28 Cottrell Street · Mystic, CT 06355 · Phone 860-245-0191 · Fax 860-536-6607

28 Cottrell Street · Mystic, CT 06355 · Phone 860-245-0191 · Fax 860-536-6607

28 Cottrell Street · Mystic, CT 06355 · Phone 860-245-0191 · Fax 860-536-6607

28 Cottrell Street · Mystic, CT 06355 · Phone 860-245-0191 · Fax 860-536-6607

28 Cottrell Street · Mystic, CT 06355 · Phone 860-245-0191 · Fax 860-536-6607

28 Cottrell Street · Mystic, CT 06355 · Phone 860-245-0191 · Fax 860-536-6607

To The Board of Directors
Flight Safety Technologies, Inc.

We have audited the accompanying balance sheet of Flight Safety Technologies, Inc. as of May 31, 2004, and the related statements of operations and comprehensive loss, changes in stockholders' equity, and cash flows for the years ended May 31, 2004 and 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all materials respects, the financial position of Flight Safety Technologies, Inc. as of May 31, 2004, and the results of its operations and its cash flows for the years ended May 31, 2004 and 2003, in conformity with accounting principles generally accepted in the United States of America.

Farmington, Connecticut
July 7, 2004, except for Note 12 as to
          which the date is August 12, 2004

Note 1 - Summary of Significant Accounting Policies:

Significant accounting policies followed by Flight Safety Technologies, Inc. (the "Company") in determining financial position and the results of operations are as follows:

On June 27, 2003, Flight Safety Technologies Operating, Inc. was merged into Flight Safety Technologies, Inc. All previous inter-company accounts and transactions have been eliminated in the consolidation.

The Company is engaged in the development of two proprietary sensor technologies:  SOCRATES and UNICORN.

SOCRATES (Sensor for Optically Characterizing Ring-eddy Atmospheric Turbulence Emanating Sound) is designed to detect clear air turbulence, microbursts and aircraft generated vortices which result in hazardous conditions to safe air travel.

UNICORN (Universal Collision Obviation and Reduced Near-Miss) is a technology that is being designed based upon an arrangement of radar which gives both visual and audible warning indication of approaching aircraft to pilots.

On May 29, 1997, the Company was awarded its first contract in the amount of $1,326,335, sponsored by the Federal Aviation Administration (FAA), to commence the development and "Proof-of-Principle" of Socrates. During the period February 22, 1998 through May 31, 1999, the FAA added seven modifications to this contract totaling $1,664,821.

The total contract funding for Phase I of Socrates in fiscal years 1997 and 1998 was $2,991,156. An additional $4,927,898 was awarded on August 29, 1999 for Phase II of Socrates, and Phase II was further increased to $6,041,448 on February 20, 2003. On September 30, 2003, Phase III of SOCRATES was funded for a total of $3,975,004 and as of May 31, 2004, the remaining funding for Phase III is $1,514,476.

The Company's Federal contract, with represents 100% of the revenues for 2004 and 2003, with modifications, was issued and is managed by The Volpe Center of the U.S. Department of Transportation. The Company submits, and receives payment on, monthly invoices, which represent progress payments covering the Company's total direct and indirect costs on the project.

The Company's primary office is in Mystic, Connecticut, and it also has offices in Baltimore, Maryland; Chicago, Illinois; and North Kingstown, Rhode Island. In addition to its full-time employees, the Company is further supported by a team of consultants and subcontractors, including Lockheed Martin Corporation, with whom the Company has a long-term Teaming Agreement, ICF Consulting Services, British Telecommunications, Alaska Native Technologies, Anteon Corporation and Georgia Tech Applied Research Corporation.

Note 1 - Summary of Significant Accounting Policies: (Continued)

Depreciation of property and equipment is provided using the straight-line method over estimated useful lives of five years. Expenditures for major renewals and betterments, which extend the useful lives of property and equipment, are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.

Deferred taxes arise from differences in recording depreciation, amortization, and net operating loss carryforwards for financial statement and tax purposes.

The Company had amounts in excess of $100,000 in a single bank during the year. Amounts over $100,000 are not covered by the Federal Deposit Insurance Corporation.

