United States Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended March 31, 2007

For the transition period from                     to                     

Commission File Number 000-51822

(813) 281-1061
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

There were 16,302,144 shares outstanding of the issuer’s common stock, par value $0.001 per share, as of March 31, 2007.

 

ITEM 1. Financial Statements

STINGER SYSTEMS, INC.

ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements for Stinger Systems, Inc. (the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal and recurring nature. These financial statements should be read in conjunction with the audited financial statements as of December 31, 2006. Operating results as of March 31, 2007 for the three-month period then ended are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.

Management of the Company has determined that the Company’s operations are comprised of one reportable segment as that term is defined by SFAS No. 131 “Disclosures About Enterprise and Related Information.”, therefore, no separate segment disclosures have been included in the accompanying notes to the financial statements.

Certain reclassifications have been made to the 2006 consolidated financial statements in order to conform to the 2007 presentation.

Basic loss per share is determined based on the weighted average number of common shares outstanding during each period. Diluted loss per share is the same as basic loss per share as all common share equivalents are excluded from the calculation, as their effect is anti-dilutive. The weighted average number of shares of common stock outstanding for the three month period ended March 31, 2007 and March 31, 2006 was 15,876,911 and 14,993,500, respectively. Options and warrants to purchase 2,977,001 and 1,800,000 shares of common stock were outstanding at March 31, 2007 and 2006, respectively, and were excluded from the computation of diluted earnings per share as the effect of these options and warrants would have been anti-dilutive.

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts in the consolidated financial statements. Therefore, actual results could differ materially from those estimates used in the preparation of these financial statements.

The Company recognizes revenue when delivery of the product has occurred or services have been rendered, title has been transferred, the price is fixed and collectibility is reasonably assured. Sales of goods are final, with no right of return.

Inventories are stated at the lower of average cost or market. Inventories consisted of the following at March 31, 2007 and December 31, 2006:

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)) which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including stock option grants, based on estimated fair values. SFAS 123(R) supersedes previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), for periods beginning in fiscal year 2006.

SFAS 123(R) requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statements of Operations. The Company adopted SFAS 123(R) using the modified prospective transition method that requires the application of the accounting standard starting on January 1, 2006, without restatement of prior years. Stock options were granted at an exercise price equal to the Company’s stock price at the date of grant.

Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Under the intrinsic value based method, stock-based compensation expense for employee stock options was recognized in the Company’s Consolidated Financial Statements as the difference in the exercise price of the option and the Company’s stock price at the date of grant.

The Company has selected the Black-Scholes option-pricing model as the most appropriate method for determining the estimated fair value for stock-based awards.

The fair value of the stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions:

General and Administrative Expenses — Other includes the following:

In January 2007, the Company entered into a capital lease for a tool room mill machine in which the Company pays $631 per month for a term of four years, and the initial lease term ends December 2010. The lease agreement contains a bargain purchase option after the initial term of the lease or when the obligation has been completely performed, at which time the Company may purchase the leased equipment for $101.

The balance of the Company’s notes payable to related parties at March 31, 2007 and December 31, 2006 was $962,500.

In September 2006, the Company issued a note payable to a related party for $500,000 in which the related party paid a vendor $146,279 on the Company’s behalf and the remaining proceeds of $353,721 were advanced to the Company. The terms of the note payable include a principal balance of $500,000, 10% interest per annum, and the note is due on demand.

In October 2006, the Company issued a note payable to the same related party for $200,000 in which the proceeds were advanced to the Company. The terms of the note payable include a principal balance of $200,000, 10% interest per annum, and the note is due on demand.

In December 2006, the Company issued a note payable to the same related party for $100,000 in which the proceeds were advanced to the Company. The terms of the note payable include a principal balance of $100,000, 10% interest per annum, and the note is due on demand.

In December 2006, the Company issued another note payable to the same related party for $100,000 in which the proceeds were advanced to the Company. The terms of the note payable include a principal balance of $100,000, 10% interest per annum, and the note is due on demand.

Notes payable to related parties at March 31, 2007 and December 31, 2006 also consisted of two notes of $31,250 each to the two major shareholders. The notes bear interest at 4% per annum and are due on demand. The two shareholders have the right to receive payment of the note and accrued interest in common stock of the Company at a conversion rate of $0.40 per share. As of March 31, 2007 and December 31, 2006, if the shareholders demand payment in stock, the Company would be obligated to issue 172,884 and 171,166 shares, respectively, of common stock to the two major shareholders.

On January 25, 2007, the Company and certain existing warrant holders (the “Warrant Holders”) entered into an amendment and exercise agreement (the “Agreement”) pursuant to which (i) the Company reduced the exercise price of the warrants then held by the Warrant Holders (the “Existing Warrants”) to $0.60 per share; (ii) the Warrant Holders exercised all of the Existing Warrants at an exercise price of $0.60 per share

and acquired 999,999 shares of the Company’s common stock; and (iii) the Company issued to the Warrant Holders new warrants (the “New Warrants”) to purchase up to an aggregate of 1,500,000 shares of the Company’s common stock at an exercise price of $2.00 per share. The Company granted the Warrant Holders certain registration rights with respect to the resale of the shares issued upon exercise of the Existing Warrants and the shares to be issued upon exercise of the New Warrants. Neither the shares issued upon exercise of the Existing Warrants or the shares issuable upon exercise of the New Warrants have been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States in the absence of an effective registration statement or exemption from the registration requirements.

