10-Q 1 form10qfor033102.txt FORM10QFOR033102 U.S. Securities and Exchange Commission Washington, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended March 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _______ to _______ COMMISSION FILE NUMBER 0-28348 DBS INDUSTRIES, INC. (Exact name of small business issuer as specified in its charter) Delaware 84-1124675 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 100 Shoreline Highway, Suite 190A Mill Valley, CA 94941 (Address of principal executive offices) (415) 380-8055 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Securities: Common Stock, $.0004 Par Value Shares Outstanding as of May 31, 2002: 33,465,653 Transitional Small Business Disclosure Format: Yes: ___ No X ----- INDEX PAGE PART I - FINANCIAL INFORMATION................................................1 ITEM 1. Financial Statements.................................................1 Condensed Consolidated Balance Sheets (unaudited): As of March 31, 2002 and December 31, 2001....................................1 Condensed Consolidated Statements of Operations (unaudited): For the Three Months Ended March 31, 2002 and March 31, 2001 and for the period from April 25, 1990 (Inception) to March 31, 2002..........2 Condensed Consolidated Statements of Cash Flows (unaudited): For the Three Months Ended March 31, 2002 and March 31, 2001 and for the period from April 25, 1990 (Inception) to March 31, 2002 .........3 Notes to Condensed Consolidated Financial Statements.......................4-12 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................13-21 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings...................................................22 ITEM 4. Submission of Matters to a Vote of Security Holders.................24 ITEM 6. Exhibits and Reports on Form 8-K............... ....................24 The accompanying notes are an integral part of these condensed consolidated financial statements. PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DBS INDUSTRIES, INC. AND SUBSIDIARIES (A Development Stage Company) CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

DBS INDUSTRIES, INC. AND SUBSIDIARIES (A Development Stage Company) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

DBS INDUSTRIES, INC. AND SUBSIDIARIES (A Development Stage Company) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

NOTE 1 UNAUDITED INTERIM FINANCIAL STATEMENTS The information presented in these condensed consolidated financial statements of DBS Industries, Inc. (DBSI or the Company), its wholly owned subsidiaries, Global Energy Metering Services, Inc. and Newstar Limited, and its majority owned subsidiary, E-SAT, Inc. (collectively, the subsidiaries), is unaudited. The condensed consolidated financial statements include all adjustments consisting of only normal recurring adjustments which are, in the opinion of management, necessary to present fairly the condensed consolidated financial position of DBSI at March 31, 2002 and the condensed consolidated results of operations and cash flows for the interim periods reported. The results of operations for the 2002 interim period presented are not necessarily indicative of expected results for the full 2002 fiscal year. The Company was organized as a Delaware corporation on August 3, 1989. Since inception the Company has been in the development stage. The Company's current business plan is to develop a data communication service using a constellation of low earth orbit satellites and the Internet. The Company's financial statements have been prepared assuming the Company will continue as a going concern. Since inception, the Company has devoted substantially all of its efforts to developing its business. The Company has therefore incurred substantial losses and negative cash flows from operating activities as reflected in these condensed consolidated financial statements. Accordingly, the Company has relied primarily upon obtaining equity capital and debt financing to support its operations. The Company does not expect revenue to exceed costs and expenses in 2002 and, accordingly, will continue to incur losses and negative cash flows from operating activities. To address financing needs, the Company is pursuing various financing alternatives. These circumstances raise substantial doubt about the Company's ability to continue as a going concern. These condensed consolidated financial statements do not reflect any adjustments that might result from the outcome of the above uncertainty. During fiscal 2001, the Company raised approximately $2.5 million, net of stock issuance costs, from warrant exercises, issuance of debentures, and sale of shares of common and preferred stock. However, the Company will need substantial additional capital, at least $60 million, to construct its proposed E-SAT satellite constellation. Such financing is likely to result in a significant dilution in the equity interests of the current stockholders. The construction of the first two of the six planned satellites was required to be completed by March 2002 pursuant to the terms of the Federal Communications Commission (the FCC) license granted to E-SAT. (See Note 3 - "License Costs".) On March 29, 2002, the Company notified the FCC that it has not achieved this milestone and requested a two-year extension. On May 23, 2002, the Company entered into a contract with an agency of the State of California. (See Note 8 - "Subsequent Events".) The Company believes the implementation of this contract, if successful, would provide a portion, but not all, of the funding for the further development of the E-SAT system. However, there is no assurance that the Company will be able to successfully finance and implement this contract. Certain information and footnote disclosures normally contained in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The condensed consolidated financial statements should be read in conjunction with the financial statements and notes contained in DBSI's 2001 Annual Report on Form 10-K. NOTE 2 LICENSE COSTS In October 1994, the Company and EchoStar formed E-SAT, Inc. (E-SAT) for the purpose of filing with the FCC for a license to operate a low earth orbit satellite system. E-SAT filed with the FCC on November 16, 1994. The Company holds an 80.1% interest in E-SAT. The Company's total investments in, and advances to, E-SAT as of March 31, 2002 were $851,490. The investment is accounted for using the equity method. On March 31, 1998, the FCC approved E-SAT's application for a low earth orbit satellite license. E-SAT is required to meet certain milestones and other covenants in order to maintain its license. On April 8, 1999, the Company notified the FCC that it had entered into a construction contract for the first two satellites of the E-SAT system on March 31, 1999. On July 30, 1999, the Company entered into an agreement with EchoStar under which it received 60.1% of E-SAT's shares from EchoStar in exchange for consideration, including the grant of rights to use up to 20% of the satellite capacity of the E-SAT system by EchoStar. As a result of this transaction, which was subsequently approved by the FCC, the Company now owns 80.1% of the E-SAT shares. In connection with the negotiations of the share purchase agreement with EchoStar, the Company paid $1,517,187 to a consultant during 1999 and capitalized such costs in the E-SAT investment account. NOTE 3 LICENSE AND SATELLITE CONSTRUCTION COSTS During the construction of its satellite system, the Company is capitalizing all license, design, engineering, launch and construction costs. Such costs amounted to approximately $14.6 million as of March 31, 2002. Of that amount, approximately $2 million was paid to Alcatel Space Industries ("Alcatel") for preliminary engineering design review for the Company's system, including the payload design and designs for the gateway earth station and tracking facilities, as well as the satellite orbital analysis and communications link margins to and from space. On October 8, 1999, the Company signed a contract with Alcatel for the final design, construction and delivery to the launch site of six little low earth orbiting satellites. This agreement also includes the final design, construction and delivery of the ground infrastructure, including the gateway earth station, mission center, satellite control center, ground communications network and ground-based transceivers to be installed into devices, like utility meters. Alcatel is also responsible for providing in-orbit testing of the E-SAT system. The total contract price for the end-to-end system is $88.5 million. Either party has the right to terminate this agreement under certain circumstances. As noted above, the Company paid $2 million in construction payments to Alcatel for engineering specifications. The Company has not made a further payment required by the agreement with Alcatel, due at the end of 1999, of approximately $9.1 million in cash and the equivalent of $5 million in Common Stock. This payment was necessary for Alcatel to continue work and to trigger an effective date for the Company's full system development schedule. Because these services have not been performed, the