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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
    FORM 10-KSB   x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended
September 30, 2004o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition period
from to
 Commission file number: 0-50775 XENONICS HOLDINGS, INC.    Nevada
    
    84-1433854(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)
 2236 Rutherford Road, Suite 123Carlsbad, California
    
    92008-7297(Address of principal executive offices)
    
    (Zip Code)
 Issuers telephone number: (760) 438-4004 Securities registered under Section 12(b) of the Act: None. Securities registered under Section 12(g) of the Act: Common Stock, $.001 par
value. Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months
(or for such shorter period that the issuer was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes
x  No  o Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and no disclosure will be contained, to the best
of the issuers knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. o Issuers revenues for its most recent fiscal year: $11,927,000. Aggregate market value of voting stock held by non-affiliates of the Issuer as
of November 30, 2004 was approximately $72,883,444. There were 14,166,878 shares of the Companys common stock outstanding on
November 30, 2004. Transitional Small Business Disclosure Format: Yes  o No  x Documents Incorporated by Reference: Certain portions of the issuers Proxy
Statement for the 2005 annual meeting of stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A, not later than
120 days after the close of the issuers fiscal year, are incorporated by
reference under Part III of this Form 10-KSB.




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TABLE OF CONTENTS PART IITEM 1.
    
    DESCRIPTION OF BUSINESS
    
    3ITEM 2.
    
    DESCRIPTION OF PROPERTY
    
    11ITEM 3.
    
    LEGAL PROCEEDINGS
    
    11ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    11PART IIITEM 5.
    
    MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
    
    12ITEM 6.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
    
    14ITEM 7.
    
    FINANCIAL STATEMENTS
    
    F-1ITEM 8.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
    
    iiITEM 8A.
    
    CONTROLS AND PROCEDURES
    
    iiITEM 8B.
    
    OTHER INFORMATION
    
    iiiPART IIIITEM 9.
    
    DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
    
    ivITEM 10.
    
    EXECUTIVE COMPENSATION
    
    ivITEM 11.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
    
    ivITEM 12.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    ivITEM 13.
    
    EXHIBITS
    
    vITEM 14.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    viEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
  i




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Introductory Comment Throughout this annual report on Form 10-KSB, the terms we, us, our,
and our company refer to Xenonics Holdings, Inc., a Nevada corporation
formerly known as Digital Home Theater Systems, Inc., and, unless the context
indicates otherwise, also includes our subsidiary, Xenonics, Inc., a Delaware
corporation. Forward-Looking Statements This annual report contains forward-looking statements, which reflect the
views of our management with respect to future events and financial
performance. These forward-looking statements are subject to a number of
uncertainties and other factors that could cause actual results to differ
materially from such statements. Forward-looking statements are identified by
words such as anticipates, believes, estimates, expects, plans,
projects, targets and similar expressions. Readers are cautioned not to
place undue reliance on these forward-looking statements, which are based on
the information available to management at this time and which speak only as of
this date. Our actual results may differ materially from results anticipated
in these forward-looking statements. We undertake no obligation to update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise. For a discussion of some of the factors that may
cause actual results to differ materially from those suggested by the
forward-looking statements, please read carefully the information under
Factors that May Affect Future Results and Market Price of Our Stock. 2




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PART I 
 ITEM 1. DESCRIPTION OF BUSINESS Overview We design, manufacture and market high-end, high-intensity portable
illumination products. Our core product line consists of lightweight,
long-range, ultra-high intensity illumination products used in a wide variety
of applications by the military, law enforcement, security, search and rescue
and, to a lesser extent, in commercial markets. We hold several patents for
our technology platform, which applies high efficiency dimmable electronic
ballast circuitry and precision optics to xenon light to produce an
illumination device that delivers improved performance over current
technologies. We are largely dependent upon government orders for our
revenues. Existing customers include all branches of the United States Armed
Forces, including such elite forces as the U.S. Navy SEALs, USMC FAST and the
U.S. Army Rangers. Other customers include the U.S. Border Patrol, the U.S.
Secret Service, the U.S. Coast Guard, and the California Highway Patrol. We market our illumination products under the NightHunter brand name. The
NightHunter series of products is produced in a variety of configurations to
suit specific customer needs. These include compact hand-held systems for
foot-borne personnel and stabilized systems for airborne, vehicular and
shipboard use. These NightHunter illumination systems are used for
reconnaissance, surveillance, search and rescue, physical security, target
identification and navigation. The systems allow the user to illuminate an
area, an object or a target with visible or non-visible light, and to improve
visibility through many types of obscurants such as smoke, haze and most types
of fog. We conduct all of our operations through our subsidiary, Xenonics, Inc.
In July 2003, under our former name of Digital Home Theater Systems, Inc., we
acquired 100% of the outstanding capital stock of Xenonics, Inc. for 8,750,000
shares of common stock. Upon the closing of this transaction, Digital Home
Theater Systems, Inc. changed its name to Xenonics Holdings, Inc. The
transaction was accounted for as a reorganization of Xenonics, Inc. with
issuance of stock for cash. For accounting purposes, Xenonics, Inc. is treated
as the acquirer and, as such, its historical financial statements will continue
and are included in this Form 10-KSB. On December 14, 2004, a former
holder of a warrant to purchase shares of Xenonics, Inc. exercised
his warrant to purchase 135,000 shares of Xenonics, Inc. As a
result, we currently own approximately 98.5% of the issued and
outstanding capital stock of Xenonics, Inc. Fiscal 2004 marks our first year in which revenue levels have been able to
sustain profits. Our goal is to continue to increase our revenues and profits,
but we understand that in order to accomplish these goals we will have to
improve our current products, introduce new products and expand our customer
base. In addition to improving current products through improved technology
and processes, we are attempting to lower costs wherever possible to improve
our operating margin. We are in the process of determining the new products,
opportunities and distribution channels that will best help us to reach our
goal of an expanded customer base. Our strategy is to further increase our sales to the military by
demonstrating the various benefits and uses of our products. We plan to
attempt to capitalize on our success with our military sales process by
duplicating that process with the United States Department of Homeland
Security. Our current challenge is to supplement government sales with
commercial sales of both our current products and new products. 3




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History Our operating subsidiary, Xenonics, Inc., was incorporated in 1996.
During its first five years, Xenonics, Inc. completed the development of the
NightHunter product, conducted extensive field trials, filed patent claims on
advances to its core technologies, and implemented the processes, policies and
procedures necessary for commercial operations. Although occasional sales of
NightHunter products were made in connection with the field-testing process,
the transition from development stage to commercial production did not occur
until the fourth quarter of 2000. However, because Xenonics, Inc. was
primarily engaged in product development, it experienced operating losses
through fiscal 2003. Fiscal 2004 was the companys first year of profitable
operations. Until we acquired Xenonics, Inc. in a reorganization in July 2003, our
company was known as Digital Home Theater Systems, Inc. This company was
incorporated in 1997 to engage in the business of designing and selling digital
home theater systems. Digital Home Theater Systems was unsuccessful in its
operations, and discontinued its operations in 1999. From 1999 until its
reorganization with Xenonics, Inc., Digital Home Theater Systems did not engage
in any business and did not undertake any activity other than to complete a
private placement of 1,459,652 shares of its common stock in July 2003 at a
price of $0.875 per share, for an aggregate amount of $1,277,196. Immediately
prior to the reorganization in July 2003, we had no liabilities and our only
asset was the net proceeds from our sale of the 1,459,652 shares of common
stock. Digital Home Theater Systems acquired Xenonics, Inc. in a share-for-share
exchange that was structured as a tax-free reorganization. After the
reorganization, Digital Home Theater Systems changed its name to Xenonics
Holdings, Inc. In the reorganization, we issued 8,750,000 shares to the former
stockholders of Xenonics, Inc. in exchange for all of the issued and
outstanding shares of Xenonics, Inc. As a result of the share exchange, the
former stockholders of Xenonics, Inc. became the majority stockholders of
Digital Home Theater Systems, and Xenonics, Inc. became a wholly-owned
subsidiary. The number of shares that Digital Home Theater Systems issued to
the former stockholders of Xenonics, Inc. was determined in arms-length
negotiations based on the assets and business prospects of Xenonics, Inc. at
the time of the reorganization, and the assets that Digital Home Theater
Systems had at the time of the reorganization (the proceeds of the $1,277,196
private placement). After the completion of the reorganization and the private
placement, a total of 12,709,652 shares of common stock were outstanding,
consisting of the 2,500,000 shares of Digital Home Theater Systems that were
owned by the historical stockholders of Digital Home Theater Systems, 1,459,652
shares of common stock that were sold at $0.875 in the private placement, and
the 8,750,000 shares that were issued to the historical stockholders of
Xenonics, Inc. On December 14, 2004, a former
holder of a warrant to purchase shares of Xenonics, Inc. exercised
his warrant to purchase 135,000 shares of Xenonics, Inc. As a
result, we currently own approximately 98.5% of the issued and
outstanding capital stock of Xenonics, Inc. The principal reason that Digital Home Theater Systems elected to effect
the reorganization was to acquire an operating business. For its part,
Xenonics, Inc. wanted to effect the reorganization in order to obtain access to
the Digital Home Theater Systems cash and to obtain the benefits of the listing
of our shares of common stock on the Pink Sheets LLC, a centralized electronic
quotation service on which unrestricted shares can be sold publicly. Xenonics,
Inc. believed that having shares listed on the Pink Sheets would increase its
future ability to raise additional capital. 4




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Our Products The NightHunter series of products currently consists of three versatile
compact illumination systems  NightHunter, NightHunterII and
NightHunterext.
Our products are lightweight, ruggedized for operation in harsh environments,
and allow users to illuminate objects with visible or infrared (IR) light at
distances of more than one mile. With our infrared filter accessory in place,
the NightHunter products emit non-detectable infrared light. When used with
night vision devices or low-light cameras, our NightHunter products can
illuminate a target without the target knowing that it is being illuminated.
We have also developed an ultraviolet filter which enables our product to
fluoresce materials from great distances for applications including forensics
and special lighting effects. Each NightHunter product incorporates a
mechanical focusing design that enables the user to vary the flood spread of
the beam. For example, the systems can be focused at a 0.5° spread that
results in only a 60-90 foot footprint at one mile, or at a 10° spread that
results in a 900 foot footprint at one mile. Unlike other high intensity
lighting systems (and traditional flashlights), the NightHunter products do not
have a black hole at the center of the light beam that obstructs the field of
view (that is, there is no blind spot in the beam), allowing the user to keep
the illumination centered on the target area. Our NightHunter and
NightHunterII both have an internal rechargeable battery and built-in charger.
In addition, the NightHunter and NightHunterext can be operated from external
power sources. Depending on the functionality and accessories of the product,
the prices for our products range from $2,000 to $3,200 per unit. Our currently available products and their respective features are listed
below. NightHunterThe NightHunter system is a lightweight (9.7 lbs.)
illumination system that can be readily adapted to a variety of uses and
platforms, from handheld to fixed mounted use on vehicles, boats, and
helicopters. The NightHunter can be powered from its internal rechargeable
battery or from any 12-32 VDC power source. NightHunterIIThe NightHunterII is a self-contained, durable, waterproof
and lightweight (4.4 lbs) unit. The unit has an extended battery life (1.5 hrs
on a single charge), can recharge in 1.5 hours, and is durable and waterproof.
To date, we have received most of our orders for this system. The
NightHunterII is manufactured for us by PerkinElmer Electronics, Inc. NightHunterextThe NightHunterext is a durable and lightweight (5.5 lbs)
illumination system that is designed for fixed mounted applications, for use on
stationary platforms or vehicles, boats, or helicopters. The NightHunterext
has the same range as the NightHunter, but with an increased field-of-view.
The NightHunterext can be equipped with an optional pistol grip and utilized as
a powerful spotlight. 5




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The Markets The actual and potential markets for our products consist of the
following. Military Forces, of the United States and Foreign Allies Military forces in the United States currently represent the primary
target market for our NightHunter products. Through September 30, 2004, we
have sold approximately $14.1 million of NightHunter brand illumination systems
into this market for testing or deployment. Our customers include the U.S.
Army 75th Ranger Regiment, U.S. Army 82nd and 101st Airborne Divisions, the
10th Mountain division, the U.S. Air Force Kuwait Physical Security unit, the
U.S. Navy SEALs, and individual U.S. Marine Corps units. Recently, we have
received several significant orders for our products from units currently
deployed in Iraq and Afghanistan and from units preparing for deployment. In the Defense Appropriations Bill for 2003 and 2004, the U.S. Congress
included a total of $6.4 million to be used for purchases of the NightHunter
and NightHunterII designated for the XVIII Airborne Corps. Also, individual
Army, Marine Corps, Air Force and Navy units have ordered NightHunters directly
us. We have also received orders from the discretionary budget dollars funds
of several U.S. military units, and we have sold small quantities to foreign
military units from Canada, the United Kingdom and Australia. The
Defense Appropriations Bill for 2005 was $3.0 million for the
Marine Corps to purchase the NightHunter products. According to the International Institute for Strategic Studies and the
U.S. Department of Defense, there are nearly 5 million active troops, almost 10
million reserve troops, 660 warships, and 858 amphibious, major mine, and
support ships, 30,839 heavy tanks, and 64,679 armored infantry vehicles in the
armed forces of the United States and its allies. Given the large number of
applications for NightHunter products, we believe that this represents a
substantial market opportunity. U.S. Department of Homeland Security The agencies of the U.S. Department of Homeland Security represent another
key market for NightHunter products. These agencies include the U.S. Customs
and Border Protection, Federal Emergency Management Agency, the Transportation
Security Administration, the U.S. Secret Service and the U.S. Coast Guard. Our
products have been tested and deployed in key strategic locations for port,
waterway, coastline, airport and border security, and as of September 30, 2004
we have sold more than $1.4 million of NightHunter products to these
organizations. We believe that the increased concern about homeland security
and the higher amounts budgeted for new security products may make homeland
security a potentially significant market for our products. While we do not currently have a specific line item in the 2005 Homeland
Security budget, we believe that a higher spending in this area may have a
potentially positive impact on our revenue. We already have experience in
government sales. Our goal is for agencies within the United States Department
of Homeland Security to use discretionary funding to purchase our products, and
we believe that in the future we may achieve specific line items in the budget
similar to our experience with the defense budget. 6




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U.S. Law Enforcement, Corrections and Fire, Search & Rescue We are in the early stage of pursuing additional opportunities for sales
of NightHunter illumination systems to U.S. law enforcement, corrections and
fire, search & rescue organizations. Thus far sales to this market group have
been limited. However, law enforcement, corrections, and fire, search & rescue
represent potentially significant market opportunities. More than 780,000 law
enforcement personnel are estimated to be employed in the United States. In
addition, according to a report purchased by us, there currently are over
11,000 federal, state, local and private prisons and over 51,000 fire, search &
rescue departments in the United States. U.S. Private Security Firms, Maritime and Hunting & Outdoors To date, our marketing focus has been on military and government agencies
and not on the private security, maritime or the hunting and outdoor recreation
markets in the United States. However, given the wide range of applications in
which NightHunter products currently are being used, we believe that these
segments may represent large potential market opportunities. A report of the
Security Industry Association for 1999-2000 estimated that there were over 1.7
million privately employed security guards or personnel in the United States.
According to a report obtained by the company, over $50 billion is spent
annually in the U.S. for equipment used by the more than 100,000 U.S. maritime
vessels and the 116 million hunting and outdoor enthusiasts in the United
States. Sales & Marketing We
generate most of our revenue from the direct sale of our products to
customers. To date, most of our sales have been to the United States military.
The strategy for generating revenue in this market segment is two-fold. We
communicate to those in the field the existence and application of our
products. Once the application and need are substantiated, we help determine
how the specific military unit might find funding for the purchase of the
products. The successful deployment of our products to some branches of the US
Army has led to purchase orders from other Army units that are currently
deployed in Afghanistan, Kosovo, Bosnia and Iraq. We believe that testimonials
from military units currently employing our NightHunter products in active
military situations may assist us in penetrating other units of the military
that also could benefit from the use of our products. As this bottom-up marketing process is unfolding, we also communicate
the existence and application of the products from the top-down to the
appropriate offices of the various military branches located in Washington, DC
and to the offices of those members of Congress involved in appropriating funds
for specific needs in the defense budget. Our contacts with these offices in
Washington DC are initiated either by our officers and directors or on our
behalf by lobbyists. It is also possible for a military unit to spend
discretionary funds to purchase our products. We have generated military sales
from both line item budgets and discretionary spending from specific units. We also generate sales from the United States Border Patrol, which
recently became realigned under the Department of Homeland Security. In the
past, our products were sold directly to specific border patrol locations. We
expect that with the new Homeland Security organizational structure, the
marketing effort will be similar to that used with the military. Small orders are also sold to numerous other customers including
international customers, law enforcement and resellers. 7