On March 19, 2007, the Company and a certain investor entered into a Securities Purchase Agreement for the investor to subscribe and acquire 140,187 shares of the Company’s common stock at a purchase price of $1.07 per share, pursuant to the agreement. The Company granted the investor certain registration rights with respect to the resale of the shares issued. The shares issued have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States in the absence of an effective registration statement or exemption from the registration requirements. The shares were offered and sold only to “accredited investors” (as defined in section 501(a) of Regulation D) pursuant to an exemption from the registration requirements under Section 4(2) of the Securities Act.

On March 28, 2007, the Company and a certain investor entered into a Securities Purchase Agreement for the investor to subscribe and acquire 93,458 shares of the Company’s common stock at a purchase price of $1.07 per share, pursuant to the agreement. The Company granted the investor certain registration rights with respect to the resale of the shares issued. The shares issued have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States in the absence of an effective registration statement or exemption from the registration requirements. The shares were offered and sold only to “accredited investors” (as defined in section 501(a) of Regulation D) pursuant to an exemption from the registration requirements under Section 4(2) of the Securities Act.

The Company has experienced significant operating losses since its inception in 2004. The process of developing and commercializing the Company’s products requires significant research and development, engineering, testing, significant marketing and sales efforts, and manufacturing capabilities. These activities, together with the Company’s general and administrative expenses, require significant investments and are expected to continue to result in operating losses for the foreseeable future while the Company introduces its Stinger product line to the marketplace. To date, revenues recognized from its current products have not been sufficient for the Company to achieve or sustain profitability. The Company believes it is unlikely that its existing cash resources will be sufficient to fund its operations for 2007 at its planned levels of research, development, sales, and marketing activities. Thus, execution of its current strategies will require it to raise additional capital through debt or equity transactions in order to finance its operations through 2007. The Company believes that additional financing may be available to it, but there can be no guarantee that financing will be available on acceptable terms or at all. If adequate funds are not available, the Company may be required to delay, reduce the scope of or eliminate its research and development programs, reduce its commercialization efforts, or effect changes to its facilities or personnel, and its ability to operate as a going concern may be adversely impacted.

On April 23, 2007, the Company and a certain investor entered into a Securities Purchase Agreement for the investor to subscribe and acquire 170,000 shares of the Company’s common stock at a purchase price of $0.60 per share, pursuant to the agreement. The Company granted the investor certain registration rights with respect to the resale of the shares issued. The shares issued have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States in the absence of an effective registration statement or exemption from the registration requirements. The shares were offered and sold only to “accredited investors” (as defined in section 501(a) of Regulation D) pursuant to an exemption from the registration requirements under Section 4(2) of the Securities Act.

On May 15, 2007, the Company and certain investors entered into a Convertible Senior Promissory Note (“Note”) to loan the Company $204,000 at a rate of 10% per annum. The Note is due and payable on the earlier of May 31, 2009 or when the Company achieves revenues of $8,000,000 annually beginning June 1, 2007. The Company has the right to convert the Note into the Company’s common stock upon achieving $8,000,000 in revenues annually beginning June 1, 2007 at a rate of $0.60 per share, pursuant to the agreement. The investor reserves the right to convert the Note into the Company’s common stock at any time at the discretion of the investor.

     The following discussion and analysis of the Company’s financial condition and results of operations should be read together with the financial statements and related notes appearing in Item 1 of this Part I and the financial statements and notes thereto and the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”).

     The following discussion and analysis of the financial condition and results of operations should be read in conjunction with the consolidated financial statements, related notes, and other detailed information included elsewhere in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 (this “Form 10-Q”). This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements other than historical information or statements of current condition. We generally identify forward-looking statements by the use of terms such as “believe”, “intend”, “expect”, “may”, “should”, “plan”, “project”, “contemplate”, “anticipate”, or other similar statements. Examples of forward looking statements in this Quarterly Report on Form 10-Q include, but are not limited to statements concerning: (a) the timely development and acceptance of new products, (b) sources of supply and concentration of customers, (c) acceptance in the marketplace, establishment and expansion of our distribution channels, (d) endorsement of opinion leaders in the law enforcement community, (e) implementation risks of manufacturing automation, (f) risks associated with rapid technology change, (g) impact of media publicity, (h) dependence upon sole or limited source suppliers, (i) existing or potential lawsuits, (j) risks of governmental regulations and (k) dependence upon key employees and other factors detailed in the Company’s filings with the SEC. These factors should not be considered exhaustive. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We caution you not to put undue reliance on these forward-looking statements. These forward-looking statements relate to our plans, objectives and expectations for future operations. In light of the risks and uncertainties inherent in all such projected operational matters, the inclusion of forward-looking statements in this Form 10-Q should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that any of our operating expectations will be realized. Our actual financial results realized could differ materially from the statements made herein, depending in particular upon the risks and uncertainties described in our filings with the SEC.

     Stinger Systems is in the business of producing and marketing less-lethal electronic restraint products to law enforcement, correctional facilities, professional security and military sectors. The Company purchased Electronic Defense Technologies, LLC (“EDT”) in September 2004 based on the anticipated value of the EDT licenses and patents, prototype projectile stun gun, existing product lines and track record in serving the law enforcement community. The Company’s products include the Ultron II ^® handheld contact stun gun, the Ice-Shield electronic immobilization riot shield, and the Bandit / REACT system, an electronic immobilizing restraint. The Company’s primary focus is the “Stinger” projectile stun gun and its success is largely dependent upon the commercialization of this product.