Company has recorded no liability. As of March 31, 2002, this payment has not been made, and Alcatel therefore has the right to consider this contract void as to further work, and that the contract is therefore not currently in effect. If the Alcatel contract is never brought into effect, the Company retains the engineering specifications provided by Alcatel, which would still be used by the Company's other contractors in the construction of the Company's satellite network. On March 31, 1999, the Company signed construction and launch contracts with Surrey Satellite Technology Limited ("Surrey") and Eurockot, respectively, and made advance payments of $7.8 million in April 1999 and $2.0 million in July 1999. Total payments under these cancelable contracts will amount to approximately $47 million. In July 1999, the Company, Surrey and Eurockot reached agreements under which $3.2 million of the required milestone payments due in July 1999 totaling $4.8 million were deferred to yet to be agreed upon dates. Surrey's construction contract, which was to build the satellite infrastructures that would house the telecommunications payload, was to be managed by Alcatel as prime contractor, if and when the Company paid Alcatel $14.1 million to trigger the Alcatel contract effective date. As this payment has not been made, the Alcatel contract is not in effect and Surrey remains a direct contractor of the Company. In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company reviews capitalized satellite construction and FCC license costs for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. The Company's management and Audit Committee of the Board has concluded that no such events or changes in circumstances have occurred and, accordingly, it would be inappropriate to write down the capitalized satellite construction costs as impaired as of March 31, 2002. The Company evaluated a number of factors in its consideration of impairment events and changes in circumstances including: (1) whether the Company's failure to meet its FCC milestone requirements would result in termination of the license; (2) whether the assets continue to have value notwithstanding the delay since contracting; (3) whether the Company's failure to bring the Alcatel prime contract into effect prevents the Company from constructing its system; (4) whether the state of difficulties in the satellite financing capital markets were likely to prevent the Company from financing its system in the future; (5) whether the telecommunications industry had overcapacity such that there would be no business opportunity for the E-SAT system; and (6) whether the Company's implementation of an Iridium-based system effectively replaced the E-SAT system. In more detail, the Company concluded the following: a. The Company believes that its failure to meet its milestones are not likely to result in termination of the license. The Company recognizes that the loss of the FCC license held by its subsidiary E-SAT, Inc. would be a change in circumstance and that the failure to meet certain milestones could lead to a loss of the license. The Company currently lacks adequate financing and time to build and launch two low earth orbiting satellites in advance of the required FCC construction and launch dates of March 2002 and September 2002, respectively. As part of the Company's impairment analysis, the Company received a report and opinion from Leslie Taylor Associates, its regulatory counsel, that the license was likely to be extended. This opinion was based on the satellite construction progress to-date, including the launch of one satellite, and the fact that there were no other pending applicants for the spectrum covered by E-SAT's license. As recommended by Leslie Taylor Associates, on March 29, 2002, E-SAT filed the request for an extension of milestones with the FCC and is awaiting a reply. Based on these facts, the Company believes, while there is no guarantee, that the FCC will grant the extension and that it is therefore not in imminent danger of losing its FCC license but will continue to monitor the situation for any changes. b. The Company believes that its satellite construction assets continue to have value notwithstanding the delay since contracting. Included in the capitalized satellite construction costs are payments to Alcatel Space Industries, Eurockot and Surrey Satellite. The Company paid Alcatel for the production of engineering specifications and analysis which information remains the property of the Company. These specifications are an integral part of E-SAT's ability to construct the satellites and were transferred by the Company to Surrey Satellite in 2001, and will be used by Surrey in satellite construction regardless of whether the Alcatel contract is ever brought into effect. Surrey Satellite was paid for the design of the satellite ground station, among other things, which is crucial to the design of the system and remains an important element to completion of a complete satellite communication network. Eurockot was paid for the launch of the satellites and although the launch date has been extended past 2002, E-SAT's right to Eurockot's launch services remains intact. c. The Company believes that its failure to bring the Alcatel prime contract into effect does not prevent the Company from constructing its system. The Company's contract with Alcatel called for a payment by the Company at the end of 1999 that has not been paid to-date and, as a result, Alcatel has the option to terminate the contract. Alcatel has not indicated to the Company that it intends to terminate the contract, and the Company believes that Alcatel would seek to bring the contract into effect when the Company receives financing. In addition, the Company believes that alternative suitable prime contractors are currently available to manage construction as prime contractor, including Surrey Satellite, for a significantly lower cost than negotiated with Alcatel, and so the Company may not choose to reinstate the Alcatel contract. As noted above, the Company has received viable assets consisting of engineering specifications and analysis in return for the $2.1 million paid to Alcatel. d. The Company believes that the state of difficulties in the satellite financing capital markets is not likely to prevent the Company from financing its system in the future. The Company believes that satellite financing is cyclical and further that the low cost of its system, approximately $60 million, compared to other global telecommunications systems, allows it to be financed through a wide variety of sources, including customers and strategic partners. The Company believes that the primary impediment to financing is therefore a demonstration of market viability of low-earth-orbiting satellites for data communications to remote infrastructure. e. The Company believes that current telecommunications industry overcapacity does not obviate the market opportunity for the E-SAT system. The Company believes that the E-SAT system will have unique competitive advantages even if the telecommunications industry maintains a position of low per minute costs due to overcapacity. These advantages are primarily low terminal cost due to usage of low power-spread spectrum transceivers permitted by the E-SAT license, and high penetration of buildings, remote terrain and poor weather because the E-SAT license uses VHF frequencies. f. The Company believes that the Company's implementation of an Iridium-based system is not a substitute for the E-SAT system. The Company believes that the Iridium-based system, which has a higher transceiver cost and operates on the L-Band which requires line of sight, is potentially complementary to the E-SAT system with lower transceiver cost and operates on VHF frequencies which have strong building, terrain and weather penetration. The Company believes that if the funding necessary to complete the satellite network and to remain a going concern is obtained, the capitalized satellite construction costs will be recoverable from future operating cash flows. On May 23, 2002, the Company entered into a Demand Reserves Authority Provider Agreement with the California Power Authority to implement a satellite-based (using Iridium capacity) automated conservation system design to conserve significant electrical usage on demand at peak or emergency times. The Company believes that implementation of this program, if successful, would provide a portion, but not all, of the funding for the further development of the E-SAT system. There is no assurance that the Company will be able to successfully finance and implement this contract, however. Should the FCC extension request be denied, or any of the other above factors materially change, the Company may be required to record an impairment of the capitalized satellite construction costs. NOTE 4 CUSTOMER ADVANCES The Company's wholly-owned subsidiary, Global Energy Metering Services, Inc. (GEMS), is party to a contract to deliver 10,000 satellite radio units. The purchase order is for $1.2 million and under the terms of the purchase order, GEMS would receive a total of $500,000 in advance payments on the contract, based on certain milestone