CHALLENGER POWERBOATS, INC. - CPBXQ Annual Report (Small Business Issuers) (10KSB) PART I

We design and manufacture high-performance commercial boats used by fire, police, and military personnel for fire, rescue and patrol. We are a complete design-to-manufacturing organization, creating or licensing designs, and creating tooling, molds, and parts necessary to assemble our products in-house. Our products combine innovative designs with power, safety, handling and stability to create boats designed to protect and save lives. We market our low cost, rapid response boats directly to municipalities and other government agencies, such as, fire departments, police departments, city port-authorities and the military. We did not have any revenues in the fiscal year ended December 31, 2003.

We are a publicly traded company, which trades on the Over-the-Counter bulletin Board of the National Quotation Service under the ticker symbol "XTME."

The address of our principal executive office is 11782 Western Avenue, Unit 18, Stanton, California 90680. Our telephone number is (714) 895-0944. Our website address is www.xtremecos.com. Information contained on our website does not constitute part of this report and our address should not be used as a hyperlink to our website.

We incorporated in the State of Nevada on August 14, 1994 as Shogun Advertising, Inc. On May 10, 1998, we changed our name to Xtreme Webworks. As Xtreme Webworks, we offered services to Internet companies that assisted in higher recognition placement with search engines. We also designed and hosted Internet web sites, and designed and published online and printed newsletters. On April 24, 2002, we changed our name to Xtreme Companies, Inc. On November 30, 2002, we determined that our internet hosting and marketing business was not strategic to our ongoing objectives and discontinued capital and human resource investment in the business.

As Xtreme Companies, Inc., our business was to assist in the acquisition, development and finance of energy related entities. To that end, on April 26, 2002, we executed an Acquisition Agreement with Waste Renewal Systems, Inc., a Nevada Corporation. As a wholly-owned subsidiary, Waste Renewal Systems, Inc., provided an innovative and proprietary waste processing solution for municipal solid waste disposal. Further, on May 15, 2002, we executed an Acquisition Agreement with Nucon International, Inc. a Nevada Corporation who later changed its name to Nuclear Reduction Systems, Inc. As a wholly-owned subsidiary, Nuclear Reductions Systems, Inc. provided cutting edge technology in the nuclear waste treatment industry.

In July 2003, we discontinued the operation of our wholly-owned subsidiaries Waste Renewal Systems, Inc. and Nuclear Reduction Systems, Inc. due to the failure to negotiate satisfactory terms for the extension of the license agreements and its inability to commercialize its products.

On October 1, 2003, we entered into an Agreement and Plan of Reorganization with Rockwell Power Systems, Inc. a Delaware corporation. As a result of the transaction, Rockwell Power Systems, Inc. became our wholly-owned subsidiary. In addition, the entire former management team and board of directors resigned and we employed a new management team and appointed a new board of directors.

Rockwell Power Systems was incorporated in Delaware on January 29, 2001 under the name Rockwell Healthcare Systems, Inc. We changed its name on April 12, 2001 to Rockwell Power Systems. We had no operations until October 1, 2003 when we purchased the Fire & Rescue and the Recreational Boat Division from Sonic Jet Performance, Inc. Pursuant to the Bill of Sale Agreement executed between the parties, Rockwell was granted a license for a period of twenty years to the use the "Sonic Jet Performance" name. Additionally, Rockwell was granted the authority to market and sell Fire and Rescue and Recreational boats everywhere in the world except the Middle East(including Egypt, Lebanon, Turkey, Syria, Jordan, Iraq, Saudi Arabia, Bahrain, Oman, Qatar, the UAE and Yemen).

Since October 1, 2003, we have focused our efforts on manufacturing, marketing and selling specialty boats designed for fire and rescue purposes.

