**ANNEX
      A**





**TANKLESS
      SYSTEMS WORLDWIDE, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      FINANCIAL STATEMENTS**




**INDEX
                TO FINANCIAL STATEMENTS**Page
                No.REPORT OF INDEPENDENT REGISTERED PUBLIC
              ACCOUNTING FIRM
            F-2CONSOLIDATED FINANCIAL STATEMENTSCONSOLIDATED
              BALANCE SHEETS
            F-3CONSOLIDATED
              STATEMENTS OF OPERATIONS
            F-4CONSOLIDATED
              STATEMENTS OF STOCKHOLDER’S DEFICIT
            F-5CONSOLIDATED
              STATEMENTS OF CASH FLOWS
            F-6NOTES TO CONSOLIDATED FINANCIAL
              STATEMENTS
            F-7
                - F-19















































**F-1**


1





Report
      Of Independent Registered Public Accounting Firm








To
      the
      Board of Directors


Skye
      International Inc (Formerly Tankless Systems Worldwide Inc)


Las
      Vegas, Nevada





We
      have
      audited the accompanying balance sheet of Skye International Inc (Formerly
      Tankless Systems Worldwide Inc) as of December 31, 2004, and the related
      statements of operations, stockholders’ equity and cash flows for the year then
      ended. These financial statements are the responsibility of the Company’s
      management. Our responsibility is to express an opinion on these financial
      statements based on our audits.





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





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Skye International Inc (Formerly
      Tankless Systems Worldwide Inc) as of December 31, 2004 and the results of
      its
      operations and its cash flows for the year then ended, in conformity with
      accounting principles generally accepted in the United States of
      America.





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 9 to the financial
      statements, the Company’s net losses and accumulated deficit of $6,012,643 as of
      December 31, 2004 raise substantial doubt about its ability to continue as
      a
      going concern. Management’s plans concerning these matters are also described in
      Note 9. The financial statements do not include any adjustments that might
      result from the outcome of this uncertainty.





***/s/
      Moore & Associates Chartered***


Moore
      & Associates Chartered


Las
      Vegas, Nevada


June
      9,
      2006











**F-2**


2




**Tankless
                Systems Worldwide, Inc. and Subsidiaries****CONSOLIDATED
                BALANCE SHEETS****ASSETS**Years
                Ended December 31,2004
            
            
            2003CURRENT
                ASSETSCash
            
            $
            18,690
            
            $
            412Accounts
                Receivable, Net
            
            
            110
            
            
            58,726Inventory
                at Cost
            
            
            54,170
            
            
            98,813Prepaid
                Expenses
            
            
            115,000
            
            
            50,660Total
                Current Assets
            
            
            187,970
            
            
            208,611EQUIPMENT,
                NET
            
            
            47,648
            
            
            73,327OTHER
                ASSETSPatents
                and Software, Net
            
            
            -
            
            
            63,463Deposits
            
            
            -
            
            
            7,514Total
                Other Assets
            
            
            -
            
            
            70,977Total
                Assets
            
            $
            235,618
            
            $
            352,915**LIABILITIES
                AND STOCKHOLDERS' EQUITY**LIABILITIESAccounts
                Payable
            
            $
            87,478
            
            $
            673,612Other
                Payables
            
            
            3,838
            
            
            46,799Notes
                Payable
            
            
            1,057,956
            
            
            876,579Accrued
                Interest Payable
            
            
            81,626
            
            
            72,708Warranty
                Accrual
            
            
            15,276
            
            
            4,908Customer
                Deposits
            
            
            -
            
            
            43,643Total
                Current Liabilities
            
            
            1,246,174
            
            
            1,718,249Notes
                Payable Subject to Compromise
            
            
            846,523Liabilities
                Subject to Compromise
            
            
            773,381
            
            
            -Total
                Liabilities
            
            
            2,866,078
            
            
            1,718,249STOCKHOLDERS'
                EQUITY (DEFICIT)Common
                Stock authorized is100,000,000
                shares at $0.001par value.Issued
                and outstanding on December 31,2004
                is 13,125,977 shares, December 31,2003
                is 11,374,456.
            
            
            13,126
            
            
            11,374Paid
                in Capital
            
            
            3,369,057
            
            
            2,742,605Accumulated
                Deficit
            
            
            (6,012,643
            )
            
            (4,119,313
            )Total
                Stockholders' Equity (Deficit)
            
            
            (2,630,460
            )
            
            (1,365,334
            )TOTAL
                LIABILITIES ANDSTOCKHOLDERS
                EQUITY
            
            $
            235,618
            
            $
            352,915





**The
      accompanying notes are an integral part of these Consolidated Financial
      Statements.**




**F-3**


3





**Tankless
                Systems Worldwide, Inc. and Subsidiaries****CONSOLIDATED
                STATEMENTS OF OPERATIONS**Years
                Ended December
                31,2004
            
            
            2003INCOMEProduct
                Sales
            
            $
            205,640
            
            $
            85,985Other
                Income
            
            
            251
            
            
            1,621Total
                Income
            
            
            205,891
            
            
            87,606Cost
                of Goods Sold
            
            
            215,856
            
            
            72,521Gross
                Income
            
            
            403
            
            
            15,085EXPENSESLegal
                and Professional
            
            
            711,916
            
            
            36,125General
                and Administrative
            
            
            504,066
            
            
            279,067Research
                and Development
            
            
            285,544
            
            
            21,378Advertising
            
            
            27,431
            
            
            7,039Loss
                on Disposal of Assets
            
            
            89,076
            
            
            -Impairment
                Loss
            
            
            39,778
            
            
            -Depreciation
            
            
            29,578
            
            
            14,065Amortization
            
            
            23,685
            
            
            4,265Interest
                Expense
            
            
            182,659
            
            
            24,967Total
                Expenses
            
            
            1,893,733
            
            
            386,906Net
                (Loss) before Income Taxes
            
            
            (1,893,330
            )
            
            (371,821
            )Income
                Tax Expense
            
            
            -
            
            
            -NET
                (LOSS)
            
            $
            (1,893,330
            )
            $
            (371,821
            )Basic
                and diluted (loss) per share
            
            $
            (0.16
            )
            $
            (0.09
            )Weighted
                Average Number of CommonShares
                Outstanding
            
            
            12,016,132
            
            
            4,152,144




**The
      accompanying notes are an integral part of these Consolidated Financial
      Statements.**





**F-4**


4





**Tankless
        Systems Worldwide, Inc. and Subsidiaries**
 **CONSOLIDATED
        STATEMENTS OF STOCKHOLDER’S DEFICIT**
 Common
                  Stock
              
              Paid
                  in
              
              
              Accumulated
              
              TotalShares
              
              
              Amount
              
              
              Capital
              
              
              (Deficit)
              
