, the results of operations of Pulsar have been
included in the Companys consolidated financial statements from June 14, 1999.

BIZ Acquisition

On August 24, 2001, pursuant to an Agreement and Plan of Reorganization
dated July 3, 2001 with BIZ Interactive Zone, Inc., a Delaware Corporation, the
Company completed an acquisition transaction (the Acquisition) whereby BIZ
became a wholly-owned subsidiary of the Company. BIZ is a development stage
enterprise devoting substantially all of its efforts to develop, design, and
market security solutions for the financial, government, healthcare, education,
and entertainment industries. Concurrent with the acquisition, the Company
changed its name from Litronic Inc., to SSP Solutions, Inc. The Company
combined the business of SSP and BIZ into a single operating unit under the
name SSP Solutions, Inc.

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In connection with the Acquisition, the Company issued an aggregate of
10,875,128 shares of SSP common stock in exchange for all of the outstanding
shares of BIZ common stock and preferred stock. In addition, the Company
reserved for issuance an aggregate of approximately 860,000 shares of its
common stock for issuance upon exercise of BIZ options and warrants assumed by
the Company (note 4).

(2) Summary of Significant Accounting Policies

Basis of Financial Statement Presentation and Principles of Consolidation

The consolidated financial statements and related notes presented herein
have been retroactively adjusted to reflect the Reorganization. The capital
structure presented in these consolidated financial statements is that of SSP.
The consolidated financial statements include the accounts of SSP and its
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.

Loss Per Share

Basic earnings (loss) per share includes no dilution and is computed by
dividing earnings (loss) available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted earnings
per share reflects the potential dilution of securities that could share in the
earnings of an entity. Such shares are not included when there is a loss as the
effect would be anti-dilutive.

Revenue Recognition

Revenue from product sales, including hardware (with embedded software)
and software, is recognized upon shipment unless contract terms call for a
later date. The Company records an allowance to cover estimated warranty costs
in cost of sales. Customers do not have the right of return except for product
defects, and product sales are not contingent upon customer testing, approval
or acceptance. The costs of providing post contract customer support are not
significant. Revenue under service and development contracts is recorded as
services are rendered. The Companys revenue recognition policies for software
are in compliance with the American Institute of Certified Public Accountants
(AICPA) Statements of Position (SOP) 97-2, Software Revenue Recognition and
SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect
to Certain Transactions. Revenues under research arrangements with government
agencies are recorded as services are rendered or products are shipped.

Included in research and development revenue for the year ended December
31, 1999 is $798 related to a contract with the National Security Agency
(NSA). There was no revenue related to research and development for the years
ended December 31, 2000 and 2001. The Company led a joint effort with Atmel
Corporation (Atmel) and NSA to develop Forté, a 32-bit cryptographic System
On Chip (SOC) meeting certain minimum NSA specifications. The Company
contracts with others to perform certain aspects of the project. All related
project costs are expensed as research and development as incurred. The amounts
received from the NSA are not refundable regardless of the results of the
development efforts. No other amounts were recorded as research and development
revenue during any of the periods presented. The related research and
development costs are not separately identifiable; therefore the corresponding
costs of the entire development effort are included in research and development
expenses. Although no additional amounts related to the development of Forte
are being received from NSA, the joint effort with Atmel and the NSA to develop
Forté has continued.

Revenue from time and material, network deployment service contracts is
recognized on the basis of man-hours incurred plus other reimbursable contract
costs incurred during the period.

Revenue from network deployment products is recognized upon transfer of
title, generally upon delivery. Product and service revenues from the Companys
electric security systems contracts were recognized in accordance with SOP
81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts. The Company recognized this revenue on a percentage
of completion basis, based on estimated labor dollars incurred.

The Companys revenue recognition policies are in accordance with the
Securities and Exchange Commissions Staff Accounting Bulletin No. 101.

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Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of
three months or less at the date of purchase to be cash equivalents.

Investments

The Companys investments are classified as trading securities. The
securities are comprised of Class A common stock of Wave Systems Corp. received
in the Acquisition.

Securities are carried at fair value with the unrealized gains and losses, net
of applicable taxes, reported in the statement of operations. The cost of
securities sold is based upon the specific identification method.

Inventories

Inventories are stated at the lower of first-in, first-out cost or market
using net realizable value.

Property and Equipment

Property and equipment are stated at cost. Furniture and equipment are
depreciated by the straight-line method over the useful lives of the assets,
generally 2-3 years. Leasehold improvements are amortized by straight-line
method over the term of the related lease or the estimated useful lives of the
assets, whichever is shorter. Property and equipment sold or retired is
eliminated from the accounts in the year of disposition and the resulting gain
or loss is reflected in the consolidated statement of operations.

Goodwill and Other Intangibles Assets

The Company amortizes intangible assets relating to businesses acquired
and costs in excess of the fair value of net assets of businesses acquired
using the straight-line method over the estimated useful lives of the
intangible assets.

The Company applies Statement of Financial Accounting Standards No. 121
(Statement 121), Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. Statement 121 requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Under the provisions of Statement 121, if the sum
of the expected future cash flows (undiscounted and without interest charges)
is less than the carrying value of the asset, an impairment loss is recognized.
The amount of impairment, if any, is measured as the amount by which the
carrying amount of the asset exceeds the fair value of the asset. The estimate
of fair value considers prices for similar assets and the results of valuation
techniques to the extent available in the circumstances.

During 2000, the Company engaged the services of an independent valuation
firm to do a valuation of Pulsar. This valuation was undertaken because the
Company determined the integration of Pulsar would not be completed as planned,
and the anticipated operating synergies would not be realized. Based on the
results of the independent valuation, the Company recorded an impairment charge
of $31,400 in the fourth quarter of 2000, related to unamortized goodwill and
other intangible assets acquired in the purchase of Pulsar. The remaining
unamortized intangible assets of $783 as of the date of impairment, acquired in
the purchase of Pulsar are being amortized over the remainder of the original
10 year useful life.

The Company has adopted Statements 141 and 142, Business Combinations
and Goodwill and Other Intangible Assets for the Acquisition that was
completed on August 24, 2001. In accordance with Statement 142 goodwill is not
amortized for business acquisitions that were completed after June 30, 2001 but
rather will be evaluated at least annually for impairment. Other identifiable
intangible assets acquired from business acquisitions that were completed after
June 30, 2001, are amortized on a straight-line basis over their estimated
useful lives of between one and three years. Accordingly, the Company has not
recorded amortization of goodwill related to the Acquisition.

During the fourth quarter of 2001, the Company determined that certain
identifiable technology and developed technology acquired in connection with
the Acquisition were no longer going to be pursued. Additionally, the Company
delayed or indefinitely reduced the projected revenues from the Acquisition.
Accordingly, the Company performed a Statement 121 analysis for identifiable
intangible assets and Accounting Principle Board Opinion No. 17 for goodwill.

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In evaluating identifiable intangibles assets, the Company utilized a
discount cash flow and, due to the uncertainties surrounding the companys
ability to fund its operations concluded all identified intangibles assets
associated with the acquisition should be written-off. In evaluating the
goodwill associated with the Acquisition, the Company utilized a fair value
approach. The fair value was measured utilizing the most recent indicator of
fair value, which was the secured convertible promissory notes (note 19).
Consequently, the Company recorded an impairment charge of $36,299 in the
fourth quarter of 2001 related to all identifiable intangible assets and
developed technology, as well as a portion of the goodwill acquired in
connection with the acquisition of BIZ. After this impairment charge, goodwill
is the only remaining intangible asset.

Amortization of goodwill and other intangibles was $1,448, $2,828 and
$746, respectively, for the years ended December 31, 1999, 2000 and 2001.

Segment Reporting

The Company applies Statement 131, Disclosures about Segments of an
Enterprise and Related Information, which requires entities to report
financial and descriptive information about its reportable operating segments.
The Company had historically operated in two business segments, information
security solutions and electronic interconnect products. On June 14, 1999, with
the acquisition of Pulsar, the Company expanded into the network solution
business segment (see note 10). The Company combined the businesses of SSP and
BIZ into a single reportable operating segment.

Stock-Based Compensation for Employees and Non-Employees

The Company accounts for its employee stock option plans using the
intrinsic value method. When stock options are granted to employees with
exercise prices less than the fair value of the underlying common stock at the
date of grant, the difference is recognized as deferred compensation expense,
which is amortized over the vesting period of the options.

The Company accounts for stock options issued to non-employees using the
fair value method. The associated cost is recorded in the same manner as if
cash were paid.

Fair Value of Financial Instruments

As of December 31, 2000 and 2001, management believes the fair value of
all financial instruments approximated carrying value, due to their short-term
nature.

Income Taxes

Prior to June 8, 1999, the Company had elected to be taxed as an S
corporation under the provisions of Section 1362 of the Internal Revenue Code
and used the accrual basis of reporting for income tax purposes. Accordingly,
the Company had not provided for Federal income taxes since the liability was
that of the shareholders. The Company was subject to state income taxes on
earnings before taxes.

On June 8, 1999, the Company reorganized from an S Corporation to C
Corporation. The Company now provides for federal income taxes recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. A valuation allowance
will be provided where it is more likely than not that the deferred tax assets
will not be realized.

Comprehensive Income

The Company has no transactions, other than net loss, that would be
considered other comprehensive income.

Accounts Receivable Financing

The Company adopted Statement 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities. Statement 140 is
effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring after March 31, 2001, and it is effective for
recognition and reclassification of collateral and for disclosures relating to
securitization

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transactions and collateral. Statement 140 outlines the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures (see note 8).

Use of Estimates

The consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the balance sheets and revenues and expenses for
the periods. Actual results could differ from those estimates.

New Accounting Standards

In July 2001, the FASB issued Statement 141, Business Combinations, and
Statement 142, Goodwill and Other Intangible Assets. Statement 141 requires
that all business combinations be accounted for under a single method  the
purchase method. Use of the pooling-of-interests method is no longer permitted.
Statement 141 requires that the purchase method be used for business
combinations initiated after June 30, 2001. Statement 142 requires that
goodwill no longer be amortized to earnings, but instead be reviewed for
impairment. Under Statement 142, the amortization of goodwill ceases upon
adoption of the Statement, which is effective for fiscal years beginning after
December 15, 2001, which for calendar year-end companies, will be January 1,
2002. In all cases, the provisions of Statement 142 shall be initially applied
at the beginning of a fiscal year. Goodwill and intangible assets acquired
after June 30, 2001, but prior to full adoption of Statement 142, are to be
amortized, or not, in accordance with Statement 142 (see note 4).

In June 2001, the FASB issued Statement 143, Accounting for Asset
Retirement Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. The standard applies to legal
obligations associated with the retirement of long-lived assets that result
from the acquisition, construction, development and (or) normal use of the
asset. Statement 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The fair value of the liability
is added to the carrying value of the associated asset and this additional
carrying amount is depreciated over the life of the asset. The liability is
accreted at the end of each period through charges to operating expense. If the
obligation is settled for other than the carrying amount of the liability, the
Company will recognize a gain or loss on settlement. The Company is required
and plans to adopt the provisions of Statement 143 for the quarter ending March
31, 2003. Management does not believe adoption of this standard will have a
material adverse effect on the Companys consolidated financial position,
results of operations or liquidity.

On October 3, 2001, the FASB issued Statement 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets
and supersedes Statement 121. Statement 144 retains many of the fundamental
provisions of Statement 121. Statement 144 also supersedes the accounting and
reporting provisions of APB 30, Reporting the Results of Operations Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions, for the disposal of a
segment of a business. However, it retains the requirement in APB 30 to report
separately discontinued operations and extends that reporting to a component of
an entity that either has been disposed of (by sale, abandonment, or in a
distribution to owners) or is classified as held for sale.

Statement 144 is effective for fiscal years beginning after December 15, 2001
and interim periods within those fiscal years. The Company is currently
examining the impact of this pronouncement on its results of operations and
financial position, but believes the impact will not be material.

Reclassifications

Certain reclassifications were made to the 1999 and 2000 consolidated
financial statements to conform to the 2001 presentation.

(3) Liquidity

These condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
the realization of assets and satisfaction of liabilities in the normal course
of business. The Company has incurred significant operating losses, has used
cash in operating activities, has an accumulated deficit, and deficit working
capital. The Company currently anticipates that existing resources will not be
sufficient to satisfy contemplated working capital requirements for the next
twelve months.

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The Company had previously indicated its plan to begin shipping its XBOARD
(formerly known as the CipherServers) in mid-2001. The operating forecast
assumed the CipherServer product launch would go as planned and that
anticipated sales of the CipherServers would be realized. The Company has not
realized the sales previously anticipated. Furthermore, the Companys market
research has indicated that recent technology advancements within the chip
market have rendered the technology in the CipherServers obsolete. Accordingly,
the Company does not plan to continue developing enhancements for nor
re-launching the CipherServer family of products as previously indicated. The
Company has written off all inventory related to CipherServer products.