achievements. As of December 31, 1998, this purchase order had been suspended by both parties when the Argos System, with which the radio units communicated, became unavailable. The $400,000 in milestone payments received are reported as customer advances on the accompanying balance sheet. These milestone payments could be subject to refund in whole or in part. NOTE 5 CONVERTIBLE DEBENTURES On August 31, 2001, the Company sold to an accredited investor an aggregate of $500,000 principal amount of convertible debentures due August 31, 2006, together with warrants to purchase up to an aggregate of 250,000 shares of Common Stock of the Company at an exercise price of $1.06 per share. The Company accrues simple interest on the $500,000 at the rate of 6% per annum. As of March 31, 2002, the Company accrued $23,300 in interest expense relating to these debentures. The principal and accrued interest are convertible into shares of Common Stock of the Company at the lower of (i) a fixed conversion price equal to $.98 (maximum conversion price) or (ii) a variable conversion price equal to 85% of the market price, but in no event lower than $.21 per share (minimum conversion price). On March 8, 2002, the holder of the above Convertible Debenture converted $150,000 into 714,286 shares of Common Stock at $.21 per share and elected to receive 22,381 shares of Common Stock of the Company in lieu of accrued interest of $4,700. Emerging Issues Task Force (EITF) Issue No. 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" as clarified by EITF 00-27, "Application of Issue No. 98-5 to Certain Convertible Instruments", requires the Company to compute the Beneficial Conversion Feature (BCF) of the convertible debt. Therefore, a BCF of approximately $223,000 was recorded as a debt discount and is amortized as interest expense over the five-year life of the debenture. Additionally, the Company estimated the value of the warrant, using the Black Scholes model, at approximately $134,000 and recorded it as a debt discount. This amount will also be amortized over the five-year life of the debenture. As of March 31, 2002, the Company has recorded approximately $136,400 as interest expense relating to the amortization of the value of the warrants and BCF and the portion of the BCF and debt discount attributed to the converted debentures. NOTE 6 NET LOSS PER SHARE Basic net loss per share is computed based on the weighted average number of common shares outstanding and excludes any potentially dilutive securities. Options and warrants to purchase 31,381,225 shares of common stock with exercise prices from $0.10 to $5.60 were outstanding as of March 31, 2002 and were excluded from the net loss per share calculation for the three month period then ended as they have the effect of decreasing net loss per share. Options and warrants to purchase 9,127,286 shares of common stock with exercise prices from $0.39 to $5.60 were outstanding as of March 31, 2001 and were excluded from the net loss per share calculation for the quarter then ended as they have the effect of decreasing net loss per share. NOTE 7 EQUITY TRANSACTIONS Equity Transactions with Non-Employees On January 30, 2002, the Company granted a warrant to purchase 100,000 shares of its Common Stock to a consultant for services rendered, and to be rendered, between January 30, 2002 and July 31, 2002. The warrant is exercisable for three years from date of grant at $0.10 per share with 10,000 shares vested at the date of the grant and the remaining 90,000 vesting in increments of 15,000 each month for six months. The fair value of the vested warrants is being calculated on a monthly basis using the Black-Scholes option pricing model. As of March 31, 2002, a total of $5,240 had been recorded as consulting expense. On February 1, 2002, the Company granted a warrant to purchase 12,000 shares of its Common Stock to a consultant for services rendered. The warrant is exercisable for four years from the date of grant at $.12 per share and vests 2,000 each month for six months from the date of grant. The fair value of the vested warrants is being calculated on a monthly basis using the Black-Scholes option pricing model. As of March 31, 2002, a total of $230 had been recorded as consulting expense. On March 8, 2002, a Series A preferred stockholder converted 2,000 Series A preferred shares into 35,294 shares of Common Stock of the Company at $1.70 per share. On March 18, 2002, Series B preferred stockholders converted 24 Series B preferred shares into 375,000 shares of Common Stock of the Company at $.064 per share. The preferred stockholders elected to receive 54,286 shares of Common Stock of the Company at $.064 in lieu of accrued cash dividends of $3,474. A beneficial conversion feature of $80,000 was recorded as a preferred dividend in relation to the conversion. Equity Transactions with Employees In January 2002, the Company issued 19,565 shares of Common Stock to a director for past services on the Board. The fair value of such shares, which amounted to $9,000, was recorded as an expense. On February 5, 2002, in exchange for cancellation of loans and interest to the Company totaling $66,500, six warrants were granted to a director of the Company to purchase an aggregate of 6,650,000 shares of Common Stock of the Company at $0.10 per share. Each warrant is exercisable for a short period of time as follows: Warrant 1 for 1,100,000 shares is exercisable until March 15, 2002; Warrant 2 for 1,100,000 shares is exercisable until April 15, 2002; Warrant 3 for 1,100,000 shares is exercisable until May 15, 2002; Warrant 4 for 1,100,000 shares is exercisable until June 15, 2002; Warrant 5 for 1,100,000 shares is exercisable until July 15, 2002; and Warrant 6 for 1,150,000 shares is exercisable until August 15, 2002. If Warrants Nos. 1, 2 and/or 3 or a portion thereof are exercised prior to their expiration dates, replacement warrants to purchase the number of shares exercised, up to 1,100,000 shares, are issued and exercisable for six months from the date of each exercise at $0.10 per share. On March 7, 2002, Warrant 1 was exercised in full and the Company issued 1,100,000 restricted shares of Common Stock and a replacement warrant to purchase an additional 1,100,000 shares of Common Stock at $0.10 per share. On March 25, 2002 a portion of Warrant 2 was exercised for 50,000 shares and the Company issued 50,000 restricted shares of Common Stock and a replacement warrant to purchase an additional 50,000 shares of Common Stock at $0.10 per share. On February 5, 2002, the Company granted to a newly appointed member of the Board of Directors non-qualified options under the 2000 Stock Option Plan to purchase 13,333 shares of Common Stock exercisable for ten years at $0.10 per share. Also on February 5, 2002, a non-plan, non-qualified option to purchase 450,000 shares of Common Stock exercisable for ten years at $0.12 per share was granted to the Company's Chief Operating Officer. On March 1, 2002, the Company granted a non-plan, non-qualified option to a director to purchase 450,000 shares of its Common Stock for financial officer consulting services rendered. The fair value of such options, which amounted to $51,750, was recorded as general and administrative expense. The following variables were used to determine the fair value of such instruments under the Black-Scholes option pricing model: volatility of 122%, expected life of ten years, risk free interest of 5%, and underlying stock prices of $0.12 at the time of grant. On March 4, 2002, the Company received proceeds in a private placement of $100,000 from its Chief Executive Officer, through an affiliated business entity of that individual. Of the $100,000 proceeds, $30,000 was received by the Company in exchange for warrants to purchase an aggregate of 2,250,000 shares of Common Stock at the then current market price of $0.12 per share; and $70,000 was received by the Company upon exercise of certain of those warrants. Each of the warrants purchased is exercisable for a short period of time as follows: Warrant 1 for 416,666 shares is exercisable until April 4, 2002; Warrant 2 for 416,666 shares is exercisable until May 4, 2002; Warrant 3 for 416,667 shares is exercisable until June 4, 2002; Warrant 4 for 416,667 shares is exercisable until July 4, 2002; Warrant 5 for 416,667 shares is exercisable until August 4, 2002; and Warrant 6 for 416,667 shares is exercisable until September 4, 2002. If Warrants Nos. 1, 2 and/or 3 or a portion thereof are exercised prior to their expiration dates, replacement warrants to purchase the number of shares exercised, up to 416,666, shares are issued and exercisable for six months from the date of each exercise at $0.12 per share. Of the $100,000 proceeds, $70,000 was received from the full exercise of Warrant 1 for 416,666 shares and partial exercise of Warrant 2 for 166,667 shares. In accordance with the terms of each warrant, the Company issued 416,666 shares and 166,667 restricted shares of Common Stock of the Company, and two replacement warrants to purchase an additional 416,666 and 166,667 shares of Common Stock of the Company at $0.12 per share. On March 7, 2002, the Company received proceeds in