     Since the acquisition of EDT, the Company has extensively redesigned its projectile stun gun, now referred to as the Stinger, with the goal of providing a weapon with the feel and size of a traditional firearm, but offering a unique look that would not readily be confused with a traditional firearm. After the design was essentially completed, mold design and redesign of the electronics began. The electronics needed to be reduced to incorporate an overall smaller electronics package than existed in the predecessor gun, and to incorporate a number of additional features including data capture and display of the time and date of use, ambient temperature, duration of use and number of cycles fired.

     After producing numerous versions of the Stinger projectile stun gun, the Company began limited production in March 2005. However, significant inefficiencies in the design hampered production and required correction before volume commercial production could commence. These inefficiencies included the mold design, electronics design, camera mount, design of the ammunition cartridges, internal packaging and numerous assembly issues. The Company hired outside engineering firms to address these issues. In October 2005, the Company announced initial sales and volume production of the Stinger projectile stun gun. In the fourth quarter of 2005, the Company began commercial production, and based on feedback received, the Company decided to make certain modifications to the Stinger. The Company’s ability to generate future revenues is dependent upon the overall market reception of the Stinger product and the volume of production and sales that the Company is able to generate. Additional engineering, medical testing, and final testing of the product may be required as production commences. The Company also expects to incur significant marketing costs over the next twelve months. It is possible that the Stinger product line will require further modifications before commercial shipments of the Stinger are possible. As a result, the Company can give no definitive assurances that it will be able to achieve commercial production of the Stinger on the anticipated timeline.

     Concurrently, the Company invested its research and development resources in its new two dart projectile stun weapon, called the Stinger S-200, to directly compete with other two dart projectile stun weapons on the market. The engineering efforts during the 2006 fiscal year have developed a state-of-the-art stun gun that includes features that are desired by the end-user and an advanced technology.

     The Company plans to mass market and introduce the new Stinger S-200 in the marketplace in fiscal year 2007. The Company’s ability to generate future revenues is dependent upon the overall market reception of the Stinger product line and the volume of production and sales that the Company is able to generate. It may be the case that further modifications of the Stinger product line projectile stun gun will be required. As a result, the Company can give no definitive assurances that it will continue commercial production during fiscal year 2007.

     The Company plans to use third parties to manufacture components for its products and assemble the products. The Company is under no contractual obligation with these parties. Because the Stinger projectile stun gun is classified as a firearm and subject to various regulations of the U.S. Bureau of Alcohol, Tobacco, and Firearms (ATF), the Company ships all products from its production and manufacturing facility and maintains proper records. While the Company hopes to manufacture the Stinger and its components in the United States, there can be no assurances that it will be able to do on. The Company believes that electronics are easily sourced throughout the world and the Company will continually seek best pricing and highest quality components for its products. The Company expects to continue handling the shipment of its products.

     Once the Stinger is ready for commercial deployment, the Company’s success will be dependent upon its ability to attract high quality distributors and manufacturer’s representatives to market its products. To date, the Company has been able to attract distributors and manufacturer’s representative groups with a solid track record selling firearms to the law enforcement, correctional, and/or military community. The Company is unable to provide forecasts as to the number of Stingers it anticipates selling. As of March 31, 2007, the Company has contracts with thirteen (13) U.S. distributors, twenty (20) International distributors, and two (2) U.S. manufacturers’ representative groups. The Company has trained all its U.S. distributors and manufacturers representatives in the use of its products.

     Due to the limited sales volume of its existing products, the Company reported a net loss of $6,306,345 for the year ending December 31, 2006 (net loss of $0.42 per share) and a net loss of $10,085,529 for the year ending December 31, 2005 (net loss of $0.67 per share).

     At the present time, the Company does not generate sufficient revenues from its operations to pay its operating costs. Management believes that the Company will need additional outside sources of funding in the future to continue the production and promotion of its products.

     Revenues. Revenue decreased $21,969 or 19% to $96,169 for the three months ended March 31, 2007 compared to $118,138 for the three months ended March 31, 2006. The decrease from 2006 to 2007 was due to the limited sales volume of our existing products in the first quarter of 2007.

     Cost of Goods Sold. Cost of Goods Sold increased $25,297 or 35% to $98,052 for the three months ended March 31, 2007 compared to $72,755 for the three months ended March 31, 2006. The increase from 2006 to 2007 was primarily due to an inventory write-off in 2007 for obsolete raw materials in our inventory. The cost of production for the three months ended March 31, 2007, includes manufacturing costs such as materials, labor and identifiable overhead related to finished goods and components.

     Gross Margin. Gross margin decreased $47,266 to $(1,883) for the three months ended March 31, 2007 compared to $45,383 for the three months ended March 31, 2006. The decrease in gross margin for the three month period was principally due to an increase in the costs of goods sold related to an inventory write-off for obsolete raw materials in 2007.

     Selling Expenses. Selling Expenses decreased $31,345 to $40,726 for the three months ended March 31, 2007 compared to $72,071 for the three months ended March 31, 2006. The decrease was based primarily on decreased expenses related to our efforts to promote current products and the branding of the Stinger name.