We believe the next great opportunity in the boating industry for business expansion and profits is in Homeland Security fulfillment, defense, surveillance, and emergency response boats for municipalities and governments. According to White House documents, after September 11, the United States government took a wide range of urgent steps to protect the Nation's highest risk targets and critical infrastructure systems such as nuclear power plants, hydroelectric dams, telecommunication nodes, border crossings, chemical facilities, sea and water ports, water and sewer plants, electric power plants, gas pipelines, dams and bridges - all national assets that are critical to economic and national security. This includes protecting the open coastline, waterways, and private industrial sites such as nuclear power plants and oil refineries

In addition to the increase in federal funding for homeland security, two other important programs are in place that will benefit those fire departments and private organizations looking to participate and take advantage of the additional funding being provided to these specific areas. These programs include: The 2004 Assistance to Firefighters Grant Program presented by the Office of Domestic Preparedness ("ODP") and Operation Safe Commerce ("OSC") funding.

The ODP is currently offering $750 million in grants to fire departments across the United States. With Fireboats being elevated to a Priority One Status for this year's grant program, we have aggressively pursued the more than 5,200 fire departments with responsibilities on the water by offering a grant assistance program for any fire department interested in purchasing one of our boats. The program has been well received with more than thirty fire departments applying so far. However, we cannot determine if the ODP will grant any awards to fire departments that apply, if any. We have not generated any revenue or sales from this program to date but, if successful, we could see future boat sales as a result of the program.

By specific order of the Transportation Security Administration, Operation Safe Commerce, which concentrates on the ports of New York/New Jersey, Seattle/Tacoma, and Los Angeles/Long Beach, is a public-private partnership that uses federal grants to test pilot programs in order to improve security at these ports and others like them throughout the United States. The funding allocated to OSC is $58 million, which is the first step of a multi-faceted program. Strategically located near the Long Beach & Los Angeles Ports, and having already sold boats to the New York Port Authority, Xtreme is positioning itself to play an integral role in our ports security and emergency response capabilities.

The Coast Guard's port security mission has grown from approximately 1-2 percent of daily operations to between 50-60 percent. Additional national security missions are focused upon illegal immigration, drug interdiction, port security, and the provision of enhanced defenses for critical high-risk vessels, coastal facilities, coastal nuclear power plants and oil refineries. The 2003 Federal Budget increased funding for these homeland security-related missions by $282 million, to an overall level of $3.5 billion to enhance the capabilities of America's first responders, a greater than 10-fold increase in Federal resources, allowing state and local agencies to purchase a wide range of equipment needed to respond effectively to a terrorist attack, including the purchase of new technology-based patrol and surveillance boats.

The target markets for our boats include municipalities, state and federal agencies, fire, rescue, police and military units. The approximately 181,518 miles of waterways in the United States offer numerous opportunities for us to sell our commercial boats, particularly those used for rescue, patrol and fire fighting operations. We believe our products offer a cost effective solution for our target customers.

Our boats combine power, safety, handling and stability in rough water along with high-speed performance. The innovative patents and patents-pending that we license, give the boats eye-catching visual market retention, and a competitive advantage in the boating industry, home defense and world markets.

The unique convergence of design and technology give our boats the ability to be highly maneuverable in as little as ten inches of water, essential in areas where submerged objects such as street signs, vehicles or rocks will interfere with other craft. Even with a full crew and injured passengers, the boat stays high on the water, affording a speedy, safe access and egress.

The boats are quick-response craft that can be easily transported to emergency areas. The hulls incorporate patented "V" shaped hull designs, and are built using hand laid "S" glass which produces a fiberglass hull that is stronger yet lighter than conventional fiberglass hulls, and provides extraordinary stability and handling in rough waters, and at high speeds.

We currently offer two commercial boats which are similar in design but distinct in functions. Each model comes equipped with Mercury Marine Sport Jet 175 XR2 two stroke engines that generate 175 horse power, and Mercury Marine single stage axial flow jet pumps. We have also developed new models for California, and international markets that no longer allow 2 stroke motors. We have redesigned the boat to accept power systems which meet the strict emissions standards in California and the year 2006 emissions requirements mandated by the United States Environmental Protection Agency. The boats come with a two-year warranty on the engine, the fuel system, and the electrical system, and a five-year warranty on the hull.