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We currently have three persons engaged on a full-time basis in sales and
marketing. In addition, our senior executives actively assist in our marketing
efforts by initiating and maintaining customer relationships and interacting
with external consultants who assist the company with its marketing activities. In the future, we may consider partnering with others to generate
additional sales though distributorships and/or licenses and may utilize such
models to expand our sales capabilities in certain domestic market segments as
well as internationally. We may offer exclusive marketing and/or manufacturing
licenses to partners in key markets, such as China, Japan, the Middle East,
South America and Europe. We are currently attempting to recruit
representatives to market our products in the United States and Europe. Manufacturing We conduct manufacturing and final assembly operations on the NightHunter
and NightHunterext at our headquarters in Carlsbad, California, and own all of
the equipment required to manufacture and assemble these finished products. In
addition, we also own all molds, schematics, and prototypes utilized by our
vendors in the production of the components and sub-assemblies used in our
products. With our current work force and facilities, we are able to produce
approximately 150 NightHunters per month. We can expand our production
capabilities by adding additional personnel with negligible new investment in
tooling and equipment. We currently purchase both commodity off-the-shelf components and
custom-designed fabricated parts and sub-assemblies for use in our products
from a number of qualified local, national and international suppliers. We
believe that there are readily available alternative suppliers that can
consistently meet our needs for these components. Although we currently obtain
these components from single source suppliers, we believe we could obtain
components from alternative suppliers without incurring significant production
delays. We acquire all of our components on a purchase order basis and do not
have long-term contracts with suppliers. We believe that our relations with
our suppliers are good. In January 2003, we entered into a three-year agreement with PerkinElmer
Electronics, Inc. for the manufacturing of our NightHunterII product.
PerkinElmer, a publicly traded company (NYSE: PKI), is a leader in the life
sciences, fluid sciences and optoelectronics industries. Under the terms of
this agreement, PerkinElmer will manufacture all NightHunterII products
exclusively for Xenonics, on a fixed price basis. In return, we have agreed
not to purchase any NightHunterII products from any other manufacturer or to
manufacture any NightHunterII products ourselves. In addition, PerkinElmer
agreed not to produce, market, or sell NightHunterII products to any entity
except Xenonics. PerkinElmer further agreed that all intellectual property
relating to the NightHunterII products is solely owned by Xenonics. PerkinElmer is responsible for the purchasing, shipping and receiving,
production, inventory management and quality assurance of the NightHunterII.
PerkinElmer provides the working capital required for inventory and manages the
labor pool required to meet our delivery requirements without any cash
investment by Xenonics. PerkinElmer has demonstrated the ability to increase
production to meet growing demand. Despite this sole source relationship,
Xenonics retains all documentation and know-how to build the NightHunterII and
owns all tooling required to produce NightHunterII products and related
components, and we believe we could transition to a second source if required
without significant disruption. 8




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Competition Other companies that offer high intensity, portable lighting products
include Reva International and Peak Beam Systems, Inc. We believe that neither
of these companies currently offers a product with the features or range of
applications of our NightHunter series. To our knowledge, only one company,
Peak Beam Systems, supplies a short-arc xenon-based product. Peak Beams
product also has the capability of utilizing infrared and ultraviolet filters,
and provides a long-range light beam. However, unlike our products, we believe
that Peak Beams products project a black hole and hence an obstructed
field-of-view. In addition to these suppliers of hand-held high intensity lighting
products, we believe that other companies that use first generation xenon
technology, such as Spectrolab (helicopter searchlights), Phoebus
(entertainment spotlights), and Strong (entertainment spotlights) could enter
our market in the future. Our strategy is to become the recognized market and
technology leader before competitors can deliver a comparable product to the
market. In addition, we have begun developing a second-generation product
which we believe will enhance our competitive position. It is our intention to complete and release this new product in 2005.
However, there can be no assurance that we will be able to develop and produce
this second generation product on time, or ever. Regulation We applied to the United States Department of Commerce, Bureau of Export
Administration for an export license. In response to our inquiry, the
department assigned an EAR classification of 99. We can now export our product
without a license to all countries that are not on the restricted list IAW part
746 of the EAR. Intellectual Property We have nine design and utility patents issued, allowed or pending,
including patents for our technology platform, which applies high efficiency
dimmable electronic ballast circuitry and precision optics to xenon light. We
continue to make advancements, and have recently filed for an additional patent
covering certain technologies that complement our NightHunter product
technologies. In addition to the foregoing patents, we also rely on certain
know-how and trade secrets related to the design and manufacture of our
products. We believe that the patents (both granted and pending) and our
know-how and trade secretes provide protection to certain of our core
technologies, and allow us to develop future products that can be scaled up or
down (or to develop alternative packages for the existing products). We are
not aware of any infringement of our patents or that we are infringing any
patents owned by third parties. However, in a lawsuit that we initiated in a
California court against one of our former directors and consultants, the
former director and consultant has filed a cross complaint against us and our
subsidiary, Xenonics, Inc. asking the court to (i) rescind the assignment of
the NightHunter II patent application that he assigned to us in November 2003,
and (ii) declare that he is the sole owner of the NightHunter II patent
application. 9




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We also are the licensee of an issued patent, which will be transferred to
us based on an agreement with Lightrays, Inc. (Lightrays). The licensed patent
is not used in any of our current products. In December 2004, we entered into
a term sheet with the licensor, pursuant to which we agreed to issue 97,000
shares of our common stock and other consideration to Lightrays as payment in
full for all obligations we may owe Lightrays, including the $400,000 cash
payment, and Lightrays agreed to assign and transfer the Lightrays patent and
related intellectual property to us. The transaction contemplated by the
foregoing term sheet has been incorporated into a definitive agreement and is
expected to be completed in the next 60 days. Our NightHunter and Xenonics trademarks have been registered with the
United States Patent and Trademark Office. Research and Development We
maintain an engineering, research and development program for the
development and introduction of new products and accessories and for
the development of enhancements and improvements to our existing
products. In addition, we collaborate closely with certain of our
largest customers in the design and improvement of our products to
suite their respective needs. As such, we consider our research and
development program to be an important element of our business,
operations and future success. Our research and development efforts currently are focused on (i)
improving our current product line, (ii) designing and developing product line
extensions that employ our proprietary illumination and electronics platforms,
and (iii) designing and developing new products complementary to our existing
products. We maintain an active research and development program at our
facilities in Carlsbad, California, and as needed we retain outside consultants
who can provide any necessary additional engineering or technological
expertise. In addition, our relationship with PerkinElmer provides us with the
resources and know-how of a multi-billion dollar manufacturing company. Under
terms of our exclusive agreement, any intellectual property relating to new
products or improvements to our existing products that result from our
relationship will belong to us. We also regularly work with our outside
vendors and manufacturers to improve product performance and manufacturability,
and to reduce manufacturing costs. During the fiscal year ended September 30, 2004 and the nine-month
transition period ended September 30, 2003, we spent $248,000 and $237,000,
respectively, on engineering, research and development. Employees As of September 30, 2004, we employed 13 persons. There are three members
in our executive management team, five persons employed in operations, one
person in engineering and four persons involved in sales and administrative
support. We are not a party to any collective bargaining agreements. 10




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Seasonality During our limited operating history, we have experienced stronger sales
in the second and third fiscal quarters (January through June) compared to
sales during the first and fourth quarters (July through December). We believe
that this seasonal pattern of sales primarily reflects the customary timing of
purchases by our military customers. We expect that the seasonal pattern of
revenue generation may change if our plans to enter additional,
non-governmental market segments are successful. 
 ITEM 2. DESCRIPTION OF PROPERTY Our principal operations and executive offices are located at 2236
Rutherford Road, Suite 123, Carlsbad, California 92008 and our telephone number
is (760) 438-4004. The facility consists of approximately 9,200 square feet of
leased office, warehouse and manufacturing space in Carlsbad, California. The
lease on this facility expires in the year 2008. 
 ITEM 3. LEGAL PROCEEDINGS On July 2, 2004, we filed a complaint for cancellation of a stock
certificate and rescission of a contract against Gregory Jigamian, a former officer, director and
consultant and Viking Engineering Industries, Inc., a company purportedly owned by such individual in the Superior
Court of California, County of San Diego. The suit alleges a failure to
perform contractual obligations under a written contract to provide lighting
equipment valued at $250,000 to our subsidiary, Xenonics, Inc., in exchange for
250,000 shares of Xenonics, Inc.s common stock. We allege that the stock
certificate is void or voidable. In our complaint, we requested that i) the
250,000 shares be declared void or the defendants be ordered to pay
us $1,250,000,
or the current value of the 250,000 shares of our common stock plus interest at
the rate of 10% per year. We have also asked the court to award us costs of
the lawsuit. The foregoing 250,000 shares are currently treated as outstanding
shares for all purposes, including the financial statements. An answer to our complaint was filed on August 11, 2004 in which the
defendants denied our allegations, and asserted a number of affirmative
defenses. On the same day, a cross complaint was also filed against us and our
subsidiary, Xenonics, Inc. The cross complaint asks the court to (i) rescind
the assignment of the NightHunterII patent application that one of the
defendants assigned to us in November 2003, (ii) declare that one of the
defendants is the sole owner of the NightHunterII patent application and that
he is the inventor of an unrelated xenon illumination and television camera
system, (iii) enjoin us form further exploitation of the NightHunterII and the
xenon illumination and television camera system, and (iv) account for all
profits that we have earned on the NightHunterII from November 25, 2003. The
defendant alleges that we purportedly have not provided the agreed upon
consideration for assignment of the NightHunterII patent application, and that
we have not recognized the defendant as the inventor of the xenon illumination
and television camera system. This matter is in the discovery stage and at the
present time we cannot reasonably assess the
ultimate outcome. We are occasionally subject to legal proceedings and claims that arise in
the ordinary course of our business. It is impossible for us to predict with
any certainty the outcome of pending disputes, and we cannot predict whether
any liability arising from pending claims and litigation will be material in
relation to our consolidated financial position or results of operations. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 11




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PART II 
 ITEM 5. Market for Common Equity and Related Stockholder Matters Our common stock is currently traded under the symbol XNNC on the OTC
Bulletin Board. Prior to October 26, 2004, our common stock was quoted, and
sporadically traded, in the Pink Sheets, a quotation service operated by Pink
Sheets LLC that collects and publishes market maker quotes for over-the-counter
securities. We acquired Xenonics, Inc. on July 24, 2003. To our knowledge,
there was no trading in our common stock until shortly before the acquisition
of Xenonics, Inc. on July 24, 2003, and any such prior trading was not based on
our companys current operations. Accordingly, the following table only sets
forth the high and low bid information for our common stock on both the OTC
Bulletin Board and Pink Sheets for each quarter since July 23, 2003. These
represent prices between dealers, exclusive of retail markup, markdown or
commission and do not necessarily represent actual transactions. Year ended September 30, 2004
    
    High
    
    LowFirst Quarter
    
    
    7.00
    
    
    
    1.70Second Quarter
    
    
    7.30
    
    
    
    4.10Third Quarter
    
    
    8.75
    
    
    
    4.75Fourth Quarter
    
    
    6.50
    
    
    
    3.00
 Year ended September 30, 2003
    
    High
    
    LowFourth Quarter (as of 7/23/03) (1)
    
    
    2.50
    
    
    
    1.75
   (1) Reflects initial trading activity commencing on July 24, 2003 through
the end of the calendar quarter ended September 30, 2003.
 As of September 30, 2004, there were 14,166,878 common shares outstanding
and approximately 168 shareholders of record, not including holders who hold
their stock in street name. Dividends The Company has never paid any cash dividends on its common stock. The
Company currently anticipates that it will retain all future earnings for use
in its business. Consequently, it does not anticipate paying any cash
dividends in the foreseeable future. The payment of dividends in the future
will depend upon our results of operations, as well as our short-term and
long-term cash availability, working capital, working capital needs and other
factors, as determined by our Board of Directors. Currently, except as may be
provided by applicable laws, there are no contractual or other restrictions on
our ability to pay dividends if we were to decide to declare and pay them. Repurchase of Securities We did not repurchase any shares of our common stock during the fourth
quarter of the year ended September 30, 2004. 12




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Recent Sales of Unregistered Securities On July 1, 2004, we issued a five-year warrant for the purchase of 25,000
shares of our common stock to Neil G. Berkman Associates. The warrants, having
an exercise price equal to the bid price as of the close of trading on July 1,
2004 ($5.05 per share), were issued as partial consideration for the engagement
of Neil G. Berkman as our investor relations firm. The shares were issued
without any public solicitation or the payment of any commissions pursuant to
an exemption available under Section 4(2) without the use of an underwriter. In July 2004, a warrant holder exercised warrants for 5,000 shares of
common stock at a price of $0.60. Equity Compensation Plan Information The following table summarizes as of September 30, 2004, the number of
securities to be issued upon the exercise of outstanding derivative securities
(options and rights); the weighted-average exercise price of the
outstanding derivative securities; and the number of securities remaining
available for future issuance under our equity compensation plans. Number of Securities
    
    Weighted-average
    
    Number of securitiesto be issued upon
    
    exercise price of
    
    remaining available forexercise of
    
    outstanding
    
    future issuance underoutstanding options
    
    options,
    
    equity compensation plansand rights
    
    and rights
    
    (excluding column(a))Plan Category
    
    (a)
    
    (b)
    
    (c)Equity compensation
plans approved by
security holders
    
    
    1,245,000
    
    
    $
    0.96
    
    
    
    Equity compensation
plans not approved
by security holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    1,245,000
    
    
    $
    0.96
    
    
    
    
 The equity compensation plan approved by the security holders is the 2003
Stock Option Plan of Xenonics Holdings, Inc. The Company has not adopted
without the approval of security holders any equity compensation plan under
which securities of the issuer are authorized for issuance. 13