     General and Administrative Expenses. General and Administrative (G&A) expenses decreased $1,491,755 or 64% to $857,283 for the three months ended March 31, 2007 compared to $2,349,038 for the three months ended March 31, 2006. Employee acquisition costs for the three months ended March 31, 2007 increased by $1,144 to $1,144 compared to $0 for the three months ended March 31, 2006. The increase from 2006 to 2007 was primarily due to the acquisition of warehouse employees. We did, however, incur stock based compensation expense of $127,107 for the three months ended March 31, 2007 related to the grant of stock options to our employees and directors as further explained in Note 5 in the Notes to Financial Statements. Additionally, other operating expenses for the three months ended March 31, 2007, include legal and professional fees of $84,945, and other costs in the amount of $122,756 compared to legal and professional fees of $345,623, insurance expense in the amount of $316,528, expenses related to stock options in the amount of $1,031,822 and other costs in the amount of $148,350 for the three months ended March 31, 2006.

     Research and Development Expenses. Research and Development (R&D) expenses decreased $80,338 or 41% to $116,468 for the three months ended March 31, 2007, compared to $196,806 for the three months ended March 31, 2006. The Company’s decrease in R&D expense is attributable to the advanced stages of product development, and the accumulated engineering knowledge associated with improving the design of the Stinger projectile stun gun product line. The Company expects to have ongoing research and development costs associated with future generations of the projectile stun gun product line.

     Interest Income. Interest income decreased $14,144 to $1,814 for the three months ended March 31, 2007, compared to $15,958 for the three months ended March 31, 2006. The decrease from 2006 to 2007 was due to a reduction in working capital.

     Net Loss. Net loss decreased by $1,444,570 or 61% to $(921,633) or $(0.06) per common share for the three months ended March 31, 2007 compared to a net loss of $(2,366,203) or $(0.16) per common share for the three months ended March 31, 2006. The improvement in the net loss was due primarily to the decrease in stock option expense, and the reduction of legal and professional fees, research and development, and insurance expense.

     Based on the Company’s current plans and market conditions, management does not believe that the Company’s existing cash and current operations will be sufficient to satisfy its anticipated cash

requirements for the next twelve months. In addition, the Company is unable to provide assurance that its planned levels of revenue, costs and expenses will be achieved. If the Company’s operating results fail to meet its expectations or if the Company fails to manage its inventory, accounts receivable or other assets, it will have a negative impact on the Company’s liquidity and the Company will be required to seek additional funding through public or private financings or other arrangements. In addition, due to the planned expansion of its product offerings, marketing efforts, channels and geographic presence, the Company may require additional working capital. If this were to occur, it is possible that adequate funds may not be available when needed or may not be available on favorable or commercially acceptable terms, which could have a negative effect on the Company’s business and results of operations.

     At March 31, 2007, we had negative working capital of approximately $(1,803,000), including a cash balance of approximately $126,000. This represents an increase in working capital of approximately $112,000 from working capital of ($1,915,000) at December 31, 2006 and a cash balance of approximately $121,000. This increase in working capital is principally due to a decrease in insurance expense, as well as decreased legal and professional fees. Operating activities for the three months ended used cash of $819,136 and $951,532 during 2007 and 2006, respectively. The decrease in the negative cash flow from operating activities during the three months ended March 31, 2007, as compared to 2006 was primarily due to the decrease in stock option expense and the general timing of obligations. The Company had a decrease of 49% in general and administrative expenses (excluding depreciation, amortization, and stock option expense).

     The long-term continuation of the Company’s business plans is dependent upon generation of sufficient revenues from its products to offset expenses. In the event that the Company does not generate sufficient revenues, it will be required to obtain additional funding through public or private financing, if available, and/or reduce certain discretionary spending. Management believes certain operating costs could be reduced if working capital decreases significantly and additional funding is not available. Failure to generate sufficient revenues, raise additional capital and/or reduce certain discretionary spending could have a material adverse effect on the Company’s current operations and its ability to achieve its intended long-term business objectives.

     Revenues we currently generate from our product sales are insufficient to cover our expenses. Our existing capital resources and revenue from expected product sales will not be sufficient for us to maintain our current operations for the next 12 months, and we will require additional capital to fund our operations beyond the second quarter of 2007. Our requirements for additional capital are substantial. We currently have no committed source of capital, although we are evaluating a number of alternatives. We cannot assure you that financing will be available to us or, if available, that it will be on favorable terms. To the extent we raise additional capital through the sale of equity securities, the issuance of those securities could result in substantial dilution to our existing stockholders. In addition, if we obtain debt financing, we may be required to pledge all or a significant portion of our assets to secure such debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness and we may become subject to financial covenants and other terms that restrict the manner in which we can operate our business. If we are unable to raise additional capital, we may need to sell assets, pursue other strategic alternatives and/or curtail significantly our development and commercialization activities, and we may be unable to continue as a going concern.

     We have identified the following policies as critical to our business operations and the understanding of our results of operations. The preparation of these financial statements require us to make estimates and assumptions that effect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. The effect of these policies on our business operations is discussed below where such policies affect our reported and expected financial results.

     Revenue Recognition. Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We recognize revenue when delivery of the product has occurred or services have been rendered, title has been transferred, the price is fixed and collectibility is reasonably assured. Sales of goods are final, with no right of return.