Patrol Rescue Jet
The Patrol Rescue Jet is designed to provide security in inland waterways and in harbors. With a speed of up to 55 miles per hour, the Patrol Rescue Jet can deliver law enforcement and emergency assistance to virtually any location on or around the water. This boat is available in either a 12 foot design or a 15 foot design.

Fire and Rescue Jet
The Fire and Rescue Jet is designed to fight fires on the water and in near shore areas. The Fire Rescue Jet comes equipped with a patented water pump that can supply up to 750 gallons of water per minute. The Fire and Rescue Jet is uniquely designed so one person can control the boat and the fire apparatus. This boat is also available in either a 12 foot design or a 15 foot design.

Sales: We currently utilize a direct sales team consisting of three team members which sell our products primarily in the United States. Furthermore, we currently work with several independent sales agents to sell our products throughout the United States. We hope to increase the size of our independent sales agent team in 2004 from two to six. By doing so we will be able to expand our reach into agencies nationwide that are looking for our products. In addition, through personal presentation, consultation and collaboration with government agencies, municipalities, and national foundations, we plan to provide demonstrator products for law enforcement, fire, rescue, patrol, and military departments for expositions, training, agency certifications, and demonstrations.

Marketing: Our marketing efforts include participating in industry trade shows, direct assistance to fire departments and municipalities for grant applications and communicating through our corporate website.

- The New York Port Authority bought two 1250 Fire and Rescue Jets in September of 2003 and has an open purchase-order agreement which allows them to buy more boats from us for the next two years at their option. The revenue from this sale was recognized by Force Protection, Inc., which formerly owned the boat assets that we now own. However, we received $70,474 from Force Protection on December 10, 2003, Inc. for these sales, which was recognized as additional paid in capital on our balance sheet.

- The Anglesea Volunteer Fire Company No.1 in North Wildwood, New Jersey purchased one 1250 Fire and Rescue Jet boat on December 1, 2003 that was delivered in March, 2004. The revenue from the boat sale will be recognized in the First Quarter of 2004.

We compete against large international companies that have greater financial, technical and marketing resources, customer bases, longer operating histories and greater name recognition. However, management believes our products offer the following advantages over competitive products:

Durability: The hulls are constructed using hand laid "S" glass. This produces a fiberglass hull that is stronger yet lighter than conventional fiberglass hulls.

High Performance and Stability: Most boats capable of exceeding 55 miles per hour are inherently unstable and virtually uncontrollable at those speeds. Management believes the patented "V" shape hull design makes the boats safe and stable at high speeds, thereby eliminating this problem.

Best Cost: The prices for commercial boats are competitive with the prices offered by competitors.

- Boston Whaler: Offers a wide range of commercial and recreational products. Their fireboats typically exceed twenty feet in length.

- Nichols Bros: Manufactures a large variety of commercial boats. They primarily build large boats at extravagant costs. Their newest fireboat is 105 feet in length and was delivered at a cost of $8.9 Million.

- Triad Marine: Offers commercial and recreational inflatable boats ranging in size from eight to thirty feet in length.

- Safe Boats: Builds inflatable rigid hull patrol boats ranging in size from nine feet to thirty-nine feet in length.

- Nautica International: Manufactures patrol boats, commercial boats and recreational boats.

- Silver Ships and Northwind Marine: Manufactures a line of commercial and fire boats primarily 25-feet in length and above.

Manufacturing: The hulls for our boats were manufactured in Nanning, China. We currently have a surplus of hulls in our storage facility in Riverside, California and are not utilizing the manufacturing facility which we lease on a contract basis to specifically manufacture the hulls. If and when our supply of hulls is depleted, we may explore using this facility again to manufacture the boats.

Assembly: Boat prototyping and boat assembly is performed in Stanton, California, strategically positioned near the Los Angeles, and Long Beach Harbors. Final boat assembly is located in a 3,000 square foot facility, with an additional 3,000 square feet in Riverside, California for storage.