              Equity**Balance
                  December 31, 2002**
              
              
              7,931,484
              
              $
              7,931
              
              $
              1,941,620
              
              $
              (3,747,492
              )
              $ (1,797,941)Common
                  Shares issued for Cash
              
              
              434,894
              
              
              435
              
              
              967,925
              
              
              
              
              968,360Common
                  Shares issued in recapitalization
              
              
              3,008,078
              
              
              3,008
              
              
              (166,940
              )
              
              
              
              (163,932)Net
                  (Loss)
              
              
              -
              
              
              -
              
              
              -
              
              
              (371,821
              )
              (371,821)**Balance
                  December 31, 2003**
              
              
              11,374,456
              
              
              11,374
              
              
              2,742,605
              
              
              (4,119,313
              )
              (1,365,334)Common
                  Shares issued for services
              
              
              800,000
              
              
              800
              
              
              228,080
              
              
              
              
              228,880Common
                  Shares issued to retire Debt and interest of $91,281
              
              
              172,354
              
              
              172
              
              
              91,109
              
              
              
              
              91,281Common
                  Shares issued for cashthrough
                  exercise of warrants
              
              
              66,667
              
              
              67
              
              
              16,600
              
              
              
              
              16,667Common
                  Shares cancelled inacquisition
                  settlement
              
              
              (2,075,000
              )
              
              (2,075
              )
              
              2,075
              
              
              
              
              -Common
                  Stock Options issued forservices
              
              
              
              
              
              
              
              
              19,000
              
              
              
              
              19,000Common
                  Stock issued for prepaidservices
              
              
              2,250,000
              
              
              2,250
              
              
              110,250
              
              
              
              
              112,500Common
                  Shares valued at $159,876Issued to obtain $1,075,000 debt
              
              
              537,500
              
              
              538
              
              
              159,338
              
              
              
              
              159,876Net
                  (Loss)
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,893,330
              )
              (1,893,330)**Balance
                  December 31, 2004**
              
              
              13,125,997
              
              $
              13,126
              
              $
              3,369,057
              
              $
              (6,012,643
              )
              
              
              
              $
                  (2,630,460)


**The
      accompanying notes are an integral part of these Consolidated Financial
      Statements.**





**F-5**


5





**Tankless
                Systems Worldwide, Inc. and Subsidiaries****CONSOLIDATED
                STATEMENTS OF CASH FLOWS**Years
                Ended December 31,2004
            
            
            2003Cash
                Flows from Operating Activities:Net
                (Loss)
            
            $
            (1,893,330
            )
            $
            (371,821
            )Adjustments
                to reconcile net loss to net cash used in operating activities:Purchased
                (Negative) Capital frombusiness
                acquisition
            
            
            -
            
            
            (1,125,661
            )Shares
                cancelled for terminated service
            
            
            -
            
            
            (16,250
            )Common
                Share Options issued for service
            
            
            19,000
            
            
            6,300Shares
                issued for services rendered
            
            
            388,756
            
            
            319,195Shares
                issued to retire debt and interest
            
            
            91,281
            
            
            27,865Amortization
                of intangible assets
            
            
            23,685
            
            
            4,265Depreciation
                Expense
            
            
            29,579
            
            
            14,065Loss
                on disposal of capital assets
            
            
            89,076
            
            
            -Impairment
                Loss
            
            
            39,778
            
            
            -Changes
                in operating assets and liabilities:Inventory
            
            
            44,643
            
            
            (98,813
            )Accounts
                Receivable
            
            
            58,615
            
            
            (58,726
            )Prepaid
                Expense
            
            
            (64,340
            )
            
            (41,924
            )Deposits
            
            
            7,514
            
            
            -Accrued
                Interest Payable
            
            
            8,918
            
            
            32,161Accounts
                Payable & Other Payables
            
            
            67,001
            
            
            669,129Warranty
                Accrual
            
            
            10,368
            
            
            4,908Customer
                Deposits
            
            
            159,084
            
            
            43,643Net
                Cash Provided (Used) by Operating Activities
            
            
            (920,371
            )
            
            (591,664
            )Cash
                Flow From Investing ActivitiesPurchase
                of Patents and Software
            
            
            -
            
            
            (67,728
            )Purchase
                of Equipment
            
            
            (11,503
            )
            
            (87,392
            )Notes
                receivable
            
            
            (37,526
            )
            
            -Net
                Cash Provided (Used) by Investing Activities
            
            
            (49,029
            )
            
            (155,120
            )Cash
                Flow From Financing ActivitiesPrinciple
                Received on convertible debentures
            
            
            1,075,679
            
            
            -Proceeds
                from sale of Common Stock
            
            
            16,667
            
            
            -Notes
                Payable
            
            
            (104,668
            )
            
            746,579Net
                Cash Provided by Financing Activities
            
            
            987,678
            
            
            746,579Net
                Increase/(Decrease) in Cash and Cash Equivalents
            
            
            18,278
            
            
            (205
            )Cash,
                Beginning of Period
            
            
            412
            
            
            617Cash,
                End of Year
            
            $
            18,690
            
            $
            412Supplemental
                Disclosure of Information:Taxes
            
            $
            -
            
            $
            -Interest
            
            $
            182,659
            
            $
            24,967








**The
      accompanying notes are an integral part of these Consolidated Financial
      Statements.**





**F-6**


6
 **TANKLESS
          SYSTEMS WORLDWIDE, INC.**
 **NOTES
          TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
          31, 2004 and December 31, 2003**


**Note
      1.**  **THE
      COMPANY** ****







**The
      Company**





Tankless
      Systems Worldwide, Inc., a Nevada corporation, was originally organized on
      November 23, 1993 as Amexan, Inc., and then on June 1, 1998 the name was changed
      to Nostalgia Motorcars, Inc. On June 11, 2002, the Company changed its name
      to
      Elution Technologies, Inc., on June 4, 2003; it changed its name to Tankless
      Systems Worldwide, Inc.





On
      November 7, 2003, the Company acquired Envirotech Systems Worldwide, Inc.
      (Envirotech), a private Arizona corporation, as a wholly owned subsidiary.
      Through this merger, the former shareholders of Envirotech acquired a
      controlling interest in Tankless Systems Worldwide, Inc. (Tankless) and
      accordingly, the Merger is accounted for as a reverse merger with Envirotech
      being the accounting acquirer of Tankless. Accordingly, the Financial Statements
      present the historic financial position, operations and cash flows of Envirotech
      for all periods presented with the December 31, 2003 balance sheet adjusted
      to
      consolidate and reflect the fair values assigned to the acquisition balance
      sheet of Tankless. Refer to Note 4, Acquisition of Subsidiary for additional
      information and disclosures related to the merger.





Envirotech
      was organized December 9, 1998 and has a limited history of operations. The
      initial period of its existence involved research and development of a line
      of
      electronic, tankless water heaters. The first sales of its products occurred
      in
      calendar year 2000.