Liquidity and Capital Resources

At December 31, 2001, the Company had deficit working capital of $5,779
and the Company incurred a loss from operations for the year then ended. The
Company expects to continue to incur substantial additional losses in 2002.
Given the December 31, 2001 cash balance and the projected operating cash
requirements, the Company anticipates that existing capital resources will not
be adequate to satisfy cash flow requirements through December 31, 2002. The
Company will require additional funding. The Companys cash flow estimates are
based upon achieving certain levels of sales, reductions in operating expenses
and liquidity available under the accounts receivable financing. Should sales
be less than forecast, expenses be higher than forecast or the liquidity not be
available under the accounts receivable financing or through additional
financings of debt and/or equity, the Company will not have adequate resources
to fund its operations. During the past year, the Company has incurred defaults
under both the Companys accounts receivable financing and the long-term
convertible notes. The Company obtained waivers for its accounts receivable
financing through March 31, 2002 and for the long-term convertible notes
through January 1, 2003. However, there is no guarantee the lenders will
continue to waive defaults in the future, should they occur, and the lenders
may declare amounts owed by the Company due and payable. Subsequent to March
31, 2002, the Company remained in default under the accounts receivable
financing. The Company does not expect future fixed obligations to be paid from
operations and the Company intends to satisfy fixed obligations from additional
financings, use of the accounts receivable financing, extending vendor payments
and issuing stock as payment on obligations.

The Companys current financial condition is the result of several factors
including the following:



| |  |  | Operating results were below expectations.                                                                                                                                                                                                                     
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The events of September 11, 2001 affected the operations and delayed
the decisions of the U.S. government. This caused sales the Company had
anticipated to be delayed. The events may also affect potential
investors and related terms of investment capital.
|
| |  |  | Sales of products through channels acquired in the BIZ acquisition
are taking longer than originally anticipated to develop.                                                                                                                                   
|
| |  |  | Market demand for our Xboard product (formerly known as CipherServer
Product line) did not materialize as anticipated and therefore our sales
were below forecast.                                                                                             
|
| |  |  | Reduced credit line availability affected the sales volume of our Pulsar subsidiary.                                                                                                                                                                           
|
| |  |  | Research and development expenses from the BIZ acquisition increased costs.                                                                                                                                                                                    

The Company currently has a need for a substantial amount of capital to
meet its liquidity requirements. The amount of capital that the Company will
need in the future will depend on many factors including, but not limited, to:



| |  |  | the ability to extend terms received from vendors                                                                                                      
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the market acceptance of products and services                                                                                                         
|
| |  |  | the levels of promotion and advertising that will be required to
launch new products and services and attain a competitive position in
the market place
|
| |  |  | research and development plans                                                                                                                         
|
| |  |  | levels of inventory and accounts receivable                                                                                                            

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| |  |  | technological advances                                                
| | - |  | ----------------------------------------------------------------------
|
| |  |  | competitors responses to our products and services                   
|
| |  |  | relationships with partners, suppliers and customers                  
|
| |  |  | projected capital expenditures                                        
|
| |  |  | reduction in the valuation of marketable investment securities        
|
| |  |  | downturn in economy                                                   
|
| |  |  | defaults on financing which will impact the availability of borrowings

In addition to the Companys current deficit working capital situation,
current operating plans show a shortfall of cash during 2002. The Company
intends to mitigate its position through one or more of the following:



| |  |  | Additional equity capital  The Company will seek additional equity
capital, if available. Equity capital will most likely be issued at a
discount to market, and require the issuance of warrants causing a
dilution to current shareholders. In addition, providers of new equity
capital may require additional concessions in order for them to provide
needed capital to the Company.                                                                                                                                                                                                                                                                                                                
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Additional convertible
debt  Depending upon the market conditions, the
Company may issue an additional debt instrument. The types of
instruments available in the market would likely contain a provision
for the issuance of warrants and may also be convertible into equity.
On April 16, 2002, simultaneous with the filing of
Form 10-K for 2001, the Company completed a private placement of
$5,000 in the form of $4,000 in 10% secured convertible promissory
notes, $653 in secured non-convertible promissory notes ($153 held by
Co-Chairman Kris Shah and $500 held by Co-Chairman Marvin Winkler)
and the pre-payment of a $500 note due from Kris Shah, less a
discount of $153 (note 19).
|
| |  |  | Off balance sheet financing  The Companys operations are not
relatively capital intensive. However, should the Company need to add
equipment or decide to expand the facilities, the Company may use an
operating lease transaction to acquire the use of capital assets. An
operating lease would not appear on our balance sheet and would be
charged as an expense as payments accrue.                                                                                                                                                                                                                                                                                                               
|
| |  |  | The Company will finance receivables in conjunction with the WFBC
agreement to generate cash. In the past the Company incurred defaults
under the WFBC line for late payments to vendors, for which the Company
received waivers from January 31, 2002 through March 31, 2002. Should
defaults occur in the future, the Company may not receive the required
waivers and may not have funds available under the line.                                                                                                                                                                                                                                                                                     

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| |  |  | The Company will sell investments to generate cash. The market value
of trading securities was approximately $1.4 million at December 31,
2001. Since that date, the Company has generated over $100 through the
sales of securities.                                                                                                                                          
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The Company is negotiating with vendors regarding payment of existing
accounts payable over extended terms of forty eight (48) months with no
interest. The Company has reached a verbal agreement with one large
vendor and is working with remaining vendors. The Company previously
executed term out agreements with a number of vendors that must now be
further extended.
|
| |  |  | Deferral of cash payments through suspension of development projects.                                                                                                                                                                                                                                                                                                          
|
| |  |  | Issuance of stock as payment for existing and future obligations.
$1,389 of accrued liabilities as of December 31, 2001 are anticipated to
be paid by the future issuance of common stock.                                                                                                                                                                                     
|
| |  |  | Issuance of stock to pay interest on long term debt.                                                                                                                                                                                                                                                                                                                           
|
| |  |  | Reductions in work force.                                                                                                                                                                                                                                                                                                                                                      

Should the Company not receive adequate financing, it could be forced to merge
with another company or cease operations.

Ultimately, the Companys ability to continue as a going concern is
dependent upon its ability to successfully launch its new products, grow
revenue, attain operating efficiencies, sustain a profitable level of
operations and attract new sources of capital.

(4) Business Combinations

Pulsar Acquisition

The Company entered into a stock acquisition agreement with Pulsar that
was affected simultaneously with the Offering. This acquisition was completed
on June 14, 1999. Litronic acquired all of the outstanding shares of Pulsar in
exchange for 2,169,938 shares of the Companys common stock. The acquisition
was accounted for using the purchase method and, accordingly, the results of
operations of Pulsar have been included in the Companys consolidated financial
statements from June 14, 1999. The excess of the purchase price over the fair
value of the net assets acquired less the liabilities assumed, resulted in a
total of $36,143 recorded as goodwill and other intangible assets, to be
amortized on a straight-line basis (see note 1).

The purchase price of the Pulsar acquisition of $23,870 or $11 per share
was based on the fair market value of the common stock issued on June 14, 1999
and was allocated as follows:

|                                             |                                                   |   |         |        | 
|-------------------------------------------- | ------------------------------------------------- | - | ------- | ------ | 
|Acquisition costs                            |                                                   | $ | (122    | )     
|Tangible assets                              |                                                   |   | 6,255   |       
|Liabilities and debt assumed                 |                                                   |   | (18,406 | )     
|Identifiable intangible assets and goodwill: |                                                   |   |         |       
|                                             | Distribution channel                              |   |         | 12,048 | 
|                                             | Customer base                                     |   |         | 12,047 | 
|                                             | Goodwill                                          |   |         | 12,048 | 
|                                             |                                                   |   |         |       
|                                             | Total identifiable intangible assets and goodwill |   |         | 36,143 | 
|                                             |                                                   |   |         |       
|Market value of common stock issued          |                                                   | $ | 23,870  |       
|                                             |                                                   |   |         |       

The Company allocated the purchase price to tangible assets, liabilities,
identifiable intangible assets and goodwill based on managements estimates of
the fair value.

During the fourth quarter of 1999, the Company recorded approximately $300
of adjustments to increase goodwill related to the acquisition of Pulsar. The
adjustments were primarily attributable to a reduction in the fair value of
certain assets as compared to the amount originally estimated and the
settlement of a pre-existing lawsuit for $140, net of a reimbursement from the
former majority shareholder of Pulsar and were partially offset by reductions
in certain accounts payable and accrued liabilities not determined necessary
after further investigation. During the second quarter of 2000, the Company
recorded approximately $331 of adjustments to increase goodwill related to the
acquisition of Pulsar. The adjustments were primarily attributable to additions
in certain accounts payable and accrued liabilities and the settlement of a
pre-existing lawsuit.

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The following unaudited pro forma financial information presents the
combined results of operations of SSP and Pulsar for 1999 as if the acquisition
had occurred as of the beginning of 1999, after giving effect to certain
adjustments including amortization of goodwill and other intangibles, increased
interest expense on debt assumed and related income tax effects. The pro forma
financial information does not necessarily reflect the results of operations
that would have occurred had SSP and Pulsar constituted a single entity during
such periods.

|                                      |  |              |         |  
|------------------------------------- |  | ------------ | ------- | -
|                                      |  | Year Ended  
|                                      |  | December 31,
|                                      |  | 1999        
|                                      |  |             
|Total revenue                         |  | $            | 49,230  |  
|                                      |  |              |         |  
|Net loss                              |  | $            | (11,713 | )
|                                      |  |              |         |  
|Net loss per share, basic and diluted |  | $            | (1.19   | )
|                                      |  |              |         |  

As part of the Pulsar acquisition the Company assumed $12,422 in debt. The
majority of the debt was paid on June 14, 1999. The remaining outstanding debt
was paid in July 1999.

See discussion on impairment of goodwill and other intangibles at Note 2.

BIZ Acquisition

On August 24, 2001, pursuant to an Agreement and Plan of Reorganization
dated July 3, 2001 with BIZ, the Company completed the Acquisition, whereby BIZ
became a wholly-owned subsidiary of the Company. In connection with the
Acquisition, the Company issued an aggregate of 10,875,128 shares of SSP common
stock in exchange for all of the outstanding shares of BIZ common stock and
preferred stock. In addition, the Company reserved for issuance an aggregate of
approximately 860,000 shares of its common stock for issuance upon exercise of
BIZ options and warrants assumed by the Company.

The Acquisition has been accounted for under the purchase method of
accounting in accordance with generally accepted accounting principles. The
Company recorded a one-time charge for purchased in-process research and
development (IPR&D) expenses of $1,600.

The Company utilized an independent third-party appraiser to assess and
allocate values to the IPR&D. The values assigned to these projects were
determined by identifying projects that have economic value but that had not
yet reached technological feasibility and that have no alternative future use.
These products have not been released to the market as of the date of the
Acquisition, but the features and functionality of the products had been
defined.

The values of these projects were determined using the Income Forecast
Method. In applying the Income Forecast Method, the value of the acquired
technologies was estimated by discounting to present value, the free cash flows
generated by the products with which the technologies are associated.
Adjustments were made to provide for a fair return to fixed assets, working
capital, and other assets that contribute to value. The estimates were based on
the following assumptions:



| |  |  | The estimated revenues assume average compound annual revenue growth
rates of 44% to 197% during fiscal years 2002 through 2007, depending on
the product line. These projections are based on managements estimates
over the expected remaining economic lives of the technologies. The
IPR&D value is comprised of three on-going projects. The estimated cost
of revenues as a percentage of revenues is expected to be approximately
55%. The estimated cost to complete the two on-going projects is
expected to be $4,025.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The discount rates used in the valuation reflect the relative risk of
the product lines. For IPR&D projects, the discount rates ranged from
45% to 50%, which was based on the amount and risk of effort remaining
to complete the respective development projects.                                                                                                                                                                                                                                                              

The Company believes that the foregoing assumptions used in determining
the income forecast associated with the IPR&D products are reasonable. No
assurance can be given, however, that the underlying assumptions used to
estimate the income forecast, the ultimate revenues and costs on such projects,
or the events associated with such projects, will transpire as estimated.
During the fourth quarter of 2001, the Company terminated its development on
one of the technologies classified as IPR&D. To date, the Company has spent
approximately $1,112 on those projects.