     Warranty Costs. We warrant our products against manufacturing defects for a period of one year. As of March 31, 2007, we have had no significant warranty claims on products sold. Once significant volume sales of our stun gun commence, we expect to make an accrual for warranty claims based on our sales volumes and warranty cost experience.

     Intangible Assets. We have substantial intangible assets. Our estimate of the remaining useful life of these assets and the amortization of these assets will affect our gain from operations. Since we do not have a method of quantifying the estimated number of units that may be sold, we have elected to amortize these intangibles over a seven year period beginning in the first quarter of 2005.

     Purchase Accounting. Our purchase accounting policy is to record any acquisitions in accordance with current accounting pronouncements and allocate the purchase price to the net assets. We evaluate the fair market values of tangible and intangible assets based on current market conditions, and financial and economic factors. Intangible assets are valued using several cash flow projection models and financial models to establish a baseline for their respective valuations. We valued our acquisition of the stun gun technology based on the competitive advantage the technology provides. These competitive advantages are analyzed in relation to the current market and may include valuation techniques, such as the cost to develop the technology, the cost of designing around the claims of the patent or technology, comparable transactions of like-kind patents or technology, and discounted cash flows of future incremental profits that may be generated. We valued our intangible assets, including our stun gun technology, utilizing the aforementioned techniques. We valued our stun gun technology by comparing current competitor’s revenue and assumed a 10% market penetration of this revenue. We also assumed a factor for the increase in the general use of this stun gun technology, the estimated economic life of this current technology of approximately seven years, and the anticipated profit margins that we believed was achievable. Our policy is to expense in-process research and development costs at acquisition.

     Stock Options. We have a stock option plan under which options to purchase shares of our common stock may be granted to employees, consultants and directors at a price no less than the fair market value on the date of grant. Prior to January 1, 2005, we accounted for grants to employees in accordance with the provisions of APB No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of our stock and the exercise price of the option and is recognized ratably over the vesting period of the option. Because our options must be granted with an exercise price equal to the quoted market value of our common stock at the date of grant, we recognized no stock compensation expense at the time of the grant in accordance with APB No. 25. As discussed more fully in the Notes to our Consolidated Financial Statements, as a result of the issuance of SFAS No. 123(R) in December 2004, we began to expense the fair value of our options as of January 1, 2006. The amount of compensation expense recognized using the fair value method requires us to exercise judgment and make assumptions relating to the factors that determine the fair value of our stock option grants. We account for equity instruments issued to non-employees in accordance with SFAS No. 123(R) and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.

     Limited Trading Market. Until February 22, 2006, our common stock was only traded on the Pink Sheets. An investment in a security quoted on the Pink Sheets is speculative and involves a high degree of risk. Many Pink Sheet securities are relatively illiquid, or “thinly traded,” which tends to increase price volatility. Illiquid securities are often difficult for investors to buy or sell without dramatically affecting the quoted price. In some cases, the liquidation of a position in a Pink Sheet security may not be possible within a reasonable period of time. Reliable information regarding issuers of Pink Sheet securities, their prospects, or the risks associated with the business of any particular issuer or an investment in the issuer’s securities may not be available. As a result, it may be difficult to properly value an investment in a Pink

Sheet security. Pink Sheets is not a securities exchange or a broker-dealer. Pink Sheets is an electronic quotation and information service provided to registered broker-dealers to facilitate efficient transactions in Pink Sheet securities. Investors must contact an SEC registered broker-dealer that is a member of the National Association of Securities Dealers (NASD) to invest in a security quoted on the Pink Sheets. We used the Pink Sheet price to determine fair market value at the date of the respective transactions in order to value the transactions to best reflect the financial valuation of those parties involved in the transactions. Since February 23, 2006, our stock has been quoted on the OTC Bulletin Board.

     Our exposure to market risk is currently confined to our cash and cash equivalents and restricted cash. We currently do not hedge interest rate exposure. We have not used derivative financial instruments for speculation or trading purposes. Because of the short-term maturities of our cash, cash equivalents and marketable securities, we do not believe that an increase in market rates would have any significant impact on the realized value of our investments, but may increase the interest expense associated with any future debt.

     Our most liquid assets are cash and cash equivalents. Because of their liquidity, these assets are not directly affected by inflation. We also believe that we have intangible assets in the value of our intellectual property. Due to the nature of this intellectual property, we believe that these intangible assets are not affected by inflation. Because we intend to retain and continue to use our equipment, furniture and fixtures and leasehold improvements, we believe that the incremental inflation related to replacement costs of such items will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and contract services, which could increase our level of expenses and the rate at which we use our resources.

(a) Evaluation of Disclosure Controls and Procedures

     Our management, including our principal executive and principal financial officers, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this report has been appropriately recorded, processed, summarized and reported. Based on that evaluation, our principal executive and principal financial officers have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

     Our management, including our principal executive and principal financial officers, has evaluated any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the period covered by this report and has concluded that there was no change that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 1. Legal Proceedings

     The Company has been responding to an investigation by the Securities and Exchange Commission (“SEC”), which commenced in December 2004. In connection with the investigation, the Company has received a “Wells Notice” from the SEC indicating that the staff intends to recommend that the SEC institute an action against the Company, alleging that the Company violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Sections 5(a), 5(c), and 17(a) of the securities Act of 1933. The proposed allegations relate to purported representations that the Company made about one of the

Company’s products regarding when the Company would be shipping the product, the product’s status with the Bureau of Alcohol, Tobacco, and Firearms, the performance of the product, and where the Company’s stock was trading. The allegations further related to the lack of registration for sales of stock in late 2004, made by three individuals who were not officers, directors, or employees of the Company. Under the Wells process established by the SEC, the Company has been provided an opportunity to respond in writing before the staff makes a formal recommendation to the SEC regarding any action. The Company has responded to the Wells Notice and is fully cooperating with the SEC to resolve this matter as promptly as practicable. A judgment from this action adverse to the Company’s interests could jeopardize our business operations and exhaust the Company’s cash reserve and investors may lose their entire investment.