With
      the
      acquisition of Envirotech, the Company is in the business of designing,
      developing, manufacturing and marketing several models of electronic, tankless
      water heaters.





During
      January 2004 the Company organized ION Tankless, Inc. (Ion) an Arizona
      Corporation as a wholly owned subsidiary. ION is organized to do research,
      development and marketing of new tankless technologies.





**Nature
      of Business**





The
      Company produces and markets tankless electronic water heaters. The company’s
      products, together with a limited quantity of related parts purchased for
      resale, are sold primarily through Internet and wholesale distributors and
      major
      retailers in the United States and Canada. Based upon the nature of the
      Company’s operations, facilities and management structure, the Company considers
      its business to constitute a single segment for financial reporting
      purposes.





**Basis
      of Consolidation**





The
      accompanying consolidated financial statements reflect the operations, financial
      position and cash flows of the Company and include the accounts of the Company
      and its subsidiaries after elimination of all significant intercompany
      transactions in consolidation.





**Basis
      of Presentation** ****





The
      Consolidated Financial Statements of Tankless Systems Worldwide, Inc. together
      with its subsidiaries and all of its wholly owed subsidiaries.











**F-7**


7
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**


Note
      1.  **THE
      COMPANY** **-
      continued**





The
      accompanying Consolidated Financial Statements for the years ended December
      31,
      2004 have been prepared in accordance with Statement of Position 90-7 (“SOP
      90-7), “Financial Reporting by Entities in Reorganization under the Bankruptcy
      Code” (See Note 2). Accordingly, all pre-petition liabilities subject to
      compromise have been segregated in the consolidated balance sheet as of December
      31, 2004 and classified as Liabilities Subject to Compromise, at the estimated
      amount of allowable claims. Liabilities not subject to compromise are separately
      classified.




These
      Consolidated Financial Statements have been prepared on a going concern basis,
      which contemplates the realization of assets and the satisfaction of liabilities
      in the normal course of business. Accordingly, the financial statements do
      not
      include any adjustments that might be necessary should the Company be unable
      to
      continue as a going concern. As described more fully below, there is substantial
      doubt about the Company's ability to continue as a going concern, which is
      predicated upon, among other things, the ability to generate cash flows from
      operations and, when necessary, obtaining financing sources sufficient to
      satisfy the Company’s future obligations, as well as obtaining relief from its
      Envirotech Subsidiary’s liabilities through a reorganization under Chapter 11 of
      the Bankruptcy Code and development of new products to replace the Envirotech
      products.




**Recently
      Issued Accounting Standards**





Below
      is
      a listing of the most recent accounting standards and their effect on the
      Company.





SFAS
      123R Share-Based
      Payment




In
      December 2004, the FASB issued FAS No. 123R, “Share-Based Payment.”
This statement is a revision to FAS No. 123, “Accounting for Stock-Based
      Compensation,” it supersedes APB Opinion No. 25, “Accounting for Stock Issued to
      Employees,” and amends FAS No. 95, “Statement of Cash Flows.” Generally the
      approach in FAS No. 123R is similar to the approach described in FAS
      No. 123. However, FAS No. 123R requires all share-based payments to
      employees, including grants of employee stock options, to be recognized in
      the
      income statement based on their fair values. Pro forma disclosure is no longer
      an alternative. This statement also provides guidance on valuing and expensing
      these awards, as well as disclosure requirements of these equity arrangements.




FAS
      No. 123R must be adopted no later than December 15, 2005. Early
      adoption will be permitted in periods in which financial statements have not
      yet
      been issued. We expect to adopt FAS No. 123R on December 15, 2005. FAS
      No. 123R permits public companies to adopt its requirements using one of
      two methods, the modified prospective or the modified retrospective method.




The
      Company is currently evaluating the two different methods for the adoption
      of
      FAS No. 123R and has not determined which of the two methods will be
      adopted.




As
      permitted by FAS No. 123, the Company currently accounts for share-based
      payments to employees using APB Opinion No. 25’s intrinsic value method;
      and as such, the Company generally recognizes no compensation cost for employee
      stock options. Accordingly, the adoption of FAS No. 123R’s fair value
      method will have a material impact on the Company’s results of operations,
      although it will have no impact on the Company’s overall financial position. The
      impact of adoption of FAS No. 123R cannot be predicted at this time because
      it will depend in part on levels of share-based payments granted in the future.
      However, had the Company adopted FAS No 123R in prior periods using the Black-
      Scholes valuation model, the impact of that standard would have approximated
      the
      impact of FAS No. 123 as described in the disclosure of pro forma net loss
      and
      net loss per share in Note 3 to our consolidated financial statements.




FAS
      No. 123R also requires the benefits of tax deductions in excess of
      recognized compensation cost to be reported as a financing cash flow, rather
      than as an operating cash flow as required under current literature. The Company
      cannot estimate what those amounts will be in the future (because they depend
      on, among other things, when employees exercise stock options, and whether
      the
      Company will be in a taxable position). There is no tax impact related to the
      prior periods since we are in a net loss position.




**F-8**





8
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**


**Note
      1.****THE
      COMPANY-
      continued**




**SFAS
      149 Amendment of Statement 133 on Derivative Instruments and Hedging
      Activities**





This
      Statement amends and clarifies financial accounting and reporting for derivative
      instruments, including certain derivative instruments embedded in other
      contracts (collectively referred to as derivatives) and for hedging activities
      under FASB Statement No. 133, *Accounting
      for Derivative Instruments and Hedging Activities.*





SFAS
      150
      Financial Instruments with Characteristics of both Liabilities and
      Equity





This
      statement requires that such instruments be classified as liabilities in the
      balance sheet. SFAS 150 is effective for financial instruments entered into
      or
      modified after May 31, 2003.





FIN
      46
      Consolidation of Variable Interest Entities





Interpretation
      No. 46 (FIN 46 *)* In
      January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
      Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,
      which addresses consolidation by business enterprises of variable interest
      entities ("VIEs"). In December 2003, the FASB completed deliberations of
      proposed modifications to FIN 46 (Revised Interpretations) resulting in multiple
      effective dates based on the nature as well as the creation date of the VIE.
      The
      Revised Interpretations must be applied no later than the second quarter of
      fiscal year 2004. The adoption of FIN 46 had no impact on the Company's
      consolidated financial statements as of December 31, 2004.




The
      adoption of these new Statements is not expected to have a material effect
      on
      the Company’s current financial position, results or operations, or cash flows.




**Note
      2.**   **SUBSIDIARY’S
      PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE**




The
      Company’s wholly-owned subsidiary, Envirotech, decided to file for
      reorganization under Chapter 11, as it offered the most efficient alternative
      to
      restructure the Company’s balance sheet and access new working capital while
      continuing to sells its products and work with its parent to explore alternative
      business objectives to become financially viable. On August 6, 2004, Envirotech
      filed a voluntary petition with the United States Bankruptcy Court for the
      District of Arizona (Case No. 2:04-13908-RTB )
      seeking
      relief under Chapter 11 of the Bankruptcy Code as a means to resolve all
      existing litigation, judgments and efforts to collect on judgments entered
      against Envirotech. On December 2004, the Company filed its proposed plan of
      reorganization and disclosure statement with the Bankruptcy Court. However,
      there can be no assurance that the Bankruptcy Court will approve the Plan.
      The
      Company expects that it will take until at least the third quarter of 2005
      to
      obtain confirmation of its plan of reorganization.




With
      the
      exception of a guarantee to one critical supplier in the approximate amount
      of
      $42,500, the Registrant has not assumed any liability for the obligations of
      Envirotech. As of the date of the filing of the Chapter 11 Bankruptcy Petition,
      Envirotech had liabilities of approximately $1.6 million. Several creditors
      not
      related to the supply of parts or the assemblies of products have obtained
      judgments against Envirotech and were seeking to collect such judgments, and
      an
      action was pending in the U.S. District Court, Southern District of Texas,
      alleging patent infringement. The filing of the Bankruptcy Petition has stayed
      all creditors and lawsuits.





The
      Company cannot predict the outcome of any of the foregoing proceedings; however,
      it is not uncommon for reorganization plans proposed by debtors in bankruptcy
      proceedings to be amended on one or more occasions in response to a variety
      of
      circumstances, including negotiations among the debtors, their creditors and
      the
      equity security holders. At the present time however, the Company is unable
      to
      predict whether the proposed Plan will be amended and, if so, to what
      extent.





After
      the
      Bankruptcy Court approves a plan of reorganization, continuation of the business
      thereafter is dependent upon the success of future operations and the Company's
      ability to meet its obligations as they become due.








**F-9**


9
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**


**Note
      2.****SUBSIDIARY’S
      PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE -
      continued**




AICPA
      Statement of Position 90-7, "Financial Reporting by Entities in Reorganization
      under the Bankruptcy Code" ("SOP 90-7") provides financial reporting guidance
      for entities that are reorganizing under the Bankruptcy Code. The Company
      implemented this guidance in the consolidated financial statements for periods
      subsequent to September 30, 2004.




Pursuant
      to SOP 90-7, companies are required to segregate pre-petition liabilities that
      are subject to compromise and report them separately on the balance sheet.
      Liabilities that may be affected by a plan of reorganization are recorded at
      the
      amount of the expected allowed claims, even if they may be settled for lesser
      amounts. Substantially all of the Company's liabilities at December 31, 2004
      have been reclassified as liabilities subject to compromise. Obligations arising
      post-petition, and pre-petition obligations that are secured are not classified
      as liabilities subject to compromise.




Additional
      pre-petition claims (liabilities subject to compromise) may arise due to the
      rejection of executory contracts or unexpired leases, or as a result of the
      allowance of contingent or disputed claims.




As
      of
      December 31, 2004, Tankless and its subsidiaries (including Envirotech the
      “Debtor”) operated their business as debtors-in-possession pursuant to the
      Bankruptcy Code.





**Note
      3.**  **SIGNIFICANT
      ACCOUNTING POLICIES**





**Use
      of Estimates and Assumptions**





The
      discussion and analysis of the Company's financial condition and results of
      operations are based upon the Company's 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
      making estimates and assumptions that affect the reported amounts of assets
      and
      liabilities, disclosure of contingent assets and liabilities at the date of
      the
      financial statements, and the reported amounts of revenues and expenses during
      the reporting period. Actual results may differ from these estimates under
      different assumptions or conditions. Critical accounting policies are defined
      as
      those that entail significant judgments and estimates, and could potentially
      result in materially different results under different assumptions and
      conditions.





The
      accompanying balance sheets as of December 31, 2004 and December 31, 2003,
      and
      the related statements of operations, stockholders’ equity, and cash flows for
      the periods ended December 31, 2004, and 2003 reports the activity of its
      subsidiary Envirotech up to the date of purchase November 7, 2003 and
      consolidates the activity of the Company for all reported periods from the
      date
      of purchase to December 31, 2004 and its subsidiary ION from inception (January
      2004) to December 31, 2004.





The
      Consolidated Financial Statements for fiscal 2004 contained herein have been
      prepared in accordance with Statement of Position 90-7, “Financial Reporting by
      Entities in Reorganization under the Bankruptcy Code” (“SOP 90-7”). The
      Consolidated Financial Statements for fiscal 2003 are not prepared in accordance
      with SOP 90-7 because the Chapter 11 case was filed in fiscal 2004. See Note
      2
      to the Consolidated Financial Statements. The amounts reported in subsequent
      financial statements will materially change due to the restructuring of the
      Company’s assets and liabilities as a result of the Plan and the application of
      the provisions of SOP 90-7 with respect to reporting upon emergence from Chapter
      11 (“fresh start” accounting). Financial statements for periods subsequent to
      the Company’s emergence from Chapter 11 will not be comparable with those of
      prior periods.





**Cash
      Equivalent**





Cash
      and
      Cash Equivalents - All highly liquid debt instruments with a maturity of three
      months or less at the time of purchase are considered to be cash equivalents.
      Cash equivalents are stated at cost, which approximates fair value because
      of
      the short-term maturity of these instruments.





**Fair
      Value of Financial Instruments**





Financial
      instruments consist of cash and cash equivalents, accounts payable, accrued
      expenses and short-term and long-term convertible debt obligations. Including
      our promissory notes, and related party liabilities, the fair value of these
      financial instruments approximates their carrying amount as of December 31,
      2004 and 2003 due to the nature of or the short maturity of these instruments.




F-10


10
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**




**Note
      3.****SIGNIFICANT
      ACCOUNTING POLICIES - continued**




**Research
      and Development**





The
      Company's research and development efforts concentrate on new product
      development, improving product durability and expanding technical expertise
      in
      the manufacturing process. The Company expenses product research and development
      costs as they are incurred. With the organization of its new subsidiary ION,
      the
      Company continues to expense research and development costs as incurred in
      developing additional products based on new technologies.




**Marketing
      Strategy**





The
      Company sells directly to individuals through the Internet, through
      distributors, and through high volume retailers. The Company periodically
      advertises on cable television stations, at trade shows and through trade
      magazines and it maintains an extensive website.





**Revenue
      Recognition**





The
      Company records sales when revenue is earned. The Company usually sells its
      units through credit card sales to individuals and normally does not maintain
      receivables. However, the Company does sell on credit to distributors. Due
      to
      the company’s Warranty and Right of Return policy, six percent of the sales are
      recognized immediately and the balance is recognized 30 days after shipment
      of
      the product to the customer. All shipments are FOB shipping point. Sales to
      distributorships are sold FOB shipping point with 30-day terms on receivables.
      In 2004, substantially all of the Company’s gross revenues of $205,891 were
      generated by the Envirotech subsidiary.





**Accounts
      Receivable**





Accounts
      receivable are recorded when an order is received from a distributor and
      shipped. An allowance for doubtful accounts was set up based on the actual
      rate
      of uncollected accounts. Net accounts receivable is as follows:







Year
              Ended December 31
            
            
            2004
            
            
            2003Accounts
                Receivable
            
            $
            110
            
            $
            65,511Less Allowance
                for Doubtful Accounts
            
            
            -
            
            
            (6,785
            )Net Accounts
                Receivable
            
            $
            110
            
            $
            58,726








**Allowance
      for Doubtful Accounts**





The
      company maintains allowances for doubtful accounts for estimated probable losses
      resulting from inability of the company’s customers to make the required
      payments. The company continues to assess the adequacy of the reserves for
      doubtful accounts based on the financial condition of the Company’s customers
      and external factors that may impact collectability. As of December 31, 2004
      there were no uncollectible accounts.





**Advertising**





Advertising
      expense included the cost of sales brochures, print advertising in trade
      publications, displays at trade shows and maintenance of an Internet site.
      Advertising is expensed when incurred. Advertising expense for the years ended
      December 31, 2004 and December 30, 2003 is $27,431 and $7,039
      respectively.





**Inventory**





The
      Company contracts with a third party to manufacture the units and are neither
      billed for nor obligated for any work-in-process. The Company only supplies
      certain parts and materials and is then billed for completed products. Parts
      and
      material inventory is stated at the lower of cost (first-in, first-out) or
      net
      realizable value.








**F-11**


11
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**


Note
      3.  **SIGNIFICANT
      ACCOUNTING POLICIES - continued**





**Property
      and Equipment**





Property
      and equipment are depreciated or amortized using the straight-line method over
      their estimated useful lives, which range from two to seven years. Fixed assets
      consist of the following:





Years
              Ended December 31,
            
            
            2004
            
            
            2003Tooling,
                machinery, furniture and fixtures
            
            $
            163,429
            
            $
            181,358Less: Accumulated
                depreciation
            
            
            (115,781
            )
            
            (108,031
            )Total
            
            $
            47,648
            
            $
            73,327





**Patents**





Patent
      and software costs include direct costs of obtaining patents. Costs for new
      patents are capitalized and amortized over the estimated useful lives of
      seventeen years and software over five years. The Company determined that the
      current patents and software were impaired due to uncertainty in connection
      with
      the pending patent litigation, as well as the efforts to develop a new product
      line as of December 31, 2004.







Years
              Ended December 31,
            
            
            2004
            
            
            2003Patents
              and Heater Software
            
            $
            132,274
            
            $
            132,274Accumulated
              Amortization
            
            
            (92,496
            )
            
            (68,811
            )Impairment
              Loss
            
            
            (39,778
            )
            
            -Net
              Patents and Heater Software
            
            $
            -
            
            $
            63,463







**Earnings
      per Share**





The
      basic
      (loss) per share is calculated by dividing the Company’s net loss available to
      common shareholders by the weighted average number of common shares outstanding
      during the year.





The
      Company has no potentially dilutive securities outstanding at the end of the
      statement periods. Therefore, the basic and diluted earnings (loss) per share
      are presented on the face of the statement of operations. There are 700,000
      options at $.50 and $.55 per share available at this time. All outstanding
      warrants were either exercised or cancelled and convertible debt is
      anti-dilutive.





**Stock
      Based Compensation**





The
      Company accounts for its stock based compensation based upon provisions in
      SFAS
      No. 123, *Accounting
      for Stock-Based Compensation* .
      In this
      statement stock based compensation is divided into two general categories,
      based
      upon who the stock receiver is, namely: employees/directors and
      non-employees/directors. The employees/directors category is further divided
      based upon the particular stock issuance plan, namely compensatory and
      non-compensatory. The employee/directors non-compensatory securities are
      recorded at the sales price when the stock is sold. The compensatory stock
      is
      calculated and recorded at the securities’ fair value at the time the stock is
      given. SFAS 123 also provides that stock compensation paid to non-employees
      be
      recorded with a value which is based upon the fair value of the services
      rendered or the value of the stock given, whichever is more reliable. The common
      stock paid to non-employees was valued at the value of the services rendered.
      Because the Company establishes the exercise price based on the fair market
      value of the Company’s stock at the date of grant, the options have no intrinsic
      value upon grant, and therefore no expense is recorded.





**Warranty
      and Right of Return**





In
      connection with the sale of each product, the Company provides a 30-day money
      back guarantee less a 6% restocking charge. After the 30 days the Company
      provides a five year warranty on replacement of parts. The tank chamber is
      warranted not to leak for 20 years. The Company has limited history with claims
      against its warranty. The Company defers a portion of the revenue as would
      generally be required for post contract customer support ("PCS") arrangements
      under SOP 97-2. Accordingly, the revenue allocated to the warranty portion
      of
      such sales is deferred and recognized ratably over the life of the warranty.
      As
      of December 31, 2004 a total of $15,276 in refunds and warranty allowances
      were
      recorded against Product Sales.




F-12


12
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**




Note
        3.  **SIGNIFICANT
        ACCOUNTING POLICIES - continued**
 Balance
                of Warranty Accrual for
                2003
              
              $
              4,908Balance
                of Warranty Accrual for
                2004
              
              
              10,368Total
                Warranty Accrual as of December 31,
                2004
              
              $
              15,276


**Note
      4.**   **ACQUISITION
      OF SUBSIDIARY**





On
      November 7, 2003, the Company acquired Envirotech Systems Worldwide, Inc. a
      private Arizona corporation (Envirotech), as a wholly owned subsidiary. On
      the
      date of purchase the Company had 3,008,078 common shares issued and outstanding.
      The purchase was made in a one-for-one stock exchange of 8,366,778 shares of
      the
      Company’s common stock for all of the issued and outstanding shares of
      Envirotech. The Statement of Stockholders’ Equity has been retroactively
      restated to reflect the affect of a recapitalization of Envirotech at the time
      of purchase.




**Note
      5.**  **NOTES
      PAYABLE AND CAPITAL LEASE OBLIGATIONS** ****





During
      the year ended December 31, 2004, the Company received $1,075,000 through
      private placements to accredited investors. The investor received a one-year
      debenture with an interest rate of 10% per year, payable, quarterly.
      Additionally, the investor received one (1) share of the Company’s restricted
      common stock for each Two Dollars ($2.00) of debentures purchased. The principle
      and unpaid interest is convertible at the option of the Company to common stock
      at the rate of one share of stock for every $1.00 outstanding at the due date.
      Rather that enforcing conversion as provided by the language of the notes,
      the
      Company makes offers of conversion to the note holders to accept conversion
      based on current stock values or repayment of the note. During 2004 a $30,000
      and a $50,000 note including associated interest were converted to common
      stock.





**Notes
      payable and capital lease obligations consist of the
      following:**





Year
                Ended December 31
            
            
            2004
            
            
            2003Convertible
              Notes, Unsecured, Matured March
              2001
                bear 12.5% Interest, principle and interest
              convertible
                into one common share and one
              warrant
                at 75% of the average closing price over
              the
                10-day period prior to conversion. Warrants****
              have
                expired and notes have not been
              converted
                and are in default.
            
            $
            100,000
            
            $
            100,000Convertible
                Notes, unsecured, matured March
              2002
                bear 12.5% interest, principle and interest
              convertible
                into one common share and one
              warrant
                at 75% of the average closing price over
              the
                10-day period prior to conversion. Warrants
              have
                expired and note has been converted.
            
            
            -
            
            
            30,000Convertible
                Notes, Unsecured, Matured one-year
              from
                issue date, bear 10% Interest payable quarterly,
              principle
                and interest convertible, at the option of the
              Company,
                into one common share for each $1.00
              outstanding.
                 Thirty-six notes were issued
              Aggregate
                Amount of principal and interest:
            
            
            1,106,626
            
            
            -Aggregate
                amount of principle and interest
              on
                notes payable of Subsidiary Envirotech,
              2004
                subject to compromise
            
            
            846,523
            
            
            746,579Total
              Notes Payable
            
            $
            2,053,149
            
            $
            876,579




F-13




13
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**




**Note
      6.**   **STOCKHOLDERS’
      EQUITY**




On
      December 31, 2004 and 2003 common stock issued and outstanding were 13,125,977
      and 11,374,456 shares respectively.





On
      July
      25, 2002, the Company adopted an employee stock incentive plan setting aside
      1,000,000 shares of the Company’s common stock for issuance to officers,
      employees, directors and consultants for services rendered or to be rendered.
      The proposed maximum offering price of such shares is $1.00 per
      share.





A compensation
        committee appointed by the Board of Directors, or, if none, the entire Board
        of
        Directors has the right to grant awards or stock options as administers the
        plan.




On
      October 15, 2002, the Company filed a Registration on Form S-8 with the
      Securities Exchange Commission covering the 1,000,000 shares provided by this
      plan, at a maximum offering price of $1.00 per share.





As
      of
      December 31, 2002, 540,000 shares of common stock have been issued at $0.10
      per
      share under this plan leaving a balance of 460,000 shares available under the
      plan, all of which were subsequently issued in 2003.





On
      August
      19, 2003, the Company adopted an employee stock incentive plan setting aside
      960,000 shares of the Company’s common stock for issuance to officers,
      employees, directors and consultants for services rendered or to be rendered.
      The proposed maximum offering price of such shares is $1.00 per
      share.





A
      compensation committee appointed by the Board of Directors, or, if none, the
      entire Board of Directors has the right to grant awards or stock options as
      administers the plan.





On
      September 12, 2003, the Company filed a Registration on Form S-8 with the
      Securities Exchange Commission covering the 960,000 shares provided by this
      plan, at a maximum offering price of $1.00 per share.





From
      the
      date of adoption of the Plan to November 7, 2003, the Company issued all of
      the
      shares covered by this Plan.





On
      December 1, 2003, the Company adopted an employee stock incentive plan setting
      aside 165,000 shares of the Company’s common stock for issuance to officers,
      employees, directors and consultants for services rendered or to be rendered.
      The proposed maximum offering price of such shares is $1.00 per share.





A
      compensation committee appointed by the Board of Directors, or, if none, the
      entire Board of Directors has the right to grant awards or stock options as
      administers the plan.





On
      December 19, 2003, the Company filed a Registration on Form S-8 with the
      Securities Exchange Commission covering the 165,000 shares provided by this
      plan, at a maximum offering price of $1.00 per share.





As
      of
      March 31, 2004, the Company has issued all of the shares covered by the 2003
      Stock Incentive Plan adopted by the Company on December 1, 2003.





On
      December 23, 2004, the Company accepted the return and cancellation of 2,075,000
      common shares in settlement of action taken by the company against prior
      officers, directors and shareholders of Envirotech in connection with claims
      made during its purchase.





The
      Company was initially capitalized November 30, 1993 with the issue of 500,000
      shares for $5,000 and at December 31, 2004 had 13,125,977 common shared
      outstanding. Since December 31, 2003 the Company has issued 537,500 common
      shares valued at $159,876 for debenture purchase incentives; 800,000 common
      shares for services valued at $228,880; 66,667 common shares for
      $16,667 **** cash
      in
      exercise of outstanding warrants; 172,354 common shares to retire $80,000 in
      debt and 11,281 interest; 2,250,000 shares were issued for prepaid expenses
      of
      $112,500; and 2,075,000 shares were
      surrendered and cancelled in settlement of Envirotech acquisition dispute.
      The
      total common stock issued and outstanding at December 31, 2004 is 13,125,977
      shares. **F-14**


14
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**


Note
      6.   **STOCKHOLDERS’
      EQUITY - continued**




**Warrants** ****





On
      December 31, 2003 there were 66,667 share purchase warrants outstanding
      entitling the holders the right to purchase one common share for each warrant
      held at $0.75 per share. On May 19, 2004, the Company revised the exercise
      price
      to $0.25 per share and accepted $16,667 in exercise of these warrants for 66,667
      common shares. No additional warrants are outstanding.





**Stock
      Options** ****





In
      connection with the acquisition of Envirotech Systems Worldwide, Inc., the
      Company issued immediately vested stock options on October 29, 2003 to one
      of
      the principal shareholders of Envirotech. He was granted the right to purchase
      300,000 restricted common shares at $0.55 per share until October 29, 2004
      (extended to December 31, 2004 and now expired).




On
      February 11, 2004 the company granted 5-year stock options to purchase 600,000
      shares of restricted common stock at $0.50 per share to consultants assisting
      in
      company operations. Using a discounted stock price of $0.43, exercise price
      of
      $0.50, 5-year option, risk-free rate of 4.1% and a volatility rate of .038
      the
      value of these options is calculated at $0.03 using the Black-Scholes model.
      The
      aggregate value of 600,000 options is $18,000.





On
      December 31, 2004 options to purchase 100,000 restricted common shares were
      granted as part of a settlement agreement. The options are immediately vested
      and the holder has the right to purchase 100,000 restricted shares at an
      exercise price of $0.55 per share and will expire in one year (December 31,
      2005). Using a discounted stock price of $0.44, exercise price of $0.55, 1-year
      option, risk-free rate of 4.1% and a volatility rate of .038 the value of these
      options is calculated at $0.01 using the Black-Scholes model. The aggregate
      value of 100,000 options is $1,000.