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ITEM 6. Managements Discussion and Analysis or Plan of Operation Forward-Looking Statements The following Managements Discussion and Analysis or Plan of Operations,
as well as information contained elsewhere in this report, contain statements
that constitute forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, and Section 21E of the Securities Exchange Act
of 1934. These statements include statements regarding the intent, belief or
current expectations of us, our directors or our officers with respect to,
among other things: anticipated financial or operating results, financial
projections, business prospects, future product performance and other matters
that are not historical facts. The success of our business operations is
dependent on factors such as the impact of competitive products, product
development, commercialization and technology difficulties, the results of
financing efforts and the effectiveness of our marketing strategies, general
competitive and economic conditions. Forward-looking statements are not
guarantees of future performance and involve risks and uncertainties. Actual
results may differ materially from those projected in the forward-looking
statements as a result of various factors, including those described under
Factors Affecting Our Business and Prospects below. Overview Xenonics, Inc. was founded in 1996 to design, manufacture and market
technologically-advanced, high-intensity portable illumination products. We
currently hold several patents for our technology platform, which applies high
efficiency dimmable electronic ballast circuitry and precision optics to xenon
light to produce an illumination device that delivers improved performance over
current technologies. Existing customers include all branches of the United
States military, including such elite forces as the U.S. Navy SEALs, USMC FAST
and the U.S. Army Rangers. Other customers include the U.S. Border Patrol, the
U.S. Secret Service, the U.S. Coast Guard, and the California Highway Patrol. We market our illumination products under the NightHunter brand name. The
NightHunter series of products is produced in a variety of configurations to
suit specific customer needs. These include compact hand-held systems for
foot-borne personnel and stabilized systems for airborne, vehicle and shipboard
use. These NightHunter illumination systems are used for reconnaissance,
surveillance, search and rescue, physical security, target identification and
navigation. The system allows the user to illuminate an area, an object or a
target with visible or non-visible light, and to improve visibility through
many types of obscurants such as smoke, haze and most types of fog. In July 2003, Digital Home Theater Systems, Inc. acquired 100% of the
outstanding capital stock of Xenonics, Inc. for 8,750,000 shares of common
stock. Upon the closing of this transaction, Digital Home Theater Systems,
Inc. changed its name to Xenonics Holdings, Inc. The transaction was accounted
for as a reorganization of Xenonics, Inc. with issuance of stock for cash. For
accounting purposes, Xenonics, Inc. is treated as the acquirer and, as such,
its historical financial statements will continue and are included in our
financial statements. As of the end of our last fiscal year, we owned
100% of the outstanding capital stock of Xenonics, Inc. In December 2004, a former
holder of a warrant to purchase shares of Xenonics, Inc. exercised
his warrant to purchase 135,000 shares of Xenonics, Inc. As a
result, we currently own approximately 98.5% of the issued and
outstanding capital stock of Xenonics, Inc. In 2003, we changed our fiscal year from a fiscal year ending December 31
to a fiscal year ending September 30. Accordingly, our financial statements at
September 30, 2003 include the results of our operations and cash flows for the
nine-months then ended, while our financial statements at September 30, 2004
include our operations and cash flows for the twelve month year then ended. 14




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Our consolidated financial statements have been prepared on a continuing
operations basis which contemplates the realization of assets and the
settlement of liabilities and commitments in the normal course of business. We
are largely dependent upon government orders for our revenues. How We Generate Revenue We generate our revenue from the sale of our products to customers. To
date, most of our sales have been to the United States military. The strategy
for generating revenue in this market segment is two-fold. We communicate to
those in the field the existence and application of our products. Once the
application and need are substantiated, we help determine how the specific
military unit might find funding for the purchase of the products. As this
marketing process is unfolding at one level, we also communicate the existence
and application of the products to the appropriate offices of the various
military branches located in Washington, DC and to the offices of those members
of Congress involved in appropriating funds for specific needs in the defense
budget. Our contacts with the foregoing offices in Washington DC are initiated
either by our officers and directors or on our behalf by lobbyists. It is also
possible for a military unit to spend discretionary funds to purchase our
products. We have generated military sales from both line item budgets and
discretionary spending from specific units. We also generate sales from the United States Border Patrol, which
recently became realigned under the Department of Homeland Security. In the
past, our products were sold directly to specific border patrol locations. We
expect that with the new organizational structure, the marketing effort will be
similar to that used with the military. Small orders are also sold to numerous other customers including
international customers, law enforcement and resellers. Trends in Our Business The current fiscal year marks our first year in which revenue levels have
been sufficient to generate net income. In order to maintain and improve on
our current revenue levels, we are currently focusing on improving our current
products, introducing new products and expanding our customer base. In addition
to improving current products through improved technology and processes, we
continually look to lower costs wherever possible to improve our operating
margin. We are in the process of determining the new products, opportunities
and distribution channels that will best help us to reach our goal of an
expanded customer base. We believe that there is an opportunity to further increase our sales to
the military by demonstrating the various benefits and uses of our products.
We plan to attempt to capitalize on our success with our military sales process
by duplicating that process with the United States Department of Homeland
Security. Our current challenge is to supplement government sales with
commercial sales of both our current products and new products. Risks include
new competitors entering the market, decreases in government budgets
(particularly the defense budget) and our inability to penetrate other markets. 15




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Critical Accounting Policies and Estimates The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and expenses
during the period reported. The following accounting policies involve a
critical accounting estimate because they are particularly dependent on
estimates and assumptions made by management about matters that are highly
uncertain at the time the accounting estimates are made. In addition, while we
have used our best estimates based on facts and circumstances available to us
at the time, different estimates reasonably could have been used in the current
period, and changes in the accounting estimates we used are reasonably likely
to occur from period to period which may have a material impact on the
presentation of our financial condition and results of operations. We review
these estimates and assumptions periodically and reflect the effects of
revisions in the period that they are determined to be necessary and reviewed
by the audit committee. Accounts Receivable- We recognize revenue upon shipment in accordance
with Staff Accounting Bulletin (SAB) No. 101. Our history indicates that we
will collect all of our accounts receivable, 54% of which on September 30, 2004
were due from the U.S. government. Accordingly, we have not established any
reserve for doubtful accounts. Since we bear certain risks of loss due to this
high concentration, as well as the impact of the political, budget and
regulatory environment, failure to collect all accounts receivable will affect
our balance sheet and results of operations. Tax Valuation Allowance- A tax valuation allowance is established, as
needed, to reduce net deferred tax assets to the amount for which recovery is
probable. We have established a full valuation allowance against our U.S. net
deferred tax assets because our history of losses. In the event it becomes
more likely than not that some or all of the deferred tax assets will be
realized, we will adjust our valuation allowance. Depending on the amount and
timing of taxable income we ultimately generate in the future, as well as other
factors, we could recognize no benefit from our deferred tax assets, in
accordance with our current estimate, or we could recognize a portion of or
their full value. Inventory Valuation We regularly assess the valuation of inventories and
reserves for those inventories that are obsolete. As of September 30, 2004 and
2003, our inventory reserve totaled $10,000 and $50,000, respectively. A
physical inventory is completed on a monthly basis, and adjustments are made
quarterly based on such inspections. If it is determined that our estimates of
the valuation of inventories is incorrect, we may need to establish additional
reserves, which would negatively affect any future earnings. 16




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Results of Operations Twelve-months ended September 30, 2004 compared to the unaudited, pro-forma
twelve-months ended September 30, 2003 During 2003, we changed our fiscal year from the period ending December 31
to the period ending September 30. Since the prior fiscal year ending on
September 30, 2003 contained only nine months compared to the current 12-month
period ended September 30, 2004, the following discussion of our results of
operations compares the year ended September 30, 2004 to the
unaudited
twelve-months ended September 30, 2003. The following table reflects the
operating results of these comparable twelve-month periods. September 30,
    
    2004
    
    2003$ in thousands
    
    
    
    
    
    UnauditedRevenue
    
    $
    11,927
    
    
    $
    2,162Cost of Goods Sold
    
    
    6,916
    
    
    
    1,673Gross Profit
    
    
    5,011
    
    
    
    489Selling, General and Administrative
    
    
    3,113
    
    
    
    1,854Engineering, Research and Development
    
    
    248
    
    
    
    262Income (Loss) from Operations
    
    
    1,650
    
    
    
    (1,627
    )Other Expenses
    
    
    16
    
    
    
    588Income (Loss) Before Taxes
    
    
    1,634
    
    
    
    (2,215
    )Income Taxes
    
    
    158
    
    
    
    1Net Income (Loss)
    
    $
    1,476
    
    
    $
    (2,216
    )
 Revenues:We operate in one industry segment, the security lighting
systems industry, and all of our revenues are derived from sales of our
illumination products to various customers in that segment. Revenues for the
year ended September 30, 2004 increased by $9,765,000 over the revenues for the
pro-forma twelve-months ended September 30, 2003. The increase in revenue was
the result of the increased size and number of purchase orders received by us
during the prior year which continued throughout the current year. In March of
2003, we received an order of $2,980,000 from the United States military.
However, since we only recognize revenues when we ship the ordered products, a
significant portion of the revenue generated through this contract was
recognized after October 1, 2003 in the current fiscal year. Revenues
recognized under this contract amounted to $1,802,000 and $1,115,000 for the
year ended September 30, 2004 and the pro-forma twelve-months ended September
30, 2003, respectively. Other U.S. Army orders received since March 2003
contributed an additional $7,272,000 of revenue during the current period. In
the current year, orders filled from government contractors and the U.S. Border
Patrol totaled $2,034,000 and $534,000, respectively, compared to $381,000 and
$460,000, respectively, during the pro-forma twelve-months ended September 30,
2003. The balance of this periods sales (approximately $285,000) was
generated from international customers and other U.S. military branches (other
than the U.S. Army) and other governmental entities. In the pro-forma
twelve-months ended September 30, 2003, sales from other U.S. military branches
(other than the U.S. Army) and other governmental entities 17




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constituted $206,000 of that periods revenues. During the year ended
September 30, 2004, sales to the U.S. military represented 94% of our revenues,
sales to the U.S. Border Patrol represented 4% of our revenues, and
international sales and other miscellaneous U.S. sales each constituted 1% of
our revenues. For the pro-forma twelve-months ended September 30, 2003, sales
to the U.S. military and U.S. Border patrol represented 73% and 21% of our
revenues, respectively, while international sales and other miscellaneous U.S.
sales represented 4% and 2%, respectively. Although our plan is to expand our
customer base to more commercial and international clients, we anticipate that
the U.S. military will continue to be our largest customer in the fiscal year
ended September 30, 2005. Cost of Goods and Gross Profit:Cost of goods consist of our cost of
manufacturing our NightHunter products and the price that we pay to PerkinElmer
for NightHunterII products that PerkinElmer manufactures for us under our
manufacturing agreement. The gross profit percentage on revenue increased to
42% for the year ended September 30, 2004 compared to 23% for the pro-forma
twelve-months ended September 30, 2003. This improvement is due to
efficiencies and lower cost as manufacturing volume increased and our ability
to cover fixed costs improved. Our headcount did not materially change from
the prior years pro-forma twelve-month period to the current year ended
September 30, 2004. As a result, as revenue increased, our gross profit
percentage was positively impacted. Additionally, as volumes increased in the
current period, we were able to work with our vendors to improve pricing and
lower the cost of goods sold. We review costs and processes on an ongoing basis in an effort both to
maintain quality and to reduce costs when possible. With an emphasis on both
increased volume requirements and quality issues, the addition or replacement
of vendors may be required. Selling, General and Administrative:Selling, general and administrative
expenses increased by $1,259,000 to $3,113,000, or 26% of revenue, in the year
ended September 30, 2004 compared to $1,854,000, or 86% of revenue, for the
pro-forma twelve-months ended September 30, 2003. The increase in expenses
reflected additional expenses related to corporate governance matters, our
conversion to a public company that is required to file documents with the
Securities and Exchange Commission, and the additional costs resulting from our
significant increase in sales. These incremental expenses consisted primarily
of increases in legal expenses of $490,000, sales commissions, marketing and
travel expenses of $212,000, accounting fees of $166,000 and salaries and
wages. Salaries and wages increases were primarily due to rate increases,
bonus expense and costs of the addition of new employees. Although we are leanly staffed, we recently increased staff in the
following departments: accounting, marketing, customer service and engineering.
These employment costs will increase our future selling, general and
administrative expenses. In addition, if our business continues to grow, we
will have to increase our staffing in other areas. As a result, we are
currently evaluating potential headcount increases and determining specific
personnel needs, all of which are expected to result in additional increased
selling, general and administrative expenses in the current year ending
September 30, 2005. Engineering, Research & Development:Engineering, research and development
expenses decreased by $14,000 during the year ended September 30, 2004 compared
to the pro-forma twelve-months ended September 30, 2003. However, as a result
of the significant increase in revenues during the current fiscal period, as a
percentage of revenues, our investment in engineering, research and development
decreased significantly for the year ended September 30, 2004 compared to the
pro-forma twelve-months ended September 30, 2003. Engineering, research and
development spending levels are, however, expected to increase in the future as
we have increased our efforts to develop new products and make improvements to
our existing products. 18




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We will continue to try to improve our current product line and are
attempting to create a second generation of products. The improvements to our
products are based on customer feedback. In addition, we recognize the need to
develop additional products in an effort to expand our customer base and
product selection to our current customers. In order to meet these goals, we
expect to increase our research and development budget for fiscal 2005. Other Expense:The major component of other expense in both the September
30, 2004 and 2003 twelve-month periods consisted primarily of interest expense.
Interest expense, net of interest received, decreased to $16,000 for the year
ended September 30, 2004 compared to net interest expense of $588,000 for the
pro-forma twelve-months ended September 30, 2003. Interest expense related to
notes payable and short-term borrowings. Interest expense decreased due to
reductions in our outstanding debt. A significant number of the notes were
convertible into our common stock and were, in fact, converted into equity in
connection with the acquisition of Xenonics, Inc. in July of 2003. During the
year ended September 30, 2004, all remaining notes payable and short-term
borrowings were either repaid in cash or converted in accordance with their
terms to equity. In addition, our interest expenses were partially offset
during the year ended September 30, 2004 by $15,000 of interest we earned on
significantly larger cash balances during the 2004 period. Provision for Income Taxes:The $158,000 provision for income taxes
consists primarily of California state franchise tax payable as the result of
our taxable income of $1,634,000 for the year ended September 30, 2004 compared
to the pretax loss of $2,215,000 we incurred for the pro-forma twelve-months ended
September 30, 2003. Our net operating losses currently are limiting our
federal income tax obligations. However, in 2002, the State of California
enacted legislation that suspended the deduction of net operating loss
carryovers for the 2002 and 2003 tax years. In connection with the suspension,
the carryover period for losses sustained in tax years beginning in or prior to
2002 was extended. Accordingly, we were unable to utilize our net operating
loss carryovers to reduce California taxes. We will, however, be able to
utilize our net operating loss carryovers to reduce California taxes in the
current fiscal year ending September 30, 2005. Nine months ended September 30, 2003 compared to the unaudited, pro-forma nine
months ended September 30, 2002. During 2003, we changed our fiscal year from the period ending December 31
to the period ending September 30. Since the first fiscal year ending on
September 30, 2003 contains only nine months compared to the 12-month period of
the last audited fiscal yearend (the year ending December 31, 2002), the
following discussion of our results of operations compares the nine-month
period ending September 30, 2003 to the comparable unaudited nine-month period ending
September 30, 2002. The following table reflects the operating results of
these comparable nine-month periods. September 30,
    
    2003
    
    2002$ in thousands
    
    
    
    
    
    UnauditedRevenue
    
    $
    1,580
    
    
    $
    642Cost of Goods Sold
    
    
    1,241
    
    
    
    610Gross Profit
    
    
    339
    
    
    
    32Engineering, Research
and Development
    
    
    237
    
    
    
    101Selling, General and
Administrative
    
    
    1,551
    
    
    
    707Loss from Operations
    
    
    (1,449
    )
    
    
    (776
    )Other Expenses
    
    
    (514
    )
    
    
    (189
    )Net Loss
    
    $
    (1,963
    )
    