We purchase key materials, components and equipment, including engines, fire pumps and other components from third party suppliers. We obtain most of our critical raw materials and components from a single or limited number of suppliers. When possible, we also develop and maintain alternative sources for essential materials and components. The inability to obtain sufficient quantities of these materials or components may result in delays, increased costs, and reductions in our product shipments.

Our intellectual property is important to our business. We rely on a combination of license rights, trade secret laws, confidentiality procedures and contractual provisions to protect our intellectual property. We license patents and patents-pending that relate to the construction and design of the sleek, progressive "V" and double pad-bottomed "V-hull" boat. The hull is designed so that as water hits the hull, it flows to the next convenient degree, creating a lift and literally raising the boat to the top of the water.

Pursuant to the Business Asset Sale, License and Assignment of Rights Agreement between Sonic Jet Performance, Inc. and Rockwell Power Systems, Inc., we were granted a license for a period of twenty years to use the "Sonic Jet Performance" name and granted Rockwell the authority to market and sell Fire and Rescue and Recreational boasts everywhere in the world except the Middle East(including Egypt, Lebanon, Turkey, Syria, Jordan, Iraq, Saudi Arabia, Bahrain, Oman, Qatar, the UAE and Yemen).

In addition, Rockwell was assigned the contractual right to use the Fire and Rescue Jet design as provided for under the 2001 License Agreement made between Sonic Jet Performance, Inc. and Mardikian Marine Design et al dated December 21, 2001. The term of agreement is from December 27, 2001 to December 31, 2006 with an option for renewal of one 5 year term until December 31, 2011 unless terminated pursuant to the Agreement. Pursuant to the License Agreement, we have agreed to pay to the Licensor a royalty equal to the greater of (a) $60,000 per year or (b) the percentage of the License's yearly gross revenue resulting from the sale of watercraft or other product that incorporate or include any of the licensed designs according to the following schedule:

Our target market is primarily fire departments, port authorities, and other governmental agencies. Thus, we have a limited customer base.

Obtaining government contracts may involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, budgetary constraints, political agendas, extensive specification development, price negotiations and milestone requirements. Each government agency also maintains its own rules and regulations with which we must comply and which can vary significantly among agencies. Governmental agencies also often retain some portion of fees payable upon completion of a project and collection of these fees may be delayed for several months.

We presently employ four employees in the United States, including factory workers, sales, and administrative and management personnel. We also employ two contractors, which assist us in our sales efforts.

Environmental Matters
We are subject to federal, state, local and foreign laws, and regulations regarding protection of the environment, including air, water, and soil. Our manufacturing business involves the use, handling, storage, and contracting for recycling or disposal of, hazardous or toxic substances or wastes, including environmentally sensitive materials, such as batteries, solvents, lubricants, degreasing agents, gasoline and resin. We must comply with certain requirements for the use, management, handling, and disposal of these materials. However, we do not maintain insurance for pollutant cleanup and removal. If we are found responsible for any hazardous contamination, any fines or penalties, we may be required to pay, or any clean up we are required to perform, could be very costly. Even if we are charged, and later found not responsible, for such contamination or clean up, the cost of defending the charges could be high. If either of the foregoing occurs, our business, results from operations and financial condition could be materially adversely affected.

Other Regulatory Matters
Our operations and products are subject to extensive government regulation, supervision, and licensing under various federal, state, local and foreign statutes, ordinances and regulations. Certain governmental agencies such as the EPA and the Occupational Safety and Health Administration, or OSHA, monitor our compliance with their regulations, require us to file periodic reports, inspect our facilities and products, and may impose substantial penalties for violations of the regulations. For example, we are subject to federal regulation under the Boat Safety Act of 1971 that requires boat manufacturers to recall products for replacement of parts or components that have demonstrated defects affecting safety. Although manufacturers of certain equipment we use in our boats have instituted recalls, there has never been a recall resulting from our design or manufacturing process.

While we believe that we maintain all requisite licenses and permits and are in compliance with all applicable federal, state, local and foreign regulations, there can be no assurance that we will be able to maintain all requisite licenses and permits. The failure to satisfy those and other regulatory requirements could have a material adverse effect on our business, financial condition, and results of operations.