Outstanding
      stock options are as follows:




SharesBalance,
              December 31, 2003
            
            
            300,000Granted
            
            
            700,000Canceled
            
            
            (300,000
            )Balance,
              December 31, 2004
            
            
            700,000




**Note
      7.**  **INCOME
      TAXES**





The
      Company provides for income taxes under Statement of Financial Accounting
      Standards No. 109, *Accounting
      for Income Taxes* .
      SFAS
      No. 109. Under
      SFAS No. 109, deferred tax assets and liabilities are recognized based on
      temporary differences between the financial statement and tax basis of assets
      and liabilities using enacted tax rates in effect in the years in which the
      differences are expected to reverse. SFAS No. 109 requires current recognition
      of net deferred tax assets to the extent that it is more likely than not that
      such net assets will be realized. To the extent that the Company believes that
      its net deferred tax assets will not be realized, a valuation allowance must
      be
      recorded against those assets.





SFAS
      No.
      109 requires the reduction of deferred tax assets by a valuation allowance
      if,
      based on the weight of available evidence, it is more likely than not that
      some
      or all of the deferred tax assets will not be realized. In the Company’s
      opinion, it is uncertain whether they will generate sufficient taxable income
      in
      the future to fully utilize the net deferred tax asset. Accordingly, a valuation
      allowance equal to the deferred tax asset has been **** recorded.
      The total deferred tax asset is $416,532, as of December 31, 2004, which is
      calculated by multiplying a 22% estimated tax rate by the cumulative NOL of
      $3,540,489. The total valuation allowance is a comparable $416,532.




Year
              Ended December 31
            
            
            2004
            
            
            2003
            
            
            2002Deferred
                Tax
                Asset
            
            $
            416,532
            
            $
            81,800
            
            $
            253,976Valuation
                Allowance
            
            
            (416,532
            )
            
            (81,800
            )
            
            (253,976
            )Current
                Taxes
                Payable
            
            
            0
            
            
            0
            
            
            0Income
                Tax
                Expense
            
            $
            0
            
            $
            0
            
            $
            0




F-15


15
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**


**Note
      7.****INCOME
      TAXES - continued**





Below
      is
      a chart showing the estimated federal net operating losses and the years in
      which they will expire.




Year
            
            
            Amount
            
            
            Expiration2001
            
            
            120,900
            
            
            20212002
            
            
            1,154,438
            
            
            20222003
            
            
            371,821
            
            
            20232004
            
            
            1,893,330
            
            
            2024Total
            
            $
            3,540,489




**Note
      8.**  **LEASES
      AND OTHER COMMITMENTS**





The
      Company leases certain office facilities and equipment under leases with varying
      terms. Certain leases contain rent escalation clauses. These rent expenses
      are
      recognized on a straight-line basis over the respective term of the lease.
      The
      Company occupies space leased by Envirotech. The lease extends to June 30,
      2005.
      The numbers shown below assume that the Company will remain in its current
      office space.





Future
      minimum lease payments of non-cancelable operating leases having initial or
      remaining lease terms in excess of one year as of December 31, 2004 are as
      follows:




2005Office
              Lease
            
            $
            12,715




**Note
      9.**  **GOING
      CONCERN**





The
      accompanying financial statements have been prepared on a going concern basis,
      which contemplates the realization of assets and the satisfaction of liabilities
      in the normal course of business. The Company has incurred net losses since
      inception and has an accumulated deficit of $6,012,643 as of December 31,
      2004. The Company will not generate meaningful revenues in the foreseeable
      future.





These
      factors, among others, raise substantial doubt about the Company’s ability to
      continue as a going concern. The Company’s independent registered public
      accountants, Shelley International CPA, indicated in their audit report on
      the
      2004 consolidated financial statements that there is substantial doubt about
      the
      Company’s ability to continue as a going concern.





Listed
      below are some of the challenges which the Company is facing, and why these
      raise a question as to the Company’s ability to continue as a going concern.
      Also described are management’s plans to turn the Company around.





**Company’s
      Challenges**





The
      Company has a substantial deficit in retained earnings from losses for the
      previous years. Its subsidiary, Envirotech has not been able to generate enough
      sales to cover annual expenses and has survived only by raising funds. The
      Company must continue to raise funds in the near future to survive. Management
      has been successful in the past in raising these funds. There is no assurance
      that management can continue to find investors to cover the losses
      generated.





**Management’s
      Plans**





Management
      feels that industry trends are encouraging. Advertising will likely continue
      through the printed media, cable television and the Internet. As new
      homebuilders become aware of the product it will be included in original house
      plans.




On
      February 1, 2004, the company initiated its management transition plan as a
      result of its acquisition of its subsidiary Envirotech. The Company entered
      into
      several consulting agreements to assist in day-to-day operations and provide
      financial, management and other consulting services to the Company and its
      subsidiaries. These persons will serve as part of the management team during
      the
      periods of their engagement and will perform a variety of services to
      include:





1.
            The
                evaluation of potential business
                opportunities


2.
            The
                business operations and management


3.
            The
                development of business strategies


4.
            Raising
                public and private capital


F-16


16
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**




Note
      8.  **LEASES
      AND OTHER COMMITMENTS - continued**




Pursuant
      to these agreements, the company committed to issue 700,000 shares of common
      stock and has granted options to purchase an additional 600,000 restricted
      shares at a price of $0.50 per share at any time prior to February 1, 2009.
      All
      stock issued or to be issued is subject to the limitations imposed by Rule
      144.
      Management believes these individuals and entities are crucial to the future
      of
      the Company and that the consideration paid for their services is fair and
      reasonable.





**Note
      10.**  **PENDING
      LITIGATION**





The
      Company’s subsidiary Envirotech is currently a defendant in a patent
      infringement lawsuit. Management feels that this action is baseless and that
      the
      Company will prevail. No contingent liability has been recorded nor contemplated
      at this point. The action has been stayed through Bankruptcy
      Petition.





In
      2004
      Envirotech was named in three separate lawsuits for unpaid legal and consulting
      fees totaling $268,000. Envirotech believed it had meritorious defenses to
      each
      of these suits.  On April 14, 2004, Envirotech settled one of these suits,
      considering it a nuisance claim. In connection with that settlement, Envirotech
      reimbursed the plaintiff for alleged


out-of-pocket
      expenses and the Company issued 10,000 shares of common stock, restricted under
      Rule 144, to the plaintiff on the basis of a loan from the Company to
      Envirotech.  In the other two suits, Envirotech elected not to spend funds
      to defend the action and judgments were granted in the aggregate amount of
      approximately $155,500. These judgments have been stayed through Bankruptcy
      Petition (see Note 3). Any settlements of these suits will be reflected as
      a
      charge in the year of the settlement.





On
      August
      13, 2004, the Company filed a verified complaint in the United States District
      Court in and for the District of Arizona against certain key individuals who
      were principals of Envirotech prior to its acquisition. The actions alleged
      against various defendants included claims for Breach of Fiduciary Duty, Aiding
      and Abetting Breach of Fiduciary Duty, Breach of Contract, Breach of Implied
      Covenant of Good Faith and Fair Dealing, Fraud and Intentional
      Misrepresentation, Conspiracy to Defraud, Arizona Securities Fraud, Federal
      Securities Fraud, Negligent Misrepresentation, Misappropriation of Trade Secrets
      and Confidential Business Information, Conversion/Embezzlement, Intentional
      Interference with Business Relations and Prospective Economic Advantage, Unjust
      Enrichment, and Promissory Estoppel. The Company sought relief, which included,
      but was not limited to, Damages, Constructive Trust, Rescission and Injunctive
      Relief. This action has been settled with the return and cancellation of
      2,075,000 shares of common stock and the agreement of the defendants to other
      conditions, including agreements not to compete for specified periods of
      time.





**Note
      11.**   **COMMON
      STOCK TO BE GRANTED**





On
      December 24, 2004 the Company issued 2,250,000 shares of common stock for
      $112,500 in anticipation of executing various consulting agreements for services
      to be performed in 2005. These shares are reported in the financial statements
      as prepaid expense. However, the anticipated agreements have not yet been
      executed therefore the conditions that give rise to their issuance have not
      been
      satisfied. The Company does not consider these shares to be owned by the
      certificate holders as of December 31, 2004.





The
      Company’s transfer agent (First American Stock Transfer, Inc.) confirms a hold
      notification on the subject shares and that no transfers have been made or
      attempted with respect to these certificates.





**Note
      12.**  **LIABILITIES
      SUBJECT TO COMPROMISE**




As
      a
      result of the Company's Chapter 11 filing (see Notes 1 and 2), pursuant to
      SOP
      90-7, the Company is required to segregate pre-petition liabilities that are
      subject to compromise and report them separately on the consolidated balance
      sheet. Liabilities that may be affected by a plan of reorganization are recorded
      at the amount of the expected allowed claims, even if they may be settled for
      lesser amounts. Substantially all of the Company's pre-petition debt is recorded
      at face value and is classified within liabilities subject to compromise.




**F-17**







17
 
 **TANKLESS
        SYSTEMS WORLDWIDE, INC.**
 **NOTES
        TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2004 and December 31, 2003**




**Note
      13.**  **CONTROLS
      AND PROCEDURES**





**Disclosure
      Controls and Procedures**




An
      evaluation was carried out under the supervision and with the participation
      of
      our management, including our Chief Executive
      Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our
      disclosure controls and procedures as of December  31,
      2004 .
      Disclosure controls and procedures are procedures that are designed with the
      objective of ensuring that information required to be disclosed in our reports
      filed under the Securities Exchange Act of 1934, such as this Form 10-KSB/A,
      is
      recorded, processed, summarized and reported within the time periods specified
      in the Securities and Exchange Commission’s rules and forms. Based on the
      material weakness in internal control over financial reporting discussed below,
      our management, including our Chief Executive Officer and Chief Financial
      Officer, concluded that the disclosure controls and procedures were not
      effective as of the end of the period covered by this report.




**Internal
      Control Over Financial Reporting**




As
      of December
      31, 2004 , the
      Company had a
      deficiency in internal controls over the accounting treatment of the reverse
      merger and subsidiary bankruptcy. Specifically, an effective review of the
      documents related to these two events was made. As a result of the ineffective
      initial review, an error in the year-end 2004 calculation was not detected
      prior
      to the issuance of the annual 2004 consolidated financial statements. This
      control deficiency resulted in the restatement of our annual 2004 consolidated
      financial statements as described in Notes 2 and 14. Management has concluded
      that this control deficiency constitutes a material weakness.





**Management
      Remediation Plan**




We
      have
      undertaken remedial action to address and correct the weakness in our internal
      controls and disclosure controls identified subsequent to the end of 2004.
      These
      actions include adopting an adequate review of the accounting treatment of
      significant events and adding qualified accounting personnel. These actions
      were
      put in place during the quarter beginning January 1, 2006.




**Changes
      in Internal Control over Financial Reporting**




With
      the
      exception of the material weakness note above, there were no other changes
      in
      our internal control over financial reporting during the quarter ended December
      31, 2004 that
      have materially affected, or are reasonably likely to materially affect, our
      internal control over financial reporting.




**Note
      14.**  **RESTATEMENT**





Subsequent
      to the filing of its Annual Report on Form 10-KSB for the year ended
      December 31, 2004 the Company determined that there are
      six
      categories of errors that the Company addresses in this restatement of its
      financial statements:





·
            Accounting
                for the reverse merger with Envirotech;


·
            The
                financial reporting treatment related to Envirotech’s bankruptcy
                filing;


·
            Assumptions
                to estimate the impairment of intangible and fixed assets;


·
            Physical
                inventory adjustments


·
            Accounting
                for Customer Warranties


·
            Analysis
                of the collectability of Accounts Receivable










F-18


18


which
      resulted in a $181,784 understatement of income in its financial statements
      for
      the year ended December 31, 2004. As a result of the errors, the Company
      restated its consolidated financial statements as of and for the year ended
      December 31, 2004. A summary of the significant effects of the restatement
      is as follows:




As Previously Reported
            
            
            As
              Restated
            
            
            ChangePaid
              in Capital & Subscriptions
              Receivable
            
            
            1,010,148
            
            
            3,369,057
            
            
            2,359,909Bankruptcy
            
            
            (Liabilities
              subject to Compromise were not
              segregated)Impairment
              of Intangible Assets
            
            
            -
            
            
            39,778
            
            
            (39,778
            )Disposal
              of Fixed Assets
            
            
            -
            
            
            89,079
            
            
            (89,076
            )Sales
            
            
            262,121
            
            
            205,891
            
            
            (56,230
            )General
              Administrative Expenses
            
            
            1,242,014
            
            
            1,215,981
            
            
            (26,032
            )Amortization
&
depreciation42
            
            
            42,123
            
            
            53,263
            
            
            11,140Net
              Loss
            
            
            (1,701,177
            )
            
            (1,893,330
            )
            
            (192,153
            )Loss
              Per Share
            
            
            (.14
            )
            
            (.16
            )
            
            (.02
            )




Notes
      2,
      3, 4, 6, 7, 8, 12, 13 and 14 have also been restated to reflect the results
      of
      the above restatement adjustment.





























**F-19**




19