    $
    (965
    )
 19




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Revenues:All of our revenues are generated from the sale of our
NightHunter products. Revenues increased by $938,000 in the period ending
September 30, 2003 over the same period in the prior year as a result of a
$2,980,000 order for our NightHunter products that we received from the United
States military in March 2003. This order represented a 71% of revenue that we
recognized during the September 30, 2003 fiscal period. Since all of the
products ordered in March 2003 were not shipped by September 30, 2003, the
remaining balance of the order was recognized as revenue in the fiscal year
ending September 30, 2004 as the remaining products were shipped. During the
2003 nine-month period, 92% of the revenues were from sales to the U.S.
military, 4% of our revenues came from international sales, 2% of our revenues
were from sales to the U.S. Border Patrol, and the remaining 2% represented
various other U.S. sales. In comparison, 65% of sales came from sales to the
U.S. Military, 25% of the revenues were from sales to the U.S. Border Patrol,
6% came from international sales, and 4% from other U.S. sales from the same
period in the prior year. Cost of Goods and Gross Profit:Gross profit as a percentage of revenue
increased to 22% in the period ending September 30, 2003 compared to 5% in the
prior period. This increase was due to efficiencies and lower costs that
resulted from increased quantity of products ordered and our increased ability
to cover fixed costs. In addition, in January 2003, we entered into a
manufacturing agreement with PerkinElmer to manufacture one of our three
products for us. PerkinElmer, a global manufacturer of optoelectronic
products, is able to manufacture our products for us at prices and in
quantities that are favorable to us. These benefits were first realized in the
2003. The increase in the number of units manufactured in the September 30,
2003 period and the PerkinElmer manufacturing agreement positively impacted the
gross profit percentage. Additionally, as unit order volumes increase, we were
able to obtain more favorable pricing from our vendors and thereby lower the
cost of goods sold. We expect our gross margins as a percentage of revenues to
increase as revenues increase. Engineering, Research & Development:While the amount of funds expended
for engineering, research and development almost doubled in the period ending
September 30, 2003 from the prior period ending September 30, 2002, as a
percentage of revenues such expense remained unchanged between 15% and 16% of
revenue in both periods. Our engineering, research and development efforts are
aimed at new products, product improvement and cost reduction. Selling, General and Administrative:Selling, general and administrative
expenses increased to $1,551,000 in the period ending September 30, 2003 from
$707,000 for the period ending September 30, 2002 primarily as a result of one
time charges that made up approximately $646,000 of the 2003 expense. These
charges consisted of a compensation expense of $271,000 related to issuance of
common stock to employees as a bonus, and charges of $375,000 related to
reissuance and repricing of outstanding stock options. Other factors that
caused the increase in selling, general and administrative expenses in the
nine-month period ended September 2003 included $74,000 for sales commission,
$63,000 for increased personnel, $47,000 additional legal and accounting fees,
and $14,000 of increased insurance costs. Other Expense:The major component of other expense in the periods ending
September 30, 2003 and September 30, 2002 related primarily to interest
expense. Interest expense increased to $515,000 in the period ending September
30, 2003 from $188,000 in the prior period ending September 30, 2002. The
interest expense increase in 2003 of $354,000 consisted of both interest paid
on outstanding indebtedness and a non-cash charge for $320,000 related to
reissuance of warrants in July 2003 in connection with the reorganization of
Xenonics, Inc. Because warrants were re-issued at a lower exercise price, we
recorded a non-cash charge based on the fair market value of the warrants.
Interest expense related to notes payable and short-term borrowings decreased
as we reduced our outstanding debt by either repaying such debt or converting
it into common stock. A 20




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total of $2,450,000 of outstanding indebtedness was converted into equity
in connection with the acquisition of Xenonics, Inc. in July of 2003. Interest
expense related to the converted notes was $46,000 and $155,000 in 2003 and
2002, respectively. While our revenues increased in the period ending September 30, 2003 over
the same period in the prior year, increases in engineering, research and
development and one-time general and administrative expenses caused our net
loss to increase from $965,000 in the 2002 period to $1,963,000 in the 2003
period. Liquidity and Capital Resources As of September 30, 2004, we had working capital of $3,014,000 and a
current ratio of 2.9-to-1. Until the current fiscal year, we had invested substantial resources in
the development of our products and in the establishment of our business, which
negatively impacted our cost structure and created a significant accumulated
deficit ($7,481,000 as of September 30, 2004 and $8,957,000 as of September 30,
2003). Prior to the year ended September 30, 2004, we relied on the sale of
equity and the issuance of short-term promissory notes to fund our working
capital needs. During the year ended September 30, 2004, however, our operations
significantly improved, as did our liquidity and our capital structure. On
September 30, 2004, cash at the end of the period increased by $3,143,000 from
the amount of cash on hand at September 30, 2003, and our total current assets
(substantially all of which is either cash or accounts receivable) increased by
$3,796,000. The increase in our liquidity is the result of the improvement in
our operations and our financing activities (both in raising capital and in
converting outstanding indebtedness). We did not have any material commitments for capital expenditures as of
September 30, 2004 and currently do not anticipate any such material
expenditures during the current fiscal year ending September 30, 2005. Our net income of $1,476,000 for the year ended September 30, 2004
contributed cash to the company. During the year ended September 30, 2004, we
generated $1,670,000 of cash from operations, which differs from our net income
primarily as a result of the timing of the recognition of sales and the
collection of accounts receivables, as well as changes in other significant
assets, such as inventory, and liabilities. In the year ended September 30,
2004 our accounts receivable decreased by $274,000 to $253,000, which generated
additional cash. Virtually all of our accounts receivable are from sales to
the U.S. military and are expected to be paid in the normal 30-day payment
period we have historically experienced from such sales. With increased sales,
inventory levels increased by $738,000 and accounts payable, most of which is
payable to PerkinElmer for products manufactured for us, increased by $548,000. Financing activities for the year included a private placement of 600,000
shares of common stock at $2.50 per share (from which we received $1,500,000),
the private sale of 200,000 shares of common stock and warrants to purchase an
additional 50,000 shares (from which sale we received $850,000), and the
repayment in cash of $716,000 of short-term borrowings and notes payable.
Additionally, another note payable for $250,000, plus accrued interest of
$17,000, was converted into 533,726 shares of common stock in accordance with
the terms of that note at $0.50 per share. Our noncash transactions included
the issuance of 20,000 shares of our common stock, valued at $2.50 per share,
to Bryant Park Capital, Inc. as compensation for services. 21




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Accounts payable for the period ending September 30, 2003 increased by
$111,000 due to increased sales volumes. Financing activities for the nine month period ending September 30, 2003,
included proceeds of $575,000 through notes payable. All the notes were
created by Xenonics prior to the reorganization in July 2003. The Company used
$484,000 for repayment of these notes. All but $50,000 was repaid after or
concurrent with the reorganization described below. The following is a summary of our contractual cash obligations at
September 30, 2004 for the following fiscal years: Contractual
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2009Obligations
    
    Total
    
    2005
    
    2006
    
    2007
    
    2008
    
    and thereafterLong-Term Office Lease
    
    $
    431,000
    
    
    $
    100,000
    
    
    $
    104,000
    
    
    $
    108,000
    
    
    $
    110,000
    
    
    $
    9,000
 We do not believe that inflation has had a material impact on our business
or operations. We are not a party to any off-balance sheet arrangements and do not engage
in trading activities involving non-exchange traded contracts. In addition, we
have no financial guarantees, debt or lease agreements or other arrangements
that could trigger a requirement for an early payment or that could change the
value of our assets. Based on the amount of working capital that we had on hand on September
30, 2004 and the amount of unfilled orders we have pending, we believe that we
have sufficient financial resources to fund our operations for the next 12
months. While management believes that our current cash and cash flows from
operations will be sufficient to operate our company for the next twelve
months, we may from time to time decide to access the capital markets and issue
our securities in order to raise additional capital; such issuances may have a
dilutive effect on current stockholders. There are, however, many conditions
that could impact our proposed business plan and could adversely impact our
ability to market, sell or produce our products. We cannot give any assurance
that we will be able to continue profitable operations and obtain the cash
required for us to continue to successfully develop, market or sell our
products. Factors that May Affect Future Results and Market Price of Our Stock An investment in our common stock is subject to a high degree of risk.
The risks described below should be carefully considered, as well as the other
information contained in this annual report and in the documents incorporated
by reference. If any of the following risks actually occur, our business,
financial condition or operating results and the trading price or value of our
securities could be materially adversely affected. FACTORS ASSOCIATED WITH OUR COMPANY We have a limited operating history, which makes it difficult for investors to
evaluate our future prospects. While we have been developing high illumination products since 1997, we
have only been engaged in selling our products for the past three years and
have only generated material sales since March 2003. As a result, we have a
very limited operating history for investors to consider in evaluating an
investment in our common stock. 22




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Fluctuations in our quarterly and annual operating results make it difficult to
assure future profitability. Prior to the fiscal year ended September 30, 2004, we experienced losses
in each year since our formation. Our net losses totaled $832,000 in 1999,
$1,043,000 in 2000, $1,593,000 in 2001, $1,196,000 in 2002 and $1,963,000 for
the period ended September 30, 2003, a nine-month transition period due to a
change in fiscal year end from December 31 to September 30. However, for the
most recent fiscal year, the period ended September 30, 2004, we generated net
income of $1,476,000 on sales of $11,927,000, compared to a pro forma loss
$2,216,000 on revenues of $2,162,000 for the twelve-month period ending
September 30, 2003. The significant improvement in both revenues and net
income are the result of several large orders that we have received since March
2003. Since our revenues currently still are primarily dependent upon the
receipt of large orders from the military and other governmental organizations,
which orders are sporadic and unpredictable, our revenues fluctuate
significantly from quarter to quarter and from year to year. No assurance can
be given that we will continue to generate sales at these increased levels or
that any additional sales that may be generated will result in the ongoing
profitability or viability of this company. The loss of any one of our major customers would have an adverse effect on our
revenue We are dependent on a few large customers. For the fiscal year ended
September 30, 2004, sales to the U.S. Army represented 76% of our total sales.
Accordingly, the loss of either the U.S. Army as a customer could have a
material adverse impact on the results of our operations and on our financial
condition. Other than currently outstanding purchase orders, we do not have
any long-term purchase commitments from the U.S. Army or any other customer.
No assurance can be given that our existing customers will continue to purchase
our products or that we will receive similar orders from other customers. Most of our NightHunter illumination products that we have recently sold
and shipped have been shipped to U.S. Army forces operating in, or related to,
the currently on-going military operations in Afghanistan and Iraq. These
shipments have contributed to the recent significant increase in our sales.
While we believe that we would have received orders from the U.S. Army even
without the recent military activity in Afghanistan and Iraq, the events in
Afghanistan and Iraq have affected the amount of our recent sales and the
timing of the delivery of the products ordered by the military. The withdrawal
of U.S. forces from these regions, or any other reduction in the militarys
need for our illumination products, may in the future reduce the demand for our
products by such military forces. The loss of our existing contracts with U.S. government agencies would
adversely affect our revenue. To date, substantially all of our sales have been derived from sales to
military and security organizations, such as the U.S. military, the U.S. Border
Patrol, and various other governmental law enforcement agencies. While we
believe that we will continue to be successful in marketing our products to
these entities, there are certain considerations and limitations inherent in
sales to governmental or municipal entities such as budgetary constraints,
timing of procurement, political considerations, and listing requirements that
are beyond our control and could affect our future sales. There is no
assurance that we will be able to achieve our targeted sales objectives to
these governmental and municipal entities or that we will continue to generate
any material sales to these entities in the future. 23




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Because we compete against many larger, more established competitors, potential
customers may prefer our competitors technology and products. The ultra-high intensity lighting industry, in which we operate, is
characterized by mature products and established industry participants. We
compete with other providers of specialized lights in the United States and
abroad, which have created or are developing technologies and products similar
to the products we are selling to many of the same purchasers in our targeted
markets. Although we believe that our competitors do not offer products as
advanced as ours, competition from these companies is intense. Because we are
currently a small company with a limited marketing budget, our ability to
compete effectively will depend on the benefits of our technology and on our
patents. There can be no assurance that potential customers will select our
technology over that of a competitor, or that a competitor will not market a
competing technology with operating characteristics similar to those owned by
us. Many of the companies that currently compete in the portable, high
intensity illumination products market, or that may in the future compete with
us in that market, have substantially greater capital resources, research and
development staffs, facilities, field trial experience, and experience in the
marketing and distribution of products than we do. Our products could be
rendered obsolete or uneconomical by the introduction and market acceptance of
competing products, technological advances by current or potential competitors,
or other approaches. If such a development were to occur, we might be required
to reduce our prices in order to remain competitive and these lower prices
could affect our profitability. We will be competing on the basis of a number
of factors in areas in which we have limited experience, including marketing to
the military and governmental agencies, and customer service and support.
There can be no assurance that we will be able to compete successfully against
current or future competitors. Because we have limited marketing and sales experience in the illumination
products marketplace, we may be unable to compete successfully against other
companies that have a history and track record in the high-intensity lighting
marketplace. We have a small marketing and sales division and relatively limited
experience in marketing, sales and distribution of illumination products. We
currently only have two persons engaged on a full-time basis in marketing and
sales. Although our other officers have experience in the operations and
management of various businesses and have experience in the high intensity
lighting field, they have limited experience in the management of a company
engaged in the high volume sale of high-intensity lighting. In addition, while
we have had success in marketing to certain branches of the U.S. military and
to certain other U.S. governmental agencies; we have not been successful in
generally marketing our products to a wider market. There can be no assurance
that our limited marketing and sales capabilities will be enable us to compete
successfully against competitors that have a history and track record in the
high-intensity lighting marketplace. If we do not establish or maintain an
effective marketing and sales organization, our business will be adversely
affected. The interests of our current stockholders will be diluted if we seek additional
equity financing in the future, and any debt financing that we seek in the
future will expose us to the risk of default and insolvency. While we currently have sufficient funds to continue our current
operations, we intend to seek additional equity or debt financing in the
future. Any equity financing may involve substantial dilution of the interests
of the current stockholders. Any debt financing would subject us to the risks
associated with leverage, including the possible risk of default and
insolvency. 24




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We are subject to government regulation which may require us to obtain
additional licenses and could limit our ability to sell our products outside
the United States. The sale of certain of our products outside the United States is subject
to compliance with the United States Export Administration Regulations.
Compliance with government regulations may also subject us to additional fees
and costs. The absence of comparable restrictions on competitors in other
countries may adversely affect our competitive position. The need to obtain
licenses could limit or impede our ability to ship to certain foreign markets.
Although we currently hold the requisite export licenses required under current
requirements, future laws and regulations cannot be anticipated that could
impact our ability to generate revenues from the sale of our products outside
the United States, which could have a material adverse effect on our business,
financial condition and results of operations. We may experience production delays if suppliers fail to deliver materials to
us, which could reduce our revenue. The manufacturing process for our products consists primarily of the
assembly of purchased components. Although we can obtain materials and purchase
components from different suppliers, we rely on certain suppliers for our
components. If a supplier should cease to deliver such components, this could
result in added cost and manufacturing delays and have an adverse effect on our
business. Our operations involve evolving products and technological change, which could
make our products obsolete. Ultra-high intensity portable illumination products are continuously
evolving and subject to technological change. Our ability to maintain a
competitive advantage and build our business requires us to consistently invest
in research and development. Many of the companies that currently compete in
the portable illumination market, or that may in the future compete with us in
our market, may have greater capital resources, research and development
staffs, facilities and field trial experience than we do. Our products could
be rendered obsolete by the introduction and market acceptance of competing
products, technological advances by current or potential competitors, or other
approaches. RISKS RELATED TO OUR PRODUCTS We may not have adequate protection of our intellectual property, which could
result in a reduction in our revenue if our competitors are able to use our
intellectual property or if we lose our rights to the NighthunterII patent
application. We own the rights to four patents (or allowed patent applications) and
four patent pending applications relating to the design and configuration of
our xenon illumination technology. There can be no assurance however that our
patents will provide competitive advantages for our products or that our
patents will not be successfully challenged or circumvented by our competitors.
Most of our patents and patent applications are design patents, which protect
the design and appearance of our products and not any technological or
mechanical component of the products. Design patents typically provide less
protection than utility patents that protect the technology of a product.
Also, no assurance can be given that our pending patent applications will
ultimately be issued or provide patent protection for improvements to our base
technology. Under current law, the right to a patent in the United Sates is
attributable to the first to invent, not the first to file a patent
application. While be we believe that our patent rights are valid, we cannot
be sure that our products or technologies do not infringe on other patents or
intellectual property or proprietary rights of third parties. In the event
that any relevant claims of third-party patents are upheld as valid and
enforceable, we could be prevented from selling our products or could be
required to obtain licenses from the owners of such patents or to 25