For purposes of reporting cash flows, cash and cash equivalents include cash on hand and short-term investments maturing within ninety days. As a result of the business combination with Reel Staff, Inc., the following non-cash transactions were recorded in 2003:

Intangible assets consist of patent costs associated with SOCRATES and UNICORN. Patents are being amortized using the straight-line method over a period of seventeen years.

Company sponsored research and development costs, including proposal costs and un-reimbursed expenditures for developmental activities are charged against income in the year incurred.

Note 1 - Summary of Significant Accounting Policies: (Continued)

The Company recognizes income from contracts under the percentage of completion method of accounting for financial reporting purposes. Revenues are measured by the ratio of the costs incurred to date divided by the estimated total costs for each contract. Contracting costs include all direct material, labor, and subcontracting costs. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Revenue related to claims is recorded at the lesser of actual costs incurred or the amount expected to be realized.

Income or (loss) per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during each period. Potential common shares have not been included due to their anti-dilutive effect.

The estimated fair value of financial instruments has been determined based on the available market information and appropriate valuation methodologies. The carrying amounts of cash, accounts receivable, other current assets, accounts payable and accrued expenses approximate fair value at May 31, 2004, because of the short maturity of these financial instruments.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Concentration of credit risk exists with respect to contract receivables. This risk is mitigated by the fact that these receivables are with the United States Government.

Note 1 - Summary of Significant Accounting Policies: (Continued)

The Company applies Accounting Principles Board Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its stock awards, and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). Under APB 25, compensation expense is recognized over the vesting period to the extent that the fair market value of the underlying stock on the measurement date exceeds the exercise price of the employee stock award.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") 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". All transactions in which services are received for issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the earlier of the date on which the counterparty's performance is complete or the date on which it is probable that performance will occur.

Note 2 - Contract Receivables and Other Receivables:

At May 31, 2004, accounts receivable consisted of the following:

The Company classifies its debt and marketable equity securities into held-to-maturity, trading, or available-for-sale categories according to the provisions of Financial Accounting Standards Board Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Debt securities for which the Company does not have the intent or ability to hold to maturity are classified as available for sale. Held-to-maturity securities are recorded as either short-term or long-term on the balance sheet based on contractual maturity date and are stated at amortized cost. Marketable securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses recognized in earnings. Debt and marketable equity securities not classified as held-to-maturity or as trading are classified as available-for-sale and are carried at fair market value, with the unrealized gains and losses, net of tax, included in the determination of comprehensive income or loss and reported in shareholders' equity. A summary of these investments is as follows:

Contractual maturities of held-to-maturity securities at May 31, 2004, are as follows:

Note 4 - Property and Equipment:

Property and equipment are summarized by major classifications as follows:

Depreciation expense for the years ended May 31, 2004 and 2003 was $77,432 and $49,825, respectively

The gross patent costs as of May 31, 2004 were $183,959. Related accumulated amortization was $33,969. Amortization expense for the years ended May 31, 2004 and 2003 was $10,621 and $9,258, respectively. Amortization expense for the next five years is expected to be $12,600 per year.

The Company utilizes the lobbying services of a firm that is wholly-owned by one of the Company's directors. Total expenses related to these services were $96,244 and $74,818 for the years ended May 31, 2004 and 2003, respectively. As of May 31, 2004 and 2003, fees of $9,962 and $6,865 remained unpaid in this regard, respectively.

Note 7 - Stockholders' Equity:

During the year ended May 31, 2004, the Company had a public placement of 3,028,600 common shares which raised gross proceeds of $9,085,800, and after deduction of expenses, net proceeds were $7,593,138. The Company also had 850,000 warrants exercised, which raised $1,700,000.

The exercise price of the options and warrants was increased from $2.00 to $6.00 as a result of the reverse split. There were no options or warrants granted to employees in 2003. Of the 632,955 options outstanding at May 31, 2004 586,080 are vested. The public offering warrants represents one warrant for each unit of common stock sold with a warrant price of $3.30. The underwriter warrants are priced at $3.60 for 270,000 and $5.40 for 135,000 warrants.

Stock based expense attributable to options issued to non-employees based on the fair value of the shares issued was $9,062 for the year ended May 31, 2004. Deferred stock based expense for the unvested portion of the options issued was $13,594. Stock based expense attributable to employees was $29,375 in 2004. Deferred stock based expense for the unvested portion of the options issued was $88,125. Stock base expense would have been $171,250 under the fair value method in SFAS No. 123. Net loss would have been $566,089 and net loss per share would have been $.09 per share.