a private placement of $200,000 from a director. Of the $200,000 proceeds, $90,000 was received by the Company in exchange for warrants to purchase an aggregate of 7,500,000 shares of Common Stock at the then current market price of $0.12 per share, and $110,000 was received by the Company in exercise of certain warrants granted on February 5, 2002. Each of the warrants purchased is exercisable for a short period of time as follows: Warrant 1 for 1,250,000 shares is exercisable until September 15, 2002; Warrant 2 for 1,250,000 shares is exercisable until October 15, 2002; Warrant 3 for 1,250,000 shares is exercisable until November 15, 2002; Warrant 4 for 1,250,000 shares is exercisable until December 15, 2002; Warrant 5 for 1,250,000 shares is exercisable until January 15, 2003; and Warrant 6 for 1,250,000 shares is exercisable until February 15, 2003. If Warrants Nos. 1, 2 and/or 3 or a portion thereof are exercised prior to their expiration dates, replacement warrants to purchase the number of shares exercised, up to 1,250,000 shares, are issued and exercisable for six months from the date of each exercise at $0.12 per share. Of the $200,000 proceeds, $110,000 was received from the full exercise of a warrant granted February 5, 2002 for 1,100,000 shares at $.10 per share. In accordance with the terms of the warrant, the Company issued 1,100,000 restricted common shares, and a replacement warrant to purchase an additional 1,100,000 shares of Common Stock at $0.10 per share. Also, pursuant to the terms of this March 7, 2002 investment, the director has a 33% anti-dilution protection through March 8, 2003, if he invests an additional $1.4 million in the Company prior to that date. Such anti-dilution protection is limited to the authorized outstanding shares of Common Stock of the Company. The warrants with reloads sold to a director and the Chief Executive Officer on February 5, 2002, March 4, 2002 and March 7, 2002 were valued by an independent valuation specialist. The fair value of the warrants was determined to be $800,628. The difference of $612,128 between the purchase price of the warrants and their fair value was recorded as general and administrative expense. NOTE 8 SUBSEQUENT EVENTS On April 15, 2002, the Company received $105,000 upon the exercise of a warrant by a director of the Company. In accordance with the terms of the warrant, the Company issued 1,050,000 restricted shares of Common Stock and a replacement warrant to purchase an additional 1,050,000 shares of Common Stock at $0.10 per share. Also on April 15, 2002, the Company received approximately $80,000 upon the exercise of warrants to purchase an aggregate of 666,666 shares held by an affiliated business entity of the Company's Chief Executive Officer. In accordance with the terms of the warrants, the Company issued 666,666 restricted shares of Common Stock and replacement warrants to purchase an additional 666,666 shares of Common Stock at $0.12 per share. On May 3, 2002, the holder of a Convertible Debenture converted the remaining balance of $350,000 into 1,169,787 shares of Common Stock at $.2992 per share and elected to receive 47,571 shares of Common Stock in lieu of accrued cash dividends of $14,233. On May 8, 2002, the Company granted a warrant to purchase 50,000 shares of its Common Stock to a consultant for services rendered. The warrant is exercisable for three years from the date of grant at $.40 per share. On May 10, 2002, the Company received approximately $200,000 upon the exercise of warrants to purchase an aggregate of 666,668 shares held by an affiliated business entity of the Company's Chief Executive Officer. On May 15, 2002, a director exercised his Warrant 3 for 1,100,000 shares. In accordance with terms of the warrant, the Company issued 1,100,000 restricted shares of Common Stock and a replacement warrant to purchase an additional 1,100,00 shares of Common Stock at $0.10 per share exercisable for six months from date of grant. On May 17, 2002, the Company granted a warrant to purchase 20,000 shares of its Common Stock to a consultant for services rendered. The warrant is exercisable for three years from the date of grant at $.42 per share. On May 23, 2002, the Company entered into a Demand Reserves Authority Provider Agreement with the California Consumer Power and Conservation Authority to Implement a satellite-based (using Iridium capacity) automated conservation system designed to conserve significant electrical usage on demand at peak or emergency time. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATONS This discussion, other than the historical financial information, may consist of forward-looking statements that involve risks and uncertainties, including quarterly and yearly fluctuations in results, the timely availability of new communication products, the impact of competitive products and services, and the other risks described in the Company's SEC reports, including this report. These forward-looking statements speak only as of the date hereof and should not be given undue reliance. Actual results may vary significantly from those projected. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. General We were formed in Delaware in 1989 and our principal executive offices are located in Mill Valley, California. We completed a share exchange reorganization with DBS Network in 1992. Since 1994, our focus has been to pursue business opportunities in satellite telecommunications. We began this pursuit originally by purchasing interests in direct broadcast satellite licensees. During 1997, we sold our last indirect interest in a direct broadcast satellite license. We formed E-SAT, Inc., a Colorado corporation, in partnership with EchoStar Communications Corp. in November 1994 for purposes of applying for a Little LEO FCC license. On March 31, 1998, the FCC issued a license to E-SAT to launch and operate a Little LEO satellite system. Pursuant to the agreement entered into with EchoStar in July 1999, we now hold 80.1% of the capital stock of E-SAT and EchoStar holds the remaining 19.9%. During the intervening years, we raised financing and began the development of a Little LEO satellite system (the "E-SAT system") to provide automated meter reading and short messaging services. We signed a contract with Eurockot for the launch of the satellites, a contract with Surrey Satellite for the development of ground stations and the satellite bus and a contract with Alcatel for the engineering and production of the satellites (this work was subsequently transferred to Surrey Satellite). However, we have been unable to secure financing to complete the launch and commercialization of the satellite system On June 2, 2001, we signed a seven-year operator-to-operator agreement with Iridium Satellite LLC to provide remote monitoring and control services to the energy industry. Through this agreement, we hope to begin providing specialized satellite-based data services using Iridium's commercially available satellite network during fiscal 2002. On June 14, 2001, we demonstrated to California state officials how a satellite-based energy control system could curtail electricity consumption by temporarily deactivating air conditioning units located on the rooftops of California shopping malls. Shortly thereafter, we commenced negotiations with the State of California to provide satellite-based energy management services. On April 12, 2002, the California Power Authority approved a Demand Reserves Program that was essentially based on our proposals, and authorized negotiations. Effective May 23, 2002, we entered into a five-year, Demand Reserves Provider Agreement with the California Power Authority. Under the agreement, we shall provide a minimum of 200 megawatts and a maximum of 360 megawatts of daily available demand reduction from qualified end users. This minimum and maximum of daily available demand reduction increases to 400 megawatts and 560 megawatts, respectively, effective June 1, 2003. We are currently seeking financing to implement and complete the engineering and deployment of the automated load curtailment system which is estimated to cost approximately $15 to $20 million over the next two years. In addition, we are in the process of signing up customers to participate in the program. We hope to begin generating revenues as early as the third quarter of fiscal 2002. Successful implementation and completion of the California Power Authority contract would also offer us a basis for offering similar services to other entities worldwide. Additionally, cash flow from such satellite-based energy management services would provide us with funds to continue the development of the E-SAT system. Until then, and on a continuing basis if we are not successful, we will seek to satisfy our short-term cash requirements by raising new equity and debt capital. Plan of Operations Bankruptcies in the satellite sector and sharp declines in telecommunications and technology sectors have impeded our financing efforts and have required us to modify our business strategy. Our current strategy is to take advantage of the telecommunications downturn to secure low-cost capacity on existing satellite systems and combine it with the energy communications technologies we have developed over the past ten years, with an objective of generating revenue and proving our market potential in fiscal 2002. Throughout the first quarter of fiscal 2002, we have focused on this strategy, reducing operating expenses and concentrating our efforts on raising short-term and strategic financing, while establishing a current operating business utilizing the existing satellite capacity held by Iridium. At the same time, we have continued our efforts to reduce the overall cost of the E-SAT system and to identify and commence negotiations with strategic partners who may serve as both customers and financial partners for our proposed satellite-based energy management systems. The Company currently lacks adequate financing and time to build and launch two Low earth orbiting satellites in advance of the required FCC construction and launch date of March 2002 and September 2002, which could result in the loss of our FCC license. We have filed with the FCC to extend these milestones and we continue to plan to construct and deploy a low-cost global satellite system utilizing our E-SAT FCC and international licenses. The current circumstances in the satellite and telecommunications industry, as well as in the financial markets, particularly in relation to technology stocks, have led to delays in our ability to raise short-term operating capital. Our right to raise capital by selling common shares to the Torneaux Fund has been limited by our stock price, which, during the first quarter of fiscal 2002 has been below the contractual minimum threshold price of $1.00 per share. Any sale of shares to the Torneaux Fund at prices below that threshold price requires Torneaux's approval. As a result of deficiencies in short-term capital raising, we have delayed payment to many of our vendors, and certain of our employees. As of March 31, 2002, our cash and cash equivalents amounted to $87,748 while our current liabilities, including amounts owed to employees, amounted to $4,833,273. Throughout the first quarter of fiscal 2002, we have continued to focus on reducing operating expenses while concentrating our efforts on raising short-term and strategic financing and establishing a current operating business utilizing the existing satellite capacity held by Iridium. Until we begin to generate positive cash flow through our operations, we will continue to seek to satisfy our cash requirements by raising new equity and debt capital, as well as by seeking the exercise of previously issued third-party warrants and stock options. The issuance of additional equity securities by us will result in significant dilution of the equity interests of the current stockholders. Critical Accounting Policy During the construction of its E-SAT system, the Company is capitalizing all license, design, engineering, launch and construction costs. Such costs amounted to approximately $14.6 million as of March 31, 2002. Because of our difficulties in financing construction of the E-SAT system and resulting inability to meet required FCC milestones, the Company reviews its capitalized satellite construction and FCC license costs for impairment whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. The Company's management and Audit Committee of the Board concluded no such event or changes in circumstances exist and, accordingly, it would be inappropriate to write down the capitalized satellite construction costs as impaired as of March 31, 2002. In reaching this conclusion, the Company applied Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". Under this standard, the Company periodically reviews whether there have been events or changes in circumstances that indicate that the carrying amount of the satellite construction costs may not be recoverable. If an impairment event exists, the amount of the impairment loss, if any, would be calculated based on the excess of the carried amount of the assets over their fair value. Of the capitalized amounts, approximately $2 million was paid to Alcatel Space Industries ("Alcatel") for preliminary engineering design review for the Company's system, including the payload design and designs for the gateway earth station and tracking facilities, as well as the satellite orbital analysis and communications link margins to and from space. On October 8, 1999, the Company signed a contract with Alcatel for the final design, construction and delivery to the launch site of six Little Low earth orbiting satellites. This agreement also includes the final design, construction and delivery of the ground infrastructure, including the gateway earth station, mission center, satellite control center, ground communications network and ground-based transceivers to be installed into devices, like utility meters. Alcatel is also responsible for providing in-orbit testing of the E-SAT system. The total contract price for the end-to-end system is $88.5 million. Either party has the right to terminate this agreement under certain circumstances. As noted above, the Company paid $2 million in construction payments to Alcatel for engineering specifications. The Company has not made a further payment required by the agreement with Alcatel, due at the end of 1999, of approximately $9.1 million in cash and the equivalent of $5 million in Common Stock. This payment was necessary for Alcatel to continue work and to trigger an effective date for the Company's full system development schedule. Because these services have not been performed, the Company has recorded no liability. As of December 31, 2001, this payment has not been made, and Alcatel therefore has the right to consider this contract void as to further work, and that the contract is therefore not currently in effect. If the Alcatel contract is never brought into effect, the Company retains the engineering specifications provided by Alcatel, which would still be used by the Company's other contractors in the construction of the Company's satellite network. On March 31, 1999, the Company signed construction and launch contracts with Surrey Satellite Technology Limited ("Surrey") and Eurockot, respectively, and made advance payments of $7.8 million in April 1999 and $2.0 million in July 1999. Total payments under these cancelable contracts will amount to approximately $47 million. In July 1999, the Company, Surrey and Eurockot reached agreements under which $3.2 million of the required milestone payments due in July 1999, totaling $4.8 million were deferred to yet to be agreed upon dates. Surrey's construction contract, which was to build the satellite infrastructures that would house the telecommunications payload, was to be managed by Alcatel as prime contractor, if and when the Company paid Alcatel $14.1 million to trigger the Alcatel contract effective date. As this payment has not been made, the Alcatel contract is not in effect and Surrey remains a direct contractor of the Company. The Company evaluated a number of factors in its consideration of whether an impairment event has incurred, including: (1) whether the Company's failure to meet its FCC milestone requirements would result in termination of the license; (2) whether the assets continue to have value notwithstanding the delay since contracting; (3) whether the Company's failure to bring the Alcatel prime contract into effect prevents the Company from constructing its system; (4) whether the state of difficulties in the satellite financing capital markets were likely to prevent the Company from financing its system in the future; (5) whether the telecommunications industry had overcapacity such that there would be no business opportunity for the E-SAT system; and (6) whether the Company's implementation of an Iridium-based system effectively replaced the E-SAT system. In more detail, the Company concluded the following: 1. The Company believes that its failure to meet its milestones are not likely to result in termination of the license. The Company recognizes that the loss of the FCC license held by its subsidiary E-SAT, Inc. would be a change in circumstance and that the failure to meet certain milestones could lead to a loss of the license. The Company currently lacks adequate financing and time to build and launch two Low earth orbiting satellites in advance of the required FCC construction and launch dates of March 2002 and September 2002, respectively. As part of the Company's impairment analysis, the Company received a report and opinion from Leslie Taylor Associates, its regulatory counsel, that the license was likely to be extended. This opinion was based on the satellite construction progress to-date, including the launch of one satellite, and the fact that there were no other pending applicants for the spectrum covered by E-SAT's license. As recommended by Leslie Taylor Associates, on March 29, 2002 E-SAT filed the request for an extension of milestones with the FCC and is awaiting a reply. Based on these facts, the Company believes, while there is no guarantee, that the FCC will grant the extension and that it is therefore not in imminent danger of losing its FCC license, but will continue to monitor the situation for any changes. 2. The Company believes that its satellite construction assets continue to have value notwithstanding the delay since contracting. Included in the capitalized satellite construction costs are payments to Alcatel Space Industries, Eurockot and Surrey Satellite. The Company paid Alcatel for the production of engineering specifications and analysis which information remains the property of the Company. These specifications are an integral part of E-SAT's ability to construct the satellites and were transferred by the Company to Surrey Satellite in 2001, and will be used by Surrey in satellite construction regardless of whether the Alcatel contract is ever brought into effect. Surrey Satellite was paid for the design of the satellite ground station, among other things, which is crucial to the design of the system and remains an important element to completion of a complete satellite communication network. Eurockot was paid for the launch of the satellites and although the launch date has been extended past 2002, E-SAT's right to Eurockot's launch services remains intact. 3. The Company believes that its failure to bring the Alcatel prime contract into effect does not prevent the Company from constructing its system. The Company's contract with Alcatel called for a payment by the Company at the end of 1999 that has not been paid to-date and, as a result, Alcatel has the option to termination the contract. Alcatel has not indicated to the Company that it intends to terminate the contract, and the Company believes that Alcatel would seek to bring the contract into effect when the Company receives financing. In addition, the Company believes that alternative suitable prime contractors are currently available to manage construction as prime contractor, including Surrey Satellite, for a significantly lower cost than negotiated with Alcatel, and so the Company may not choose to reinstate the Alcatel contract. As noted above, the Company has received viable assets consisting of engineering specifications and analysis in return for the $2.1 million paid to Alcatel. 4. The Company believes that the state of difficulties in the satellite financing capital markets is not likely to prevent the Company from financing its system in the future. The Company believes that satellite financing is cyclical and further that the low cost of its system, approximately $60 million, compared to other global telecommunications system, allows it to be financed through a wide variety of sources, including customers and strategic partners. The Company believes that the primary impediment to financing is therefore a demonstration of market viability of low-earth-orbiting satellites for data communications to remote infrastructure. 5. The Company believes that current telecommunications industry overcapacity does not obviate the market opportunity for the E-SAT system. The Company believes that the E-SAT system will have unique competitive advantages even if the telecommunications industry maintains a position of low per minute costs due to overcapacity. These advantages are primarily low terminal cost due to usage of low power-spread spectrum transceivers permitted by the E-SAT license, and high penetration of buildings, remote terrain and poor weather because the E-SAT license uses VHF frequencies. 6. The Company believes that the Company's implementation of an Iridium-based system is not a substitute for the E-SAT system. The Company believes that the Iridium-based system, which has a higher transceiver cost and operates on the L-Band which requires line of sight, is potentially complementary to the E-SAT system with lower transceiver cost and operates on VHF frequencies which have strong building, terrain and weather penetration. The Company believes that if the funding necessary to complete the satellite network and to remain a going concern is obtained, the capitalized satellite construction costs will be recoverable from future operating cash flows. On May 23, 2002, the Company entered into a Demand Reserves Authority Provider Agreement with the California Power Authority to implement a satellite-based (using Iridium capacity) automated conservation system design to conserve significant electrical usage on demand at peak or emergency times. The Company believes that implementation of this program, if successful, would provide a portion, but not all, of the funding for the further development of the E-SAT system. There is, however, no assurance that the Company will be able to successfully finance and implement this contract. Should the FCC extension request be denied, or any of the other above factors materially change, the Company may be required to record an impairment of the capitalized satellite construction costs. Results of Operations Revenues The Company remains in the development stage and did not generate revenues in either the quarter ended March 31, 2002 or March 31, 2001. Operating Expenses Total operating expenses for the quarters ended March 31, 2002 and 2001 were $1,698,480 and $861,827, respectively. DBSI's operating expenses are related to marketing and sales expenses, general and administrative expenses, and research and development expenses. Marketing and Sales Expenses Marketing and sales expenses are primarily the costs of personnel (including non-cash stock compensation) and travel. Marketing and sales expenses for the three months ended March 31, 2002 and 2001 were $88,801 and $44,839, respectively. The increase of $43,962 is primarily due to increased consulting fees incurred on the California Power Authority project. General and Administrative Expenses General and administrative expenses include the costs of finance, legal, administrative and general management functions of DBSI. General and administrative expenses for the three months ended March 31, 2002 and 2001 were $1,341,375 and $816,474, respectively. The increase of $524,901 was primarily due to the increase compensation expense of $734,128, including expense related to sales of warrants as discussed below, and an increase in legal fees of $25,000, offset by a decrease in consulting fees of $285,000. During the quarter ended March 31, 2002, in order to finance its operations, the Company issued six warrants to a director of the Company to purchase an aggregate of 6,650,000 shares of Common Stock of the Company at $0.10 per share in exchange for cancellation of loans and interest to the Company totaling $66,500. In addition, in order to finance operations, the Company sold warrants to purchase an aggregate of 2,250,000 shares of Common Stock at the then current market price of $0.12 per share for $30,000 to the Company's Chief Executive Officer and sold warrants to purchase an aggregate of 7,500,000 shares of Common Stock at the then current market price of $0.12 per share for $90,000 to a director of the Company. Based on a valuation by an independent valuation specialist, the value attributed to these warrants, which include warrant reloads, sold to the director and Chief Executive Officer amounted to $800,628. The difference between the warrant value and warrant purchase price was $612,128 and was recorded as general and administrative expense. See Liquidity and Capital Resources below. Research and Development Expenses Research and development expenses primarily represent the costs incurred to develop the system to be used for the California Power Authority contract. Research and development expenses for the three months ended March 31, 2002 and 2001 were $268,304 and $514, respectively. The increase was due to consulting fees incurred on the California Power Authority project. Other Income (Expense) We experienced a non-operating loss of $493,185 and $12,693 for the quarters ended March 31, 2002 and 2001, respectively. The increase is primarily due to (1) an increase in interest expense of approximately $201,325 arising from the issuance of convertible debentures in the amount of $500,000 in August of 2001 and to the amortization of the Beneficial Conversion Feature contained in and debt discount related to the convertible debenture and (2) the remeasurement of warrants included in liabilities of $237,860. Net Loss Our net loss for the quarter ended March 31, 2002 and 2001 was $2,138,065 and $874,520, respectively. The increase in net loss was due to increased expenditures attributable to the California Power Authority project. Liquidity and Capital Resources The Company has been in the development stage since its inception and has not recognized any significant revenues. Our monthly expenses averaged approximately $460,000 per month during the first quarter of fiscal 2002, compared to $291,000 during the first quarter of fiscal 2001. If we proceed to raise sufficient financing, expenses will increase during fiscal 2002 with the demands of increased efforts in developing our systems and in implementing our business plan. Additional capital will be necessary to expand operations and continue current operations. During the quarter ended March 31, 2002, we received approximately $23,750 in loans from stockholders. We also received proceeds from the exercise of warrants totaling $185,000. Additionally, during the quartered ended March 31, 2002, the Company sold six warrants to a director of the Company to purchase an aggregate of 6,650,000 shares of Common Stock at $0.10 per share in exchange for cancellation of loans and interest to the Company totaling $66,500. The loans were made during fiscal 2001. Further, the Company sold warrants to purchase an aggregate of 2,250,000 shares of Common Stock at the then current market price of $0.12 per share for $30,000 to the Company's Chief Executive Officer and sold warrants to purchase an aggregate of 7,500,000 shares of Common Stock at the then current market price of $0.12 per share for $90,000 to a director of the Company. In determining the value of the warrants, the board considered, among other factors, the financial condition of the Company, lack of revenues, the Company's current obligations and working capital needs and that the Company had sought various sources of financing with no success. Based on an independent valuation, the value attributed to these warrants sold to the director and Chief Executive Officer amounted to $800,628. The difference between the warrant value and warrant purchase price was $612,128 and is recorded as compensation expense as discussed above. In determining the warrant valuation, among the items considered by the valuation specialist were the exercise price of the warrants, the historical stock price of the Company, the reload feature and the exercise period of the warrants. However, the valuation did not take into consideration the financial condition of the Company. We had cash and cash equivalents of $87,748 as of March 31, 2002 and negative working capital of $4,625,864 as of March 31, 2002. Until we are able to either: 1) successfully implement our program with the California Power Authority to provide satellite-based energy management services, or 2) develop, construct and operate the E-SAT system and derive revenues therefrom, we must continue to rely solely on outside sources to raise cash for our operations. Net cash used in operating activities for the three months ended March 31, 2002 was $301,498. This resulted from a net loss of $1,379,477, offset primarily by (1) Common Stock issued for consulting services in the amount of $26,871, (2) the effect of remeasurement of warrants in the amount of $237,860, and (3) an increase in accounts payable and accrued liabilities by $866,451, and increased by a reduction in accounts receivable, prepaid and other current assets of $67,680. Net cash used in investing activities for the three months ended March 31, 2002, was $5,000 as compared to $0 for the quarter ended March 31, 2001. Due to the Company's focus on its financing efforts, no fixed assets were purchased nor payments made for the construction of its satellite system. Net cash provided by financing activities for the three months ended March 31, 2002, was $373,752 as compared to $598,247 for the three months ended March 31, 2001. Net cash provided by financing activities during the quarter ended March 31, 2002 was related primarily to proceeds from the sale of warrants in the amount of $185,000, the exercise of warrants in the amount of $120,000, and loans from stockholders in the amount of $23,752. In 1996, we received milestone payments under the terms of a $1.2 million purchase order for 10,000 satellite radio units from ABB. Under this agreement, the Company was eligible to receive up to $500,000 towards development costs upon meeting the milestone requirements of the contract. We met the first four milestones of the contract and have received $400,000 in cash. The parties agreed to suspend all development under this agreement due to the expiration of the Company's agreement for the use of the Argos System on December 31, 1997, and the subsequent limits placed on future commercial use of the Argos System. Therefore, such milestone payments could be subject to refund, in whole or in part. As of June 4, 2002, the Company has outstanding options, warrants or other commitments to issue 33,556,433 shares of Common Stock. In addition to those outstanding commitments, pursuant to an investment by Mr. Apatoff, a director of the Company, on March 7, 2002, the Company is required to issue reload warrants for 3,750,000 shares of Common Stock if certain warrants are exercised during 2002. Also, pursuant to the terms of this March 7, 2002 investment, Mr. Apatoff has 33% anti-dilution protection through March 8, 2003, if he invests an additional $1.4 million in the Company prior to that date. Such anti-dilution protection is limited to the authorized outstanding shares of Common Stock of the Company. Risks and Uncertainties Affecting Future Operating Results A number of factors could cause future results to differ materially from historic results. In addition to the risks described below, you should also carefully review the risk factors detailed in our Annual Report on Form 10-K for the period ended December 31, 2001 and other reports or documents we file from time to time with the Securities and Exchange Commission. We are a development stage company and as of March 31, 2002, we had generated no revenues. Given our limited operating history and lack of revenues, no assurances can be given that we will be able to construct and implement our systems, and, if implemented, to develop a sufficiently large customer base to be profitable. While we continue the strategic fund-raising efforts (see "Plan of Operations") that are necessary to our ultimate success, our continued cost of operations significantly exceeds our short-term capital. We currently estimate that we may require up to approximately $18 million to complete the engineering and deployment of the system currently under discussion with the State of California. Given the risks and uncertainties in this undertaking, we cannot assure you that actual cash requirements will not exceed our estimates. Further, the current state of capital markets is uncertain, and is even more difficult for telecommunications companies, and we cannot assure you that we will be able to raise the funds required to complete the development and installation of the system, or that the timing and terms of any such financing will be favorable to us. If we are unable to obtain a sufficient amount of financing necessary to complete the system on commercially acceptable terms, our business and future success will be severely and adversely affected. Unless and until we begin to generate revenues, we will continue to generate further operating losses and negative net cash flow both for engineering the system and for our daily operations. Our contract with the State of California for energy management services is subject to a number of risks. Some of these risks are that we will need additional financing to build and operate the Irdium-based system, that the state may not pay in a timely manner or at all, that the state may not grant a blackout exemption which we believe will be required by shopping malls to participate in agreeing to have their electricity usage curtailed, that even with such a blackout exemption participants may not sign up, that we may be unable to install our equipment, that our system design may be more costly than anticipated or may be flawed, and that the system may not work correctly. In order to comply with development milestones required by E-SAT's FCC license, we have entered into various development contracts including satellite construction contracts with Alcatel Space Industries and Surrey Satellite and a satellite launch contract with Eurockot. Entering into these and other development and service contracts are critical to the overall development of the E-SAT System. The Alcatel satellite construction and launch contract requires progress payments of approximately $60.0 million over a 12 month period. We do not, at this time, anticipate making these progress payments. Failure to maintain these contracts would ultimately render them void and, if we are unable to arrange acceptable alternatives, would adversely affect our ability to construct the E-SAT System. Any cancellation or termination of these contracts could cause delay in construction of the E-SAT system that could result in the loss of the FCC license for failure to meet the FCC milestones of March 2002 for building two satellites and September 2002 for launching two satellites. Even if these contracts are brought into effect, there may be insufficient time available to meet these milestones, and there can be no assurance that the FCC will extend these milestone dates. Other factors, in addition to those identified in this filing, which could affect future results would include the dependence and uncertainty of utility companies or other commercial customers to utilize our data messaging service, the reliance on third parties for the advancement of the design, manufacturing and marketing of our systems, the fulfillment of contract obligations by suppliers and other third parties, the availability of qualified personnel and equipment, delays in the receipt of or failure to receive necessary governmental approvals, obtaining permits and licenses or renewals thereof, risks and uncertainties relating to general economic and political conditions both domestically and internationally, changes in the law and regulations governing our activities in LEO satellite technology, unscheduled delays or technological difficulties, satellite launch risks, potential satellite malfunction, limited availability of insurance, marketing conditions, competition, and other risk factors related to our business. Readers of this filing are cautioned not to put undue reliance on "forward looking" statements that are, by their nature, uncertain as reliable indicators of future performance. Successfully addressing the factors discussed above is subject to various risks described in this report, as well as other factors that generally affect the market for stocks of development stage, high technology companies. These factors could affect the price of our stock and could cause such stock prices to fluctuate significantly over relatively short periods of time. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. RECENT SALES IN UNREGISTERED SECURITIES (a) In January 2002, the Company issued 19,565 shares of Common Stock to a director for past services on the Board. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (b) On January 30, 2002, the Company granted a warrant to purchase 100,000 shares of its Common Stock to a consultant for services rendered, and to be rendered, between January 30, 2002 and July 31, 2002. The warrant is exercisable for three years from date of grant at $0.10 per share with 10,000 shares vested at the date of the grant and the remaining 90,000 vesting in increments of 15,000 each month for six months. The fair value of the vested warrants is being calculated on a monthly basis using the Black-Scholes option pricing model. As of March 31, 2002, a total of $5,240 had been recorded as consulting expense. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (c) On February 1, 2002, the Company granted a warrant to purchase 12,000 shares of its Common Stock to a consultant for services rendered. The warrant is exercisable for four years from the date of grant at $.12 per share and vests 2,000 each month for six months from the date of grant. The fair value of the vested warrants is being calculated on a monthly basis using the Black-Scholes option pricing model. As of March 31, 2002, a total of $230 had been recorded as consulting expense. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (d) On February 5, 2002, in exchange for cancellation of loans and interest to the Company totaling $66,500, six warrants were granted to a director of the Company to purchase an aggregate of 6,650,000 shares of Common Stock of the Company at $0.10 per share. Each warrant is exercisable for a short period of time as follows: Warrant 1 for 1,100,000 shares is exercisable until March 15, 2002; Warrant 2 for 1,100,000 shares is exercisable until April 15, 2002; Warrant 3 for 1,100,000 shares is exercisable until May 15, 2002; Warrant 4 for 1,100,000 shares is exercisable until June 15, 2002; Warrant 5 for 1,100,000 shares is exercisable until July 15, 2002; and Warrant 6 for 1,150,000 shares is exercisable until August 15, 2002. If Warrants Nos. 1, 2 and/or 3 or a portion thereof are exercised prior to their expiration dates, replacement warrants to purchase the number of shares exercised, up to 1,100,000 shares, are issued and exercisable for six months from the date of each exercise at $0.10 per share. On March 7, 2002, Warrant 1 was exercised in full and the Company issued 1,100,000 restricted shares of Common Stock and a replacement warrant to purchase an additional 1,100,000 shares of Common Stock at $0.10 per share. On March 25, 2002 a portion of Warrant 2 was exercised for 50,000 shares and the Company issued 50,000 restricted shares of Common Stock and a replacement warrant to purchase an additional 50,000 shares of Common Stock at $0.10 per share. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (e) On February 5, 2002, the Company granted to a newly appointed member of the Board of Directors non-qualified options under the 2000 Stock Option Plan to purchase 13,333 shares of Common Stock exercisable for ten years at $0.10 per share. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (f) Also on February 5, 2002, a non-plan, non-qualified option to purchase 450,000 shares of Common Stock exercisable for ten years at $0.12 per share was granted to the Company's Chief Operating Officer. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (g) On March 1, 2002, the Company granted a non-plan, non-qualified option to a director to purchase 450,000 shares of its Common Stock for consulting services rendered. The warrant is exercisable for ten years from the date of the grant at $.12 per share. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (h) On March 4, 2002, the Company received proceeds in a private placement of $100,000 from its Chief Executive Officer, through an affiliated business entity of that individual. Of the $100,000 proceeds, $30,000 was received by the Company in exchange for warrants to purchase an aggregate of 2,250,000 shares of Common Stock at the then current market price of $0.12 per share; and $70,000 was received by the Company upon exercise of certain of those warrants. Each of the warrants purchased is exercisable for a short period of time as follows: Warrant 1 for 416,666 shares is exercisable until April 4, 2002; Warrant 2 for 416,666 shares is exercisable until May 4, 2002; Warrant 3 for 416,667 shares is exercisable until June 4, 2002; Warrant 4 for 416,667 shares is exercisable until July 4, 2002; Warrant 5 for 416,667 shares is exercisable until August 4, 2002; and Warrant 6 for 416,667 shares is exercisable until September 4, 2002. If Warrants Nos. 1, 2 and/or 3 or a portion thereof are exercised prior to their expiration dates, replacement warrants to purchase the number of shares exercised, up to 416,666, shares are issued and exercisable for six months from the date of each exercise at $0.12 per share. Of the $100,000 proceeds, $70,000 was received from the full exercise of Warrant 1 for 416,666 shares and partial exercise of Warrant 2 for 166,667 shares. In accordance with the terms of each warrant, the Company issued 416,666 shares and 166,667 restricted shares of Common Stock of the Company, and two replacement warrants to purchase an additional 416,666 and 166,667 shares of Common Stock of the Company at $0.12 per share. The transactions were exempt from registration in reliance upon Section 4(2) of the Securities Act. (i) On March 7, 2002, the Company received proceeds in a private placement of $200,000 from a director. Of the $200,000 proceeds, $90,000 was received by the Company in exchange for warrants to purchase an aggregate of 7,500,000 shares of Common Stock at the then current market price of $0.12 per share, and $110,000 was received by the Company in exercise of certain warrants granted on February 5, 2002. Each of the warrants purchased is exercisable for a short period of time as follows: Warrant 1 for 1,250,000 shares is exercisable until September 15, 2002; Warrant 2 for 1,250,000 shares is exercisable until October 15, 2002; Warrant 3 for 1,250,000 shares is exercisable until November 15, 2002; Warrant 4 for 1,250,000 shares is exercisable until December 15, 2002; Warrant 5 for 1,250,000 shares is exercisable until January 15, 2003; and Warrant 6 for 1,250,000 shares is exercisable until February 15, 2003. If Warrants Nos. 1, 2 and/or 3 or a portion thereof are exercised prior to their expiration dates, replacement warrants to purchase the number of shares exercised, up to 1,250,000 shares, are issued and exercisable for six months from the date of each exercise at $0.12 per share. Of the $200,000 proceeds, $110,000 was received from the full exercise of a warrant granted February 5, 2002 for 1,100,000 shares at $.10 per share. In accordance with the terms of the warrant, the Company issued 1,100,000 restricted common shares, and a replacement warrant to purchase an additional 1,100,000 shares of Common Stock at $0.10 per share. The transactions were exempt from registration in reliance upon Section 4(2) of the Securities Act. (j) On March 8, 2002, a Series A preferred shareholder converted 2,000 Series A preferred shares into 35,294 shares of Common Stock of the Company at $1.70 per share. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. (k) On March 18, 2002, Series B preferred shareholders converted 24 Series B preferred shares into 375,000 shares of Common Stock of the Company at $.064 per share. The preferred shareholders elected to receive 54,286 shares of Common Stock of the Company at $.064 in lieu of accrued cash dividends of $3,474. The transaction was exempt from registration in reliance upon Section 4(2) of the Securities Act. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 6. (a) Exhibits: None. (b) Reports on Form 8-K: Report on Form 8-K filed on May 30, 2002 reporting the signing of a Demand Reserves Provider Agreement with the California Power Authority of the State of California. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DBS INDUSTRIES, INC. DATE: June 17, 2002 By: /s/ Fred W. Thompson --------------------------------- FRED W. THOMPSON President Chief Financial Officer

DBS INDUSTRIES INC 10-Q