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redesign our products to avoid infringement. In addition, many of the
processes of our products that we deem significant are not protected by patents
or pending patent applications. We regard portions of the designs and technologies incorporated into our
products as proprietary and we attempt to protect them with a combination of
patent, trademark and trade secret laws, employee and third-party nondisclosure
agreements and similar means. Despite these precautions, it may be possible
for unauthorized third parties to copy certain portions of our products or to
otherwise obtain and use to our detriment information that we regard as
proprietary. There can be no assurance that the agreements we have entered
into with employees or third parties to maintain the confidentiality of our
confidential or proprietary information will effectively prevent disclosure of
our confidential information or provide meaningful protection for our
proprietary information or that our confidential or proprietary information
will not be independently used by our competitors. In addition, in a lawsuit we brought against a former director and
consultant, the defendant has asked the court to rescind the assignment of the
NightHunter II patent application that he assigned to us in November 2003 and
to declare that he is the sole owner of that NightHunter II patent application.
The defendants cross-complaint does not address or affect our four patents
(or allowed patent applications) or our other three pending patent applications
relating to the design and configuration of our xenon illumination technology.
We believe the defendants claims are without merit. See, Item 3  Legal
Proceedings. However, if the defendant prevails in his claims, we will have
to re-engineer our NighthunterII product to avoid any conflict with that patent
application, and until we re-engineer our NighthunterII product, we will have
to stop producing and selling our NighthunterII product. In such event, a
cessation of sales of the NighthunterII product would materially and adversely
affect our revenues, profits, business and financial condition. Because we currently only have a single line of products, any delay in our
ability to market, sell or ship these existing products would adversely affect
our revenue. To date, all of our revenues have been generated from the sales of our
three NightHunter illumination system products (the NightHunter, NightHunterII
and NightHunterEXT) and related accessories. Other than the three NightHunter
models, we currently do not have any other products that we market. While we
are currently developing other illumination products, we will be dependent upon
our NightHunter line of products until such time, if ever, that we develop or
acquire other products. The profitability and viability of our company is
dependent upon our continued ability to sell, manufacture and ship our three
illumination models, particularly the NightHunterII illumination system, and
any delay or interruption in our ability to market, sell, or ship our
NightHunter illumination systems and related accessories will have a material
adverse affect on our business and financial condition. Further, our future growth and profitability will depend on our ability to
both successfully commercialize NightHunter and to develop and commercially
release other products. While our goal is to develop and commercialize a line
of ultra-high intensity illumination systems, our research and development
programs with respect to other potential products are at an early stage, and it
is uncertain whether we will be able to develop any other commercially viable
products. If we are unable to develop and release other products, the future
of this company will depend on the commercial success of our existing three
NightHunter products. 26




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Because we depend on a single manufacturer to make our NightHunterII products,
any failure by the manufacturer to honor its obligations to us will impair our
ability to deliver our products to customers. In January 2003, we entered into a three-year manufacturing agreement with
PerkinElmer, a global provider of products and services to, among others, the
optoelectronics industries, for the manufacture of NightHunterII products.
Under this agreement, PerkinElmer is the sole and exclusive manufacturer of the
NightHunterII products, and we are not permitted to engage any other
manufacturer. In addition PerkinElmer is responsible for testing, packaging,
maintaining product inventories, and shipping the NightHunterII products
directly to our customers. Accordingly, we are dependent upon PerkinElmer for
the manufacture and delivery of our principal product, the NightHunterII. To
date, as a small company with limited resources, our arrangement with
PerkinElmer has provided us with the manufacturing, packaging and shipping
expertise normally only available to larger firms. However, should PerkinElmer
for any reason in the future be unable or unwilling to fully live up to its
obligations under our manufacturing agreement, we would lose the ability to
manufacture and deliver our principal product until PerkinElmer recommences
manufacturing, or until we obtain an alternate manufacturer. While we believe
that we could replace PerkinElmer in such an event, any such event would
adversely affect our operations and financial results during the period in
which we transitioned to another manufacturer. RISKS RELATED TO OUR COMMON STOCK Because a liquid public trading market for our common stock may not develop,
stockholders may have difficulty selling their securities. There has been no long-term established public trading market for our
common stock, and there can be no assurance that a regular and established
market will be developed and maintained for our securities. There can also be
no assurance as to the depth or liquidity of any market for the common stock or
the prices at which holders may be able to sell the shares. Our common stock
currently is traded only on the OTC Bulletin Board. Companies that have their
shares listed on the OTC Bulletin Board normally are not followed by many
market analysts, if any, and many institutional investors are prohibited from,
or do not invest in such companies. As a result, trading on the OTC Bulletin
Board is characterized by a lack of liquidity, sporadic trading, larger spreads
between bid and ask quotations, and other conditions that may affect an
investors ability to re-sell our shares. Substantial share overhang could adversely affect on our stock price. As of November 30, 2004, we had outstanding 14,166,878 shares of common
stock, of which approximately 3,109,000 shares are currently freely tradable
shares or registered for resale under a prior prospectus, dated September 24,
2004. The remaining 11,058,000 shares were restricted Securities (as that
term is defined under Rule 144 promulgated under the Securities Act of 1933, as
amended) and have not been available for public sale on the OTC Bulletin Board.
After December 24, 2004 approximately 10,263,000 of the restricted shares will
become eligible for public resale under Rule 144, and the balance will be
eligible for resale over the next few months. No prediction can be made if or
when such shares will be offered for sale over the public market, or what the
effect that the sales of shares of common stock, or the availability of such
shares for sale, will have on the market prices prevailing from time to time.
Because there are so few freely tradable shares, the sudden release of trading
shares onto the market, or the perception that such shares will come onto the
market, could have an adverse affect on the trading price of the stock. 27




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Our stock is thinly traded, so you may be unable to sell at or near ask
prices or at all if you need to sell your shares to raise money or otherwise
desire to liquidate your shares. Our common shares are thinly-traded on the OTC Bulletin Board, meaning
that the number of persons interested in purchasing our common shares at or
near ask prices at any given time may be relatively small or non-existent. This
situation is attributable to a number of factors, including the fact that we
are a small company that is relatively unknown to stock analysts, stock
brokers, institutional investors and others in the investment community that
generate or influence sales volume, and that even if we came to the attention
of such persons, they tend to be risk-averse and would be reluctant to follow
an unproven, early stage company such as ours or purchase or recommend the
purchase of our shares until such time as we became more seasoned and viable.
As a consequence, there may be periods of several days or more when trading
activity in our shares is minimal or non-existent, as compared to a seasoned
issuer which has a large and steady volume of trading activity that will
generally support continuous sales without an adverse effect on share price.
Due to these conditions, we can give you no assurance that you will be able to
sell your shares at or near ask prices or at all if you need money or otherwise
desire to liquidate your shares. There has been, and may continue to be significant volatility in our stock
price. Since the closing of the acquisition of Xenonics, Inc., the closing price
of our shares of common stock on the Pink Sheets electronic trading system and
on the OTC Bulletin Board has fluctuated from $2.00 per share to $12.25 per
share. The future market price of our common stock may be affected by many
factors and may continue to be subject to significant fluctuations in response
to variations in our operating results and other factors such as investor
perceptions, supply and demand, interest rates, general economic conditions and
those specific to the industry, developments with regard to our activities,
future financial condition and management. The exercise of outstanding stock purchase options and warrants would dilute
the ownership interests of our stockholders. There are currently outstanding common share purchase options and warrants
entitling the holders to purchase 4,012,465 shares, including a number granted
to directors, officers, employees and consultants that are subject to vesting
conditions. These options and warrants have exercise prices ranging from $0.25
per share to $8.00 per share. It is likely that a number of the holders of
these options and warrants will exercise and sell common stock when the stock
price exceeds their exercise price and lead to the dilution of ownership of the
common stockholders. 28




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ITEM 7. FINANCIAL STATEMENTS INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE XENONICS HOLDINGS, INC. Reports of Independent Certified Public Accountants
    
    
    F-2Consolidated Financial Statements:Balance Sheet as of September 30, 2004
    
    
    F-4Statement of Operations for the twelve month year ended September 30, 2004
and nine month transition period ended September 30, 2003
    
    
    F-5Statement of
Shareholders Equity (Deficit) for the twelve month year ended September 30, 2004
and nine month transition period ended September 30, 2003
    
    
    F-6Statement of Cash Flows for the twelve month year ended September 30, 2004
and nine month transition period ended September 30, 2003
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8
 F-1




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders
Xenonics Holdings, Inc.
Carlsbad, California We have audited the consolidated balance sheet of Xenonics Holdings, Inc. and subsidiaries as of
September 30, 2004, and the related consolidated statements of operations, shareholders equity
(deficit) and cash flows for the year then ended. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Xenonics Holdings, Inc. and subsidiaries as of
September 30, 2004 and the consolidated results of their operations and their consolidated cash
flows for the year then ended, in conformity with accounting principles generally accepted in the
United States of America. Eisner LLP New York, New York
November 19, 2004 With respect to the sixth paragraph of Note 7
December 3, 2004 F-2




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and
shareholders of Xenonics Holdings, Inc.: We have audited the accompanying consolidated statements of operations, changes in shareholders
equity (deficit) and cash flows of Xenonics Holdings, Inc. for the nine-month period ended
September 30, 2003. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated statements of operations, changes in shareholders equity
(deficit) and cash flows referred to above present fairly, in all material respects, the
consolidated results of operations and cash flows of Xenonics Holdings, Inc. for the nine-month
period ended September 30, 2003, in conformity with accounting principles generally accepted in the
United States of America. /s/ Windes & McClaughry Accountancy Corporation Long Beach, California
January 14, 2004, except for Note 2  Earnings Per
Common Share and Restated Earnings Per Share Amounts
to which the date is December 17, 2004 F-3




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##### Table of Contents



CONSOLIDATED BALANCE SHEET September 30,2004$ in thousands, except share amountsAssetsCurrent assets:Cash
    
    $
    3,269Accounts receivable, net of allowance for doubtful accounts of $0
    
    
    253Inventories, net
    
    
    922Other current assets
    
    
    189Total Current Assets
    
    
    4,633Equipment, furniture and fixtures at cost, less accumulated
depreciation of $59
    
    
    35Other non-current assets
    
    
    24Total Assets
    
    $
    4,692Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    1,126Accrued royalty
    
    
    400Accrued payroll and related taxes
    
    
    93Total Current Liabilities
    
    
    1,619Commitments
and contingencies (Note 12)Shareholders equity:Preferred shares, $0.001 par value, 5,000,000 shares authorized,
0 shares issued and outstanding
    
    
    Common shares, $0.001 par value, 20,000,000 shares authorized,
14,166,878 shares issued and outstanding
    
    
    14Additional paid-in capital
    
    
    10,540Accumulated deficit
    
    
    (7,481
    )Total Shareholders Equity
    
    
    3,073Total Liabilities and Shareholders Equity
    
    $
    4,692
 The accompanying notes are an integral part of these consolidated financial statements. F-4




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CONSOLIDATED STATEMENTS OF OPERATIONS Year
    
    Nine-monthsEnded
    
    EndedSeptember 30,
    
    September 30,2004
    
    2003Audited
    
    Audited$ in thousands, except share amountsRevenues
    
    $
    11,927
    
    
    $
    1,580Cost of goods sold
    
    
    6,916
    
    
    
    1,241Gross profit
    
    
    5,011
    
    
    
    339Selling, general and administrative
    
    
    3,113
    
    
    
    1,551Engineering, research and development
    
    
    248
    
    
    
    237Income (loss) from operations
    
    
    1,650
    
    
    
    (1,449
    )Other income/(expense), net:Interest income
    
    
    15
    
    
    
    2Interest expense
    
    
    (31
    )
    
    
    (515
    )Income (loss) before provision for income taxes
    
    
    1,634
    
    
    
    (1,962
    )Provision for income taxes
    
    
    158
    
    
    
    1Net income (loss)
    
    $
    1,476
    
    
    $
    (1,963
    )Net income (loss) per share:Basic (2003 restated)
    
    
    .11
    
    
    
    (.29
    )Diluted (2003 restated)
    
    
    .09
    
    
    
    (.29
    )Weighted average shares outstandingBasic (2003 restated)
    
    
    13,508
    
    
    
    6,799Diluted (2003 restated)
    
    
    16,932
    
    
    
    6,799
 The accompanying notes are an integral part of these consolidated financial
statements. F-5




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CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY (DEFICIT) Preferred Stock
    
    Common Stock
    
    AdditionalPaid-In
    
    AccumulatedShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Deficit
    
    TotalDollars/shares in thousandsBalance at January 1, 2003
    
    
    139
    
    
    
    1
    
    
    
    4,772
    
    
    
    48
    
    
    
    3,067
    
    
    
    (6,994
    )
    
    
    (3,878
    )Conversion of debt of $2,028 and related accrued interest
of $422 to common stock
    
    
    
    
    
    
    
    
    
    
    3,267
    
    
    
    33
    
    
    
    2,417
    
    
    
    
    
    
    
    2,450Payment of interest expense of $12 with common stock
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    12Issuance of common stock to employees, directors and
consultants
    
    
    
    
    
    
    
    
    
    
    362
    
    
    
    4
    
    
    
    267
    
    
    
    
    
    
    
    271Exchange of preferred stock for common stock
    
    
    (139
    )
    
    
    (1
    )
    
    
    333
    
    
    
    3
    
    
    
    (2
    )
    
    
    
    
    
    
    Common stock of DHTS for 100% of the Company
    
    
    
    
    
    
    
    
    
    
    2,500
    
    
    
    (76
    )
    
    
    76
    
    
    
    
    
    
    
    Issuance of common stock in private placement, net of
offering costs of $123
    
    
    
    
    
    
    
    
    
    
    1,460
    
    
    
    1
    
    
    
    1,153
    
    
    
    
    
    
    
    1,154Issuance of common stock to bridge note holders
    
    
    
    
    
    
    
    
    
    
    82
    
    
    
    
    
    
    
    72
    
    
    
    
    
    
    
    72Non-cash charge for re-issuance of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    375
    
    
    
    
    
    
    
    375Non-cash charge for re-issuance of stock warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    320
    
    
    
    
    
    
    
    320Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,963
    )
    
    
    (1,963
    )Balance at September 30, 2003
    
    
    
    
    
    
    
    
    
    
    12,792
    
    
    
    13
    
    
    
    7,757
    
    
    
    (8,957
    )
    
    
    (1,187
    )Options exercised
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    3Issuance of common stock in
private placement
    
    
    
    
    
    
    
    
    
    
    600
    
    
    
    1
    
    
    
    1,499
    
    
    
    
    
    
    
    1,500Warrants exercised
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    8Issuance of common stock in
private placement, net of
offering costs of $136
    
    
    
    
    
    
    
    
    
    
    200
    
    
    
    
    
    
    
    714
    
    
    
    
    
    
    
    714Conversion of debt of $250 and
related accrued interest of $17
to common stock
    
    
    
    
    
    
    
    
    
    
    533
    
    
    
    
    
    
    
    267
    
    
    
    
    
    
    
    267Issuance of common stock for
services
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    50
    
    
    
    

    
    
    
    50Compensation charge for stock
options issued to employees and
directors
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    185
    
    
    
    
    
    
    
    185Issuance of warrants for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    57
    
    
    
    
    
    
    
    57Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,476
    
    
    
    1,476Balance at September 30, 2004
    
    
    
    
    
    
    
    
    
    
    14,167
    
    
    $
    14
    
    
    $
    10,540
    
    
    $
    (7,481
    )
    
    $
    3,073
 The accompanying notes are an integral part of these consolidated financial statements. F-6




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##### Table of Contents



CONSOLIDATED STATEMENTS OF CASHFLOWS Year
    
    Nine-monthsEnded
    
    EndedSeptember 30,
    
    September 30,2004
    
    2003$ in thousandsCash flows from operating activities:Net income (loss)
    
    $
    1,476
    
    
    $
    (1,963
    )Adjustments to reconcile net income (loss) to net cash provided by (used for) operating
activities:Depreciation and amortization
    
    
    6
    
    
    
    4Compensation to employees and directors paid with
stock options
    
    
    185
    
    
    
    718Issuance of warrants for services
    
    
    57
    
    
    
    320Interest expense converted to common stock
    
    
    17
    
    
    
    12Issuance of common stock for services
    
    
    50
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    274
    
    
    
    (373
    )Inventories, net
    
    
    (738
    )
    
    
    (67
    )Other assets
    
    
    (156
    )
    
    
    (6
    )Accounts payable
    
    
    548
    
    
    
    111Accrued payroll and related taxes
    
    
    43
    
    
    
    25Accrued interest
    
    
    (92
    )
    
    
    45Net cash provided by (used for) operating activities
    
    
    1,670
    
    
    
    (1,174
    )Cah flows from investing activities:Purchases of equipment, furniture and fixtures
    
    
    (36
    )
    
    
    Net cash used for investing activities
    
    
    (36
    )
    
    
    Cash flows from financing activities:Repayment of short-term borrowings
    
    
    (400
    )
    
    
    (40
    )Repayments on notes payable
    
    
    (316
    )
    
    
    (484
    )Proceeds from issuance of notes payable
    
    
    
    
    
    
    575Net proceeds from issuance of common stock net of expenses
    
    
    2,214
    
    
    
    1,154Proceeds in connection with the exercise of options and warrants
    
    
    11
    
    
    
    Net cash provided by financing activities
    
    
    1,509
    
    
    
    1,205Increase in cash
    
    
    3,143
    
    
    
    31Cash, beginning of period
    
    
    126
    
    
    
    95Cash, end of period
    
    $
    3,269
    
    
    $
    126Supplemental cash flow information:Cash paid during the year for income taxes
    
    $
    237
    
    
    $
    1Cash paid during the year for interest
    
    $
    69
    
    
    $
    47Noncash transactions:Conversion of long-term debt to common stock
    
    $
    250
    
    
    $
    2,028Conversion of accrued interest to common stock
    
    $
    17
    
    
    $
    422Exchange of preferred stock for common stock
    
    
    
    
    
    $
    3Issuance of common stock of DHTS for 100% of the Company
    
    
    
    
    
    $
    76
 The accompanying notes are an integral part of these consolidated financial
statements. F-7




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except for share
amounts)  1.
    
    OPERATIONS AND OTHER ORGANIZATIONAL MATTERS Xenonics, Inc. (Xenonics) was organized under the laws of the state of
Delaware in November 1996. Xenonics was formed to develop and commercialize
compact, ultra-high intensity illumination products, based on patented
technology. Xenonics markets its products directly to end users on a contract
and purchase order basis in a variety of markets for military, law enforcement,
security, and search and rescue applications. In July 2003, Xenonics completed a reorganization with Digital Home
Theater Systems, Inc. (DHTS), a Nevada corporation that had previously operated
as a multimedia service provider. DHTS had discontinued operations in 1999.
In connection with the transaction, DHTS acquired 100% of Xenonics for
8,750,000 shares of common stock. Immediately preceding the transaction, DHTS
issued 1,459,652 shares of its stock at $0.875 per share for total gross
proceeds of $1,277. Legal and commission costs incurred in the private
placement totaled $123. Upon the closing of the reorganization, DHTS changed
its name to Xenonics Holdings, Inc. (Holdings), together with Xenonics,
collectively, the Company. The transaction was accounted for as a
recapitalization of Xenonics with an issuance of common stock for cash.
Although Holdings was the legal acquirer in the transaction, Xenonics was the
accounting acquirer and, as such, its historical financial statements will
continue. No goodwill was recorded as a result of the transaction.  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation- The consolidated financial statements
include the accounts of Holdings and its wholly owned subsidiary Xenonics. All
significant inter-company items have been eliminated upon consolidation.
Xenonics Holdings, Inc. currently is the 100% shareholder of Xenonics, Inc.
Xenonics has 135,000 warrants outstanding to one individual that did not
convert into Holdings warrants. Reporting
Periods -The Companys financial statements at September 30,
2004 include its operations and cash flows for the year then ended. The
Companys financial statements at September 30, 2003 include the results of its
operations and cash flows for the nine-months then ended. Use of Estimates- The preparation of financial statements, in conformity
with accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and 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 could
differ from those estimates. Cash
and Cash Equivalents -The Company considers all highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents. Allowance
for Doubtful Accounts -There currently is not an estimate for
the allowance for doubtful accounts based upon historical write off experience
and any known specific issues or disputes which exist as of the balance sheet
date. Management does not have any reason to believe that any outstanding
receivable balances at September 30, 2004 will not be paid. F-8




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##### Table of Contents



Equipment
and Leasehold Improvements -Equipment and leasehold
improvements are stated at cost less accumulated depreciation which is computed
using the straight-line method over the estimated useful lives of the assets,
generally ranging from five to seven years. Leasehold improvements are
amortized using the straight-line method over the shorter of the estimated
useful life of the asset or the lease term. Expenditures for repairs and
maintenance are charged to operations as incurred. Long-Lived Assets- The Company reviews long-lived assets whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Any long-lived assets held for disposal are reported at
the lower of their carrying amounts or fair value less costs to sell. Fair
Value Of Financial Instruments -The Companys principal financial
instruments represented by cash, trade receivables, accrued expenses and notes
payable, approximate their fair value due to the short-term nature of these
items. Inventories- Inventories are composed of raw materials, work-in process
and finished goods, which are stated at the lower of cost (using the first-in
first-out method) or market. Revenue Recognition- The Company recognizes revenue net of discounts upon
shipment and when it has evidence that arrangements exist and the price to the
buyer is fixed through signed contracts or purchase orders. Collectibility is
reasonably assured through one or more of the following: government purchase,
historical payment practices or review of new customer credit. Customers do
not have the right to return product unless it is damaged or defective. Advertising Costs Advertising costs are expensed as incurred. For the
year ended September 30, 2004 and for the period from January 1, 2003 to
September 30, 2003, advertising expense was approximately $101 and $32,
respectively. Industry Segment And Geographical Data-The Company operates in one
industry segment, which includes security lighting systems. Substantially all
revenue is from the US government. Industry segment and geographical data: Nine-monthYear ended
    
    period endedSeptember 30,
    
    September 30,2004
    
    2003US Military
    
    
    94
    %
    
    
    92
    %US Border Patrol
    
    
    4
    %
    
    
    2
    %International
    
    
    1
    %
    
    
    4
    %Other
    
    
    1
    %
    
    
    2
    %100
    %
    
    
    100
    %
 Cost of Goods Sold-Cost of goods sold includes raw materials and
components, labor, and manufacturing overhead. Also included are the costs
invoiced to the Company related to outside production of product through a
three-year exclusive manufacturing agreement. F-9




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##### Table of Contents



Income Taxes- Income taxes are provided for the effects of transactions
reported in the financial statements and consist of taxes currently due plus
deferred taxes related primarily to differences between the basis of certain
assets and liabilities for financial and income tax reporting. Deferred taxes
are classified as current or non-current depending on the classification of the
assets and liabilities to which they relate. Deferred taxes arising from
temporary differences that are not related to an asset or liability are
classified as current or non-current depending on the periods in which the
temporary differences are expected to reverse. A valuation allowance is
established when necessary to reduce deferred tax assets if it is more likely
than not that all, or some portion of, such deferred tax assets will not be
realized. Earnings
Per Common Share and Restated Earnings Per Share Amounts-Basic earnings per share is computed by
dividing the income available to common shareholders by the average number of
common shares outstanding. Diluted earnings per share includes the dilutive
effect, if any, from the potential exercise of stock options using the treasury
stock method. The
basic and diluted loss per share amounts for the year ended
September 30, 2003 have been restated as a result of the use of
the incorrect number of shares at the beginning of the period. The
impact of the correction is as follows: Weighted
average shares outstanding - as originally reported
    
    
    12,792Weighted
average shares outstanding - as corrected
    
    
    6,799Loss per
basic share - as originally reported
    
    
    .15Loss per
basic share - as corrected
    
    
    .29
 The weighted average shares outstanding used in the calculations
of earnings per share were as follows (in thousands): Nine-monthFor the year
    
    period endedended
    
    September 30,2004
    
    2003Shares
outstanding, beginning (2003 restated)
    
    
    12,792
    
    
    
    4,772Weighted
average shares issued (2003 restated)
    
    
    716
    
    
    
    2,027Weighted average shares outstanding -
    
    
    13,508
    
    
    
    6,799Basic (2003 restated)Effect of dilutive securities
(stock options and warrants) (2003 restated)
    
    
    3,424
    
    
    
    Weighted
average shares outstanding  diluted (2003 restated)
    
    
    16,932
    
    
    
    6,799
 Potential common
shares not included in the calculation of net income per
share, as their effect would be anti-dilutive, are as follows (in thousands): 2004Stock options and warrants
    
    
    135
 At September 30, 2004, options to
purchase 60,000 shares of the Companys
common stock, at prices ranging from $5.75 to $6.00 per share, were not
included in the computation of diluted EPS because their effect was
anti-dilutive. The options expire on various future dates through May 2014. Additionally, at September 30, 2004,
warrants to purchase 75,000 shares,
of the Companys common stock, at prices ranging from $5.05 to $8.00 per share,
were not included in the computation of diluted EPS because their effect was
anti-dilutive. The warrants expire on various future dates through June 2009. Research and Development- Engineering, research and development costs are
expensed as incurred. Substantially all engineering, research and development
expenses are related to new product development and designing improvements in
current products. F-10




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##### Table of Contents



Stock Options- The Company uses the fair value based method of accounting
for share-based compensation provided to our employees in accordance with
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation. We value stock options issued based upon an
option-pricing model and recognize this fair value as an expense over the
period in which the options vest. Major Concentrations For the year ended September 30, 2004, the US Army
contributed 76% of revenue. This consisted of orders from eight different
units, although two units contributed 44% and 16%, respectively. For the
nine-month period ended September 30, 2003, the US Army contributed 71%,
primarily through one unit, and one other customer individually represented 13%
of the Companys total revenue. As of September 30, 2004, two customers represented 93% of the Companys
total accounts receivable with 39% and 54%, respectively. As of September 30,
2003, one customer represented 95% of the Companys total accounts receivable. For the year ended September 30, 2004, one vendor represented 84% of cost
of goods sold and 65% of accounts payable as of September 30, 2004. (See Note
12, Commitments and Contingencies). For the nine-month period ended September
30, 2003, the Company had one vendor which represented 70% of cost of goods
sold (See Note 12, Commitments and Contingencies). Recent Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
This Statement addresses financial accounting and reporting for the impairment
or disposal of long-lived assets and supersedes FASB Statement No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of. The provisions of the Statement are effective for financial
statements issued for fiscal years beginning after December 15, 2001. There was
no material effect from adoption of this pronouncement. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS 146 addresses accounting and
reporting costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity. This
statement requires that a liability for a cost associated with and exit or
disposal activity shall be recognized and measured initially at its fair value
in the period that the liability is incurred. This statement is effective for
exit or disposal activities that are initiated after December 31, 2002. The
Company does not believe that the adoption of SFAS 146 will have a significant
impact on its consolidated financial statements. In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees and Indebtedness of Others. FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provisions of
this interpretation are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002; while the provisions of the
disclosure requirements are effective for financial statements of interim or
annual reports ending after December 15, 2002. At September 30, 2003, the
Company had no guarantees outstanding. The Company has adopted FIN 45, which
had no material effect on the consolidated financial statements. F-11




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##### Table of Contents



In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based
Compensation-Transition and Disclosure: An amendment of FASB Statement 123.
This Statement amends SFAS 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock based employee compensation and the
effect of the method used on reported results. The disclosure provisions of
SFAS 148 are applicable for fiscal periods ending after December 15, 2002.
The Company has adopted SFAS 148, which had no material effect on the
consolidated financial statements. In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities,which changes the criteria by which one company includes
another entity in its consolidated financial statements. FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entitys
activities or entitled to receive a majority of the entitys residual returns
or both. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003, and apply in the
first fiscal period beginning after June 15, 2003, for variable interest
entities created prior to February 1, 2003. The Company has not entered into
any transactions or other arrangements which they believe would be considered
variable interest entities and accordingly expects that the adoption of this
Interpretation will have no impact on the Companys consolidated results of
operations or financial position. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 is intended to
result in more consistent reporting of contracts as either freestanding
derivative instruments subject to SFAS No. 133 in its entirety, or as hybrid
instruments with debt host contracts and embedded derivative features. In
addition, SFAS No. 149 clarifies the definition of a derivative by providing
guidance on the meaning of initial net investments related to derivatives.
This statement is effective for contracts entered into or modified after June
30, 2003. The Company does not believe the adoption of SFAS No. 149 will have
a material effect on its consolidated financial position, results of operations
or cash flows. In May 2003, the FASB issued SFAS No.150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
SFAS No. 150 was adopted by the Company on October 1, 2003. Management does
not believe that the adoption of the Statement will have a material affect on
the Companys consolidated financial position, results of operations or cash
flows. In November of 2004, the FASB issued SFAS No. 151, Inventory Costs. SFAS
No. 151 clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material. SFAS No. 151 requires that these
items be recognized as current-period charges. In addition SFAS No. 151
requires that allocation of fixed production overhead to the costs of
conversion be based on the normal capacity of the production facilities. This
statement is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The Company does not believe that the adoption
of SFAS No. 151 will have a material effect on its consolidated financial
position, results of operations or cash flows. F-12




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##### Table of Contents



3.
    
    FIXED ASSETS Fixed assets consist of the following: Year EndedEstimated
    
    September 30,Useful Lives
    
    2004Computer equipment
    
    
    5
    
    
    $
    58Computer software
    
    
    5
    
    
    
    19Leasehold improvement
    
    
    7
    
    
    
    1794Less: accumulated depreciation and amortization
    
    
    
    
    
    
    59$
    35
  4.
    
    INVENTORIES Inventories were comprised of (in thousands): September 30,2004Raw materials
    
    $
    78Work in process
    
    
    87Finished goods
    
    
    767Reserve for obsolescence
    
    
    (10
    )$
    922
  5.
    
    SHORT-TERM BORROWINGS As of September 30, 2003 the Company had a loan payable in the amount of
$400 scheduled to bear interest at 6.25% through October 2003. The loan
was renewed in October 2003 and bears interest at 5.5% through its maturity in
October 2004. The loan was repaid in March of 2004 and the related lien on the
Companys assets was released.  6.
    
    NOTES PAYABLE In March 2004, a convertible note totaling $250 and accrued interest of
$17 was converted into 533,726 shares of common stock, in accordance with the
terms of the note agreement. The origination date of the note was February 14,
2003. At that time, prior to the reorganization, Xenonics was a private
company and was not traded on the pink sheets. The conversion price of $0.50
per share was indicative of the deemed fair value of Xenonics common stock at
that time. The note holder is a beneficial shareholder. During the year ended September 30, 2004, an unsecured demand note payable
totaling $184 was paid. In July 2003, notes payable and accrued interest totaling $2,028 and $422,
respectively, were converted to Xenonics common stock in conjunction with the
reorganization. (See Note 1, Operations and Other Organizational Matters). In July 2003, the Company received $75 in the form of an unsecured
promissory note with interest at 7% as a bridge loan related to the Companys
reorganization. The Company issued 10,000 shares of common stock in
conjunction with the note. The note, plus accrued interest, was paid in July
2003 upon the closing of the reorganization. F-13




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##### Table of Contents



In March and April 2003, the Company received bridge loans totaling $250
related to the Companys reorganization with interest at 7%. The notes were
secured by 1,000,000 shares of the Companys common stock. In addition, the
note holders also received a total of 72,000 shares of stock in Holdings, which
represented 14,400 shares of stock for every $50 of loans made. These bridge
loans, plus accrued interest, were paid in cash in July 2003 upon the closing
of the reorganization.  7.
    
    ACCRUED ROYALTIES In March 1997, the Company entered into a license agreement with
Lightrays, Ltd. (Lightrays) pursuant to which the Company received an exclusive
license to a patent and to certain related intellectual property. In
consideration for the license, the Company issued 100,000 shares of common
stock to Lightrays and agreed to pay Lightrays up to $3,967, which would be
paid based on future gross profits and sales. At the time of the original
agreement, management believed that the Lightrays technology would be the base
technology of the Companys product for the future. Subsequent to the agreement, the Company initiated a lawsuit against
Herbert Parker who had been working as a consultant for the Company. The
lawsuit against Mr. Parker was for fraud, breach of contract, conversion and
misappropriation of trade secrets. Lightrays was named in the suit because at
the time Mr. Parker was the general partner. In April 1998, the Company and Lightrays amended the license agreement
whereby the Company agreed to pay Lightrays $400 and issued an additional
150,000 shares of common stock. At this point in time, management still
believed that the Lightrays technology would be the base technology of the
Companys product for the future. In connection with the amendment, the
Company dismissed Lightrays from the lawsuit. The $400 liability is to be paid
at the rate of 50% of the Companys after-tax income until the aggregate amount
of such payments equals $400. The full amount of the liability was accrued at
December 31, 2001 and classified as current with the expectation that the
Company would reach the required profit levels in the following year and
payment would be required. Based on the expectation of profitability in each
subsequent year, the accrued amount has remained classified as a current
liability. In 1998, the Company received, and currently still owns, a 10% interest in
Lightrays. Management believes that the Companys interest in Lightrays has no
value and, as such, no asset has been recorded. Robert Buie, the current general partner of Lightrays, became a member of
the Board as stipulated in the amended agreement in April 1998. He is also a
shareholder. On December 3, 2004, Lightrays and the Company came to an agreement where
the $400,000 liability will be satisfied through the issuance of 97,000 shares
of the Companys common stock, Xenonics 10% ownership in Lightrays was
returned and the patent was assigned to Xenonics Holdings, Inc. The Company
has not used, and is not currently using, the patented technology licensed from
Lightrays.  8.
    
    SHAREHOLDERS EQUITY The Company has two classes of stock as described below. There is no
cumulative voting by shareholders and no preemptive rights. Each shareholder
is entitled to have one vote for each share of stock held. F-14




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##### Table of Contents



Preferred Stock- During 2000, Xenonics sold 138,889 shares of Series A preferred stock to
an investor for $250 in cash. In connection with the reorganization (Note 1,
Operations and Other Organizational Matters), the Series A preferred stock was
converted into Xenonics common stock and then exchanged for common stock of
Holdings. Common Stock- In March of 2004, the Company completed an offering of its common stock at
$2.50 per share. The Company issued a total of 600,000 shares of common stock
which yielded proceeds of $1,500. In March of 2004, the Company entered into a consulting agreement, as
amended, with Bryant Park Capital, Inc. (BPC). In connection with this
agreement the Company issued 20,000 shares of common stock valued at $50, and
agreed to pay a monthly fee of $10. One of the principles of BPC is the son of
the Companys Chief Executive Officer. During the year ended September 30, 2004, the Company paid BPC $176
including the fees for the private placement. In April of 2004, the Company raised $850 through the sale of units in a
private placement. Each unit was sold for $17.00 and consisted of 4 shares of
common stock and 1 warrant. Each warrant entitles the registered warrant
holder to purchase one share of common stock at an initial exercise price of
$8.00 per share (subject to adjustment for stock splits, combination and
reclassification) at any time prior to April of 2009. In accordance with the
BPC consulting agreement, the Company was permitted to reduce the transaction
fees in connection with this offering for the 20,000 shares discussed above and
monthly payments of $40. During the nine-month period ended September 30, 2003, common stock shares
outstanding increased by 8,019,437, as follows: In July 2003, Xenonics issued 361,484 shares of common stock at $0.75 per
share to certain employees, stockholders, directors, and consultants. In
addition, accrued interest of $12 was converted to Xenonics common stock at
$0.75 per share in March 2003. In July 2003, notes payable and accrued interest totaling $2,028 and $422,
respectively, were converted to Xenonics common stock at $0.75 per share in
anticipation of the reorganization (See Note 1, Operations and Other
Organizational Matters). In connection with the reorganization (Note 1, Operations and Other
Organizational Matters), Holdings issued 8,750,000 shares of common stock for
100% of Xenonics. Holdings also issued 1,459,652 shares of common stock, in
private placement for gross proceeds of $1,277, less issue costs of $123. In
addition, 82,000 shares of common stock were issued to the bridge investors of
Xenonics and Holdings historical stockholder maintained 2,500,000 shares. F-15




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##### Table of Contents



9.
    
    INCOME TAXES The provision for income taxes is summarized below (in thousands) : Nine-monthYear ended
    
    period endedSeptember 30,
    
    September 30,2004
    
    2003Current provision:State
    
    $
    158
    
    
    $
    1$
    158
    
    
    $
    1
 The principal components of
deferred tax assets,
liabilities and the valuation
allowance are as follows (in thousands): September 30, 2004
    
    September 30, 2003Accrued interest
    
    $
    
    
    
    $
    37Accrued consulting
    
    
    
    
    
    
    Accrued royalties
    
    
    159
    
    
    
    159Stock compensation expense
    
    
    259
    
    
    
    204Other
    
    
    22
    
    
    
    23Net operating loss carryforwards
    
    
    1,805
    
    
    
    2,4602,242
    
    
    
    2,883Valuation allowance
    
    
    (2,234
    )
    
    
    (2,883
    )Total deferred tax assets
    
    $
    8
    
    
    $
    Excess of book over tax basis
of equipment furniture and
fixtures
    
    
    8
    
    
    
    Net deferred
tax asset
    
    $
    
    
    
    
    
 As of September 30, 2004, the Company had federal and state net operating
loss carryforwards (NOLs) of $4,890 and $2,453, respectively, which begin to
expire in 2012 for federal tax purposes and 2010 for state purposes. A
valuation allowance of $(2,234) has been recorded to offset the federal and
state net operating losses since the realization of these assets is uncertain.
Some of these carry forward benefits may be subjected to limitations imposed by
the Internal Revenue Code. Except to the extent of the valuation allowance
that has been established, the Company believes these limitations will not
prevent the carry forward benefits from being realized. The valuation allowance decreased by $649 for the year ended September 30,
2004 and increased by $623 during the nine-month period ended September 30,
2003. The reconciliation of the federal statutory income
tax rate to the effective tax rate is as follows: Nine-monthYear ended
    
    period endedSeptember 30,
    
    September 30,2004
    
    2003Federal statutory rate
    
    
    34.0
    %
    
    
    34.0
    %State income taxes, net of federal income tax benefit
    
    
    5.8
    %
    
    
    5.8
    %Permanent differences
    
    
    3.7
    %
    
    
    (6.7
    %)Change in valuation allowance
    
    
    (34
    %)
    
    
    (31.7
    %)Utilization of NOLs
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    (1.5
    %)9.5
    %
    
    
    (0.1
    %)
 F-16




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##### Table of Contents



10.SIGNIFICANT CONTRACTS During the year ended September 30, 2004, the Company received purchase
orders from the U.S. Army of approximately $7,900. Revenue recognized under
these purchase orders for the twelve months ended September 30, 2004 amounted
to approximately $7,900. In September of 2003, the Company received purchase orders from the US
Border Patrol for NightHunter and NightHunterII searchlights. The total value
of these purchase orders is approximately $520. Recognized revenue related to
this order totaled $475 in the year ended September 30, 2004. There were no
accounts receivable at September 30, 2004 related to this contract. In
March of 2003, the US Army Communications - Electronics Command
(CECOM), Fort Monmouth, NJ announced the award of a $2.98 million firm fixed
price contract to the Company. In the year ended September 30, 2004, revenue
was $1,802. There were no accounts receivable at September 30, 2004 related to
this contract. In addition, $1.1 million of revenue was recognized in the
nine-month period ending September 30, 2003.  11.
    
    SAVINGS PLAN On July 1, 2004, the Company implemented a 401(k) Savings Plan (the
Savings Plan) which covers all eligible employees. Participants may
contribute no less than 1% and up to the maximum allowable per the Internal
Revenue Service regulations. In addition, the Company may make discretionary
contributions to the Savings Plan, subject to certain limitations. For the
year ended September 30, 3004, the Company made no matching contributions.  12.
    
    COMMITMENTS AND CONTINGENCIES Leases- The Company leases its facility under a noncancelable operating
lease through October 2008. The agreement requires that the Company pay a
pro-rata share of all operating expenses including, but not limited to, real
estate taxes, common area maintenance and utilities. The Company also leases
office equipment under noncancelable operating leases. Rent expense under
these leases totaled $145 and $100 for the year ended September 30, 2004 and
the nine-month period ended September 30, 2003, respectively. Minimum future obligations for these leases total $104, $107, $108, $110
and $9 for the years ending September 30, 2005, 2006, 2007, 2008 and 2009,
respectively. Purchase
Agreement with PerkinElmer, Inc. -In January 2003, the Company
entered into a three-year exclusive manufacturing agreement with PerkinElmer,
Inc. (PE) for the manufacture of one of its major products. PE has agreed to
manufacture the ordered product in accordance with the Companys specifications
and under price terms, quality control and workmanship standards as set out in
the agreement. F-17




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##### Table of Contents



Consulting Agreement- In November 2002, the Company entered in a one-year
agreement with Colex and Associates, Inc. to provide various consulting
services. The contract was extended for an additional year in November 2003.
The agreement requires the Company to pay a monthly fee of $16. In July 2002,
100,000 stock warrants with an exercise price of $0.825 were issued to a
principal of the consulting firm. Employment
Agreements -In July 2003, two of the Companys Chief Executive
Officer and Chief Operating Officer, who are also stockholders and directors in
the Company, entered into employment agreements retroactive to January 1, 2003.
The Company compensated its Chief Executive Officer, who is also the Chairman
of the Board and a stockholder, noteholder and director. One agreement is for the two years ended December 31, 2004, while the
other was for the twelve months ended December 31, 2003. Both agreements
provide for base compensation of $180 per year and are automatically renewed
annually with increases tied to CPI. In addition, should one of the officers
be terminated other than for cause, both agreements include severance packages
that require the Company to pay any remaining compensation through the term of
the agreement and provide for liquidating damages of an additional amount equal
to the remaining compensation through the term of the agreement. Litigation- The Company is involved in legal actions arising in the
normal course of business. After taking into consideration legal counsels
evaluation of such actions, management is of the opinion that their outcome
will not have a significant effect on the Companys financial position or
results of operations. A vendor filed a complaint against the Company on December 31, 2003 in the
amount of $201. The complaint amount includes $20 of accounts payable which
is not disputed and has been included in accounts payable since early 2002 when
the invoices were received and recorded. The Company settled this complaint in
September of 2004 for $39. On July 2, 2004, we filed a complaint for cancellation of a stock
certificate and rescission of a contract against a former officer, director and
consultant and a company purportedly owned by such individual in the Superior
Court of California, County of San Diego. The suit alleges a failure to
perform contractual obligations under a written contract to provide lighting
equipment valued at $250 to our subsidiary, Xenonics, Inc., in exchange for
250,000 shares of Xenonics, Inc.s common stock. We allege that the stock
certificate is void or voidable. In our complaint, we requested that i) the
250,000 shares be declared void or the defendants be ordered to pay us $1,250,
or the current value of the 250,000 shares of our common stock plus interest at
the rate of 10% per year. We have also asked the court to award us costs of
the lawsuit. The foregoing 250,000 shares are currently treated as outstanding
shares for all purposes, including the financial statements. An answer to our complaint was filed on August 11, 2004 in which the
defendants denied our allegations, and asserted a number of affirmative
defenses. On the same day, a cross complaint was also filed against us and our
subsidiary, Xenonics, Inc. The cross complaint asks the court to (i) rescind
the assignment of the NightHunterII patent application that one of the
defendants assigned to us in November 2003, (ii) declare that one of the
defendants is the sole owner of the NightHunterII patent application and that
he is the inventor of an unrelated xenon illumination and television camera
system, (iii) enjoin us form further exploitation of the NightHunterII and the
xenon illumination and television camera system, and (iv) account for all
profits that we have earned on the NightHunterII from November 25, 2003. The
defendant alleges that we purportedly have not provided the agreed upon
consideration for assignment of the NightHunterII patent application, and that
we have not recognized the defendant as the inventor of the xenon illumination
and television F-18




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##### Table of Contents



camera system. This matter is in the discovery stage and at the present
time the Company, based on advice of counsel, cannot reasonably assess the
ultimate outcome.  13.
    
    STOCK OPTIONS AND WARRANTS The Company accounts for stock-based instruments using the fair-value
method. Compensation cost for stock options, if any, is measured as the excess
of the fair market value of the Companys stock at the date of grant over the
exercise price the recipient must pay to acquire the stock. The fair value of
warrants is determined based on the fair market value of the warrant at the
date of issuance over the conversion price the recipient must pay to acquire
the stock. The fair value of stock-based instruments is calculated through the
use of an option pricing model. 1998
Stock Option Plan -In December 1998, the Board of Directors (the
Board) of Xenonics formed a stock option plan (the 1998 Option Plan). Under
the 1998 Option Plan, options to purchase up to 1,500,000 shares of common
stock of Xenonics were available for employees, directors, and outside
consultants. The 1998 Option Plan was administered by the Board of Xenonics.
The options outstanding under the 1998 Option Plan had seven-year terms, were
nontransferable and vested one-third upon grant, one-third after one year, and
one-third after two years. On October 24, 2001, the exercise price of all outstanding Xenonics
options was reduced from $1.00 per share to $0.25 per share. As such, Xenonics
exchanged all of its outstanding options, which had an exercise price of $1.00
per share, for an equivalent number of new options with an exercise price of
$0.25 per share. The difference between the new exercise price of $0.25 and
the deemed fair value of Xenonics common stock on the date the options were
exchanged of $0.50 resulted in a charge of $203 that was amortized over the
vesting period. As a result, the Company recognized noncash charges
of $38 for the period ended September 30, 2003. 2003 Stock Option Plan- In July 2003, the Board of the Company formed a
new stock option plan (2003 Option Plan) in connection with the reorganization
(Note 1, Operations and Other Organizational Matters). Under the 2003 Option
Plan, options to purchase up to 1,500,000 shares of common stock are available
for employees, directors, and outside consultants. The 2003 Option Plan is
administered by the Board and effectively replaced the 1998 Option Plan. Each
option is exercisable as set forth in the documents evidencing the option,
however, no option shall have a term in excess of ten years from the grant
date. Options outstanding under the 2003 Option Plan vest under one of the
following three scenarios: immediately; one-third upon grant, one-third after
one year and one-third after two years; or one-third after one year, one-third
after two years and one-third after three years. In connection with its reorganization (Note 1, Operations and Other
Organizational Matters), the Company issued an equivalent number of options,
750,000, under the 2003 Option Plan for all of the outstanding options under
the Xenonics 1998 Option Plan. The replacement options were similar, however,
changes in the option price, life and vesting from the original options caused
them to be revalued in July 2003. As such, additional compensation of $314
was recognized for the re-issuance of such options in the nine-month period
ended September 30, 2003. As of September 30, 2004, there were 640,000 of these
options outstanding. The decrease is related to the exercise of 10,000 options
and 100,000 options which were forfeited, both in the year ended September 30,
2004. F-19




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##### Table of Contents



In July 2003, the Company issued 600,000 new stock options under the 2003
Option Plan. The fair value of each option was estimated on the date of
issuance using the Black-Scholes option-pricing model, with the following
weighted-average assumptions: dividend yield of 0%; expected volatility of 0%;
risk-free interest rate of 2.25%; and expected lives of five years from the
date of grant. The Company recorded noncash compensation expense totaling $23
during the period ended September 30, 2003. As of September 30, 2004, there were 450,000 options outstanding from the
original 600,000 options granted under this plan. The decrease is due to the
forfeiture of 150,000 options. During the year ended September 30, 2004, the Company granted 155,000
options under the 2003 Option Plan in a series of issuances. Included in these
grants were 70,000 options at $2.85 per share, 30,000 options at $6.00 per
share, 30,000 options at $5.75 per share, and 25,000 options at $3.50 per
share. The fair value of the options granted during the year ended September
30, 2004, was estimated on the date of grant using the Black-Scholes option
pricing model, with the following weighted average assumptions: dividend yield
of 0%, expected volatility of 65%, risk-free interest rates ranging from 2.36%
to 4.37%, and expected lives ranging from three to seven years from the date of
grant. Included in the options granted during the year ended September 30,
2004, were a total of 30,000 options to purchase shares of common stock at
$5.75 per share to Messrs. Naughton and Rodstein each for director
compensation. During the year ended September 30, 2004, the Company recorded
compensation expense relating to stock options of $185. Lastly, options for 10,000 shares were exercised during the year ended
September 30, 2004. A summary of the Companys stock option activity and related information is as
follows (options in thousands): Nine-monthYear ended
    