     The Company is involved in litigation with its insurer, USF Insurance Company (USF), in which USF filed a case against Stinger Systems (Case No. 3:06-Civ-302-K) in the United States District Court for the Western District of North Carolina, Charlotte Division. In the suit, USF seeks to recover a payment paid by USF on our behalf in connection with the settlement of a prior litigation, together with interest and attorneys fees and costs. Stinger has brought a counterclaim against USF to recover amounts expended in defending the prior litigation, as well as attorney’s fees and costs with respect to the USF action. We intend to vigorously contest this action, but can provide no assurance as to the eventual outcome. An adverse outcome in this action may have a material adverse effect on our business and results of operations.

     On January 9, 2007, Taser International, Inc. filed a complaint against Stinger Systems, Inc. that alleges patent infringement, false advertising, and patent false marking in its case, Taser International, Inc. v. Stinger Systems, Inc., in United States District Court for the District of Arizona, Case CV-07-0042-PHX-DGC. The case is also seeking punitive damages. Absent modification or other unexpected event, the Company will incur no legal fees for its defense in this case as the Company’s attorney has agreed upon entry of appearance to act as its attorney in the case without fee. An adverse outcome in this action may have a material adverse effect on our business and results of operations.

     On December 17, 2004, Taser International filed a case against Stinger Systems, Inc. and its Chief Executive Officer, Robert Gruder. Case Number 3:04CV620K styled Taser International, Inc. v. Stinger Systems, Inc. and Robert F. Gruder, pending in the United States District Court for the Western District of North Carolina. The lawsuit between Taser International and Stinger Systems has been settled. Due to the confidentiality agreement entered into between the parties, the parties are prohibited from disclosing any of the terms of the settlement. As a result of this settlement, each party’s claims against the other were voluntarily dismissed.

     You should carefully consider the risks and uncertainties described below in addition to the other information contained in this annual report. If any of the following risks actually occur, our business, financial condition or operating results could be harmed. In that case, the trading price of our common stock could decline and investors may lose part or all of your investment. In the opinion of management, the risks discussed below represent the material risks known to the company. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also impair our business operations and adversely affect the market price of our common stock.

We have a history of operating losses and anticipate future operating losses until such time as we can generate additional sales.

     Since beginning operations in September 2004, we have sustained substantial operating losses. At the present time, we do not generate sufficient revenues to support our operating expenses. In addition, we expect the Company to continue its research and development expenses, as appropriate, to complete the advanced stages of product development, and ultimately realize value from the accumulated engineering knowledge associated with improving the design of the Stinger projectile stun gun. We expect to have ongoing research and development costs associated with future generations of our projectile stun guns.

If we are unable to raise additional capital in the near term, we may not be able to continue to operate as a going concern.

     Revenues we currently generate from our product sales are insufficient to cover our expenses. Our existing capital resources and revenue from expected product sales will not be sufficient for us to maintain our current operations for the next 12 months, and we will require additional capital to fund our operations beyond the second quarter of 2007. Our requirements for additional capital are substantial. We currently have no committed source of capital, although we are evaluating a number of alternatives. We cannot assure you that financing will be available to us or, if available, that it will be on favorable terms. To the extent we raise additional capital through the sale of equity securities, the issuance of those securities could result in substantial dilution to our existing stockholders. In addition, if we obtain debt financing, we may be required to pledge all or a significant portion of our assets to secure such debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness and we may become subject to financial covenants and other terms that restrict the manner in which we can operate our business. If we are unable to raise additional capital, we may need to sell assets, pursue other strategic alternatives and/or curtail significantly our development and commercialization activities, and we may be unable to continue as a going concern.

If we do not obtain additional funding as needed, we may be unable to fund our re-engineering and production activities and to adequately pursue our business plan.

     Our business plan requires significant ongoing expenditures for product engineering and testing and for the marketing of our products. It is likely that we will need additional outside funding sources in the future to continue the production and the promotion of our products. If we are not successful in obtaining additional funding for operations, if and when needed, we may have to discontinue some or all of our business activities and our stockholders might lose all of their investment.

Our failure to properly design the Stinger projectile stun gun would have a material adverse effect on our operations.

     We will be devoting our capital and management efforts to the design, production and marketing of the Stinger projectile stun gun. There is no assurance that our current design will meet our targeted specifications and tolerances, or that we will be able to manufacture the Stinger stun gun on a timely basis at a competitive price. The initial design of the electrical components made the Stinger stun gun difficult and time consuming to assemble. Additionally, both the original mold for the Stinger stun gun and the mold for the ammunition needed to be redesigned to provide better fit and allow for mass production on an economical basis. Any failure to timely resolve these issues will delay the rollout of the Stinger stun gun. Failure to introduce the Stinger stun gun on a timely basis would have a material adverse effect on us and investors could lose their entire investment.

If we fail to convince the market place that we have competitive products, we will not be commercially successful.

     Even if we are successful in designing products competitive to those of our competitors, it will be necessary for us to educate and convince the market place of that competitiveness. If we are unable to do so, we will not be able to achieve the market penetration necessary to become commercially successful and our investors may lose their investments.

If third party manufacturers do not perform in a commercially reasonable manner, we may not be successful.

     We rely entirely on third parties to manufacture our products. We do not have long-term supply contracts with these third party manufacturers and instead work on an order-by-order basis. By not having long-term supply contracts, we run the risk that our current suppliers will opt to discontinue their relationship with us thereby interrupting the flow of products and significantly limiting our ability to

operate our business. If alternative third party manufacturers could not be located in a timely manner, we would go out of business and investors would lose their entire investment.

     We own all of the rights, drawings, and intellectual property regarding schematics of the electronics of our products. Circuit board manufacturing and transformer winding companies are a common business throughout the world. We have already examined alternative sourcing and intend to eventually have multiple suppliers providing transformers and circuit boards when economies of scale merit such sourcing. We do not anticipate any business interruption if any of our suppliers could no longer supply or work with us on our terms.

Our primary competitor, Taser International Inc., has an established name in the marketplace with both distributors and the end-users of stun products.

     Taser International, Inc. is the dominant player in our industry. Taser has been able to successfully launch its products, and penetrate the marketplace. While we hope to design a product that is competitive with those offered by Taser, there is no assurance that we will be able to do so or that we will be able to successfully market such products if we are successful in designing them. Unless we are able to persuade distributors or manufacturer’s representatives and end-users of the competitiveness of our products, we will be unable to generate sufficient sales of our products to become viable. Further, Taser already has contracts with a number of distributors and end-users, who may be unwilling or unable to distribute or purchase our products, respectively.

     There have been a number of negative articles about the use and abuse of less-lethal weapons by law enforcement and correctional officers. There have also been accusations that stun guns have caused the deaths of subjects who have been stunned. The safety of such less-lethal weapons has become a matter of some controversy and continued negative publicity about the use of less-lethal stun devices may negatively impact the sale of our products.

     As noted above, the use of stun weapons has been associated with injuries, some serious and permanent, including death. While we are attempting to design the Stinger projectile stun gun to diminish the risk of injury, there can be no assurance that injuries will not occur from the use of the product. Such injuries could result in claims against us. Although we intend to maintain liability insurance for our products, there can be no assurance that the coverage limits of our insurance policies will be adequate. Claims brought against us, whether fully covered by insurance or not, will likely have a material adverse effect upon us.

We have been sued by Taser International, Inc. which could result in a judgment against us that could negatively impact our operations.

     The Company is a defendant in a lawsuit brought by Taser International, Inc. that alleges patent infringement, false advertising, and patent false marking in its case, Taser International, Inc. v. Stinger Systems, Inc., in United States District Court for the District of Arizona. The case is also seeking punitive damages. Absent modification or other unexpected event, the Company will incur no legal fees for its defense in this case as the Company’s attorney has agreed upon entry of appearance to act as its attorney in the case without fee. A judgment in the suit adverse to the Company’s interests could jeopardize our business operations and exhaust our cash reserve and investors may lose their entire investment.

     The Company has been responding to an investigation by the Securities and Exchange Commission (“SEC”), which commenced in December 2004. In connection with the investigation, the Company has received a “Wells Notice” from the SEC indicating that the staff intends to recommend that the SEC institute an action against the Company, alleging that we violated Section 10(b) of the Securities Exchange

Act of 1934 and Rule 10b-5 thereunder and Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933. The proposed allegations relate to purported representations that the Company made about one of the Company’s products regarding when the Company would be shipping the product, the product’s status with the Bureau of Alcohol, Tobacco, and Firearms, the performance of the product and where the Company’s stock was trading. The allegations further related to the lack of registration for sales of stock in late 2004 made by three individuals who were not officers, directors, or employees of the Company. Under the Wells process established by the SEC, the Company has been provided an opportunity to respond in writing before the staff makes a formal recommendation to the SEC regarding any action. The Company has responded to the Wells Notice and is fully cooperating with the SEC to resolve this matter as promptly as practicable. A judgment from this action adverse to our interests could jeopardize our business operations and exhaust our cash reserve and investors may lose their entire investment.

Claims by others that our products infringed their patents or other intellectual property rights could adversely affect our financial condition.

     Any claim of patent or other proprietary right infringement brought against us would be time consuming to defend and would likely result in costly litigation, diverting the time and attention of our management. Moreover, an adverse determination in a judicial or administrative proceeding could prevent us from developing, manufacturing and/or selling some of our products, which could harm our business, financial condition and operating results. Claims against our patents may cost us significant expenses to defend and if our patents are not upheld, we may not be able to continue operations and investors may lose their entire investment.

     We believe that our patent rights, trademarks, and other proprietary rights are important to our success and our competitive position. While we have patents and licenses with respect to certain of our products, there is no assurance that they are adequate to protect our proprietary rights. Accordingly, we plan to devote substantial resources to the establishment and maintenance of these rights. However, the actions taken by us may be inadequate to prevent others from infringing upon our rights which could compromise any competitive position we may develop in the marketplace.

Law enforcement, correction and military operations are government agencies which are subject to budgetary constraints, which may inhibit sales.

     Government agencies are generally subject to budgets which limit the amount of money that they can spend on weapons procurement. It may be that although a government agency is interested in acquiring our products, it will be unable to purchase our products because of budgetary constraints. Further, the lead time for an agency acquiring new weapons and receiving approval to acquire them may delay sales to such agencies. Any such delay will have an adverse effect upon our revenues.

There exist some state, local and international regulations and/or prohibitions on less-lethal weapon systems which will make it more difficult or impossible to market our products in those jurisdictions thereby limiting potential revenues.

     Some states prohibit the sale of less-lethal weapon systems. Additional negative publicity with respect to less-lethal weapon systems may cause other jurisdictions to ban or restrict the sale of our products. Internationally, there are some countries which restrict and/or prohibit the sale of less-lethal weapon systems. Further, the export of our less-lethal weapon systems is regulated. Export licenses must be obtained from the Department of Commerce for all shipments to foreign countries other than Canada. To the extent that states, local governments or other countries impose restrictions or prohibitions on the sale and use of our products or to the extent we are unable to obtain export licenses for the sales of our weapons to international customers, our sales could be materially adversely impacted.

     Our business is a technical and highly specialized area of the firearms industry. We are dependent on the principal members of the management and technical staff. The loss of key employees could disrupt our research and development and product promotion activities. We believe that our future success will depend in large part upon our ability to attract and retain highly skilled, scientific and managerial personnel. We face intense competition for these kinds of personnel from other companies and organizations. We might not be successful in hiring or retaining the personnel needed for our company to be successful.

Because our common stock is quoted only on the OTC Bulletin Board and the Pink Sheets, your ability to sell your shares in the secondary trading market may be limited.

     Our common stock is traded only on the OTC Bulletin Board and the Pink Sheets. Consequently, the liquidity of our common stock is impaired, not only in the number of shares that are bought and sold, but also through delays in the timing of transactions, and coverage by security analysts and the news media, if any, of our company. As a result, prices for shares of our common stock may be different than might otherwise prevail if our common stock was quoted or traded on a national securities exchange such as the New York Stock Exchange, NASDAQ or the American Stock Exchange.

Our stock price has been volatile and your investment in our common stock could suffer a decline in value.

     Our common stock is quoted for trading only on the OTC Bulletin Board and the Pink Sheets. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control. These factors include:

     During 2006, the closing sales price of our stock has ranged from $0.55 to $4.75. Our stock closed on March 30, 2007 at $1.26 per share.

Trading of our stock may be restricted by the SEC’s penny stock regulations, which may limit a stockholder’s ability to buy and sell our stock.

     The SEC has adopted regulations which generally define “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure

document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.

     In addition to the penny stock rules described above, the NASD (National Association of Securities Dealers Inc.) has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, the NASD believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The NASD requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for its shares.

Sales of a substantial number of shares of our common stock in the public market could lower our stock price and impair our ability to raise funds in stock offerings and impair the ability of stockholders to receive a return on their investment in Stinger Systems.

     Future sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the prevailing market price of our common stock and could make it more difficult for us to raise additional capital through the sale of equity securities and reduce the chances of persons who have invested in us of receiving a return on their investment. In addition, substantially all of the outstanding shares of our common stock are freely tradable or eligible for sale under Rule 144, subject to volume limitations.

Exercise of outstanding options, warrants and convertible securities will dilute existing shareholders and could decrease the market price of our common stock.

     As of March 31, 2007, we had 16,302,144 shares issued and outstanding, 2,977,001 shares of common stock that could be issued upon the exercise of options, warrants, grants and convertible securities, of which 857,000 shares could be issued pursuant to the exercise of options outstanding under the Stinger Systems, Inc. Employee Stock Option & Stock Bonus Plan. There can be no guarantee that any or all of the warrants, grants, options or convertible securities will be exercised or converted. To the extent these underlying shares are ultimately issued, there will be further dilution to investors. The existence or exercise of the outstanding options, grants, warrants or convertible notes may adversely affect the market price of our common stock and the terms under which we could obtain additional equity capital.

We likely will issue additional equity securities which will dilute your share ownership.

     We likely will issue additional equity securities through the exercise of options, grants, convertible notes, or warrants that are outstanding or may be outstanding, and possibly to raise capital. These additional issuances will dilute your share ownership.

Any short selling of our stock could depress the stock’s price and have a negative impact on the investments in us by our stockholders.

     Downward pressure on our stock price could result from the occurrence of any of the risk factors set forth herein as well as from other factors that relate generally to stocks that trade in the securities markets. Downward pressure on our stock could result in short sales of stock that could further depress the price. The further depression of the stock price could then encourage additional short selling with the end result being a downward spiral of our stock price. If short selling of our stock should commence in the market, the net effect could be an overall drop in share price thereby having a negative effect on any person owning shares of our stock.

We do not intend to pay any cash dividends on our common stock in the foreseeable future and, therefore, any return on your investment in our common stock must come from increases in the fair market value and trading price of our common stock.

     We have never paid a cash dividend on our common stock. We do not intend to pay cash dividends on our common stock in the foreseeable future and, therefore, any return on your investment in our common stock must come from increases in the fair market value and trading price of our common stock.

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.