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The total purchase price and allocation among the fair value of tangible
and intangible assets and liabilities (including purchased in-process research
and development) are summarized as follows:

|                                |                                     |   |        |       | 
|------------------------------- | ----------------------------------- | - | ------ | ----- | 
|Tangible assets                 |                                     | $ | 3,231  |      
|Liabilities                     |                                     |   | 3,047  |      
|                                |                                     |   |        |      
|Net tangible assets             |                                     |   | 184    |      
|Identifiable intangible assets: |                                     |   |        |      
|                                | In-process research and development |   |        | 1,600 | 
|                                | Completed technology                |   |        | 6,200 | 
|                                | Strategic relationships             |   |        | 2,800 | 
|Goodwill                        |                                     |   | 53,882 |      
|Deferred compensation           |                                     |   | 29     |      
|                                |                                     |   |        |      
|                                |                                     | $ | 64,695 |      
|                                |                                     |   |        |      

A preliminary purchase price allocation was performed and the resulting amounts
were included in the Companys September 30, 2001 Form 10-Q. The preliminary
purchase price allocation differed from the final purchase price allocation as
follows: the in-process research and development was valued at $3,300 and the
completed technology was valued at $5,900. The total purchase price did not
change, and the difference was an increase in goodwill.

The other intangible assets will be amortized on a straight-line basis
over the following estimated useful lives, in years:

|                        |  |        |  |  
|----------------------- |  | ------ |  | -
|Completed technology    |  |        |  | 5
|Strategic relationships |  | 1 to 5

The operating results of BIZ have been included in the consolidated
statements of operations since the acquisition date, August 24, 2001.

Following are the summarized unaudited pro forma combined results of
operations for the twelve months ended December 31, 2000 and December 31, 2001,
assuming the acquisition had taken place at the beginning of each of those
fiscal years. The unaudited pro forma combined statement of operations for the
twelve months ended December 31, 2000 was prepared based on the statement of
operations of SSP for the twelve months ended December 31, 2000 and the
statement of operations for BIZ from April 30, 2000 (inception) to December 31,
2000. Accordingly, eight months of amortization of the intangibles was
included. The unaudited pro forma combined statement of operations for the
twelve months ended December 31, 2001 was prepared based upon the statement of
operations of SSP for the twelve months ended December 31, 2001 and BIZ for the
period from January 1, 2001 through August 24, 2001. The unaudited pro forma
results exclude the effects of the IPR&D charge but include the amortization of
other intangibles and deferred compensation. The unaudited pro forma results
are not necessarily indicative of the future operations or operations that
would have been reported had the Acquisition been completed when assumed.

See discussion on impairment of goodwill and other intangibles at Note 2.

|                   |  |                     |         |              |  |   |         |  
|------------------ |  | ------------------- | ------- | ------------ |  | - | ------- | -
|                   |  | Twelve Months Ended
|                   |  |                    
|                   |  | December 31,        |         | December 31,
|                   |  | 2000                |         | 2001        
|                   |  |                     |         |             
|Net revenues       |  | $                   | 39,356  |              |  | $ | 22,720  |  
|                   |  |                     |         |              |  |   |         |  
|Net loss           |  | $                   | (46,106 | )            |  | $ | (68,661 | )
|                   |  |                     |         |              |  |   |         |  
|Net loss per share |  | $                   | (2.22   | )            |  | $ | (3.33   | )
|                   |  |                     |         |              |  |   |         |  

As the markets for the Companys products are characterized by rapidly
changing technology, evolving industry standards, and the frequent introduction
of new products and enhancements, it is reasonably possible that the estimates
of the anticipated future gross revenues, the remaining estimated economic
life, or both will be reduced within the next year. Reasonably possible is
defined as more than remote but less than likely. As a result, the remaining
goodwill of $26,621 related to the Acquisition at December 31, 2001, may be
reduced within the next year.

(5) Investments

The Company has an investment that is classified as trading securities.
The securities are comprised of Class A common stock of Wave Systems Corp., par
value $0.01 received in the Acquisition. As of December 31, 2001, the Company
had 607,000 shares with an

F-16



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##### Table of Contents



aggregate value of $1,360. For the period ending December 31, 2000 and
2001 the Company recorded realized loss on trading securities of $0 and $530,
respectively.

(6) Inventories

A summary of inventories follows:

|                |  |              |     |      |  |   |     | 
|--------------- |  | ------------ | --- | ---- |  | - | --- | 
|                |  | December 31,
|                |  |             
|                |  | 2000         |     | 2001
|                |  |              |     |     
|Raw materials   |  | $            | 258 |      |  | $ | 112 | 
|Work-in-process |  |              | 86  |      |  |   | 8   | 
|Finished goods  |  |              | 351 |      |  |   | 316 | 
|                |  |              |     |      |  |   |     | 
|                |  | $            | 695 |      |  | $ | 436 | 
|                |  |              |     |      |  |   |     | 

(7) Property and Equipment

A summary of property and equipment follows:

|                                               |  |              |       |      |  |   |       | 
|---------------------------------------------- |  | ------------ | ----- | ---- |  | - | ----- | 
|                                               |  | December 31,
|                                               |  |             
|                                               |  | 2000         |       | 2001
|                                               |  |              |       |     
|Leasehold improvements                         |  | $            | 65    |      |  | $ | 65    | 
|Machinery and equipment                        |  |              | 68    |      |  |   | 68    | 
|Furniture and fixtures                         |  |              | 2,140 |      |  |   | 2,383 | 
|                                               |  |              |       |      |  |   |       | 
|                                               |  |              | 2,273 |      |  |   | 2,516 | 
|Less accumulated depreciation and amortization |  |              | 1,450 |      |  |   | 2,155 | 
|                                               |  |              |       |      |  |   |       | 
|                                               |  | $            | 823   |      |  | $ | 361   | 
|                                               |  |              |       |      |  |   |       | 

(8) Long-Term Debt

A summary of long-term debt follows:

|                                                                                                                                                                                                                             |  |              |       |      |  |   |       | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----- | ---- |  | - | ----- | 
|                                                                                                                                                                                                                             |  | December 31,
|                                                                                                                                                                                                                             |  |             
|                                                                                                                                                                                                                             |  | 2000         |       | 2001
|                                                                                                                                                                                                                             |  |              |       |     
|Revolving note payable to bank with maximum availability of $5,000, bearing
interest at prime plus .625% (10.125% at December 31, 2000) through maturity
on May 10, 2002; secured by substantially all assets of the Company |  |              | 1,509 |      |  |   |      | 
|Note payable for insurance financing due in nine monthly payments beginning
July 9, 2000 at an annual percentage rate of 7.15%                                                                                               |  |              | 12    |      |  |   |      | 
|Note payable for insurance financing due in eighteen monthly payments
beginning July 9, 2000 at an annual percentage rate of 8.18%                                                                                           |  |              | 484   |      |  |   | 173   | 
|Well Fargo Business Credit accounts receivable financing, discount rate of
1.25% of the receivables factored, interest payable upon payment of receivable                                                                    |  |              |      |      |  |   | 1,522 | 
|Subordinated convertible note due December 17, 2004 with
interest rate at 8.0% per annum compounded annually, interest payable quarterly                                                                                     |  |              |      |      |  |   | 2,500 | 
|                                                                                                                                                                                                                             |  |              |       |      |  |   |       | 
|                                                                                                                                                                                                                             |  |              | 2,005 |      |  |   | 4,195 | 
|Less current installments                                                                                                                                                                                                    |  |              | 1,986 |      |  |   | 1,695 | 
|                                                                                                                                                                                                                             |  |              |       |      |  |   |       | 
|                                                                                                                                                                                                                             |  | $            | 19    |      |  | $ | 2,500 | 
|                                                                                                                                                                                                                             |  |              |       |      |  |   |       | 

GBCC Financing

In June 1999, the Company entered into a three-year lending agreement with
Guaranty Business Credit Corporation (GBCC) permitting borrowings under a
$20,000 secured revolving line of credit facility that commenced on June 14,
1999. The agreement provided for an annual interest rate of prime plus .625%;
and a pledge of substantially all of the Companys personal and real property
as collateral. Although the credit facility was for borrowings up to $20,000,
under the terms of the agreement the amount of borrowing available to the
Company was subject to a maximum borrowing limitation based on eligible
collateral.

On April 18, 2001, the terms of the Companys revolving line of credit
were amended. Under the terms of the amended agreement the maximum borrowings
were $5,000, eligible collateral excluded inventory, and the advance rate was
35%. In addition, certain of the financial covenants and requirements were
adjusted. The amended $5,000 revolving credit facility contained various
covenants

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and restrictions. Under the terms of the amended agreement, the Company
was required to obtain the lenders consent for any merger, acquisition or
consolidation. The lender was not willing to give its consent to the
Acquisition and discontinued making advances under the terms of the amended
agreement effective with the Acquisition. The lender applied all collections
subsequent to the Acquisition to outstanding borrowings until such borrowings
and related interest charges were paid in full. All amounts due to the lender
were paid in full on October 2, 2001. Once all amounts were paid in full the
lender released its security interest in the Companys assets.

Accounts Receivable Financing

On November 2, 2001, the Companys wholly owned subsidiary, Pulsar, entered
into a financing agreement with Wells Fargo Business Credit, Inc. (WFBC),
which provides for the factoring of accounts receivable. On November 2, 2001,
the Company also entered into a financing agreement for SSP. The term of the
agreement shall continue until the earlier of twelve (12) months from the date
of this agreement or upon sixty (60) days written notice by one of the parties.
The agreement shall continue for subsequent twelve (12) month periods unless
sixty (60) days prior to termination date, the Company notifies WFBC. This
financing agreement permits the Company to sell, with recourse, certain
eligible trade receivables. The agreement contains no limit on the dollar
volume of receivable financing, but provides for WFBCs approval of credit
limits for non-government customers. As receivables transferred to the
financial institution are collected, the Company may transfer additional
receivables. The discount rate charged is 1.25% of the gross receivable
factored, which may be increased by .0625% per day for accounts that do not pay
within thirty days of the receivable purchase. At the time of purchase, terms
call for WFBC to advance 85% of the gross receivable, with the balance remitted
after collection of the invoice less the discount and any other charges. The
agreement requires minimum quarterly fees and discounts totaling $63. The
balances due WFBC are guaranteed by the Companys Co-Chairmen and Co-Chief
Executive Officers, (see note 11).

Gross receivables transferred to WFBC amounted to $0 and $2,105 in 2000 and
2001, respectively. The Company is obligated to repurchase certain accounts
receivable under the program and, therefore, the transaction does not qualify
as a sale under the terms of Statement 140.

Factored receivables included in the accounts receivable balance as of
December 31, 2000 and 2001 were $0 and $1,790, respectively.

|                                      |  |              |       |      |  |   |       |  
|------------------------------------- |  | ------------ | ----- | ---- |  | - | ----- | -
|                                      |  | December 31,
|                                      |  |             
|                                      |  | 2000         |       | 2001
|                                      |  |              |       |     
|Advances from factor                  |  |              |       |      |  |   | 1,790 |  
|Amounts due from factor               |  |              |      |      |  |   | 315   |  
|Receivables assigned to factor        |  |              |      |      |  | $ | 2,105 |  
|                                      |  |              |       |      |  |   |       |  
|Unfactored accounts receivable        |  |              | 4,405 |      |  |   | 2,507 |  
|Allowances for returns and allowances |  |              | (268  | )    |  |   | (254  | )
|                                      |  |              |       |      |  |   |       |  
|                                      |  | $            | 4,137 |      |  | $ | 4,358 |  
|                                      |  |              |       |      |  |   |       |  

As of December 31, 2001, the Company was in violation of certain provisions of
the financing agreement. These violations are related to the Companys failure
to pay debts and obligations as they become due (primarily trade payables) and
delays in misdirected payments. During the first quarter of 2002, the Company
requested and received a waiver for the aforementioned violations for past
events of default through March 31, 2002 and January 31, 2002, respectively. As
the waiver expired on March 31, 2002, the Company is in default for failure to
pay debts and obligations as they become due. The Company anticipates that it
will continue to be in violation of this agreement unless it is able to raise
sufficient capital to pay debts and obligations as they become due.

Insurance Financing

The Company maintains insurance premium financing agreements with
Cananwill, Inc. for the payment of certain insurance premiums. The premiums
being financed cover policy periods from twelve to twenty four months. The
Acquisition caused the amendment of some of the policies carried by the
Company. As a result, the premium financing agreements were amended to provide
for five monthly installments covering policy periods ending June 30, 2002,
which extended the existing policy for the remaining three months. These
insurance premium financing agreements are secured by the proceeds of the
policies being financed.

Subordinated Notes

During December 2001, the Company issued four separate Subordinated Convertible
Notes (the Notes) totaling $2,500 with similar terms and conditions. The
Notes are due on December 17, 2004 and bear 8% interest per annum payable
quarterly. In connection with

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the issuance of the subordinated convertible notes the Company incurred
approximately $28 of issuance costs, which primarily consisted of legal and
other professional fees, which are to be paid at a later date. All subordinated
convertible notes mature December 17, 2004; bear interest at a rate of 8% per
annum, which will be paid quarterly in cash; These notes are convertible at the
election of the holders, at any time no such number of shares of our common
stock as is determined by dividing the outstanding principal amount of the role
being converted by the conversion price in effect at that time. The initial
conversion price provided for in the in the notes is $3.60 per share and is
subject to adjustment under certain conditions. In addition, upon the closing
of a qualified financing as defined in the notes, the then outstanding
principal and any accrued and unpaid interest on these notes will automatically
convert into such number of shares of the type of equity securities sold in
that qualified financing as is determined by dividing the amount of principal
and interest remaining on the note being converted by the lesser of (a) the
price at which the equity securities are being sold in the qualified financing
or (b) the conversion price provided in the note being converted in effect at
the time. After December 17, 2003, the Company may call for mandatory
conversion of the subordinated convertible notes prior to maturity if the
Companys common shares trade at or above an average price of 300% of the
conversion price for twenty (20) consecutive trading days and average volume of
200,000 share per day for twenty (20) consecutive trading days. Two of the
Notes totaling $750 were issued to the Companys Co-Chairmen and Co-Chief
Executive Officers of the Company.

As of December 31, 2001, the Company was in violation of certain provisions of
the Notes. These violations are related to the Companys failure to pay debts
and obligations as they become due and the cross default as a result of the
default under the Companys agreement with WFBC. During the first quarter of
2002, the Company requested and received a waiver for each of the
aforementioned violations for past and for anticipated future events of default
through January 1, 2003. Furthermore, during the second quarter of 2002, the
Company requested and received a waiver for the potential non-payment of
interest on the Notes through January 1, 2003.

On April 16, 2002, with the exception of Mr. Winkler and Mr. Shah, the
noteholders converted their subordinated convertible notes into 10% secured
convertible promissory notes (see note 19).

(9) Accrued Liabilities

A summary of accrued liabilities follows:

|                                     |  |              |       |      |  |   |       | 
|------------------------------------ |  | ------------ | ----- | ---- |  | - | ----- | 
|                                     |  | December 31,
|                                     |  |             
|                                     |  | 2000         |       | 2001
|                                     |  |              |       |     
|Professional fees                    |  | $            | 334   |      |  | $ | 161   | 
|Accrued vacation                     |  |              | 365   |      |  |   | 457   | 
|Accrued compensation                 |  |              | 426   |      |  |   | 384   | 
|Wave Development Agreement (note 13) |  |              |      |      |  |   | 1,389 | 
|Other                                |  |              | 241   |      |  |   | 952   | 
|                                     |  |              |       |      |  |   |       | 
|                                     |  | $            | 1,366 |      |  | $ | 3,343 | 
|                                     |  |              |       |      |  |   |       | 

In October 2000, BIZ signed a development agreement with Wave Systems
Corp. (Wave) for the integration of EMBASSY based systems with set-top box
master reference designs of Broadcom Corporation. The development agreement was
amended in May 2001. Under this amended agreement, the Company is required to
pay Wave $278,000 per month beginning June 1, 2001 through December 1, 2002 for
work to be performed, or a total of $5,000. Should the Company not make the
required monthly payments, Wave may request payment in the form of common
stock. As of December 31, 2001, the Company owed $1,389 to Wave for which they
have tendered monthly notices of default. The default notices convert the
obligation for payment for the delinquent installments from a cash obligation
into a stock acquisition right. To date, Wave has made no request for issuance
of stock. The $1,389 obligation is carried in Accrued Liabilities of December
31, 2001 (see note 13).

(10) Business Segments and Product Lines

The Company operates in two industry segments, the information security
segment and the network solutions segment. Following are the revenues, cost of
sales and identifiable assets of these segments as of and for the years ended
December 31, 2000 and 2001.

|        |                                            |  |   |                     |  |      |   |        |  | 
|------- | ------------------------------------------ |  | - | ------------------- |  | ---- | - | ------ |  | 
|        |                                            |  |   | Twelve Months Ended
|        |                                            |  |   | December 31,       
|        |                                            |  |   |                    
|        |                                            |  |   | 2000                |  | 2001
|        |                                            |  |   |                     |  |     
|Revenue |                                            |  |   |                     |  |      |   |       
|        | Information Security Products and Services |  | $ | 7,424               |  |      | $ | 8,246  | 
|        | Network Solutions Market                   |  |   | 31,932              |  |      |   | 14,474 | 
|        |                                            |  |   |                     |  |      |   |       

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|                    |  |                                            |  |   |        |  |  |   |        | 
|------------------- |  | ------------------------------------------ |  | - | ------ |  |  | - | ------ | 
|Cost of sales       |  |                                            |  |   |        |  |  |  
|                    |  | Information Security Products and Services |  | $ | 2,681  |  |  | $ | 4,497  | 
|                    |  | Network Solutions Market                   |  |   | 28,479 |  |  |   | 13,497 | 
|                    |  |                                            |  |   |        |  |  |  
|Identifiable assets |  |                                            |  |   |        |  |  |  
|                    |  | Information Security Products and Services |  | $ | 1,373  |  |  | $ | 27,553 | 
|                    |  | Network Solutions Market                   |  |   | 4,370  |  |  |   | 3,862  | 
|                    |  |                                            |  |   |        |  |  |  

As the Chief Operating Decision Maker does not review operating expenses
by segment beyond cost of sales or assets, except as identified, additional
segment information is not available.

During the years ended December 31, 1999, 2000 and 2001 the Company had
four distinct product lines: network deployment products, data security
products, license and service, and electric security systems. In 2000, the
Company discontinued the electric security systems product line. Therefore,
there is no activity related to the electric security product line in 2001.
Following is a summary of total revenues by product line.

|                            |                                                 |   |                     |        |      |   |        |        |  |   |        |        | 
|--------------------------- | ----------------------------------------------- | - | ------------------- | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|                            |                                                 |   | Twelve Months Ended
|                            |                                                 |   | December 31,       
|                            |                                                 |   |                    
|                            |                                                 |   | 1999                |        | 2000 |   | 2001  
|                            |                                                 |   |                     |        |      |   |       
|Network deployment products |                                                 | $ | 26,022              |        |      | $ | 31,668 |        |  | $ | 14,474 |       
|Data security products      |                                                 |   | 3,565               |        |      |   | 5,753  |        |  |   | 6,671  |       
|License and service         |                                                 |   | 834                 |        |      |   | 1,671  |        |  |   | 1,575  |       
|Electric security systems   |                                                 |   | 436                 |        |      |   | 264    |        |  |   | 0      |       
|                            |                                                 |   |                     |        |      |   |        |        |  |   |        |       
|                            | Total net product, license and service revenues |   | $                   | 30,857 |      |   | $      | 39,356 |  |   | $      | 22,720 | 
|                            |                                                 |   |                     |        |      |   |        |        |  |   |        |       

(11) Related Party Transactions

KRDS Real Property Lease

The primary shareholders of Litronic, Inc. formed KRDS, Inc., (KRDS) for
the sole purpose of purchasing real estate property. KRDSs operations
primarily consisted of a mortgage obligation, interest, depreciation and rental
income from the Company related to the real estate property.

In February 2000, KRDS leased a building to the Company for its corporate
headquarters. The lease expires in February 2007 (see note 13). The facility
has an annual rent of approximately $429. In April 2002, the Company and KRDS
entered into an agreement whereby upon sixty (60) days notice, the Company may
cancel the remaining balance of the facility lease with no future liability.
The company has not exercised the exit clause, but anticipates doing so in
connection with the lease of a new facility (see below and note 13).

Note Receivable From Shareholder

The note receivable from shareholder consists of a note acquired as part
of the Acquisition. The $500 note was received by BIZ from our co-chairman,
Kris Shah, in conjunction with the issuance of BIZ common shares prior to the
Acquisition, and therefore will be shown as a reduction of shareholders equity
until paid. The note has a stated interest rate of 5% per annum and is due on
July 24, 2005. On April 12, 2002, in a transaction approved the Companys board
of directors, Mr. Shah prepaid the note by paying to the Company $347 and the
Company recording a discount of $153 which was charged against income in the
second quarter of 2002. The discount was computed based upon a present value
calculation using a discount rate of 20%.

Notes Receivable  Related Party

On December 31, 1999, the Company had a note receivable from William
Davis, the former majority shareholder of Pulsar and the Companys former
president, for $70. This note receivable was paid in full in the fourth quarter
of 2000.

The notes receivable primarily consists of two promissory notes that were
acquired as part of the Acquisition of BIZ. As part of a hiring package, an
employee received a $10 advance and executed a demand promissory note that
included interest at 6%. Subsequently, as part of a loan agreement, the same
employee executed a separate promissory note for $37 including interest at 8%
due May 3, 2002. The balance of the related party notes includes accrued
interest. These balances are included in other current assets in the
consolidated financial statements.

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Notes Payable To Related Party

On July 31, 2001, Chase Manhattan Bank (Chase) advanced $1,000 to the
Companys Co-Chairman, Mr. Winkler, who then advanced that amount to BIZ for
the re-purchase of preferred stock held by an investor in BIZ. Mr. Winkler
executed a $1,000 demand note with Chase and BIZ executed a $1,000 demand note
due September 15, 2001 with J.A.W. Financial, L.P. (JAW), an entity
controlled by Mr. Winkler. The demand note contained an interest charge of
prime plus 1% through the maturity date and prime plus 3% after the maturity
date. On October 11, 2001, the Company made a principal payment of $30, paid
accrued interest, and executed a new promissory note to JAW for $970. The terms
of the promissory note call for interest of prime plus 3% payable monthly,
together with five monthly payments of principal in the amount of $160 and one
final payment on April 15, 2002 in the amount of $170. The promissory note
provides Chase a security interest in the shares in Wave Systems Corp. owned by
the Company, and subject to Chases loan security guidelines the rights to
proceeds from any sales of those shares. At December 31, 2001, the note payable
to related party was $304. On March 8, 2002, the promissory note was paid in
full ahead of scheduled maturity.

During 2001, a related party periodically advanced amounts required for
the operations of BIZ, which was acquired in the Acquisition. As of December
31, 2001, the Company owed the related party a balance of $88 for such
advances. No interest has been paid, accrued or due on such advances.

The combined total payable to the related party at December 31, 2001
totaled $392.

Subordinated Convertible 8% Notes

In December 2001, the Companys Co-Chairmen each purchased a three year
$375, 8% subordinated convertible note, in a total private placement of $2,500
of such notes. In April 2002, the subordinated convertible notes of the
Co-Chairmen were amended to provide that their notes can only be converted upon
a financing of $5,000 or more in equity or convertible securities in a private
placement to institutional investors at a conversion price that represents a
25% or less discount to trading price of the Companys stock. As of December
31, 2002, the Company was in violation of certain provisions of the Notes. The
Company requested and received a waiver for these violations, see note 8. On
April 16, 2002, simultaneously with the filing on Form 10-K for 2001 the
Company intends to close a financing whereby with the exception of Co-Chairmen,
the noteholders convert their subordinated convertible notes into 10% secured
convertible promissory notes (see note 19).

New Facilities Related Party Leasing

The Company arranged for the lease of two buildings approximating 63
square feet that were under construction and are now complete. The Companys
Co-Chairman, Mr. Shah, has a 25% ownership interest in the entity that owns the
two buildings. The leases have an aggregate monthly rental totaling
approximately $115, plus common area costs for seven years. On one building
totaling 23 square feet, we sublet one half of the building on terms and
conditions matching the underlying lease. The sublease is with a related party
company owned by our co-chairman, Marvin Winkler. The sub-lessee is currently
delinquent on its rent payments to the Company. The Company is in negotiations
with the landlord regarding being released from obligations under the lease for
the second building totaling 40 square feet. The Company intends to release the
sub-tenant and occupy the 23 square foot building based upon having raised
$5,000 through secured convertible promissory notes (see note 19). The Company
has accrued $2,171 as an estimate for anticipated costs relative to the
disposition of the 40 square foot building net of anticipated offsetting
sublease income.

(12) Concentration of Credit Risk and Significant Customers

Financial instruments that potentially subject the Company to
concentration of credit risk are trade receivables. Credit risk on trade
receivables is limited as a result of the Companys customer base and their
dispersion across different industries and geographic regions. As of December
31, 2000 and 2001, accounts receivable included $3,732 and $3,498,
respectively, due from the U.S. Government and related agencies. Sales to the
U.S. Government and related agencies accounted for 91%, 81% and 72% of total
revenues for the years ended December 31, 1999, 2000 and 2001, respectively.

The Company had sales to two customers that represented 31% and 12% of
1999 total revenue, respectively. The Company had sales to one customer that
represented 42% of 2000 total revenue. The Company had sales to one customer
that represented 20% of 2001 total revenue. No other customers accounted for
more than 10% of total revenue in 1999, 2000 or 2001. Trade accounts receivable
aggregated $1,191 and $1,577 from the aforementioned major customers as of
December 31, 2000 and 2001, respectively.

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Some key components used in the manufacture of the Companys products can
only be obtained from single sources.

(13) Commitments and Contractual Obligations

The Company leases office space under noncancelable operating leases. The
terms of the leases range up to seven years. The following summarizes the
future minimum lease payments under all noncancelable operating lease
obligations:

|                         |                     |   |       |       | 
|------------------------ | ------------------- | - | ----- | ----- | 
|Year ending December 31, |                     |   |       |      
|                         | 2002                |   | $     | 1,707 | 
|                         | 2003                |   |       | 769   | 
|                         | 2004                |   |       | 672   | 
|                         | 2005                |   |       | 672   | 
|                         | 2006 and thereafter |   |       | 2,075 | 
|                         |                     |   |       |      
|                         |                     | $ | 5,895 |      
|                         |                     |   |       |      

Rental expense under noncancelable operating leases was $434, $668, and
$679 for the years ended December 1999, 2000 and 2001, respectively. Rental
expense and future minimum lease payments for the years 1999, 2000 and 2001
include offsetting income from subleases in the amounts of $126 and $45,
respectively.

The commitment schedule above is net of the following sublease income:

|                    |  |   |       | 
|------------------- |  | - | ----- | 
|2002                |  | $ | 45    | 
|2003                |  |   | 722   | 
|2004                |  |   | 722   | 
|2005                |  |   | 722   | 
|2006 and thereafter |  |   | 2,165 | 
|                    |  |   |       | 
|                    |  | $ | 4,376 | 
|                    |  |   |       | 

The corporate headquarters are leased from a related party (see note 11).
The remaining term on the previously existing lease extended until September
2001. In 1999, the Company recognized a net loss on the previous lease of $129;
this loss includes offsetting sublease income.

In April 2002, the Company and KRDS entered into an agreement whereby upon
sixty (60) days notice, the Company or KRDS may cancel the remaining term of
the corporate headquarters lease with no future liability. The exit clause is
available provided that all amounts due under the lease are paid current
through the date of termination. The Company has not executed the exit clause
but anticipates doing so in the connection with the lease of the new facility.

The Company entered into two lease agreements in October 2001 with a
related party (note 11) to move its corporate headquarters to a larger
facility. The new facility consists of two buildings with an aggregate of
approximately 63 square feet, located in the Irvine Spectrum in Irvine,
California. The leases for the Spectrum facilities expire in 2009 and have an
annual rent of $1,394.

The Company is currently occupying its facility leased from KRDS, a
related party, and is subletting one-half of one of the Spectrum facilities,
consisting of approximately 23 square feet, to a related party. The subtenant
is currently delinquent on its rental payments to the Company. To date, the
Company has not received any rental income from its subtenant.

The Company is currently negotiating with the landlord of the new
facilities regarding being released from obligations for one of the facilities
consisting of approximately 40 square feet. The Company anticipates moving into
the 20 square foot building in July 2002 and releasing its subtenant from its
rental commitments. In 2001, the Company recognized a net loss on the Spectrum
leases of $2,171 which is net of anticipated future sublease income.

As of December 31, 2001, the Company had unconditional purchase
obligations of $8,873 for purchases through 2006.

EDS

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In November 2000, the Company executed an Alliance Agreement with
Electronic Data Systems Corporation (EDS) for the marketing of Company
products to EDS customers (Alliance). The Alliance calls for a joint working
relationship between the two companies, which is non-exclusive and has a term
of ten (10) years. In February 2001, the Company and EDS executed an engagement
letter for EDS to provide certain information technology and consulting
services for both the Companys organizational structure and for a specific
customer project. Under these engagements, EDS billed $1,150, of which $458
remained unpaid as of December 31, 2001.

On August 27, 2001, EDS and the Company executed a letter of intent and
temporary working agreement whereby EDS supplied software and hardware for
re-sale to Pulsar customers (Pulsar Agreement). Under the Pulsar Agreement,
as of December 31, 2001, $1,488 remained outstanding and unpaid to EDS for
purchases of hardware and software.

The Company and EDS executed a Master Services Agreement (MSA) dated as
of November 14, 2001, whereby beginning December 1, 2001 and ending December
31, 2006, the Company and EDS established a strategic teaming relationship to
implement, sell and deliver a set of secure transaction processing offerings
based upon a Trust Assurance Network (TAN). The MSA task order (Task Order)
requires that the Company to pay a monthly fee of $44 for account, test and lab
management services beginning January 1, 2002. The obligations for these
services can be terminated beginning January 1, 2003 by giving ninety (90) days
prior written notice and payment of $400, or beginning January 1, 2004 by
giving ninety (90) days prior written notice and payment of $200. Further, the
Task Order provides for EDS to provide TAN hosting and implementation in
exchange for an implementation fee of $45 payable October 1, 2002. Once
installation of the production environment TAN is complete, EDS agrees to host
the TAN in exchange for a monthly service fee of $59 for thirty-six (36) months
and $60 per month for the remaining months of the MSA. The Company may delay
implementation of the TAN by paying a fee of $200 prior to January 31, 2003.
The Company may terminate the Task Order without cause by paying $400 after
January 1, 2004 and providing ninety (90) days prior written notice. In the
event the Company is unable to obtain intellectual property rights or licensing
consents that may be required, if any, prior to January 1, 2003, and the
parties determine there are no software alternatives, then after giving ninety
(90) days prior written notice the Company may terminate the Task Order by
paying $450.

WAVE SYSTEMS CORP.

In October 2000, BIZ signed a development agreement with Wave Systems
Corp. (Wave) for the integration of EMBASSY based systems with set-top box
master reference designs of Broadcom Corporation. The development agreement was
amended in May 2001. Under this agreement, BIZ is required to pay Wave $278 per
month beginning June 1, 2001 through December 1, 2002. Should the Company not
make the required payments, Wave may request payment in the form of common
stock. As of December 31, 2001, the Company owed $1,389 to Wave, but no
requests for stock payments have been made. The Company has included this
amount in the accrued liabilities balance at December 31, 2001. These shares
are not included in shareholders equity as the agreement does not include a
limit on the number of shares which could potentially be issued upon the
exercise of the stock right by Wave. Additionally, no shares related to this
obligation have been included in the earnings per share calculation for the
year ended December 31, 2001. Under the terms of the agreement, if SSP fails to
pay any installment in full, when payable and if the default is not cured
within 30 days after written notice, the unpaid portion of the installment
shall automatically convert into stock acquisition rights exercisable by Wave
to acquire a number of fully paid, nonassessable shares of common stock of SSP
determined by dividing the fair market value, the average of closing price of
SSP common stock for the 10 trading-day period prior to the date of exercise,
of a share of SSP common stock on the date of exercise of the stock acquisition
right into the aggregate of the portion of the installment payment that is not
paid on the due date of the installment payment related to the defaults.
Separately, should the Company or not purchase $5,000 of goods or services from
Wave by June 30, 2003, the Companys exclusivity relative to certain customers
will, at Waves option, become non-exclusive.

Waves stock acquisition right may be exercised at any time within 10 years of
the date of default. SSP may elect, at any time the stock acquisition rights
are outstanding and not exercised, to redeem any of the stock acquisition
rights and convert the aggregate credit amount into SSP common stock. To date,
Wave has made no request for issuance of stock.

The Company has been in default of the agreement since August 2001. Wave has
issued monthly notices of default through January 2002. Accordingly, at
December 31, 2001, $1,389 was converted into stock appreciation rights. It is
managements intent to make all future payments under the terms of this
agreement in stock.

SSP has reserved 1,150,000 shares of its authorized but unissued common stock
for issuance to Wave.

EPAY LATINA

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Under a joint marketing alliance agreement executed in August 2001 and
will continue for a period of 20 years with ePayLatina (ePay), the Company
agreed to create the applet to allow ePays enhanced security transaction
software to communicate with the Companys card readers. As part of the
agreement ePay agreed to purchase and use the Companys card readers (or other
products with similar functionality sold by the Company), and granted the
Company a world wide, royalty free exclusive license to use their software. The
Company and ePay both agreed to bear their own costs. The Company estimates the
cost to complete the applet to be $150. The Company and ePay both agreed to
share net revenues from the sales of bundled products on a 50/50 basis.

(14) Loss Per Share

The calculation of diluted net loss per share under Statement 128 excludes
potential common shares if the effect is antidilutive. Potential common shares
are composed of incremental shares of common stock issuable upon the exercise
of stock options and warrants. The following table sets forth potential common
shares that were excluded from the diluted net loss per share calculation for
the years ended December 31, 1999, 2000 and 2001 because they are antidilutive
for the periods indicated:

|              |  |      |     |      |  |      |     |  |  |  |       | 
|------------- |  | ---- | --- | ---- |  | ---- | --- |  |  |  | ----- | 
|              |  | 1999 |     | 2000 |  | 2001
|              |  |      |     |      |  |     
|Warrants      |  |      | 370 |      |  |      | 370 |  |  |  | 394   | 
|Stock options |  |      | 236 |      |  |      | 490 |  |  |  | 1,543 | 
|              |  |      |     |      |  |      |     |  |  |  |       | 
|              |  |      | 606 |      |  |      | 860 |  |  |  | 1,937 | 
|              |  |      |     |      |  |      |     |  |  |  |       | 

(15) Shareholders Equity

1998 and 1999 Employee Stock Option Plans

Under the Companys 1998 and 1999 Employee Stock Option Plans (the
Plans) which were established in April 1998 and April 1999, respectively, the
exercise price of options granted will not be less than the fair market value
of the related common stock at the date of grant. The total number of shares of
common stock available for grant under the Plans is 1,500,000 shares. All stock
options granted under the Plans have 10-year terms. Unless otherwise provided
by the Board of Directors or a committee of the Board administering the Plans,
each option granted under the 1998 Plan vested on December 31, 1998 as to
10-15%, plus an additional 2.5% for each year of service with the Company, and
20% each December 31 thereafter until fully vested. Unless otherwise provided
by the Board of Directors, or a committee of the Board administering the Plans,
each option granted under the 1999 Plan vests 20% on each one year anniversary
from the date of grant.

During the quarter ended September 30, 2001, the Company increased the
authorized number of common shares from 25,000,000 to 100,000,000 which was
approved by shareholders on August 23, 2001. In conjunction with the
Acquisition, the Company issued approximately 10,875,128 common shares.

BIZ Interactive Zone, Inc. 2000 Stock Option Plan

The BIZ Plan was assumed as part of the Acquisition. The BIZ Plan is
closed and no additional options can be granted. As of December 31, 2001, there
were options outstanding to purchase approximately 814,000 shares.

2001 Employee Stock Purchase Plan (ESPP)

During the quarter ended September 30, 2001, the Company established the
ESPP, which was approved by shareholders on August 23, 2001. A total of
1,000,000 shares of common stock is currently authorized for issuance under the
ESPP. If a right expires or becomes unexercisable without having been exercised
in full, the shares of common stock that were subject to that right will again
become available for grant under the ESPP. The number of shares issuable under
the ESPP, and the purchase price per share, is subject to proportional
adjustments to reflect stock splits, stock dividends, mergers, consolidations
and similar events. To date, no shares have been issued under the ESPP.

Deferred Compensation

The deferred compensation consists of amounts related to stock options and
warrants assumed as part of the Acquisition, as well as non-employee stock
option grants and issuance of stock.

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Equity instruments issued to nonemployees are measured using the fair
value of the equity instrument using the stock price and other measurement
assumptions as of the earlier of the date at which a performance commitment to
earn the equity instruments is reached or the date at which the performance is
complete.

During 2001, the Company granted 25,211 stock options to non-employees.
The vesting terms of the options ranged from immediate to one year from the
date of grant. In connection with the granting of these options the Company
recorded deferred compensation of $54 and recognized compensation expense of
$67 related to these options as of and for the year ended December 31, 2001.
The terms of these options range from two to four years.




Additionally, in conjunction with the Acquisition, the Company assumed
837,396 options under the BIZ stock option plan. Selected employee stock
options were granted to employees with exercise prices less than fair value of
the underlying common stock at the date of grant. Accordingly, compensation
expense will be recognized and recorded over the vesting period. The options
generally vest 25% upon the completion of one year of service and the remaining
75% in equal monthly installments over the next three years from the date of
grant. As the Company granted the options to employees at below fair market
value the Company recorded deferred compensation and compensation expense as of
and for the year ended December 31, 2001. The term of the options is ten years.




In addition, BIZ granted 118,779 stock options to non-employees in
exchange for services prior to the Acquisition. The stock options generally
vest over one year and the term of these options is one year.




The Company recorded deferred compensation related to the BIZ options of
$1,139 at December 31, 2001, compensation expense of $132 and reversal of
deferred compensation related to terminated employees of $201 for the year ended
December 31, 2001.




Warrants

Warrants to purchase 370,000 shares of common stock at $18.15 per share
were issued to the underwriters as part of the Companys initial public
offering. The warrants are exercisable at any time, in whole or in part, during
the four-year period commencing on June 9, 2000.

Under the Acquisition, the Company assumed a warrant for approximately
24,000 shares of common stock at a price per share of $2.11. The warrants
vested immediately upon grant and have an exercise period of five years. The
warrants were issued above fair market value and accordingly no compensation
expense was recorded at the date of grant for these warrants.

Options

Following is a summary of stock option transactions (shares in thousands):

|                                         |           |  |        |       |                |   |          |  |  |      |      |  | 
|---------------------------------------- | --------- |  | ------ | ----- | -------------- | - | -------- |  |  | ---- | ---- |  | 
|                                         |           |  |        |       |                |   | Weighted
|                                         |           |  | Number |       | Average       
|                                         |           |  | of     |       | Exercise Price
|                                         |           |  | Shares |       | Per Share     
|                                         |           |  |        |       |               
|Options outstanding at December 31, 1998 |           |  | 281    |       |                | $ |          |  |  | 0.70 |      | 
|                                         | Granted   |  |        | 124   |                |   |          |  |  |      | 8.64 |  | 
|                                         | Cancelled |  |        | (53   | )              |   |          |  |  |      | 3.66 |  | 
|                                         | Exercised |  |        | (116  | )              |   |          |  |  |      | 0.70 |  | 
|                                         |           |  |        |       |                |   |          |  |  |      |      | 
|Options outstanding at December 31, 1999 |           |  | 236    |       |                |   |          |  |  | 4.17 |      | 
|                                         | Granted   |  |        | 347   |                |   |          |  |  |      | 5.43 |  | 
|                                         | Cancelled |  |        | (65   | )              |   |          |  |  |      | 5.73 |  | 
|                                         | Exercised |  |        | (28   | )              |   |          |  |  |      | 0.70 |  | 
|                                         |           |  |        |       |                |   |          |  |  |      |      | 
|Options outstanding at December 31, 2000 |           |  | 490    |       |                |   |          |  |  | 5.05 |      | 
|                                         | Granted   |  |        | 1,239 |                |   |          |  |  |      | 2.60 |  | 
|                                         | Cancelled |  |        | (111  | )              |   |          |  |  |      | 4.25 |  | 
|                                         | Exercised |  |        | (4    | )              |   |          |  |  |      | .70  |  | 
|                                         |           |  |        |       |                |   |          |  |  |      |      | 
|Options outstanding at December 31, 2001 |           |  | 1,614  |       |                |   |          |  |  | 3.26 |      | 
|                                         |           |  |        |       |                |   |          |  |  |      |      | 

The options granted of 1,239 shares in fiscal 2001 include 837 options
assumed by the Company in the Acquisition. As of December 31, 2001, there were
342 shares available for grant.

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##### Table of Contents



As of December 31, 2000 and 2001, the number of options exercisable was 57
at a weighted average exercise price of $0.70 and remaining contract life of
8.3 years and 456 at a weighted average exercise price of $2.88 and remaining
contract life of 8.9 years, respectively. The Company had 1,614 options
outstanding at December 31, 2001, with a range of exercise prices from $0.70
per share to $9.75 per share.

The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock option plans. Accordingly, no compensation cost has
been recognized for its stock options in the consolidated financial statements.
Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under Statement 123, the Companys net loss
would have been increased to the pro forma amount indicated below.

|                                               |  |              |        |      |  |   |        | 
|---------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                                               |  | Year Ended  
|                                               |  | December 31,
|                                               |  |             
|                                               |  | 2000         |        | 2001
|                                               |  |              |        |     
|Net loss as reported                           |  | $            | 41,405 |      |  | $ | 53,160 | 
|Assumed stock compensation cost                |  |              | 259    |      |  |   | 779    | 
|                                               |  |              |        |      |  |   |        | 
|Pro forma net loss                             |  | $            | 41,664 |      |  | $ | 53,939 | 
|                                               |  |              |        |      |  |   |        | 
|Pro forma net loss per sharebasic and diluted |  | $            | 4.22   |      |  | $ | 3.97   | 
|                                               |  |              |        |      |  |   |        | 

The weighted-average fair value per option granted in 2000 and 2001 was
$4.85 and $3.33, respectively. The fair value of each option grant was
estimated on the date of grant using the Black-Scholes option-pricing model
with the following assumptions in 2000 and 2001: risk-free interest rate of
6.08% and of 5.41%, respectively; dividend yield of 0.00%; and volatility of
1.38% and 1.03%, respectively. The Black-Scholes model, as well as other
currently accepted option valuation models, was developed to estimate the fair
value of freely-tradable, fully-transferable options without vesting
restrictions, which significantly differ from the Companys stock option plans.
These models also require highly subjective assumptions, including future stock
price volatility and expected time until exercise, which greatly affect the
calculated fair value on the grant date.

Reserved Shares

In connection with the Wave agreement SSP reserved 1,150,000 shares of its
authorized but unissued common stock for issuance to Wave, see note 13. As a
requirement for the secured convertible promissory note the Company has been
requested to reserve 1,150 shares for its authorized but unissued common stock,
see note 19.

Retired Shares

As part of the Stock Acquisition Agreement dated February 9, 1999, whereby
Litronic acquired all of the outstanding stock of Pulsar, Lillian Davis, as a
selling shareholder of Pulsar, agreed to indemnify the Company for certain
damages if incurred by the Company as specified in the Stock Acquisition
Agreement. In November 2000, the Company entered into an agreement with Ms.
Davis, a shareholder of the Company, whereby she would, in consideration for a
release from specific potential indemnity obligations, transfer 141,573 shares
of the Companys common stock to the Company for cancellation. The release was
for specific potential indemnity obligations and Ms. Davis was not released
from any potential indemnity obligations outlined in the Stock Acquisition
Agreement that were not specified in the release. The 141,573 shares of stock
subject to the agreement were transferred to the Company in December 2000 and
retired.

(16) Employee Retirement Savings Plan

Effective January 1, 1998, the Company established a retirement plan,
which is intended to qualify under Section 401(k) of the Internal Revenue Code.
Under the plan, eligible employees are able to contribute up to 20% of their
compensation not to exceed the maximum IRS deferral amount. The Company may
also match employee contributions at its discretion. During 1999, 2000 and
2001, the Company made contributions of $86, $142 and $143 to this plan,
respectively.

(17) Income Taxes

Effective June 9, 1999, the Company became a C corporation as a result of
the Companys initial public offering. Prior to June 9, 1999, the Company had
elected to be taxed as an S corporation under the provision of Section 1362 of
the Internal Revenue Code. Accordingly, prior to June 9, 1999, the Company had
not recorded a provision for Federal income taxes since the liability was that
of the shareholders and the S corporation was subject to a 1.5% California tax
rate on earning before income taxes.

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##### Table of Contents



The provision (benefit) for income taxes from continuing operations is
comprised of the following for the year ended ______:

|         |         |       |   |              |     |      |   |      |   |  |   |   
|-------- | ------- | ----- | - | ------------ | --- | ---- | - | ---- | - |  | - | --
|         |         |       |   | December 31,
|         |         |       |   |             
|         |         |       |   | 1999         |     | 2000 |   | 2001
|         |         |       |   |              |     |      |   |     
|Current: |         |       |   |              |     |      |   |      |   |  |   |   
|         | Federal |       | $ |             |     |      | $ |     |   |  | $ |  
|         | State   |       |   | (43          | )   |      |   | 6    |   |  |   | 53
|         | Foreign |       |   |             |     |      |   |     |   |  |   |  
|         |         |       |   |              |     |      |   |      |   |  |   |   
|         |         | Total |   | $            | (43 | )    |   | $    | 6 |  |   | $ 
|         |         |       |   |              |     |      |   |      |   |  |   |   

Deferred tax assets and liabilities result from differences between the
financial statement carrying amounts and the tax basis of existing assets and
liabilities. The significant components of deferred income taxes are as
follows:

|                          |                                 |  |              |        |      |  |       |        |   |  |        |         |  
|------------------------- | ------------------------------- |  | ------------ | ------ | ---- |  | ----- | ------ | - |  | ------ | ------- | -
|                          |                                 |  | December 31,
|                          |                                 |  |             
|                          |                                 |  | 1999         |        | 2000 |  | 2001 
|                          |                                 |  |              |        |      |  |      
|Deferred tax assets:      |                                 |  |              |        |      |  |       |        |   |  |        |        
|                          | Net operating loss carryforward |  | $            | 1,165  |      |  | $     | 3,686  |   |  | $      | 9,086   |  
|                          | Credit carryforward             |  |              | 97     |      |  |       | 314    |   |  |        | 237     |  
|                          | Accrued expenses                |  |              | 236    |      |  |       | 433    |   |  |        |        |  
|                          | Start-up cost                   |  |              |       |      |  |       |       |   |  |        | 6,444   |  
|                          |                                 |  |              |        |      |  |       |        |   |  |        |        
|Total deferred tax assets |                                 |  | 1,498        |        |      |  | 4,433 |        |   |  | 15,767 |        
|                          | Less valuation allowance        |  |              | (1,498 | )    |  |       | (4,433 | ) |  |        | (15,767 | )
|                          |                                 |  |              |        |      |  |       |        |   |  |        |        
|                          | Net deferred tax assets         |  | $            |       |      |  | $     |       |   |  | $      |        |  
|                          |                                 |  |              |        |      |  |       |        |   |  |        |        

The Company has recorded a valuation allowance in the amount set forth
above for certain deductible temporary differences, net operating loss
carryforwards and credit carryforwards where it is more likely than not that
the Company will not receive future tax benefits. The net change in the
valuation allowance for the year ended December 31, 2000 and 2001 was $2,935
and $11,334, respectively. The year 1999 was the first year that the Company
recorded deferred tax assets, as the Company was previously an S corporation
and thus no deferred tax assets had been recorded prior to June 9, 1999.

Subsequently recognized tax benefits relating to the valuation allowance
for deferred tax assets as of December 31, 2001 will be allocated as follows:

|                                                                                       |       |   |       |        | 
|-------------------------------------------------------------------------------------- | ----- | - | ----- | ------ | 
|Income tax benefit that would be reported in the consolidated
statements of operations |       | $ | 9,163 |       
|Goodwill                                                                               |       |   | 6,604 |       
|                                                                                       |       |   |       |       
|                                                                                       | Total |   | $     | 15,767 | 
|                                                                                       |       |   |       |       

As of December 31, 2001, the Company has Federal and state net operating
losses (NOL) carryforwards of approximately $25,000 and $9,900, respectively.
These NOL carryforwards will expire through year 2021 for the Federal NOL and
2006 for the state NOL. Additionally, the Company has Federal and state
research and experimentation (R&E) credit carryforwards of approximately $108
and $129, respectively. These R&E Credit carryforwards expire through 2021 for
the Federal R&E Credit and indefinitely for the state R&E Credit.

Income tax expense differs from the amount computed by applying the
Federal corporate income tax rate of 34% to income (loss) before income taxes
as follows:

|                                                                       |                    |  |                         |    |      |  |      |    |   |  |     |    |  
|---------------------------------------------------------------------- | ------------------ |  | ----------------------- | -- | ---- |  | ---- | -- | - |  | --- | -- | -
|                                                                       |                    |  | Year Ended December 31,
|                                                                       |                    |  |                        
|                                                                       |                    |  | 1999                    |    | 2000 |  | 2000
|                                                                       |                    |  |                         |    |      |  |     
|Statutory tax rate                                                     |                    |  | (34                     | )% |      |  | (34  | )% |   |  | (34 | )%
|Goodwill amortization and
impairment of goodwill and other
Intangibles |                    |  | 10                      | %  |      |  | 32   | %  |   |  | 27  | % 
|In-process research and development                                    |                    |  |                        |    |      |  |     |    |   |  | 1   | % 
|Change in valuation allowance                                          |                    |  | 30                      | %  |      |  | 7    | %  |   |  | 9   | % 
|State income taxes, net                                                |                    |  | (6                      | )% |      |  | (5   | )% |   |  | (4  | )%
|Research and experimentation credit                                    |                    |  |                        |    |      |  |     |    |   |  |    |   
|Other                                                                  |                    |  | 1                       | %  |      |  |     |    |   |  | 1   | % 
|                                                                       |                    |  |                         |    |      |  |      |    |   |  |     |   
|                                                                       | Effective tax rate |  |                         | 1  | %    |  |      |   | % |  |     |   | %
|                                                                       |                    |  |                         |    |      |  |      |    |   |  |     |   

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##### Table of Contents



Subsequent to the initial public offering, the Company had recognized a
tax benefit of $285 in the second quarter ended June 30, 1999. During the
fourth quarter of 1999, the Company determined it was more likely than not that
the Company would not realize the benefit of the net deferred tax asset, and
accordingly, recorded a tax-expense to eliminate the benefit and related
deferred tax asset from the consolidated financial statements in the fourth
quarter of 1999.

(18) Contingent Liabilities

As the Company provides engineering and other services to various
government agencies, it is subject to retrospective audits, which may result in
adjustments to amounts recognized as revenues, and the Company may be subject
to investigation by governmental entities. Failure to comply with the terms of
any governmental contracts could result in civil and criminal fines and
penalties, as well as suspension from future government contracts. The Company
is not aware of any adjustments, fines or penalties, which could have a
material adverse effect on its financial position or results of operations.

The Company had cost reimbursable type contracts with the Federal
Government. Consequently, the Company is reimbursed based upon the direct
expenses attributable to the contract, plus a percentage based upon overhead,
material handling, and general administrative expenses. The overhead, material
handling, and general administrative rates are estimates. Accordingly, if the
actual rates as determined by the Defense Contract Audit Agency are below the
Companys estimates, a refund for the difference would be due to the Federal
Government. It is managements opinion that no material liability will result
from any contract audits.

We are involved from time to time in various litigations that arise in the
ordinary course of business. We are not currently involved in any litigation
that we believe will have a material impact on our results of operations,
financial condition or liquidity.

On January 16, 1998, G2 Resources Inc. (G2) filed a complaint against
Pulsar in the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County,
Florida. G2 claimed that Pulsar breached a contract under which G2 agreed to
provide services related to the monitoring of government contracts available
for bid and the preparation and submission of bids on behalf of Pulsar. The
contract provided that Pulsar pay G2 $500 in 30 monthly installments of $16 and
an additional fee of 2% of the gross dollar amount generated by awards. In its
complaint, G2 alleged that Pulsar failed to make payments under the contract
and claimed damages in excess of $525 plus interest, costs and attorneys fees.
In the course of discovery G2 asserted that its losses/costs arising out of its
claim amounted to approximately $10,300. Pulsar asserted that G2 failed to
perform the services required under the contract and Pulsar filed a claim for
compensatory damages, interest and attorneys fees against G2. Classical
Financial Services, LLC intervened in the case. Classical claimed that G2
assigned its accounts receivable to Classical under a financing program and
that Pulsar breached its obligations to Classical by failing to make payments
under the contract with G2. Pulsar asserted defenses to Classicals claim. On
April 20, 2001, a court hearing was held and G2s complaint against Pulsar was
dismissed without prejudice on the basis of no prosecution activity for more
than 12 months. On May 22, 2001, G2 filed a new complaint against Pulsar. The
Company believes that the claims made by G2 and Classical against Pulsar are
without merit and intends to vigorously defend against these claims.

During the second quarter of 2001 Microsoft notified the Company regarding
the alleged sales of unlicensed copies of Microsoft Office. The software in
question was purchased from a major computer hardware manufacturer and was
resold to one of the Companys customers in a package that included both
hardware and software. The Company is currently investigating the matter, and
does not anticipate that the outcome will have a material impact on its results
of operations, financial condition or liquidity.

We were recently served with a lawsuit filed by Dell Marketing, LLC
pertaining to overdue amounts for computer products purchased for resell
through Pulsar. The suit asserts claim for payment of $322, which the Company
anticipates it will pay.

The Company currently holds multiple contracts with the Federal
government. In particular, three of these contracts permit the Company to
provide goods and services to various Federal government agencies. Although
these contracts are currently up for renewal, it is possible they may not be
renewed or may be cancelled by the Federal government due to the Companys
inability to perform as required under the contracts.

The Company is currently in negotiations with the various government
agencies it contracts with to initiate and implement the corrective measures
necessary to insure the uninterrupted continuity of the contracts. Although
there is no assurance that the contracts will be renewed or that they will not
be cancelled, the Company has reason to believe they will be renewed. However,
if the contracts are not renewed or if they are cancelled, then a significant
portion of the Companys revenues will be lost which would have a significant
impact on the Companys financial condition, results of operations and
liquidity.

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##### Table of Contents



As of December 31, 2001, accounts payable totaled $9,495. Of that amount,
$4,629 are aged at least 90 days. As indicated elsewhere in this footnote, one
of the Companys vendors have already commenced legal actions to collect
payables of $322, while others have threatened collection action. Unless
payment is made or satisfactory payment plans agreed to, it is likely that the
remainder of the vendors will eventually initiate legal actions to collect the
amounts owed to them. Currently, the Company has the intent to satisfy its
vendor obligations through a combination of payment negotiations, which include
extending the terms over time, partial payments of the obligations due as
payment in full and converting obligations to long term notes payable.

(19) Subsequent Events

GET/SSP LLC

GET/SSP, LLC, a Nevada limited liability company, (GET/SSP) was formed in
January 2002 as a wholly-owned subsidiary of the Company. The entity was formed
with the intention of having it conduct all business and any required financing
activities on behalf of the Company. Also, in January 2002, GET/SSP and the
Venetian Hotel based in Las Vegas, Nevada, (Venetian) executed an agreement
regarding the formation of a joint venture for the development and conduct of
on-line gaming portal(s) (Joint Venture) in venues where such activity
complies with all regulatory requirements.

While GET/SSP and the Venetian made initial estimates of development costs,
operating costs and timing, the agreement provides for the parties to work
together to refine and finalize the initial estimates. The agreement states a
required commitment for the development and start-up costs of up to $15,000.
Based upon the joint work since signing the original agreement, management
believes that these costs will not exceed $3,000. Timing for implementation was
deferred for several months, and the Venetian has expressed the desire to
market the on-line gaming venture through a separate hospitality program. As
currently contemplated, the hospitality program is to be developed under
separate contract by the Company to build upon current Venetian processes and
customer interfaces. The deployed hospitality program will then be used as a
platform to launch into on-line gaming capabilities in order to help absorb
device costs and lower customer acquisition costs.

GET/SSP and the Venetian have agreed to waive defaults existing under the
original Joint Venture and continue the process of business development. The
Joint Venture creates no legal liability for the Company to provide financing
or working capital. The Company intends to offer outside investors a financing
instrument that will reduce the Companys ownership to less than 100%, provide
the investor a priority return plus the return of invested capital and a
continuing ownership interest in GET/SSP. The amount of the financing is not
currently known, but the Company intends that GET/SSP will be a self-financing
entity, and that financial obligations will not extend to the Company.

Secured Convertible Promissory Notes

On April 15, 2002, the Company completed a private financing of $5,000 in the
form of $4,000 in 10% secured convertible promissory notes, $653 in secured
non-convertible promissory notes ($153 held by Co-Chairman Kris Shah and $500
held by co-Chairman Marvin Winkler) and the pre-payment of a $500 note due from
Kris Shah, less a discount of $153. The discount was based upon a present value
using the rate of 20% for early payment and will be charged against earnings in
the second quarter of 2002. In connection with the issuance of the secured
convertible promissory notes the Company incurred approximately $285 of
issuance costs, which primarily consisted of investment banker fees, legal and
other professional fees. All promissory notes mature December 31, 2005; bear
interest at a rate of 10% per annum, which will be paid quarterly in cash, or
at the Companys discretion, in common shares based upon the trailing thirty
(30) day average prior to the interest due date; and the $4,000 of convertible
promissory notes, in whole or in part, are convertible at the option of the
holder into an aggregate of approximately 4,000,000 shares of the Companys
common stock at any time prior to maturity, at a conversion price of $1.00 per
share, subject to adjustment under certain conditions; and the convertible
promissory notes have detachable warrants exercisable for three (3) years to
purchase an additional 2,400,000 shares at $1.30 per share. The convertible
notes are automatically converted prior to maturity if the Companys common
shares trade at or above an average price of $3.00 per share for twenty (20)
consecutive trading days and average volume of 100,000 shares per day for
twenty (20) consecutive trading days. The Company is subject to restrictive
covenants related to the secured convertible and non-convertible promissory
notes that prevents the Company from pledging intellectual property as
collateral.

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##### Table of Contents



(20) Quarterly Financial Data (Unaudited)

Selected quarterly financial data for 2001 and 2000 is as follows:

|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |       |  
|----- | -------------- |  | -------- | ------ | ------ |  | ---- | ----- | --------- |  | - | ------- | - |  | --------- | ----- | -
|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  | Basic and
|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  | Diluted  
|      |                |  | Net      |        | Gross  |  | Net  |       | loss     
|      |                |  | revenues |        | profit |  | loss |       | per share
|      |                |  |          |        |        |  |      |       |          
|2001: |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |      
|      | Fourth quarter |  | $        | 6,738  |        |  | $    | 809   |           |  | $ | (41,644 | ) |  | $         | (2.02 | )
|      | Third quarter  |  |          | 5,155  |        |  |      | 1,022 |           |  |   | (7,355  | ) |  |           | (0.52 | )
|      | Second quarter |  |          | 6,349  |        |  |      | 1,616 |           |  |   | (1,785  | ) |  |           | (0.18 | )
|      | First quarter  |  |          | 4,478  |        |  |      | 1,279 |           |  |   | (2,376  | ) |  |           | (0.24 | )
|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |      
|      | Total          |  | $        | 22,720 |        |  | $    | 4,726 |           |  | $ | (53,160 | ) |  |           |       |  
|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |      
|2000: |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |      
|      | Fourth quarter |  | $        | 10,473 |        |  | $    | 2,062 |           |  | $ | (33,872 | ) |  | $         | (3.45 | )
|      | Third quarter  |  |          | 15,111 |        |  |      | 2,760 |           |  |   | (1,652  | ) |  |           | (0.17 | )
|      | Second quarter |  |          | 9,050  |        |  |      | 2,439 |           |  |   | (2,420  | ) |  |           | (0.24 | )
|      | First quarter  |  |          | 4,722  |        |  |      | 935   |           |  |   | (3,461  | ) |  |           | (0.35 | )
|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |      
|      | Total          |  | $        | 39,356 |        |  | $    | 8,196 |           |  | $ | (41,405 | ) |  |           |       |  
|      |                |  |          |        |        |  |      |       |           |  |   |         |   |  |           |      

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##### Table of Contents



SCHEDULE II

SSP AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001(In thousands)

|                                                             |  |            |     |            |  |             |     |             |  |               |     |  |  |   |     |  |  |   |     | 
|------------------------------------------------------------ |  | ---------- | --- | ---------- |  | ----------- | --- | ----------- |  | ------------- | --- |  |  | - | --- |  |  | - | --- | 
|                                                             |  |            |     |            |  | Additions   |     |             |  |               |     |  |  |   |     |  |  |  
|                                                             |  | Balance At |     | Charged to |  | Additions   |     | Deductions- |  |               |     | 
|                                                             |  | Beginning  |     | Costs and  |  | Due to      |     | Amounts     |  | Balance At   
|Description                                                  |  | of Period  |     | Expenses   |  | Acquisition |     | Written Off |  | End of Period
|                                                             |  |            |     |            |  |             |     |             |  |              
|Year Ended December
31, 1999 Allowance
for doubtful
accounts |  | $          | 14  |            |  | $           | 327 |             |  | $             | 194 |  |  | $ | 145 |  |  | $ | 390 | 
|                                                             |  |            |     |            |  |             |     |             |  |               |     |  |  |   |     |  |  |   |     | 
|Year Ended December
31, 2000 Allowance
for doubtful
accounts |  | $          | 390 |            |  | $           | 286 |             |  | $             |    |  |  | $ | 408 |  |  | $ | 268 | 
|                                                             |  |            |     |            |  |             |     |             |  |               |     |  |  |   |     |  |  |   |     | 
|Year Ended December
31, 2001 Allowance
for doubtful
accounts |  | $          | 268 |            |  | $           | 401 |             |  | $             |    |  |  | $ | 415 |  |  | $ | 254 | 
|                                                             |  |            |     |            |  |             |     |             |  |               |     |  |  |   |     |  |  |   |     | 

S-1



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##### Table of Contents



|         |  |                                                                                                                                                                                                                                                                                                                  |  |        |  | 
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ |  | 
|EXHIBITS
|Exhibit  |  |                                                                                                                                                                                                                                                                                                                  |  | Page   |  | 
|Number   |  | Description                                                                                                                                                                                                                                                                                                      |  | Number |  | 
|        
|3.1      |  | Amended and Restated
Certificate of
Incorporation
(incorporated by reference
to Exhibit 3.3 contained
in Registrants
Registration Statement on
Form S-1 filed with the
Commission on or about
February 11, 1999)                                                                                               
|        
|3.2      |  | Bylaws of the Registrant
(incorporated by reference
to Exhibit 3.2 contained
in Registrants
Registration Statement on
Form S-1 filed with the
Commission on or about
February 11, 1999)                                                                                                                        
|        
|4.1      |  | Form of Stock Certificate
(incorporated by reference
to Exhibit 4.1 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                                                                                                                      
|        
|4.2      |  | Registration Rights
Agreement (incorporated by
reference to Exhibit 4.1
contained in Registrants
Registration Statement on
Form S-1 filed with the
Commission on or about
February 11, 1999)                                                                                                                   
|        
|4.3      |  | Warrant Agreement
(incorporated by reference
to Exhibit 4.2 contained
in Registrants
Registration Statement on
Form S-1/A filed with the
Commission on or about May
6, 1999)                                                                                                                                   
|        
|4.4      |  | SSP Solutions, Inc.
Purchase Agreement, 8.0%
Subordinated Convertible
Notes, dated December 17,
2001 (without schedules)
(incorporated by reference
to Exhibit 4.4 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                       
|        
|4.5      |  | Subordinated Convertible
Note, dated December 17,
2001, between SSP
Solutions, Inc. and
Richard P. Kiphart
(incorporated by reference
to Exhibit 4.5 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                                     
|        
|4.6      |  | Subordinated Convertible
Note, dated December 17,
2001, between SSP
Solutions, Inc. and Sandy
Tennant (incorporated by
reference to Exhibit 4.6
contained in the initial
filing of Registrants
Form 10-K filed with the
Commission on April 16,
2002)                                                          
|        
|4.7      |  | Amended and Restated
Subordinated Convertible
Note, dated December 18,
2001, between SSP
Solutions, Inc. and Marvin
J. Winkler (incorporated
by reference to Exhibit
4.7 contained in the
initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                 
|        
|4.8      |  | Amended and Restated
Subordinated Convertible
Note, dated December 18,
2001, between SSP
Solutions, Inc. and Kris
Shah (incorporated by
reference to Exhibit 4.8
contained in the initial
filing of Registrants
Form 10-K filed with the
Commission on April 16,
2002)                                         
|        
|10.1     |  | Employment Agreement with
Kris Shah (incorporated by
reference to Exhibit 10.1
contained in Registrants
Registration Statement on
Form S-1 filed with the
Commission on or about
February 11, 1999)                                                                                                            
|10.2     |  | Litronic Industries, Inc.
1998 Stock Option Plan and
form of Litronic
Industries, Inc. 1998
Stock Option Plan
Incentive Stock Option
Agreement (incorporated by
reference to Exhibit 10.24
contained in Registrants
Registration Statement on
Form S-1 filed with the
Commission on or about
February 11, 1999)
|        
|10.3     |  | SSP Solutions, Inc.
Amended and Restated 1999
Stock Option Plan
(incorporated by reference
to Exhibit 4.5 contained
in Registrants
Registration Statement on
Form S-8 filed with the
Commission on or about
November 13, 2001)                                                                                 
|        
|10.4     |  | Form of SSP Solutions,
Inc. Amended and Restated
1999 Stock Option Plan
Incentive Stock Option
Agreement (incorporated by
reference to Exhibit 4.6
contained in Registrants
Registration Statement on
Form S-8 filed with the
Commission on or about
November 13, 2001)                                        
|        
|10.5     |  | BIZ Interactive Zone, Inc.
2000 Stock Option Plan
(incorporated by reference
to Exhibit 4.3 contained
in Registrants
Registration Statement on
Form S-8 filed with the
Commission on or about
November 13, 2001)                                                                                               





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##### Table of Contents



|        |                                                                                                                                                                                                                                                                                                                                  |       
|------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------
|Exhibit |                                                                                                                                                                                                                                                                                                                                  | Page  
|Number  | Description                                                                                                                                                                                                                                                                                                                      | Number
|       
|10.6    | Form of BIZ Interactive
Zone, Inc. Stock Option
Agreement (incorporated by
reference to Exhibit 4.4
contained in Registrants
Registration Statement on
Form S-8 filed with the
Commission on or about
November 13, 2001)                                                                                                        |       
|       
|10.7    | SSP Solutions, Inc. 2001
Employee Stock Purchase
Plan (incorporated by
reference to Exhibit 4.1
contained in Registrants
Registration Statement on
Form S-8 filed with the
Commission on or about
November 13, 2001)                                                                                                            |       
|       
|10.8    | Form of SSP Solutions,
Inc. 2001 Employee Stock
Purchase Plan Subscription
Agreement (incorporated by
reference to Exhibit 4.2
contained in Registrants
Registration Statement on
Form S-8 filed with the
Commission on or about
November 13, 2001)                                                                             |       
|       
|10.9    | Award Contract between
Maryland Procurement
Office and Litronic
Industries, Inc. dated
June 27, 1997
(incorporated by reference
to Exhibit 10.11 contained
in Registrants
Registration Statement on
Form S-1/A filed with the
Commission on or about May
6, 1999)                                                               |       
|       
|10.10   | Modification dated
February 3, 1999 of
Original GSA Contract
GS-35F-4232D dated May 3,
1996 (incorporated by
reference to Exhibit 10.26
contained in Registrants
Registration Statement on
Form S-1/A filed with the
Commission on or about
June 1, 1999)                                                                       |       
|       
|10.11   | Deed of Lease Agreement
between Pulsar Data
Systems, Inc. and
Massachusetts Mutual Life
Insurance Company dated
August 11, 1998
(incorporated by reference
to Exhibit 10.27 contained
in Registrants
Registration Statement on
Form S-1/A filed with the
Commission on or about
June 1, 1999)                                   |       
|       
|10.12   | Basic Ordering Agreement
dated April 16, 1998
between the United States
of America and Litronic
(incorporated by reference
to Exhibit 10.38 contained
in Registrants
Registration Statement on
Form S-1/A filed with the
Commission on or about May
6, 1999)                                                                    |       
|       
|10.13   | Nonexclusive Distributor
Agreement dated April 27,
1999 among Litronic and
Itochu Techno-Science
Corporation and Itochu
Corporation (incorporated
by reference to Exhibit
10.39 contained in
Registrants Registration
Statement on Form S-1/A
filed with the Commission
on or about June 1, 1999)                               |       
|       
|10.14   | Equipment Purchase,
Software License and
Maintenance Agreement
dated April 20, 1999
between Bank of America
and Litronic (incorporated
by reference to Exhibit
10.40 contained in
Registrants Registration
Statement on Form S-1/A
filed with the Commission
on or about May 6, 1999)                                           |       
|       
|10.15   | Lease agreement between
KRDS, Inc., and the
Company, dated January 2,
2000 (incorporated by
reference to Exhibit 10.14
contained in Registrants
Form 10-K filed with the
Commission on or about
April 19, 2001)                                                                                                                 |       
|       
|10.16   | Purchase, Development, and
Deployment Agreement dated
October 2, 2000 between
BIZ Interactive Zone, Inc.
and Wave Systems
Corporation (incorporated
by reference to Exhibit
10.16 contained in the
initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                         |       
|       
|10.17   | Amendment No. 1, dated May
10, 2001, to Purchase,
Development, and
Deployment Agreement dated
October 2, 2000 between
BIZ Interactive Zone, Inc.
and Wave Systems
Corporation (incorporated
by reference to Exhibit
10.17 contained in the
initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002) |       
|       
|10.19   | Lease agreement, dated
October 10, 2001, between
Litronic Inc. and Research
Venture LLC, related to
real property located at
9012 Research Drive,
Irvine, California 92618
(incorporated by reference
to Exhibit 10.19 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)    |       





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##### Table of Contents



|        |                                                                                                                                                                                                                                                                                                                                           |       
|------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------
|Exhibit |                                                                                                                                                                                                                                                                                                                                           | Page  
|Number  | Description                                                                                                                                                                                                                                                                                                                               | Number
|       
|10.20   | Lease agreement, dated
October 10, 2001, between
Litronic Inc. and Research
Venture LLC, related to
real property located at
11 Cushing, Irvine,
California 92618
(incorporated by reference
to Exhibit 10.20 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                      |       
|       
|10.21   | Account Purchase Agreement
dated as of November 2,
2001 by and between Pulsar
Data Systems, Incorporated
and Wells Fargo Business
Credit, Inc. for the sale
and assignment of Accounts
Receivable (incorporated
by reference to Exhibit
10.6 contained in
Registrants Form 10-Q
filed with the Commission
on or about November 19,
2001) |       
|       
|10.22   | Account Purchase Agreement
dated as of November 2,
2001 by and between SSP
Solutions, Inc. and Wells
Fargo Business Credit,
Inc. for the sale and
assignment of Accounts
Receivable (incorporated
by reference to Exhibit
10.7 contained in
Registrants Form 10-Q
filed with the Commission
on or about November 19,
2001)               |       
|       
|10.23   | Guaranty dated as of
November 2, 2001 by Kris
Shah for the benefit of
Wells Fargo Business
Credit Inc. relative
Pulsar Data Systems, Inc.
Purchase Agreement dated
November 2, 2001
(incorporated by reference
to Exhibit 10.8 contained
in Registrants Form 10-Q
filed with the Commission
on or about November 19,
2001)               |       
|   
|10.24   | Guaranty dated as of
November 2, 2001 by Kris
Shah for the benefit of
Wells Fargo Business
Credit Inc. relative to
SSP Solutions, Inc.
Purchase Agreement dated
November 2, 2001
(incorporated by reference
to Exhibit 10.9 contained
in Registrants Form 10-Q
filed with the Commission
on or about November 19,
2001)                  |       
|       
|10.25   | Guaranty dated as of
November 2, 2001 by Marvin
Winkler for the benefit of
Wells Fargo Business
Credit Inc. relative
Pulsar Data Systems, Inc.
Purchase Agreement dated
November 2, 2001
(incorporated by reference
to Exhibit 10.10 contained
in Registrants Form 10-Q
filed with the Commission
on or about November 19,
2001)         |       
|       
|10.26   | Guaranty dated as of
November 2, 2001 by Marvin
Winkler for the benefit of
Wells Fargo Business
Credit Inc. relative to
SSP Solutions, Inc.
Purchase Agreement dated
November 2, 2001
(incorporated by reference
to Exhibit 10.11 contained
in Registrants Form 10-Q
filed with the Commission
on or about November 19,
2001)            |       
|       
|10.27   | Master Services Agreement,
dated December 1, 2001,
between SSP Solutions,
Inc., Electronic Data
Systems Corp., and EDS
Information Services LLC
(incorporated by reference
to Exhibit 10.27 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                        |       
|       
|10.28   | Task Order Number
2001-001, dated December
1, 2001, between SSP
Solutions, Inc.,
Electronic Data Systems
Corp., and EDS Information
Services LLC (incorporated
by reference to Exhibit
10.28 contained in the
initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                       |       
|       
|10.29   | Promissory Note and Pledge
Agreement, dated July 24,
2000, between Kris Shah
and BIZ Interactive Zone,
Inc. (incorporated by
reference to Exhibit 10.29
contained in the initial
filing of Registrants
Form 10-K filed with the
Commission on April 16,
2002)                                                                            |       
|       
|10.30   | Reseller Agreement between
Control Break
International Corp. and
SSP Solutions, Inc.
(incorporated by reference
to Exhibit 10.30 contained
in the initial filing of
Registrants Form 10-K
filed with the Commission
on April 16, 2002)                                                                                                   |       
|       
|10.31   | Contribution Agreement,
dated January 15, 2002,
between Venetian Casino
Resort, LLC and GET/SSP,
LLC (incorporated by
reference to Exhibit 10.31
contained in the initial
filing of Registrants
Form 10-K filed with the
Commission on April 16,
2002)                                                                                   |       
|       
|10.32   | Securities Purchase,
Registration Rights and
Security Agreement dated
as of April 16, 2002 by
and among the investors
named therein and the
Registrant (incorporated
by reference to Exhibit
10.1 contained in
Registrants Form 8-K
filed with the Commission
on April 22, 2002)                                                         |       





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##### Table of Contents



|        |                                                                                                                                                                                                              |       
|------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------
|Exhibit |                                                                                                                                                                                                              | Page  
|Number  | Description                                                                                                                                                                                                  | Number
|       
|10.33   | Form of Secured
Convertible Promissory
Note dated April 16, 2002
(incorporated by reference
to Exhibit 10.2 contained
in Registrants Form 8-K
filed with the Commission
on April 22, 2002)                  |       
|       
|10.34   | Form of Warrant to
Purchase Common Stock
dated April 16, 2002
(incorporated by reference
to Exhibit 10.3 contained
in Registrants Form 8-K
filed with the Commission
on April 22, 2002)                     |       
|       
|10.35   | Promissory Note dated
April 16, 2002 by the
Registrant in favor of
Kris Shah (incorporated by
reference to Exhibit 10.4
contained in Registrants
Form 8-K filed with the
Commission on April 22,
2002)      |       
|       
|10.36   | Promissory Note dated
April 16, 2002 by the
Registrant in favor of
Marvin Winkler
(incorporated by reference
to Exhibit 10.5 contained
in Registrants Form 8-K
filed with the Commission
on April 22, 2002) |       
|       
|21      | Subsidiaries of the
Registrant (incorporated
by reference to Exhibit 21
contained in the initial
filing of Registrants
Form 10-K filed with the
Commission on April 16,
2002)                               |