    
    
    
    
    period endedSeptember 30,
    
    
    
    
    
    September 30,2004
    
    
    
    
    
    2003Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    AverageOptions
    
    Exercise Price
    
    Options
    
    Exercise PriceOutstanding-beginning of period
    
    
    1,250
    
    
    $
    0.500
    
    
    
    750
    
    
    $
    0.250Granted
    
    
    155
    
    
    $
    4.126
    
    
    
    600
    
    
    $
    0.875Exercised
    
    
    (10
    )
    
    $
    0.250
    
    
    
    Forfeited
    
    
    (150
    )
    
    $
    0.458
    
    
    
    (100
    )
    
    $
    0.875Outstanding-end of period
    
    
    1,245
    
    
    $
    0.958
    
    
    
    1,250
    
    
    $
    0.500Exercisable at end of period
    
    
    963
    
    
    $
    0.508
    
    
    
    917
    
    
    $
    0.364Weighted-average fair value of options
granted during the period
    
    
    
    
    
    $
    4.126
    
    
    
    
    
    
    $
    0.875
 F-20




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##### Table of Contents



The following table summarizes information concerning currently outstanding and
exercisable stock options as of September 30, 2004 (number outstanding in
thousands): Options Outstanding
    
    Options Exercisableat September 30, 2004
    
    at September 30, 2004WeightedAverage
    
    Weighted-
    
    
    
    
    
    Weighted-Range of
    
    
    
    
    
    Remaining
    
    Average
    
    Number
    
    AverageExercise
    
    Number
    
    Contractual
    
    Exercise
    
    Vested and
    
    ExercisePrices
    
    Outstanding
    
    Life (Years)
    
    Price
    
    Exercisable
    
    Price$0.250
    
    
    640
    
    
    
    3.81
    
    
    $
    0.250
    
    
    
    640
    
    
    $
    0.250$0.875
    
    
    450
    
    
    
    8.82
    
    
    $
    0.875
    
    
    
    300
    
    
    $
    0.875$2.850
    
    
    70
    
    
    
    4.08
    
    
    $
    2.850
    
    
    
    23
    
    
    $
    2.850$3.500
    
    
    25
    
    
    
    4.86
    
    
    $
    3.500
    
    
    
    
    
    
    $
    3.500$5.750
    
    
    30
    
    
    
    9.64
    
    
    $
    5.750
    
    
    
    
    
    
    $
    5.750$6.000
    
    
    30
    
    
    
    4.18
    
    
    $
    6.000
    
    
    
    
    
    
    $
    6.0001,245
    
    
    
    5.81
    
    
    $
    0.958
    
    
    
    963
    
    
    $
    0.508
 Stock
Warrants -The Company, from time to time, has issued common stock
purchase warrants to employees, directors, stockholders and others. The
warrants are nontransferable and are exercisable at any time after the date of
issuance and on or before their respective expiration date, which is generally
five years. In February 2003, 250,000 warrants were issued at $0.60 in consideration
for a convertible note payable (Note 6, Notes Payable). No expense was
recognized during the period ended September 30, 2003, as the price of the
warrants issued was higher than the deemed fair-value of the Companys stock at
the various issue dates. In connection with its reorganization (Note 1, Operations and Other
Organizational Matters), the Company offered to issue replacement warrants on a
one-for-one basis for all of the outstanding warrants of Xenonics. All
outstanding warrants, except for 135,000 held by one individual, were exchanged
for new, fully-vested 5-year warrants at new conversion prices ranging from
$0.60 to $0.825. The Company recognized interest expense of $206 in connection
with the re-issuance. Subsequent to the reorganization, the Company issued 173,965 fully-vested,
five-year warrants with a conversion price of $0.875 for services related to
the private placement (Note 1, Operations and Other Organizational Matters) and
general consulting services. The fair value of each warrant was estimated on
the date of issuance using the Black-Scholes option-pricing model, with the
following weighted-average assumptions: dividend yield of 0%; expected
volatility of 0%; risk-free interest rate of 2.25%; and expected lives of five
years from the date of grant. In April 2004, 6,500 warrants were converted to common stock at $0.825 per
share. In July 2004, the Company issued 25,000 warrants to Neil G. Berkman
Associates at an exercise price of $5.05 for services rendered. The issuance
of these warrants resulted in a charge to operations of approximately $57,
based on the fair value of the warrants. The fair value of these warrants was
estimated using the Black-Scholes pricing model with the following assumptions:
interest rate of 3.08%, dividend yield of 0%, volatility factor of .65 and the
average expected life of three years. F-21




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##### Table of Contents



In July, 5,000 warrants were converted to common stock at $0.60 per share. A summary of the Companys warrant activity is as follows: Nine-monthYear ended
    
    
    
    
    
    period endedSeptember 30,
    
    
    
    
    
    September 30,2004
    
    
    
    
    
    2003Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    AverageWarrants (in thousands):
    
    Warrants
    
    Exercise Price
    
    Warrants
    
    Exercise PriceOutstanding-beginning of period
    
    
    2,459
    
    
    $
    0.698
    
    
    
    2,170
    
    
    $
    0.493Issued (prior to
reorganization)
    
    
    
    
    
    
    
    
    
    
    250
    
    
    $
    0.600Exchanged
    
    
    
    
    
    
    
    
    
    
    (2,035
    )
    
    $
    0.507Not exchanged (retained
in Xenonics)
    
    
    
    
    
    
    
    
    
    
    (135
    )
    
    $
    0.275Re-issued
    
    
    
    
    
    
    
    
    
    
    2,035
    
    
    $
    0.695Issued
    
    
    75
    
    
    $
    7.017
    
    
    
    174
    
    
    $
    0.875Exercised
    
    
    (12
    )
    
    $
    0.727
    
    
    
    
    
    
    
    Outstanding-end of period
    
    
    2,522
    
    
    $
    0.905
    
    
    
    2,459
    
    
    $
    0.698
 The following table summarizes information concerning currently outstanding and
exercisable warrants as of September 30, 2004 (in thousands): Warrants Outstanding and Exercisableat September 30, 2004WeightedNumber
    
    Average
    
    Weighted-Range of
    
    Outstanding,
    
    Remaining
    
    AverageExercise
    
    Vested and
    
    Contractual
    
    ExercisePrices
    
    Exercisable
    
    Life (Years)
    
    Price$0.600
    
    
    1,210
    
    
    
    3.79
    
    
    $
    0.600$0.825
    
    
    1,063
    
    
    
    3.79
    
    
    $
    0.825$0.875
    
    
    174
    
    
    
    3.83
    
    
    $
    0.875$5.050
    
    
    25
    
    
    
    4.75
    
    
    $
    5.050$8.000
    
    
    50
    
    
    
    4.57
    
    
    $
    8.0002,522
    
    
    
    3.81
    
    
    $
    0.905
 All such warrants were vested and exercisable as of September 30, 2004.  14.
    
    SUBSEQUENT EVENTS In
October 2004, the Company granted 230,000 options to purchase shares
of common stock at $3.75 to existing employees. Also, in October 2004, the Company granted 15,000 options to purchase
shares of common stock at $3.75 to a new employee. F-22




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##### Table of Contents



ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE Effective October 1, 2004, the Audit Committee of our Board of Directors
approved a change in auditors. The Audit Committee also approved the dismissal
of Windes & McClaughry Accountancy Corporation (Windes) as our independent
public accountants and the selection of Eisner, LLP as their replacement. Windes report on the financial statements of Xenonics Holdings, Inc. for
the last fiscal year (9 month period) ended September 30, 2003 and prior fiscal
year ended December 31, 2002, did not contain any adverse opinion or disclaimer
of opinion nor were such reports qualified or modified as to uncertainty, audit
scope or accounting principles. During our two most recent fiscal years ended September 30, 2003 and
December 31, 2002 and the subsequent interim periods through September 30,
2003, there were no disagreements with Windes on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure that, if not resolved to the satisfaction of Windes would have caused
Windes to make reference to the subject matter of the disagreements in
connection with its report. During that time, there were no reportable events
as described in Item 304(a)(1) of Regulation S-B, except for the reportable
condition discussed below. In January 2004, in connection with the audit of our financial statements
for the nine-month period ended September 30, 2003, Windes informed the Board
of Directors and management that the lack of segregation of certain duties was
a reportable condition and that we needed to improve our segregation of duties
in certain areas. Windes rendered an unqualified report on our financial
statements. We have corrected the segregation of duties issues by segregating a number
of duties within the internal accounting controls. The Board of Directors, in
coordination with our Audit Committee, continually assesses the progress and
sufficiency of the companys procedures and makes adjustments, if necessary.
While we believe that our current procedures have remedied the reportable
condition in its internal accounting control as described above, a control
system, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the control system are met, and no evaluation
of controls can provide absolute assurance that all control issues have been
detected. During fiscal years ended September 30, 2003 and December 31, 2002 and
through the subsequent interim period preceding the change, Xenonics Holdings,
Inc. did not consult with Eisner, LLP regarding any of the matters specified in
Item 304(a)(2) of Regulation S-B. 
 ITEM 8A. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms and that such
information is accumulated and communicated to this companys management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired
control objectives, and management is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures. ii




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As required by Securities and Exchange Commission Rule 13a-15(b), we
carried out an evaluation, under the supervision and with the participation of
the Companys management, including our Chief Executive Officer and the
Companys Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the
quarter covered by this report. Based on the foregoing, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures are effective to ensure the information required to be disclosed by
in our reports filed or submitted under the Exchange Act were timely recorded,
processed and will in the future be reported within the time periods specified
in the Securities and Exchange Commission rules and forms. There has been no change in our internal controls over financial reporting
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting. 
 ITEM 8B. OTHER INFORMATION None. iii




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PART III 
 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The information required is incorporated herein by reference to the
issuers definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders. 
 ITEM 10. EXECUTIVE COMPENSATION The information required is incorporated herein by reference to the
issuers definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders. 
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS The information required is incorporated herein by reference to the
issuers definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required is incorporated herein by reference to the
issuers definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders. iv




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ITEM 13. EXHIBITS ExhibitNumber
    
    Description2.1
    
    Agreement and Plan of Reorganization Among Xenonics, Inc. and Digital Home
Theater Systems, Inc., dated July 24, 2003.(1)3.1
    
    Articles of Incorporation of Digital Home Theater Systems, Inc, dated as of
October 15, 1997.(1)3.2
    
    Certificate of Amendment of Articles of Incorporation of Digital Home Theater
Systems, Inc., dated as of July 23, 2003.(1)3.3
    
    Bylaws of Xenonics Holdings, Inc. (formerly known as Digital Home Theater
Systems, Inc.).(1)4.1
    
    Specimen Stock Certificate.(1)4.2
    
    Form of outstanding Warrant Certificate of Xenonics Holdings, Inc.(1)4.3
    
    Form of Participating Dealers Warrant Agreement, entered into by Xenonics
Holdings, Inc. and certain participating broker-dealers, on July 23, 2003.(1)4.4
    
    Form of Warrant to Purchase Common Stock of Xenonics Holdings, Inc., dated
April 26, 2004, issued to White Rock Capital Partners, L.P. (1)4.5
    
    Form of Warrant to Purchase Common Stock of Xenonics Holdings, Inc., dated
April 26, 2004, issued to Texrock, Ltd. (1)4.6
    
    Engagement letter, dated March 1, 2004, as amended by letters dated April 12,
2004 and May 18, 2004, between Bryant Park Capital and Xenonics Holdings, Inc.
(1)4.7
    
    Warrant Certificate, dated July 1, 2004, for the purchase of 25,000 shares of
Xenonics Holdings, Inc. common stock, issued to Neil G. Berkman Associates(1)5.1
    
    Opinion of counsel as to legality of securities being registered. (1)10.1
    
    Form of Indemnification Agreement entered into between Xenonics Holdings, Inc.
and its directors and certain officers.(1)10.2
    
    Form of Stock Purchase Agreement entered into by Xenonics Holdings, Inc. and
certain investors in March 2004 in connection with the purchase of common
stock (which agreement contains the terms of the registration rights).(1)10.3
    
    Lease between Xenonics, Inc. and SM/CT Partners, L.P. dated August 16, 2000.(1)10.4
    
    2003 Stock Option Plan of Xenonics Holdings, Inc.(1)10.5
    
    Employment Agreement between Xenonics, Inc. and Alan P. Magerman, dated
January 1, 2003.(1)10.6
    
    Employment Agreement between Xenonics, Inc. and Jeffrey Kennedy, dated January
1, 2003.(1)10.7
    
    PerkinElmer Manufacturing Terms and Conditions Agreement, dated January 6,
2003, between Xenonics, Inc. and PerkinElmer Electronics, Inc.(1)*
 v




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ExhibitNumber
    
    Description10.8
    
    Form of Common Stock And Warrant Purchase Agreement entered into by Xenonics
Holdings, Inc. and White Rock Capital Partners, L.P. and Texrock, Ltd. in
April 2004 in connection with the purchase of common stock and warrants (which
agreement contains the terms of the registration rights).(1)10.9
    
    Agreement For The License and Transfer of Intellectual Property Rights From
Lightrays, Ltd. to Xenonics, Inc., March 27, 1997.(1)10.10
    
    Amendment to Agreement For The License and Transfer of Intellectual Property
Rights. dated April 23, 1998.(1)10.11
    
    1st Amendment to Lease Agreement, dated July 21, 2004, Bay West Equities
Carlsbad Research Center, LLC and the Xenonics, Inc.(1)10.12
    
    Settlement Agreement and Mutual Release among Xenonics Holdings, Inc.,
Xenonics, Inc. and Lightrays, Ltd. (2)21.1
    
    List of subsidiaries of Xenonics Holdings, Inc.(1)31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act31.2
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act32
    
    Certifications pursuant to Section 906 of the Sarbanes-Oxley Act
   *
    
    The Commission has granted confidential treatment to selection portions
of this document. (1) Incorporated by reference to our Registration Statement on Form SB-2
(File No. 333-115324) originally filed with the Commission on May 10, 2004,
and subsequently amended by the amended Registration Statements on Form SB-2/A
filed with the Commission on June 30, 2004, August 16, 2004, September 2, 2004,
and September 21, 2004. (2) Incorporated by reference to our Current Report on Form 8-K filed with
the Commission on December 8, 2004 
 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information required is incorporated herein by reference to the
issuers definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders. vi




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SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the
Company caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized. Xenonics Holdings, Inc.
    
    By:
    
    /s/ Alan P. MagermanDate:
December 21, 2004
    
    
    
    Alan P. MagermanChief Executive Officer
 Pursuant to the requirements of the Securities Act of 1934, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ Alan P. Magerman

Alan P. Magerman
    
    Chief Executive Officer, and
Chairman (Principal Executive
Officer)
    
    December 21, 2004/s/ Jeffrey P. Kennedy

Jeffrey P. Kennedy
    
    Chief Operating Officer and
PresidentDirector
    
    December 21, 2004/s/ Donna G. Lee

Donna G. Lee
    
    Chief Financial Officer (Principal
Financial Officer and Principal
Accounting Officer)
    
    December 21, 2004/s/ Richard Rodstein

Richard Rodstein
    
    Director
    
    December 21, 2004/s/ Richard Naughton

Richard Naughton
    
    Director
    
    December 21, 2004/s/ Michael L. Magerman

Michael L. Magerman
    
    Director
    
    December 21, 2004Robert Buie
    
    Director
    
    December   , 2004/s/ Eli Shapiro

Eli Shapiro
    
    Director
    
    December 21, 2004
 vii