The fair value of the options granted to employees and non-employees is estimated on the measurement date based on the Black-Scholes minimum value pricing model using the following assumptions:

The stock options and warrants expire as follows:

Provision for income taxes for 2004 and 2003 is as follows:

Current tax for 2004 and 2003 is due to State taxes on capital. Temporary differences relate to the differences in depreciation and amortization methods used for book and tax basis, and certain accrued liabilities. The Company has recorded a valuation allowance of 100% of the deferred tax asset because it is uncertain if the asset will be realized. The Company has Federal and State net operating loss carryforwards of approximately $1,900,000, to reduce future taxable income, if any. The Federal operating losses expire in various years through 2024 and the State operating losses expire in various years through 2009. The Company also has State tax credit carryforwards of approximately $10,000, which expire in the year 2009.

The Company has leased office space at $1,600 per month in Mystic, Connecticut, which expires March 31, 2005. The Company also leases office space, on a month to month basis, in Baltimore, Maryland, from an officer of the Company at $500 per month, and in New London, Connecticut at $357 per month from the Kildare Corporation. On April 23, 2004, the Company entered into a lease for the period of June 1, 2004 to May 31, 2005, for office space in North Kingston, Rhode Island at $1,120 per month. Rent expense was $28,427 and $24,488 for the years ended May 31, 2004 and 2003, respectively.

In connection with the transfer of the UNICORN technology from Advanced Acoustical Concepts, Inc. to the Company, the Company has agreed to pay a 3% royalty on all net sales of UNICORN products. As of May 31, 2004 and 2003, no amounts have been paid under this commitment.

The Company has commitments with various firms for lobbying services totaling $144,000 for the next fiscal year.

In connection with SOCRATES, the Company has entered into a Teaming Agreement (as defined in the Federal Acquisition Register "FAR") with Lockheed Martin Corporation ("Lockheed"). The Company will act as the primary contractor and Lockheed will function as the primary subcontractor. The agreement is for a ten year period ending in 2007, unless terminated earlier based on specific conditions identified under the agreement. As of May 31, 2004 and 2003, the Company was liable to Lockheed for $412,239 and $129,224, respectively.

On September 1, 2002, the Company's stockholders in exchange for 96.54% of its common and preferred stock receiving a 53% interest in another corporation (Reel Staff, Inc.). This transaction resulted in a business combination treated as a reverse acquisition and recapitalization whereby Flight Safety Technologies, Inc. became the surviving entity. Then Reel Staff, Inc. changed its name to Flight Safety Technologies, Inc. The stock exchange rate was two and one half shares of Reel Staff, Inc. for every share of preferred and common stock tendered by the existing stockholders of Flight Safety Technologies, Inc. The result was the issuance of 7,611,775 shares of common stock. In conjunction with the share exchange the Company issued 850,000 shares of common stock in a private placement. The private placement raised gross proceeds of $1,700,000, and after deduction of expenses, net proceeds were $1,529,643. The Proforma operating results of this transaction as of the beginning of the reporting years would be as follows:

Effective December 31, 2003, the Company completed a 1 for 3 reverse stock split. Common stock outstanding was reduced by 10,598,423 and common stock was decreased by $10,598, with a corresponding increase in additional paid-in-capital. The weighted average number of shares decreased by 7,896,134 and net loss per share increased by $(.16) for 2003.

The Company received notice on July 30, 2004, that a purported class action suit was filed that asserted claims under Section 10b of the Securities Exchange Act of 1934. The Company believes the claims are without merit and intends to vigorously contest them.

Issuer Securities Repurchase Instruction, dated as of May 15, 2003 (the "Instruction"), between FLIGHT SAFETY TECHNOLOGIES, INC. (the "Issuer") and MERRILL LYNCH (the "Broker").

WHEREAS, Issuer desires to repurchase shares of its common stock, par value $.001 per share, (the "Common Stock"), pursuant to its publicly announced Securities Repurchase Program (the "Program"); and

WHEREAS, Issuer desires to appoint Broker to repurchase shares of Common Stock on its behalf in accordance with this Instruction and the Program;

NOW, THEREFORE, the Issuer and Broker hereby agree as follows: