March 11, 2005
Mr. Kevin L. Vaughn
Division of Corporate Finance
United States Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
Telephone: 202-824-5387
Re: FORM 10-KSB FOR FISCAL YEAR ENDED SEPTEMBER 30, 2004 - COMMENTS,
FILE NO. 0-28745
Dear Mr. Vaughn:
This letter has been prepared in response to your letter dated March 9,
2005, regarding National Scientific Corporation's Form 10-KSB for fiscal year
ended September 30, 2004 (the "10-KSB") as well as the 10-QSB for the period
ending December 31, 2004 (the "10-QSB").
Below we outline point-by-point a set of changes we would propose to make
in order for our 10-KSB and 10-QSB to better conform to standards, as well as
changes we would make to future filings. As we are in the midst of working on
our annual proxy mailing as well, we would request an expedited review of these
proposed changes and responses, so that we can rapidly file the appropriately
amended 10-KSB and 10-QSB. If these changes appear to you to be appropriate, we
will file amendments promptly to put them into EDGAR. In addition to this
outline of changes, you will find a redline copy of the proposed amended 10-KSB
attached to this letter. If these changes prove appropriate, we will execute
identical changes to the 10-QSB as well.
ITEM 8A. CONTROLS AND PROCEDURES - PAGE 42
1. We note your statement that your chief executive officer and your chief
financial officer have concluded that the "disclosure controls and
procedures are effective as of September 30, 2004 for a COMPANY ITS SIZE"
(emphasis added). It does not appear that your certifying officers have
reached an unqualified conclusion that your disclosure controls and
procedures are EFFECTIVE. Please revise to address your officers'
conclusions regarding the effectiveness of your disclosure controls and
procedures. Please note this comment also applies to your Form 10-QSB as of
December 31, 2004.
OUR PROPOSED RESPONSE: We will amend our 10-KSB and 10-QSB to remove the phrase
"for a Company its size" from this sentence, leaving "disclosure controls and
-2-
procedures are effective as of September 30, 2004." See also point (4) below,
which includes the full proposed revised text for item 8A.
2. We note your statement included in your disclosure that management has
concluded that your disclosure controls and procedures are effective "to
timely alert them to material information relating to the Company
(including its consolidated subsidiaries) required to be included in the
Company's Exchange Act filings. The language that is currently included
after the word "effective" in your disclosure appears to be superfluous,
since the meaning of "disclosure controls and procedures" is established by
Rule 13a-15(e) of the Exchange Act. However, if you do not wish to
eliminate this language, please revise to clarify, if true, that your
officers have also concluded that your disclosure controls and procedures
are effective to ensure that information required to be disclosed in the
reports that you file or submit under the Exchange Act is accumulated and
communicated to your management, including your chief executive officer and
chief financial officer, to allow timely decisions regarding required
disclosure. Refer to Rule 13a-15(e) of the Exchange Act. Please note this
comment also applies to your Form 10-QSB as of December 31, 2004.
OUR PROPOSED RESPONSE: We will amend our 10-KSB and 10-QSB to remove the wording
after the word "effective" as proposed above. See also point (4) below, which
includes the full proposed revised text for item 8A.
3. We note your disclosure that "there have been no SIGNIFICANT NEGATIVE
changes in [your] internal controls over financial reporting during the
year ended September 30, 2004..." (emphasis added). Please revise your
disclosure to remove the words "SIGNIFICANT NEGATIVE" and to discuss ALL
charges in your internal control over financial reporting that have
materially affected, or that are reasonably likely to materially affect,
your internal control over financial reporting, as required by Item 308(c)
of Regulation S-B, as amended effective August 13, 2003. Please note this
comment also applies to your Form 10-QSB as of December 31, 2004.
OUR PROPOSED RESPONSE: We will amend our 10-KSB and 10-QSB to remove the words
"significant negative" as proposed above. See also point (4) below, which
includes the full proposed revised text for item 8A.
4. We note your statement that a "control system, no matter how well designed
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met..." We also note your disclosure
that "[t]hese controls and procedures" are designed to provide only
reasonable assurance of achieving their objectives. Please revise to
clarify whether these statements and the other statements regarding the
limitations of your systems of controls that currently appear in the
fourth, fifth and sixth paragraphs relate to your disclosure controls and
procedures, your internal control over financial reporting, or both. In
addition, if your revised disclosure continues to contain any statements
suggesting that your disclosure controls and procedures "cannot provide
absolute assurance" or "can provide only reasonable assurance" of achieving
their objectives, please revise the paragraph in which any such statements
-3-
appear to also state clearly, if true, that your principal executive
officer and principal financial officer have concluded that your disclosure
controls and procedures are effective at that reasonable assurance level.
Please refer to Section II.F.4 of Management's Reports on Internal Control
Over Financial Reporting and Certification of Disclosure in Exchange Act
Periodic Reports, SEC Release No. 33-8238, available on our website at
http://www.sec.gov/rules/final/33-8238.htm. Please note this comment also
applies to your Form 10-QSB as of December 31, 2004.
OUR PROPOSED RESPONSE: We will amend our 10-KSB and 10-QSB to replace the text
discussed above for item 8A, so that it will now read as follows:
"Our management has responsibility for establishing and maintaining
adequate internal control over financial reporting for us. Our management
uses a framework for establishing these internal controls. This framework
includes review of accounting detailed records on at least a quarterly
basis by multiple senior officers of National Scientific, at least one of
whom operates outside of the corporate finance and accounting area, and one
of whom operates within the area of corporate finance and accounting. This
review process includes review of significant accounting records and source
documents, such as general journal entry records, accounts payable records,
and monthly bank statement reconciliations. Documentary records are kept of
this review process.
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including its Chief Executive
Officer and Acting Chief Financial Officer and its President, of the
effectiveness, as of September 30, 2004, of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15(e). Based upon that evaluation, the Chief Executive Officer and
Acting Chief Financial Officer and its President concluded that the
Company's disclosure controls and procedures are effective.
There have been no changes in the our internal control over financial
reporting during the year ended September 30, 2004 that have materially
affected, or are reasonably likely to materially affect, the Company's
internal control over financial reporting.
The controls and procedures for our disclosure as well as our internal
controls over financial reporting are processes designed by, or under the
supervision of, the principal executive and principal financial officers,
and effected by the board of directors, management and other personnel, to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. We believe
that a control system, no matter how well designed and operated, cannot
provide absolute assurance that the objectives of the control system are
met, and no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company have been
detected. However, our Chief Executive Officer and Acting Chief Financial
Officer and its President have concluded that the Company's disclosure
controls and procedures and its internal controls and procedures are
effective at providing that reasonable level of assurance.
-4-
Our management believes that upon significant future growth in the number
of accounting transactions we process, perhaps within the next year,
additional review and enhancement of internal controls will be required.
Our management is planning to assign additional staff resources to assist
with support for growth in the internal controls area when the increase in
transaction velocity dictates this as a prudent step in order to maintain
our effective level of internal controls.
Our external auditors, Hurley and Company, have not issued an attestation
report on management's assessment of the Company's internal control over
financial reporting, as it is not yet required since the Company has less
than $75 million in "public float."
STATEMENTS OF CASH FLOWS - PAGE F-12
5. We note that cash flow from operations in 2004 was positively impacted by a
$65,501 increase in accounts payable and accrued expenses. However, based
on the balance sheet, it appears that accounts payable and accrued expenses
have decreased $154,249 from September 30, 2003 to September 30, 2004.
Supplementally reconcile the change on the balance sheet to the change
presented on the statement of cash flows, and provide appropriate
discussion of the reconciling items. In addition, revise future filings to
provide appropriate disclosure of any non-cash changes in the accounts
payable and accrued expenses. Please also refer to our comment below
regarding stock issued for services.
OUR PROPOSED RESPONSE: Accounts payable and accrued expenses decreased by
$154,249 from $643,420 at September 30, 2003 to $489,171 at September 30, 2004.
The decrease resulted from a decrease in trade payables of $37,538, and a net
decrease in accrued expenses of $116,711. The accrued expense decrease was
partly attributable to the conversion, by our CEO and Chairman, of approximately
$150,000 of back pay and accrued vacation pay to our restricted common stock,
the reduction of $69,750 from our stock retainage pool with the issue of issue
of 500,000 shares under the stock retainage program and an increase of $103,039
in accrued expenses. As a result of the foregoing, cash flow from operations in
2004 was positively impacted by a $65,501 increase in accounts payable and
accrued expenses.
Also, we will ensure that future filings comply with this guidance.
NOTE 2 - DEVELOPMENT STAGE OPERATIONS - PAGE F-17
6. We note that you have commenced your planned principal operations have
commenced and that you have begun to realize revenues from these
operations. We also note that your primary costs relate to salaries and
benefits of administration and marketing personnel and other expenses,
which include insurance costs, marketing expenses, filing fees and legal
expenses. Tell us why you believe you meet the criteria of paragraphs 8-9
of SFAS 7 for reporting as a development stage enterprise.
OUR PROPOSED RESPONSE: SFAS 7 notes that a development stage enterprise will
typically be devoting most of its efforts to activities such as financial
planning, raising capital, research and development, establishing sources of
-5-
supply and developing markets. While we have now started to have some sales,
most of the effort of management has been to do exactly those activities. You
have correctly noted that much of our costs relate to salaries and benefits of
administration and marketing personnel, but those are the people who are raising
the capital and trying to develop a viable market for the products. The filing
and legal fees are an unfortunate part of raising the capital as well. A small
portion of our legal fees relate to our patents and the research and development
side of the Company. We are hoping that we have found a niche in school buses
that will allow us to focus our resources on running the operations rather than
developing a going concern.
NOTE 5 - EARNINGS PER SHARE - PAGE F-19
7. We note your disclosure at the end of this footnote regarding potential
cash proceeds to be received upon exercise of all outstanding common stock
equivalents. Please supplementally tell us your basis for including such
disclosure. We note that a large number of your common stock equivalents
have been cancelled or forfeited in the past. Further, we note that as of
September 30, 2004, it appears that a large number of outstanding options
and warrants have exercise prices above the current market price. We
believe this disclosure may be confusing to investors as it does not appear
that such exercise of common stock equivalents is reasonably likely to
occur. If you wish to include this disclosure in future filings, we believe
you should limit your disclosure of potential proceeds to only those that
would be received from vested in-the-money options and warrants.
OUR PROPOSED RESPONSE: This disclosure represented our attempt to comply with
FAS 148. In all future filings, we will ensure that if any such disclosures are
made by us, that they are limited to disclosure of potential proceeds that would
be received from vested in-the-money options and warrants, as suggested above.
NOTE 8 - RELATED PARTY TRANSACTIONS - PAGE F-21
8. We note your disclosure that the sales goals for the stock retainage
program were not met in 2003. We also note that the program was extended
into 2004. Based on fiscal year 2004 sales levels, it appears that the
goals were not met in 2004 either. Finally, we note your disclosure that no
shares were added to the program in 2004. However, we note that 500,000
shares are shown as being issued in the statement of changes in
shareholders' equity (deficit) for 2004 relating to the stock retainage
program. Supplementally provide details of the 500,000 shares issued in
2004 relating to the stock retainage program. Your response should include
discussion of who received the shares and why.
OUR PROPOSED RESPONSE: On January 27, 2004, we issued 250,000 shares, from the
Stock Retainage Plan, to our employees Oscar Quadros, our controller, and
250,000 shares to Paul Davidson, our embedded systems development engineer.
Neither of these individuals are nor have been officers or directors of the
Company. The 500,000 shares were issued from the plan following the forfeiture
and return to the plan on August 19, 2003 of 800,000 shares from a participant
of the plan who left the company. The shares were issued at 90% of the average
market price per share, on the date of issue, of $0.155.
-6-
As discussed on Page 52 of the 10-KSB under the heading Employee Stock Retainage
Plan, the following disclosure has been made with regard to continuance of the
plan and future targets: "The plan's sales goals were not met in calendar year
2003, although the plan was nonetheless largely successful in assisting to
retain key staff, even during this period of deferred or reduced salary. In
January of 2004, our board extended this program into 2004, and set new sales
growth objectives for the year at a level 50% higher than the previous year's
program, giving plan participants an additional year to fully earn these
previously outstanding restricted stock grants. The board may extend this plan
into calendar year 2005 at its direction." In January of 2005 our board did in
fact resolve to extend the plan into 2005, keeping target levels for achievement
at the same level as the increased 2004 goals, keeping the substantial risk of
forfeiture in place as a means to incent performance and retain staff without
any additional dilution of shareholder value. We plan to cover this update in
our Proxy filing in the next few weeks.
NOTE 10 - STOCK OPTIONS AND WARRANTS -- PAGE F-23
9. Please revise future filings to provide the following additional
disclosures required by SFAS No. 123:
a) In accordance with paragraph 47(b), provide the weighted average grant
date fair value of options granted during the year. Such disclosure
should be made separately for options with exercise prices that (1)
equals, (2) exceeds, and (3) is less than the fair market value of the
options on the grant date.
b) In accordance with paragraph 47(c), provide the number and weighted
average grant date fair value of equity instruments other than
options.
c) In accordance with paragraph 47(e), provide the total compensation
cost recognized in income for stock-based employee compensation
awards.
d) In accordance with paragraph 48, provide the weighted average
remaining contractual life of all options and the weighted average
exercise price of options currently exercisable.
OUR PROPOSED RESPONSE: We will ensure that future filings comply with this
guidance.
10. We note that in 2004 you issued options to consultants in exchange for
services received. These options vested immediately and had exercise prices
below the then-current market value. Tell us how you recorded this option
issuance in your financial statements for 2004. In addition, tell us how
you calculated the fair value of this option issuance.
OUR PROPOSED RESPONSE: Options issued to consultants for services were included
in stock compensation on the Statement of Operations at the Black Scholes value
on the issue date.
-7-
11. We also note your disclosure on page 34 that "during fiscal 2003,
substantially all option grants were issued to employees." Provide us with
details of any option grants issued to non-employees, including how you
calculated the fair value of such option issuances and how the amounts are
reflected in the financial statements.
OUR PROPOSED RESPONSE: Below are details on all non-employee option issuances
during the period covered by this report.
OPTIONS GRANTED IN FISCAL 2003 TO NON-EMPLOYEES
No. of Total Black
Shares Exercise Grant Scholes
Issue date Granted Price Value Value
---------- ------- -------- ------- -------
David Mandala Consultant 10/11/2002 100,000 $ 0.04 $ 4,000 $ 7,270
David Mandala Consultant 11/5/2002 100,000 0.03 3,000 5,690
David Mandala Consultant 2/12/2003 50,000 0.05 2,500 4,905
Chris Lavoy Consultant 5/2/2003 75,000 0.10 7,500 5,250
El-Badawy El-Sharawy Consultant 7/1/2002 81,081 0.11 9,000 9,592
Tim Conroy Consultant 12/24/2002 22,000 0.10 2,200 3,071
------- ------- -------
428,081 $28,200 $35,778
======= ======= =======
OPTIONS GRANTED IN FISCAL 2004 TO NON-EMPLOYEES
No. of Total Black
Shares Exercise Grant Scholes
Issue date Granted Price Value Value
---------- ------- -------- ------- -------
Shel Berman Consultant 1/1/2004 150,000 $ 0.15 $22,500 $15,135
Greg Szabo Director 1/27/2004 20,000 0.15 3,000 2,106
Rick Cecil Consultant 5/26/2004 150,000 0.13 18,750 12,615
------- ------- -------
320,000 $44,250 $29,856
======= ======= =======
-8-
12. Revise future filings to clearly describe all significant stock
transactions, including issuance of stock, warrants and options to
non-employees for services. Clearly describe how and when you record such
issuances in your financial statements. If recording items in the financial
statements involved making estimates of fair value, your disclosures should
clearly state your method and basis for making such estimates.
OUR PROPOSED RESPONSE: We will ensure that future filings comply with this
guidance.
13. We note that you have issued certain warrants in connection with stock
offerings and debt transactions. Revise future filings to clearly describe
how you account for these warrants, including how you allocated amounts
between the debt and equity for the January 2004 transaction.
OUR PROPOSED RESPONSE: We will ensure that future filings comply with this
guidance.
EXHIBIT 31 - CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER AND ACTING CHIEF
FINANCIAL OFFICER
14. We note that the certification filed as Exhibit 31 was not in the proper
form. The required certifications must be in the exact form prescribed; the
wording of the required certifications may not be changed in any respect,
except for the modifications temporarily permitted to be made to the fourth
paragraph of the certification required to be filed as Exhibit 31 pursuant
to Part III.E of Release No. 8238. Accordingly, please file amendments to
your Forms 10-KSB and 10-QSB that include the entire filings together with
the certification of your current CEO and acting CFO in the form currently
set forth in Item 601(b)(31) of Regulation S-B.
OUR PROPOSED RESPONSE: We will amend our 10-KSB and 10-QSB to follow the
prescribed wording as follows, and we will ensure that future filings comply
with this guidance as well:
***************
EXHIBIT 31
CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER AND
ACTING CHIEF FINANCIAL OFFICER
PURSUANT TO 15 U.S.C. 78M(A) OR 78O(D)
(SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002)
I, Michael A. Grollman, certify that:
(1) I have reviewed this Annual Report on Form 10-KSB of National Scientific
Corporation;
(2) Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
-9-
(3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the small business issuer as of, and for, the periods presented in this
report;
(4) The small business issuer's other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the small business issuer and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the small
business issuer, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the small business issuer's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the small business issuer's
internal control over financial reporting that occurred during the
small business issuer's most recent fiscal quarter (the small business
issuer's fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect,
the small business issuer's internal control over financial reporting;
and
(5) The small business issuer's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the small business issuer's auditors and the audit
committee of the small business issuer's board of directors (or persons
performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the small business issuer's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the small business issuer's
internal control over financial reporting.
***************
-10-
We also accept each of the following points:
o We are responsible for the adequacy and accuracy of the disclosure in
the filings;
o Staff comments or changes to disclosure in response to staff comments
in the filings reviewed by the staff do not foreclose the Commission
from taking any action with respect to the filing; and
o We may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
Should you have any specific questions or require additional information, please
feel free to contact me at 480-948-8324. We plan to file the appropriate
amendments promptly, after we have your input on our proposed changes.
Regards,
/s/ Michael A. Grollman
Michael A. Grollman
Chief Executive Officer and Acting Chief Financial Officer
Enclosures
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-KSB/A
--------------
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended September 30, 2004
000 28745
(Commission File No.)
--------------
NATIONAL SCIENTIFIC CORPORATION
(Name of Small Business Issuer in its Charter)
--------------
Texas 86-0837077
(State of Incorporation) (I.R.S. Employer Identification No.)
14505 North Hayden Road, Suite 305
Scottsdale, AZ 85260
(Address of Principal Executive Offices) (Zip Code)
(480) 948-8324
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
PREFERRED STOCK, $0.10 PAR VALUE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $0.01 PAR VALUE
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 [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form and no disclosure will be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Revenues for the fiscal year ended September 30, 2004: $77,994.
The aggregate market value of voting stock held by non-affiliates of
National Scientific Corporation's ("NSC's") common stock, as of December 27,
2004 was approximately $ 4,693,101 (based on the last sale price of such stock
as reported by OTCBB Stock Market). The number of shares outstanding of the
registrant's common stock, as of December 27, 2004, was 84,350,657.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
PART I
FORWARD LOOKING INFORMATION
This Form 10-KSB contains certain forward-looking statements within the
meaning of the Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. For this purpose, any statements contained in
this Form 10 KSB that are not statements of historical fact may be deemed to be
forward looking statements. Without limiting the foregoing, words such as "may,"
"will," "expect," "believe," "anticipate," "estimate," or "continue" or
comparable terminology are intended to identify forward looking statements.
These statements by their nature involve substantial risks and uncertainties and
actual results may differ materially depending on a variety of factors, many of
which are not within NSC's control. These factors include, but are not limited
to, economic conditions generally and in the industries in which NSC's future
customers participate; competition within NSC's industry, including competition
from much larger competitors; technological advances which could render NSC's
products less competitive or obsolete; failure by NSC to successfully develop
new products or to anticipate current or prospective customers' product needs;
price increases or supply limitations for components purchased by NSC for use in
its products; and delays, reductions, or cancellation of orders that may be
placed with NSC. There can be no assurance that NSC will be able to develop its
products or markets for its products in the future.
ITEM 1. DESCRIPTION OF BUSINESS
OVERVIEW
Our business involves the research, development, and sale of devices and
designs commonly used in the electronics industry. The majority of our products
are electronic location-determining devices. These devices are typically very
small portable radios, intended to help establish the physical location of
people and objects to which these devices are attached. Some of our location
technologies use Global Positioning System (GPS) technology to determine
position. We also have other products that use non-GPS technology to establish
and then report position. We refer to our location-determining devices as our
location tracking products, or as location tools.
Our primary focus for these location-tracking products is the safety
market, related in many cases to the safety of children. Our products and
services help our customers keep better track of their children. Our products
are also used to keep track of adults, and as well to help keep track of
physical assets, such as equipment or vehicles. Our location tracking products
are often used in conjunction with software that displays maps, to show where
people or things are located. These mapping functions we often sell as a
service, to assist us in selling our location tracking products.
We have focused extensively on developing location tools since early 2002,
and our primary business objective is to generate revenue and profit from the
sale of our location tracking products and related services. The sale of these
products and services resulted in small amounts of revenue late in the fiscal
year ended September 30, 2002.
o Revenue was $63,579 for the fiscal year ended September 30, 2003;
o Revenue for the fiscal year ended September 30, 2004 was $77,994, all
derived from the sale of location tracking products and services;
o Net losses were $951,780 for the fiscal year ending September 30,
2004;
o Net losses were $952,564 for the fiscal year ended September 30, 2003.
2
We also have developed products that are electronic components, some of
which are used in radio equipment, and some of which have other applications in
the electronics field, such as in the memory systems of personal computers. All
of these electronic component products have been issued U.S. patents. We focused
extensively on developing these products and patenting them from 1996 through
early 2002, with the objective of licensing these products to other electronic
companies for their use. This strategy has not generated any revenue to date. In
early 2002, our focus shifted away from further development of our electronic
component products, but we continue to explore licensing opportunities for our
component products from time to time, keeping in mind that our primary objective
today is to sell our location tools products.
We originally incorporated as a Texas corporation in 1953. We changed our
name to National Scientific Corporation in 1996 and we began the activities
described in this annual report. Our principal executive offices are located at
14505 North Hayden Road, Suite 305, Scottsdale, Arizona 85260 and our telephone
number is (480) 948-8324. Our Internet site is www.national-scientific.com.
OUR BUSINESS
LOCATION PRODUCTS
Most of our customers require tracking of an object, asset, or person, and
reporting this information back to a central location. Our location products use
different technologies to determine position of the object and report it back to
the user, usually determined by whether they are trying to track items outdoors
or indoors. Our customers' choice of the type of technology to use is primarily
based on their application. Our location tools products therefore fall into two
different categories depending upon the type of application the customer
requires. These are Outdoor Location Products and Indoor Location Products.
Our current location technology has not been awarded any patents as of the
date of this report, although we have filed for provisional patent protection on
one of these products, and have been awarded trademark protection on one other.
We use a combination of confidentiality agreements and other trade secret
management to protect our trade secrets.
OUTDOOR LOCATION PRODUCTS
OVERVIEW OF THIS TECHNOLOGY
We have developed a group of products with the capability to determine
location using a technology called Global Positioning System or GPS. These
products report the location information or data back to the user through a
radio network. The products also contain a small computer to provide the overall
control and data processing of the device. In other words, the product can be
thought of as having three distinct pieces or systems. These are the data
collection system, the data control & processing system, and the data transport
system. This design concept is the basis for our outdoor location products.
DATA COLLECTION SYSTEM
This system can be thought of as the "eyes and ears" of the product. It is
comprised of two further systems. One system determines location of the product,
while the other system records specific events that the customer may be
interested in such as a door opening in a delivery truck. The location system
determines the position of the product using a technology developed by the U.S.
Government called the Global Positioning System, or GPS, as it is commonly
3
known. The U.S. Government for limited commercial use first made GPS available
in the 1980's. The system consists of approximately 24 satellites that orbit the
earth every 12 hours. It is a worldwide navigation support system that allows
users of GPS receivers to determine their precise geographic locations to within
a few meters. The network of satellites and their ground control and monitoring
stations are maintained and operated by the United States Department of Defense,
which maintains an ongoing satellite replenishment program to ensure continuous
global system coverage. Access to the system for all users is currently provided
free of charge by the U.S. Government.
GPS works by ranging and triangulating the product's position from a group
of satellites. Of the 24 GPS satellites in orbit, a minimum of four is needed to
reliably determine the product's three-dimensional position. A GPS receiver
measures distance by calculating the amount of time it takes a navigation and
time reference radio signal from the satellite to make a one-way trip to the GPS
receiver.
One of the main drawbacks with GPS is that the GPS receiver requires a
clear line of sight of the satellites. Therefore GPS receivers generally do not
work indoors. Even when the GPS receiver is outdoors, tall buildings, hills, and
dense foliage such as trees may also block reception.
Prior to May 2000, for reasons of national security, the U.S. Department of
Defense intentionally degraded GPS signals to civilian users allowing civilian
users to only obtain accurate information regarding their geographic locations
accurate as to within a radius of about 100 meters. On May 2, 2000, the U.S.
Department of Defense eased restrictions on civilian use of GPS technology,
allowing civilian users to now calculate their geographical positions to
accuracy of 10 meters or better. This change in policy significantly improves
the utility of GPS for many applications.
GPS receivers typically are very compact; it is not necessary to have a
large dish antenna to receive GPS signals. Typical information that can be
obtained from these GPS signals are latitude, longitude, elevation, speed,
direction, date and time.
The second part of this Data Collection System is customer specific. Many
customers have additional types of data that they want to know or want collected
relevant to a location. An example of this could be, every time the delivery
truck door is open, report its position and time the incident happened. Another
example could be to report every incident of when the car traveled faster than
70mph. This data input system can therefore be customized to meet the exact
needs of a customer.
Another kind of data collection technology we use in some of our products
is called RFID, which stands for Radio Frequency Identification. RFID devices
are small radios that can be used to track information about people or objects.
RFID provides a very low cost solution for certain kinds of tracking activities,
especially short-range activities, such as those at distances of less than a few
hundred feet. RFID devices often are less costly to manufacture than GPS
devices, although due to their short range, they may not be as versatile as GPS,
which can work at distances of many miles or more.
DATA CONTROL & PROCESSING SYSTEM
This system can be thought of as the "brains" of the product. A technical
term for this system is an embedded system, meaning one that lives deep inside
the overall product. An embedded system is a small special-purpose computer
system built into a larger device. The reason we use an embedded system in our
4
products is to keep cost to us low, so our products stay more competitive in
price. Simple embedded systems can cost us as little as a few dollars each and
use very little power compared to the desktop computers that many people are
familiar with, which typically cost much more. On our embedded systems there is
typically no disk drive, operating system, keyboard, or screen. Our embedded
systems instead communicate with other computers by radio. These other computers
typically have a keyboard and screens, and they are used to display our
information.
The programs that we run on these systems are custom designed and built by
our own engineers. These programs are called firmware. The firmware controls how
the data is collected, what data should be collected and what events should be
monitored and reported, what should be ignored and how and when and what data
should be sent back to the user. As we mentioned above, the system is relatively
easy to customize, and the firmware is also easy to customize as it has been
written in a modular fashion that allows changes to one section to be
implemented without the need to completely re-write the program. This helps us
keep costs down.
DATA TRANSPORT SYSTEM
This system can be thought of as the "mouth" of the product. It
communicates to the outside world where it is and what has happened. There are
many different types of technology that can be used to transport this data back
to the user, generally using some kind of wireless technology based on radios.
We currently use cellular radios, satellite radios, Wi-Fi(R) radios, and other
special purpose radios.
We use a cellular radio based on GSM cellular technology. GSM, or Global
System for Mobile Communications, is a second-generation digital mobile
telephone standard. GSM was initially developed as a pan-European collaboration,
intended to enable mobile roaming between member countries. As of 2004, there
are now one billion GSM customers in the world in 193 different countries,
according to a report published in February 2004 by the GSM Association. GSM
technology is experiencing rapid growth in the Americas and elsewhere, according
to the 3G Americas organization. We believe the use of GSM in our products makes
them more attractive to customers on an international basis.
The cellular radios typically operate in "real time." When an event occurs,
the data is immediately transported back to a user at a remote location.
While cellular coverage and reception is good in urban areas, it is less
effective in rural areas and is non-existent in most wilderness areas. Sometimes
our products are used in areas where there is poor or no cellular coverage. To
overcome this we sometimes use a special radio that communicates with satellites
in orbit around the earth. This form of communication has the advantage that our
products can be used in very remote areas almost anywhere in the world. The
major downside is that these radios are large and expensive and the airtime
usage costs can be high. Another problem associated with this technology is
that, like GPS, these satellite radios work best when there is a clear line of
site to the satellites; as such they may not work well indoors, or under dense
foliage or in deep valleys.
The satellite radios typically operate in "real time." When an event occurs
the data is immediately transported back to the user.
Some of our customers do not want to have the expense of a real time
cellular or satellite connection, nor are they interested in having the data in
real time. For this we use either a special purpose radio or a Wi-Fi(R) radio.
5
The Wi-Fi(R) radio operates in a very similar manner to cordless phones
found in many households. These phones typically consist of a base station and
handset. Our system is very similar; it consists of a base station unit that
receives data from the mobile unit that would be on the asset or vehicle being
tracked. The base station is typically attached to a personal computer that
takes the raw data from the radio and re-formats it into information that can be
displayed by other computers on the Internet. Wi-Fi(R) stands for "Wireless
Fidelity" and is a technology in very common use to connect personal computers
to other computer networks, including to the Internet.
The special purpose radios work in a very similar manner to the Wi-Fi(R)
radio, except that they can sometimes transmit data over longer distances.
Wi-Fi(R) radios operate in an unlicensed part of the radio spectrum and as
such do not have any special government licensing fees associated with them.
Because they operate in a license free spectrum the Federal Communications
Commission (FCC) imposes some restrictions on the use of these radios. One major
restriction is that the range the radio signal can go is limited to about 300
feet.
Since most of the time our product will operate well beyond 300 feet from
the base station, all the data that is collected is stored within the device for
later transmission when the product comes back into that range again. When the
vehicle or asset comes back into range of the base station the mobile units
automatically download their information. We call this mode of operation "near
time." These "near time" products do not incur any special airtime usage
charges. As such they can be significantly cheaper to operate than the cellular
or satellite equivalents.
Once the data is transmitted back to the user they can either display the
information on our Lobo(TM) mapping software (see below) or on some other
computer application.
OUTDOOR LOCATION TOOLS PRODUCTS
IBUS(TM). IBUS(TM) is a small outdoor location product designed to track
school buses, as well as logging the children riding on the school bus. We
announced this product in April of 2003. The unit contains a GPS that allows it
to determine its current location. The unit also contains an ID card reader or
thumbprint scanner. As the child enters the bus they simply swipe their ID card
or scan their thumbprint and a record is created of who boarded the bus, and
where they boarded the bus. As the bus travels along its route picking up
passengers, there is a complete manifest created of who is riding on the bus. At
journey's end the children simply swipe their ID cards or scan their thumbprints
as they disembark and another log is created. Should there be a difference in
the logs, then the driver will be notified that there could be someone left on
the bus. Management believes that the near term future of the firm may be
closely linked to market interest in future versions of this product.
This unit is designed to interface with software made by Verify Systems,
Inc., that can provide reports to schools on the whereabouts of buses and
students. We have only produced small numbers of this product, and have
presented informational samples to various school districts, which are
evaluating and testing it. We, together with Verify Systems, have run several
pilot projects using IBUSTM with school districts in Massachusetts and Arizona.
We intend to market this product directly and through other sales channels. We
have made very few commercially significant sales of this product as of the date
of this report, with total revenues from this area at approximately $10,000
since we introduced the product. However, we believe the sales cycle into school
6
districts can take several years, due to budget cycles, especially for new
safety technology, so we are uncertain if these low sales are likely to stay low
or to increase in the future. We do believe that there will be seasonal factors
which can materially impact the sale of this product, primarily driven by school
budget year cycles, but we are not able to assess the impact of these factors on
future sales at this time, as our sales have been so limited to date. Our plan
is to add video recording and biometric identification to this line in the near
future, and expand into markets beyond education, such as law enforcement and
homeland security.
STATIONMASTER(TM). StationMaster(TM) is an outdoor location product based
on GPS technology. It is designed to track and report the location of fleets of
vehicles. We announced this product in March of 2003. The product contains a GPS
and other sensor inputs as required by the customer. The product can be
configured for either real time data communication or near time data
communication again depending upon the customer's requirements. By upgrading the
embedded processor to a single board computer we can run applications
specifically designed by our customers who require a mobile general-purpose
computer that can also perform tracking and reporting functions. We have only
developed prototypes of this product, and have not shipped commercial quantities
as of this time, other than to a small number of potential development partners.
We have presented samples to various customers, who are evaluating it for
inclusion in their own products. We have made no sales of this product as of the
date of this report.
TRACKER III(TM). Tracker III(TM) is an outdoor location product based on
GPS technology. It is designed to track and report the location of vehicles and
assets. We announced this product in September of 2003. The unit contains a GPS
to determine position, as well as GSM cellular radio to transmit that position
information back to a central location. This location information can be
presented as map coordinates, or it can be shown on a map using our Lobo(TM)
tracking software (see below). This product is in the final stages of
development. Operational units are expected to be available in 2005. We have
made no sales of this product as of the date of this report.
LOBO TRACKING SOFTWARE(TM). Lobo(TM) is an internet-based mapping
application that can be used to display the location on a computer screen of our
locator products in the field. Lobo(TM) is not sold as a stand-alone product,
but instead is a service we offer to purchasers of our cellular-phone based
locators. We use Lobo(TM) to make our locator product offerings more attractive
to customers. Lobo(TM) is in active use today by most customers using our
Followit(TM) products. We have generated revenue through the sale of service on
our Lobo(TM) server service for over two years; since Lobo(TM) is part of an
overall solution that includes Followit(TM), it is difficult to accurately
separate the revenue generated solely from Lobo(TM) software from the revenue
generated from Followit(TM). We estimate that Lobo(TM) has independently
generated less than $5,000 in revenue over the last two years.
STARPILOT(TM). StarPilot(TM) is an outdoor location product based on a
single board computer and GPS technology. We announced this product in June of
2002. The product is intended for mounting inside a car or truck. The unit
contains a small computer with a hard disk drive that operates on the
commercially available Linux operating system. The unit also contains a GPS and
a small cellular telephone to transmit information back to a central location.
This location information can be presented as map coordinates, or it can be
shown on a map using our Lobo(TM) tracking software. This unit is intended for
tracking vehicles and for running applications designed by our customers who
require a mobile general-purpose computer that can also perform tracking and
reporting functions. We have only developed prototypes of this product, and have
7
not shipped commercial quantities as of this time, other than to a small number
of potential development partners. We have presented samples to various
customers, who are evaluating it for inclusion in their own products. We have
made no sales of this product as of the date of this report.
STARPILOT(TM) SENTINEL. StarPilot(TM) Sentinel is an outdoor location
product designed for tracking and reporting the location of field personnel at a
distance. We announced this product in April of 2003. The product consists of a
vehicle-mounted satellite/radio frequency (RF) location and communications
platform with a small personal RF transmitter. The unit contains a small
computer with a hard disk drive that operates on the commercially available
Linux operating system. The unit also contains a GPS. This is a concept product
intended primarily for military use in an area where most of the communications
infrastructure has been destroyed. Occasionally, troops encounter hostile action
close to their vehicles but are unable to return to them to summon help. We
developed this product as an aid to summon help. All the troops in the vehicle
carry a small radio transmitter, similar to a key fob used in car alarms. When
they experience difficulties they simply press a button on the key fob and a
signal is sent to the communications module in the vehicle. This communications
module then sends of an emergency alert over a satellite link back to command
along with its location. This location information can be presented as map
coordinates, or it can be shown on a map using our Lobo(TM) tracking software
(see above). We have only developed prototypes of this product. This product is
targeted primarily at military related uses, such as assisting soldiers or
civilians in hostile area such as Iraq to summon help in areas where cellular
coverage is limited. We have made no sales of this product as of the date of
this report.
TRAKJACK(TM). TrakJack(TM) is an outdoor location product designed for use
in the power sports industry. Examples of power sports equipment are motorcycles
or snowmobiles. We announced this product in March of 2003 (then called
TrakForce(TM)) along with our development partner Positus Corporation, formerly
known as Bike & Cycle Trak USA, Inc. The product is aimed primarily at the
expensive motorcycle industry. It is a custom designed unit and will have a
number of unique features, including a crash sensor, which allows the product to
automatically summon assistance in the event it detects an accident through a
call center. It will also act as a theft recovery device. The major components
of this product are a crash sensor, a GPS, and a cellular radio. We have
provided Positus Corporation with a proof of concept product and are currently
working with them to begin the next phase of the development cycle. Our
agreement with Positus allows us to market this product directly ourselves and
through Positus. We have generated approximately $10,000 in cash and $20,000 in
total revenue from this product design as of the date of this report.
TrakJack(TM) is a Minnesota trademark of Positus Corporation.
FOLLOWIT(TM). Followit(TM) is a small outdoor location product designed to
track vehicles. We announced availability of this product in March of 2002. The
unit contains a GPS to determine position, as well as a GSM cellular radio to
transmit that position information back to a central location. This location
information can be presented as map coordinates, or it can be shown on a map
using our Lobo(TM) tracking software (see above). The unit is designed and
manufactured for us in Sweden by Followit, AB. We currently have no units in
stock as we have sold our entire inventory of the product, and we currently have
no plans to replenish stock for this unit, although we will continue to support
our existing customers for this unit and have it available on a special order
basis. Followit(TM) is a trademark of Followit AB of Sweden.
URBANTRACKER IIK(TM). UrbanTracker IIK(TM) is a derivative of Followit(TM).
We announced this product in October of 2002. The product is a Followit(TM)
8
product carefully integrated into a child's backpack. This unit is primarily
used for tracking children. We have only developed prototypes of this product,
and have not shipped commercial quantities as of this time, other than to a
small number of potential development partners. We have presented samples to
various interested parties. We have made no sales of this product as of the date
of this report.
INDOOR LOCATION PRODUCTS
OVERVIEW OF THIS TECHNOLOGY
Indoor location presents many challenges that are not present in outdoor
location. This is largely because GPS systems work poorly if at all when used
indoors. While the GPS companies are working hard to overcome this limitation,
there have not been any major breakthroughs as of yet. Most indoor location
technology uses proprietary infrastructure and small radios called radio
frequency identification tags, or RFID tags, which are typically small radio
transmitters that run from battery power.
Most of our indoor positioning technology is based on measuring the
strength or loudness of a radio signal between the transmitter and the receiver.
We do this because the further away a transmitter is from a receiver, the weaker
or quieter the signal is that you will detect. Many types of radios can measure
this "loudness" phenomenon and convert it into a useful numerical value. If you
have three or four radio sources spread over an area and you can detect their
value you can then triangulate your position based on that information. This is
similar to the concept used by GPS, but since it does not depend on distant
satellites, it can be applied indoors. However, for this approach to work
economically, a large number of transmitters are required throughout the indoor
area. This cost has greatly limited the deployment of indoor location technology
as of the date of this report.
Today many organizations are connecting their computers using Wi-Fi(R)
technology, rather than running expensive network cables. Wi-Fi(R) is a
trademark of Wi-Fi Alliance. We often use WiFi without the hyphen in our product
names to avoid confusion with this trademark. We have developed a means of using
these new Wi-Fi(R) networks to provide the transmitters needed for indoor
positioning. We call this "piggy backing" on to the Wi-Fi(R) network, a network
which is composed of many mounted receiving devices called Wi-Fi(R) access
points.
INDOOR LOCATION TOOLS PRODUCTS
WIFI TRACKER(TM). WiFi Tracker(TM) is an indoor tracking product designed
for tracking people and other assets. We announced this product in May of 2003.
When used in conjunction with Wi-Fi(R) enabled tracking software, the tags can
be easily identified and located within the network. One of our software
partners is a Finnish company, Ekahau, Inc. They have developed a software
system that takes information determined by our tags and displays the tag's
position using Ekahau(TM) Positioning Engine(TM) tracking software. The stage
three version of the prototype, or "developer kit," of this product was
completed in December of 2003. A newer version of the developer tag, version
1.2, was completed in August of 2004. We have presented samples to several
customers, and have engaged in competitive field trials with prospective
customers, including NASA, using early versions of this product. Additionally,
we have been doing application design work with iTrack of Ireland for wireless
traffic management, though we have no formal agreements with this firm. This
product is targeted primarily at commercial users, and uses some RFID technology
9
in its design. We have made a very small number of sales of this product as of
the date of this report.
GOTCHA!(R). Gotcha!(R) is a small electronic product designed to alert
parents or guardians when their small child wanders too far away from them. We
announced this product in November of 2002, and began shipments of it during the
summer of 2003 to select distribution organizations. The product consists of two
parts, one about the size of a small pager that attaches to a parent and one the
size of a key fob that attaches to a child. When the pre-set distance is
exceeded, the child unit makes an audible sound to tell the parent that the
child has wandered too far. It is then up to the parent to locate the wayward
child by following the sound of the alert. The unit is designed to work well
indoors or outdoors, although working through walls will tend to limit the
unit's range. We believe most of our customers will use this product indoors, in
places like shopping malls. The tracker contains a small radio set used to
transmit information between the parent and child, which are a form of RFID
technology. The units are fully FCC certified and approved for operation in the
U.S. The units are also certified for use in Canada. We plan to have these units
certified for use in other countries as and when the business situation
warrants. We have filed and received a successful trademark claim on Gotcha!(R).
We are currently marketing this product through various channels for an average
price of approximately $50-$90 for a set that includes one parent unit and one
child unit. This product was featured in December of 2003, and again in February
2004, on cable television's Home Shopping Network(TM), and on QVC in April 2004.
We have manufactured this unit in quantity and have inventory available for
delivery. We have made commercially significant sales of this product, in excess
of $100,000 as of the date of this report.
LOCATION TOOLS PRODUCTS SALES AND MARKETING
We believe the products we are developing may be more readily marketable by
licensing and/or collaborating with companies that have complementary
technologies. We have undertaken a search for candidates and are in the process
of conducting investigations, technology evaluations and preliminary
negotiations with potential licensees/partners. In May 2003, we entered into a
relationship with Ekahau to co-market Wi-Fi(R) positioning products. In late
2002, we entered into an agreement with FutureCom Global of Arizona to assist in
the distribution of some of our location tools. We have also entered into
agreements with Verify Systems regarding marketing and software support for our
IBUS(TM) systems, Positus Corporation, to help market the TrakJack(TM) design,
and KidMapper for distribution of Gotcha!(R) to schools and youth organizations
We believe that maintaining a close relationship with customers and
providing customers with ongoing technical support is essential to customer
satisfaction in the radio based wireless and semiconductor communications
industry. Our staff interacts with customers during key stages of design and
production, provides customers with current product application notes and
engineering data, maintains regular contact with customer engineers and assists
in the resolution of technical problems. We intend to assign a contract account
manager to our largest customers, who will maintain regular contact with the
customer to determine their product needs and concerns. Members of senior
management are also involved with the sales process and intend to be involved in
managing relationships with significant customers. As is typical of other new
technologies, our location-based technologies can have a lengthy sales cycle
that requires extensive application engineering support. We support potential
customers' activities and consider such support an important element of our
sales and marketing efforts.
10
We hired a part time brand manager for our Gotcha!(R) product. The brand
manager is responsible for finding and integrating distribution channels for
Gotcha!(R) into marketplaces worldwide. We are currently in discussion with a
number of potential distribution partners in Europe, Canada, South Africa and
Latin America. We have also recently entered non-disclosure agreements and into
negotiations with new distributors for our Gotcha!(R) products, one for schools
in the United States, one for distribution services in Canada, and one for
distribution services in Europe.
We are marketing our location products worldwide through our internal sales
resources including our web site and other contract-based marketing resources
located throughout the U.S., Europe and Asia. Additionally, senior management
devotes substantial time and effort to developing customer relationships and
contracts.
LOCATION TOOLS AND LOCATION SERVICES INDUSTRY
The market for Location Tools with GPS-enabled products is projected to
grow during the next few years. The U.S. Department of Commerce reports that the
compound annual growth rate of the GPS market has been approximately 22% over
the last six years. The Department's studies stated that worldwide GPS sales
reached $4B by the end of 1998, $6.2B by 2000, and exceed $8B by 2002, the last
year for which figures were available from them. We believe that the following
are among the key factors underlying the projected industry growth in both
business and consumer markets now and in the near future:
o improved accuracy of GPS will lead to an increase in the functions of
devices using GPS;
o additional functions capable of being installed in devices addressing
GPS applications;
o increased efficiencies in being able to track valuable assets;
o the ability to provide relevant information (e.g. traffic reports,
weather reports, location of stores and restaurants relative to the
location of the vehicle) to occupants of passenger vehicles;
o the ongoing miniaturization of technology products; and
o the trend toward combining navigation, communications and information
technologies in a single device for use in vehicles.
To date, many market leaders in the location services industry have
concentrated primarily on vehicle or asset tracking segments of the markets
associated with providing information to owners of vehicles or assets. Real time
tracking information of a vehicle or asset is often delivered by linking a GPS
receiver to a device that is connected to a cellular network, allowing location
of the vehicle or asset to be automatically transmitted to a base station via
the Internet twenty-four hours a day. The user can, if needed, immediately
contact an appropriate provider of emergency services. In addition, this allows
those parties who are monitoring the location of the vehicle or asset to ensure
that delivery and service fleet operations are using the most effective method
of getting to a location, or to dispatch roadside assistance and emergency
services, such as police or ambulances. The primary users include owners of
expensive vehicles. This market is a segment of the overall GPS Telematics
services market. The GPS Telematics market includes all vehicle mounted GPS
systems that report their location remotely, typically using cellular phone
related devices. In October 2002 market consulting firm Frost and Sullivan
reported that revenue from this market segment exceeded $1B in 2003, and that
the segment market may surpass $2.1B by 2008. Emergency assistance mandates,
such as the U.S. Federal Communications Commission's E911 Phase II initiative
that require the manufacturers of cell phones and the providers of wireless
communication to ensure that the location of a cell phone user can be determined
11
with relative accuracy in emergency situations may also expand other wireless
location product opportunities.
LOCATION TOOLS CUSTOMERS
Our customers for location-based products include general consumers as well
as businesses that need accurate tracking of people or assets. We have sold
products to this group directly through our Internet Website and through
relationships with stores that specialize in tracking devices and related
security technologies. We do not know the final destination of all of these
retail sales, but we believe many have been to private investigators or law
enforcement users in the U.S. and Canada. We have also sold products to
developers who are exploring adapting our hardware to meet custom solutions for
specific markets, including Positus Corporation and Verify Systems. See
"Strategic Relationships Including Marketing Firms, Material Suppliers, and
Distributors." We have also sold location products to customers of the Home
Shopping Network and QVC through FutureCom Global, and implemented events on
other direct marketing outlets, including radio commercials and through
FutureCom Global. We have provided samples and demonstration products to several
dozen major U.S. retailers, as well as a few distribution firms outside the
U.S., in Mexico, Canada, and Europe. Our customers are primarily organizations
operating in the United States and Canada, although samples have been sent for
review to customers in Mexico, Central and South America, Africa, and Europe. We
have also issued proposals, but not consummated sales transactions, to a variety
of other prospective customers including hospitals, airports, trucking firms, a
resort and entertainment complex, and the U.S. government.
LOCATION TOOLS PRODUCTS - GOVERNMENT REGULATION
Since our location-based products are based on the use, in most cases, of
radio technology, we are required to comply with a variety of Federal, State,
and local regulations regarding the use of radio devices. The primary set of
regulations that concerns our products are those promulgated by the Federal
Communication Commission, or FCC, which is tasked with managing the use of the
radio spectrum in the United States. We have two strategies for compliance with
these regulations. First, we have certain products, such as our Gotcha!(R) child
safety product, which we have independently tested and certified for compliance
by the FCC or their approved third party laboratories. In the case of
Gotcha!(R), we achieved this certification, called a Grant of Equipment
Authorization, on July 26, 2003, and we were issued FCC identifier number
Q79-703 as a result. This process typically takes several months and creates
testing costs of between $5,000 and $10,000 per device certification. In other
cases, we elect to purchase complete and certified radio systems to incorporate
into our products that have already achieved this certification. This is the
case with our IBUS(TM) product, which uses 2.4GHz WiFi radios manufactured by a
supplier of ours that has already achieved this certification. Using this second
approach typically accelerates time to market over the first approach outlined,
but may add to the cost of manufacturing the product over the long term.
For markets outside the United States, we may be required to comply with
other government regulations regarding the use of radios. For example, the "CE"
certification, formally called the "European Union EMC" program, has
similarities in part to the FCC certification program in the United States.
While we design our products to meet this and other important international
regulations, we have not formally applied for the "European Union EMC"
certification on any of our products, but may choose to do so in the future,
when we believe we have more time to devote to developing sales channels in
those international markets. We may also be required to comply with government
regulations regarding the export of certain kinds of technology. To date, we
12
have no plans to export our technology to areas where such U.S. government
restrictions might be in force, such as to Cuba.
An important additional aspect of FCC government regulation that affects
our location tools products is the management of the cellular airwaves. In
particular, the FCC mandate entitled E911-Phase II puts a burden on cellular
network operators to provide position information of cellular phone users to
within approximately 100 feet of accuracy before December 31, 2005. Some
cellular network operators can provide this today. We believe that some of our
products based on cellular devices and GPS can in the future be manufactured
without the GPS unit, while still being able to accurately determine location.
This may allow us to penetrate new markets by lowering the cost and size of some
of our products.
LOCATION TOOLS PRODUCTS - ENVIRONMENTAL REGULATION
There are few if any special environmental compliance concerns unique to us
that would be different than those that apply to other design companies in the
United States in general. This is principally because we use third parties to
manufacture and distribute our location tools products, and in the opinion of
management, the significant environmental risks associated with our electronic
products relate to the manufacturing of these units, not the design function.
LOCATION TOOLS PRODUCTS - RESEARCH AND DEVELOPMENT
Over the last three full fiscal years, we have spent approximately $492,100
directly accounted for as pure research and development of our products overall,
including semiconductor products and location tools products. In addition to
these direct expenses, our small staff spends considerable time and indirect
resources in this area, and we would estimate that in excess of 50% of the
available personnel resources are involved in research and development of our
location tools products over the last three years.
In the last two full fiscal years, we have spent approximately $337,600 on
research and development, which has largely been related to our location tools
products. We have conducted several simulations and/or developed working
prototypes of most of our products. We have successfully developed and sold
several location products, most prominently our Gotcha!(R) child safety product.
We continue to conduct research in several areas, especially for new location
services products. Part of that research effort includes additional testing and
product refinement. Our research into new location tools products is expected to
be in markets such as child safety, school bus safety, military tracking
markets, healthcare asset tracking, and also into first responder safety
markets.
The following table summarizes the current development status of each of
our current location tools products. The categories below have the following
meanings:
o "Product Name" refers to the device we described in the section just
above;
o "Proof of Concept Prototype Built" means that we produced early
samples in a laboratory or test facility to demonstrate the concept of
the product's viability in a limited fashion. These early prototypes
are not useful for commercial sale without additional research and
development, and will likely not be available for testing by third
parties;
o "Pre-Production Prototype Tested and Available" means a form of the
product was created and tested that would be directly useful for
13
commercial sale, should we decide to manufacture it on a large enough
scale, and that interested third parties may receive samples from us
that they can fully test in their own environment, should they so
desire;
o "Design Available for Licensing from Us" means that we either hold
patent rights or other trade secret rights to create this product, and
that we are able and willing to enter into agreements with other
parties for them to license from us these rights for their use;
o "Production Device Available for Sale" means that either we or another
third party under license to use is manufacturing this product
currently, and is offering it for general sale in the marketplace
today.
PRE-PRODUCTION DESIGN PRODUCTION
PROOF OF PROTOTYPE AVAILABLE DEVICE
CONCEPT TESTED FOR LICENSING AVAILABLE
PRODUCT NAME PROTOTYPE BUILT & AVAILABLE FROM US FOR SALE
- -------------------------- --------------- -------------- ------------- ---------
Gotcha!(R) Complete Complete Yes Yes
WiFi Tracker(TM) Complete Complete Yes Yes
Followit(TM) Complete Complete No (1) Yes
IBUS(TM) Complete Complete Yes Yes
Lobo Tracking Software(TM) Complete Complete Yes No (2)
StationMaster(TM) Complete Complete Yes No
Tracker III(TM)(4) Complete No (3) Yes No
StarPilot(TM) Complete Complete Yes No
StarPilot(TM)Sentinel Complete No No No
UrbanTracker IIK(TM) Complete No Yes No
- --------------
(1) Followit(TM) is sold by us under a non-exclusive sales and license
agreement from Followit AB. of Sweden. See "Strategic Relationships
Including Marketing Firms, Material Suppliers, and Distributors."
(2) Lobo(TM) software is part of an overall tracking solution, and we do not
offer it for sale as a standalone product, only as a licensed product or as
part of our tracking service solution combined with other products, such as
Followit(TM) or Tracker III(TM).
(3) We are in the final stages of testing a GSM cellular telephone module to
transmit data to a remote location. We estimate that this test will be
completed in February 2005.
(4) Tracker III(TM) is used as the platform for the design of the TrakJack(TM)
product for Positus Corporation. TrakJack(TM) is a Minnesota trademark of
Positus Corporation.
LOCATION TOOLS - PATENTS AND TRADEMARKS
In the first half of calendar year 2004 we filed one provisional patent
application pending for a technology to assist in the location of first
responders in indoor environments. We were granted a United States trademark on
our Gotcha!(R) location tool for child safety applications in May of 2004.
LOCATION TOOLS PRODUCTS AND SERVICES COMPETITION
The market for communications and information products related to
location-based services is highly competitive and we expect competition to
14
increase. We believe that the principal competitive factors that will
differentiate the various competitors in this marketplace will be product
features, quality, customer service, brand, advertising, price positioning,
time-to-market, and availability. The market for GPS-based products is
relatively recent as a direct result of the U.S. Government's removal of the GPS
based filters in May 2000 to allow for more accurate tracking. Many of the
companies in the vehicle tracking market have expensive systems that are
permanently installed into the vehicle and often involve a fee-based monthly
subscription service. Most of our products are removable, and some can be used
without incurring any monthly airtime charges. Many GPS device vendors have been
offering products to the marine, aviation and outdoors enthusiast markets for
several years. We do not generally compete in those markets. For the personal
safety locating products markets, we consider our principal competitors in the
consumer market to be Wherify, Digital Angel, Angel Alert, and Child Guard. For
our commercial vehicle and asset tracking markets, our principal competitors
include @Road, Axiom Navigation, ALK, and Thales Navigation. There are
approximately 100 other smaller companies offering similar products and services
that we presently offer. There is significant other competition from large
competitors in the GPS/Navigation market, including General Motors-OnStar(R)
system. We have no current plans to directly compete with major automotive
suppliers for in-vehicle navigation solutions, due to the amount of resources
required to successfully compete.
SEMICONDUCTOR PRODUCTS
OVERVIEW
The semiconductor products market is a secondary focus for us because we
believe that we have a better chance of generating revenue from the sale of our
location tools. This is based on our assessment of the current state of the
semiconductor market, the current level of maturity of our semiconductor
products, the skills of our staff, and our current size and capital structure.
However, we believe that over a long period of time we may be able to extract
value from the semiconductor products we have, because none of our patents in
this area will expire until at least 2017 if we continue to pay required patent
maintenance fees, which we intend to do. As a result, we continue to operate in
this market, although we commit very few current resources to it, relative to
what we commit to the location tools market.
We intend to maintain key elements of our portfolio of semiconductor
intellectual property because we believe there is potential for the products we
might offer to prospective licensees in the future, as the technology required
to manufacture some of these designs is developed by others. There is no
assurance that the technology required to manufacture some of these designs will
ever be developed, or that when it is developed, that our patents will still be
enforceable.
The largest target market for our products is the electronic memory market,
which is the target for our TMOS(R) product. Electronic memory is used widely in
many computer related products, such as personal computers. Our other patents
tend to fall into the "discrete device market," which the Semiconductor Industry
Association (SIA) defines as discrete components including power transistors and
radio frequency solutions that are found in wireless consumer products. These
kinds of products are used widely in radios. These technologies form an
important part of communications systems worldwide through voice and data
communications networks, cordless and cellular wireless telephony systems and
emerging cable and wireless broadband communications networks.
15
Our sales and marketing efforts for semiconductor products are limited to
our web presence on our own internet site, our presence in the United States
Patent and Trademark office database and website, web-based marketing in a
semiconductor intellectual property sales organization named the Virtual
Component Exchange, or VCX, and very limited direct sales efforts from time to
time with prospective semiconductor technology licensees at trade shows and
other industry events.
Our long-term strategy is to develop significant new semiconductor products
that build on our existing portfolio of patents in this area, and to tie this
technology into our location tools products. We believe this may be possible
because these product families have in common the fact that they both rely on
radios. Our location tools products have radios built into them. Our
semiconductor products are components that can be used in radios. We intend to
utilize unique, patentable technologies and other proprietary technologies and
provide these enhancements to the marketplace through joint venture licensing
agreements with manufacturing firms. We do not intend to directly manufacture
any of our own technologies. When resources are available we intend to continue
research and development efforts, including simulations and creation of working
prototypes, where possible. Our efforts in the location tools product area may
delay this strategy's implementation indefinitely.
We filed patent applications on a number of product designs between 1997
and 2002 relating to semiconductor products. During this time we brought eight
major research and development projects to the patent or patent application
stage. The United States Patent and Trademark Office, the USPTO awarded our
first U.S. patent June 15, 1999. All of our products in this area are based on
paper designs, with limited laboratory work having been performed on some of
them. Our primary semiconductor and electronic device products and related
patent filings include the following areas:
PRODUCT NAME USE AND FUNCTION OF PRODUCT
- ------------------------ -----------------------------------------------------
Heterojunction Bipolar Used in the manufacture of digital circuits found in
Transistor devices such as cellular phones, personal computers
and automotive circuitry. Transistors provide
electronic control over current flow, and are a part
of many electronic circuits. Heterojunction bipolar
transistors are used most frequently in power
amplifiers, radio frequency integrated circuits and
other circuits.
Monolithic Inductor Used in a wide range of electronic circuits for
telecommunications applications. The inductor's most
common application is as a component of a radio
frequency circuit used to manipulate radio waves into
certain other electrical signals. The inductor does
this, usually in conjunction with a capacitor, by
producing an amplified current when stimulated by a
specific frequency of radio signal.
Distributed Amplifier Used in all electronic products that require some
level of power increase such as telecommunications,
microwave, internet communications, automotive and
bio-medical products as well as automated
manufacturing products.
16
PRODUCT NAME USE AND FUNCTION OF PRODUCT
- ------------------------ -----------------------------------------------------
TMOS(R) Memory Used in digital computing devices such as
microcomputers and workstations and battery powered
devices such as personal data appliances and cellular
phones that require a memory function.
Mode Dielectric Used in many applications including microwave
Resonator oscillators, narrowband microwave filters, radar
detectors, speed guns, automatic door openers,
cellular portable phones and global positioning
satellites. The resonator's most common application
is as a component of a radio frequency circuit used
to manipulate radio waves into certain other
electrical signals. The resonator does this by
producing a current of predictable size when
stimulated by a specific frequency of radio signal.
High Frequency Allows the transmission and reception of radio waves
Wireless Transceiver and is used in a variety of wireless devices.
SEMICONDUCTOR INDUSTRY, MARKETPLACE, AND COMPETITION
The semiconductor industry makes a wide variety of electrical component
products found in literally millions of different devices in common use
throughout the world. This includes everything from personal computers, to
automobiles, to household appliances, cell phones, children's toys, power
systems, and much more. The Semiconductor Industry Association, or SIA,
publishes regular reports on the projected size of this industry. In 2004, SIA
has estimated the overall size of the semiconductor products marketplace at
approximately $200B per year. SIA reports also show a regular trend for average
annual growth in excess of 10% per year for the overall industry over the last
twenty years, although there have been periods of much slower growth or even
decline for significant portions of the semiconductor marketplace, such as the
years 2001 and 2002.
The electronics products industry is intensely competitive. Our wireless
and memory technologies experience intense competition from numerous domestic
and foreign companies in all of our semiconductor products.
Based on our research and development efforts over the last seven years, we
believe our most promising semiconductor product in the near term is our TMOS(R)
product. We consider our TMOS(R) memory technologies to be competitive with
existing memory technologies in certain applications. The companies that make
memory similar to our TMOS(R) product are both potential customers as well as
potential competitors. This is because they can choose to license products we
make, or to develop competitive technologies themselves or license competitive
products from others. As competitors, the companies that make memory devices
similar to ours are much larger firms and are much better funded. They include
firms such as Samsung, Alliance Semiconductor Corporation, Cypress Semiconductor
Corporation, Integrated Device Technology, Inc., Motorola, Inc., Hitachi,
ST-Microelectronics, Toshiba, Fujitsu, and Micron Technology, Inc. and others.
They have substantially greater research and development resources than us.
Because these companies are also potential licensees for our technology, they
could also serve as sources of research and development support for our
semiconductor products. However, we have been trying for the last three years to
17
interest these kinds of large firms in licensing our semiconductor products, and
to date, we have met with little or no success.
SEMICONDUCTOR PRODUCTS - PATENTS AND TRADEMARKS
We have applied for U.S. patents relating to these technologies, most of
which have already been issued. These include the following, all of which have a
20-year life following date of filing.
EXPECTED
PATENT
EXPIRATION
PRODUCT NAME SUMMARY OF PATENT INFORMATION DATE
- ---------------------- ---------------------------------------------------- ----------
Heterojunction Bipolar On September 29, 1997, we filed a U.S. Patent Sep. 2017
Transistor application for a Heterojunction Bipolar Transistor
(HBT). U.S. Patent 5,912,481 was issued for this
device on June 15, 1999. We were also successful in
our Continuation in Process application on this
device, as the United States Patent and Trademark
Office issued us a patent on January 9, 2001 under
U.S. Patent 6,171,920, covering intellectual
property required to manufacture this transistor.
The assignment of this patent to us is recorded at
USPTO at reel no: 0111356, frame 0934.
Monolithic Inductor On October 31, 1997, we filed a U.S. Patent Oct. 2017
application for a Monolithic Inductor. The U.S.
Patent Office issued a Notice of Allowance for this
application on September 7, 1999. U.S. Patent
6,013,939 was issued for this device on January 11,
2000. We were also successful in our Continuation in
Process application on this device, as the United
States Patent and Trademark Office issued us a
patent on August 28, 2001 under U.S. Patent
6,281,778. The assignments for these patents to us
are recorded directly on the issued patent from the
USPTO.
Distributed Amplifier On July 10, 1998, we filed a U.S. Patent application Jul. 2018
for a Distributed Amplifier. The U.S. Patent Office
issued a Notice of Allowance on this application on
September 29, 1999. U.S. Patent 6,008,694 was
received for this device on December 28, 1999. On
May 23, 2001, we a filed a U.S. Patent application
for a Monolithic Balanced RF Power Amplifier,
another version of this product. U.S. Patent
6,424,227 was issued for this device on July 23,
2002.The assignments for these patents to us have
recorded directly on the issued patents from the
USPTO.
TMOS(R) Memory On December 17, 1997, we filed a U.S. Patent Dec. 2017
application for a High Performance N-Channel
Metal-Oxide-Semiconductor (NMOS) Static Random
Access Memory (SRAM). U.S. Patent 6,104,631 was
18
EXPECTED
PATENT
EXPIRATION
PRODUCT NAME SUMMARY OF PATENT INFORMATION DATE
- ---------------------- ---------------------------------------------------- ----------
received for this device on August 15, 2000. We were
also successful in our Continuation in Process
application on this device, as the United States
Patent and Trademark Office issued us a patent on
October 9, 2001 under U.S. Patent 6,301,147. The
assignment of these patents to us is recorded
directly on the issued patents from the USPTO.
Mode Dielectric On June 18, 1998, we filed a U.S. Patent application Jun. 2018
Resonator for a Mode Dielectric Resonator. The U.S. Patent
Office issued a Notice of Allowance for this
application on August 1, 2000. The U.S. Patent and
Trademark Office issued us U.S. Patent 6,169,467 for
this device on January 2, 2001. The assignment of
this patent to us is recorded at USPTO at reel
number: 011358, frame 0462.
High Frequency Wireless Patent Pending (Expected issue early 2005). Pending
Transceiver
We have filed patent applications for other semiconductor-related patents
since 2000, including some improvements to the above existing products as well
as on related devices. The commercial importance of these inventions and the
final disposition of these applications are uncertain. At this time, we are not
actively pursuing patent protection outside the United States for these
semiconductor products. We also hold the U.S. trademark to the word TMOS(R),
awarded to us July 1, 2003, U.S. Trademark registration number 2732825.
SEMICONDUCTOR PRODUCTS - GOVERNMENT REGULATION
Since our semiconductor products are used, in most cases, as parts of
radios, our customers are required to comply with a variety of Federal, State,
and local regulations regarding the use of radio devices. The primary set of
regulations that concern our customers' products are those promulgated by the
Federal Communication Commission, or FCC, which is tasked with managing the use
of the radio spectrum in the United States. However, since this is our
customers' responsibility and not ours, we do not believe we are subject to any
special level of government regulation in this line of business other than that
which would be faced by other U.S. Companies in general.
We may also be required to comply with government regulations regarding the
export of certain kinds of technology. To date, we have no plans to export our
technology to areas where such U.S. government restrictions might be in force,
such as to Cuba.
SEMICONDUCTOR PRODUCTS - ENVIRONMENTAL REGULATION
There are numerous environmental regulations that affect the manufacturing
of semiconductor products in general. However, there are few if any special
environmental compliance concerns unique to us that would be different from
those that apply to other companies in the United States in general. This is
principally because we use third parties to manufacture and distribute our
19
semiconductor products, as our business model is based on licensing our designs
to others, who then bear the main costs of complying with the environmental
rules that directly relate to manufacturing these final goods. Should any single
manufacturer be subject to special enforcement action in this area, we would
retain the right to switch to another manufacturer, as we currently have no
exclusive manufacturing relationships in this area.
SEMICONDUCTOR PRODUCTS - RESEARCH AND DEVELOPMENT
We have conducted little research and development of our semiconductor
products since 2002. Since fiscal year 2002, we have spent less than $25,000 on
research and development of our semiconductor products and $9,400 for legal
services required to protect patents for all of our products.
The following table summarizes the current development status of each of
our current semiconductor products.
PRE-PRODUCTION DESIGN PRODUCTION
PROOF OF PROTOTYPE AVAILABLE DEVICE
CONCEPT TESTED FOR LICENSING AVAILABLE
PRODUCT NAME PROTOTYPE BUILT & AVAILABLE FROM US FOR SALE
- -------------------------- --------------- -------------- ------------- ---------
TMOS(R) Memory Complete No Yes No
Mode Dielectric Resonator Complete Complete Yes No
High Frequency Wireless Transceiver Complete No Yes No
Distributed Amplifier Complete No Yes No
Monolithic Inductor Complete No Yes No
Heterojunction Bipolar Transistor No No Yes No
STRATEGIC RELATIONSHIPS INCLUDING MARKETING FIRMS, MATERIAL SUPPLIERS, AND
DISTRIBUTORS
This section covers relationships that may involve both location tools
products and semiconductor products, as some of these suppliers and distributors
may be active in both areas. However, since most of our business activity since
2002 relates to the location tools products, you can assume unless otherwise
stated below that the primary purpose of these relationships has to do with the
location tools product line.
In September of 2004, we signed a contract with KidMapper Inc. of Elmhurst,
IL. KidMapper is a privately owned company and concentrates on marketing and
distribution of a full array of child safety products into schools, youth
groups, and parent-teacher associations (PTAs). The material terms of the
contract include a two year term, exclusive marketing rights of Gotcha!(R) into
schools and PTAs using KidMapper's national sales representatives. The
Gotcha!(R) configuration for this contract is three parent units and 15 child
units. The contract specified a minimum of 100 sets that were shipped prior to
the end of our fiscal year.
In May of 2003, we commenced an informal strategic co-development and
co-marketing program with Ekahau, Inc. of Finland ("Ekahau"). The purpose of the
program is to develop and co-market tracking products based on Wi-Fi(R)
technology, where we would make tracking hardware that would work cooperatively
with tracking software made by Ekahau. Ekahau has developed a software
application called the Ekahau Positioning Engine(TM) that can be used to
determine location of Wi-Fi(R) devices in a standard Wi-Fi(R) network. We are
20
developing a hardware product to interface with Ekahau's software that can be
attached to people or objects that are moving within Wi-Fi(R) networks, to
establish the real time location of those people or objects. In December of
2003, we completed our first prototype of this Wi-Fi(R) product, and displayed
it with Ekahau at the Wi-Fi(R) Planet Conference and Exposition in San Jose,
California. Additional development of this product occurred during the spring of
2004, resulting in a new generation of products being introduced in August 2004.
We have not established a contractual relationship with Ekahau, other than a
non-disclosure agreement. Ekahau is a small privately held technology
development company with a limited customer base.
In May 2003, we entered into a six-month agreement with New York-based
Stanton, Walker & Company for business advisory and consulting services.
Stanton, Walker agreed to assist us in expanding our existing strategies for
business growth as well as developing new strategies, such as merger and
acquisition planning. We paid for the services of Stanton, Walker using our
common stock, valued at approximately $100,000 at the time of issue. We have not
yet determined what additional services, if any, we may procure from Stanton,
Walker & Company in calendar year 2004 and beyond.
In March of 2003, we received a blanket purchase order for $250,000 of
IBUS(TM) technology from Verify Systems of Connecticut, originally planned for
delivery before June of 2004. Shipments began against this order in May of 2003,
for pilot testing during the summer of 2003. Testing was continued through two
pilot programs. A third pilot program was conducted in Arizona in November and
December of 2003. The product is still being demonstrated and developed. We do
not expect the purchase order to be completed. Verify Systems is a small
privately held technology development company with a limited customer base, very
small operations, and limited assets. In May 2004, partially in response to
Verify System's failure to timely market our products, we agreed to license the
marketing materials and software tools of Verify Systems and assume the primary
sales effort for these products ourselves. The material terms of this agreement
require that Verify Systems give us an unlimited and indefinite license to use
their software products, in exchange for a cash payment of $6,000 and a royalty
of 5% of sales of their software products over the next two years.
In March of 2003, we entered into a non-binding Memorandum of Understanding
with Positus Corporation ("Positus") doing business as, Bike & Cycle Trak USA,
Inc., of Minneapolis, MN, to develop and co-market tracking products for the
power sports industry. We were later issued a $75,000 purchase order by Positus
to develop the prototype version of this product. We began work in the spring of
2003 to develop this product. A first proof of concept product was shipped in
June of 2003, when the first payment of $10,000 was received on this order. A
second prototype board was developed in the fall of 2003, and it currently
continues in testing stage. Positus is a small privately held technology
development company in its startup phase. The material terms of the agreement
provide for us to deliver additional prototypes as payment is received.
In January 2002, we signed an agreement with the Virtual Component Exchange
("VCX") in which we made the majority of our semiconductor products available
for licensure through their marketing service. VCX is an Internet based
organization focused on producing Internet tools for trading intellectual
property. We have not seen substantial results from this effort with VCX, and
may choose to discontinue marketing our semiconductor products through this
channel in the future. Our agreement required that we pay a fee of approximately
$10,000 to have our semiconductor intellectual property posted on their website
through December of 2003, plus a future royalty of 5% or less should any
licensing transaction result from such a posting. This vendor has dealt
exclusively with our semiconductor products, and not our location tools
21
products. VCX has continued to list our semiconductor intellectual property on
their Website, although they have received no additional payments from us since
our first approximately $10,000 payment in 2002.
In December of 2002, we entered into a manufacturing relationship with
Electroconnect Ltd. of Scotland ("Electroconnect") to manufacture our Gotcha!(R)
child safety product for us. The oral understanding is based on our issuing
purchase orders and specifications on an order by order basis to Electroconnect,
and Electroconnect fulfilling those orders by shipping Gotcha!(R) units to us in
Scottsdale, typically offering net 30 day terms for payment. Electroconnect is a
small to mid-sized privately held manufacturing company with a broad customer
base. As of the date of this report, Electroconnect has manufactured
approximately 6,000 units of Gotcha!(R) for us.
In December of 2002 we entered into a distribution agreement with FutureCom
Global, Inc. ("FCG"), a firm headquartered in Scottsdale, AZ. The two-year
agreement covers the non-exclusive distribution of products from us such as
Gotcha!(R), Followit(TM), and StarPilot(TM). The agreement automatically renews
for the third year unless terminated by one of the parties. FutureCom Global is
a small privately held technology development and distribution company. The
material terms of the agreement provide for payment for products delivered on
net 30 days terms, although the parties have the right to enter into specific
purchase orders where the payment terms may vary. On August 20, 2003, FCG issued
a purchase order for 5,000 units of our Gotcha!(R) product valued at
approximately $150,000. We have delivered approximately half of the ordered
units to them as of the date of this report, which they have advertised and sold
on Home Shopping Network, QVC, and through other retail channels. We are not
certain when or if they will accept the delivery of the remaining units on this
purchase order. This has caused us to seek out new distributors for our
Gotcha!(R) product, although we continue to work with FCG to sell Gotcha!(R) and
other products as well.
In December 2002, we entered into a development and co-marketing agreement
with Geotechnologies, Inc., a privately held small firm headquartered in Castle
Rock, CO. Geotechnologies is a software development firm that specializes in
making mapping software that we believe complements our location tools products.
To date our activities with them have been jointly developing and presenting
solutions that involve our location tools products and their mapping products to
various private sector and government prospective clients. No sales have
resulted from these efforts to date.
In June of 2002, we entered into an agreement with Followit AB, a Swedish
technology firm, for international distribution of GPS products. The
international distribution agreement, dated June 1, 2002, grants us
non-exclusive distribution rights for the Followit(TM) locator product in the
United States, Canada and Mexico. The Followit(TM) locator product uses the
Global Positioning System (GPS) and cellular technology, with a sophisticated
mapping interface to provide tracking capabilities for a wide variety of assets
or individuals. Distributor prices were defined in the agreement and payment
terms are letter of credit and net thirty (30) days from the receipt by us of a
correct invoice. The contract automatically renews after one year unless either
party provides written notice to end the agreement thirty (30) days prior to the
automatic renewal period. At the current time, we do not anticipate that we will
continue using their products other than on a rare special order basis, as we
have developed our own products such as our Tracker III(TM) product.
Other key suppliers over the last three years also include Digikey
Corporation of Minnesota for electronic components, and Avante Circuits of
22
Tempe, Arizona for circuit boards. We purchase most of our GPS chipsets and GPS
modules from Trimble Corporation of California. We have spent less than $25,000
with each of these suppliers over the last three years. We are not dependant on
these particular suppliers, as there are alternative sources in the market for
the kinds of component materials we use in our products. However, in the event
we needed to change over suppliers, we may experience some small delays in time
to market for certain products, or small increases in supply costs due to small
design changes that may be required in our products because of such a change.
PERSONNEL
As of the date of this report, we have four full time employees, five part
time employees, as well as a number of part time relationships with contractors
for certain services. Eight employees work in the Scottsdale, Arizona corporate
office. Management believes employee relations are good. None of our personnel
are covered by collective bargaining agreements.
SUBSEQUENT EVENTS
In mid September 2004 we began the process of moving to a new suite of
offices a short distance from our old suite. This process was completed by
mid-October 2004. Our new address is 14505 North Hayden Road, Suite 305,
Scottsdale, Arizona 85260. Our phone, fax, email, and web addresses have not
changed. The primary motivation for this move was to reduce monthly lease
expense, as discussed in the sections of this report on real estate property.
On October 1, 2004, we changed our stock transfer agent from Corporate
Stock Transfer (CST) of Colorado, to Computershare Investor Services of
Illinois. The new contact information for our stock transfer agent is
Computershare Investor Services, 2 North LaSalle Street, Chicago, IL, 60602, and
their telephone number is 312-588-4753. The principle reason for the change was
to improve shareholder services, particularly online services, which in our
opinion are much more developed at Computershare than they are today at CST.
In October 2004, David Mandala also rejoined us as a full time employee,
after a period when his work was limited to our technical advisory board. Mr.
Mandala is focused on development of some of our embedded systems technology, in
particular, our IBUS(TM) technology.
On October 8, 2004, we announced a new marketing program for our Gotcha!(R)
child safety monitor. We plan to market Gotcha!(R) to organizations arranging
field trips, focusing on the product's ability to monitor several child units
simultaneously with only one parent unit. The company will target public and
private schools, school districts, parent-teacher associations, and child and
youth organizations nationwide. We entered into a contract in support of this
effort with KidMapper, Inc., a privately owned Illinois corporation. The
material terms of that agreement call for KidMapper to aggressively use its
existing extensive network of sales representatives in the U.S. K-12 marketplace
to sell Gotcha!(R) as an adjunct for field trips. In exchange for these efforts,
NSC will provide a period of exclusivity in the U.S. K-12 territory to KidMapper
for a one-year period of time, and extended payment terms and discounts for
products purchased by KidMapper for this market.
In November 2004, we received radio frequency use approval from the
government of Canada for our Gotcha!(R)product, known as "CA" approval, IC:
5521A-P and IC: 5522A-C for the parent unit and child unit, respectively. This
is one of the steps required to sell products like Gotcha!(R)in Canada.
23
In November 2004, the Company presented its WiFi tag technology combined
with its software partner Ekahau's technology at a symposium on location
technology at East Carolina University. The objective of the competitive
presentation, which included presentations from Bosch, Nextel, CISCOR, Code
Blue, and others, was to provide novel solutions for campus student safety.
Trials from this are expected to continue in the early part of 2005.
In November 2004, we entered into a distributor agreement with Ingram Micro
of Canada. The material terms of this agreement call for us to pay regular fees
to Ingram Micro based on the number of products we stock with them in Canada, in
exchange for their promotion and distribution of our products with their
Canadian resellers, which include firms such as Radio Shack and Wal-Mart of
Canada. Either party with 30 days notice can cancel the agreement. We plan to
distribute Gotcha!(R) as well as potentially other products, including some new
video-related products we may acquire as part of a developing strategic
relationship with Aethra of Italy, a leader in video technology. In November, we
shipped an initial quantity of Gotchas to Ingram Micro in Canada.
In October 2004, we commenced a new strategic working relationship with
TurboWorx Inc. ("Turbo") regarding joint technology development and cooperative
marketing. The relationship was first memorialized in a Memorandum of
Understanding (MOU) in early November 2004. The two companies see benefit in
connecting NSC's location sensor technology to the computing engines developed
by TurboWorx. In November 2004, we entered into a Letter of Intent ("LOI") with
Turbo regarding a stock exchange transaction with Turbo, for an amount of stock
equal to less than 10% of the outstanding common stock of each company and the
payment of cash by Turbo to NSC. The LOI contemplated a due diligence process
prior to the share exchange, as well as a Securities Exchange Agreement (the
"Share Exchange Agreement") to memorialize the proposed exchange. As of the date
of this report, no Share Exchange Agreement has been completed. Completion of
the transaction is subject to completing a mutually satisfactory Share Exchange
Agreement and completion of due diligence by all parties. The LOI contemplates
us distributing to our shareholders approximately 50% of any Turbo stock we
receive under the proposed Share Exchange Agreement.
In December 2004, our Chairman Michael Grollman made a personal loan to us
in the amount of $65,000 to assist NSC with short-term cash requirements. The
loan is evidenced by an unsecured promissory note that provides for repayment
within 90 days or less, at no interest. The promissory note also provides that
if repayment takes longer than 90 days, then interest accrues at a rate of 6
percent per year until paid in full. We intend to pay this Note sometime in
January of 2005.
In December 2004 we signed an agreement with LDL Enterprises in Palm
Springs, California. Under this agreement, Marcile Wright, EDD, CEO of LDL
Enterprises, is to provide marketing services in California for various NSC
products, especially IBUS technology. This is a commission-only agreement, with
a one year term, nonexclusive.
ITEM 2. PROPERTIES
NSC leases 1,927 square feet of office space at 14505 North Hayden Road,
Suite 305 Scottsdale, Arizona 85260. The lease for the Scottsdale facility
expires October 31, 2006 and is at a rental rate that ranges from $2,890 to
$3,051 per month before taxes.
Currently, the Company does not have a policy regarding investments in real
estate, interests in real estate, real estate mortgages or securities of or
interests in persons primarily engaged in real estate activities.
24
ITEM 3. LEGAL PROCEEDINGS
We are currently a plaintiff in two lawsuits.
In January 2002, we initiated legal proceedings in Maricopa County Superior
Court against Phoenix Semiconductor, Inc. (PSI) for breach of contract. We
engaged PSI, and advanced approximately $400,000 to PSI, to build thyristors (an
electronic component) for us to sell. When we engaged PSI, we obtained a
security interest in a portion of PSI's equipment assets. Before we initiated
legal action, both PSI and its principal shareholder Chongkook John Rhee filed
for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. In
December 2002, PSI and NSC agreed to a settlement of the secured claim against
PSI in the form of a cash payment of approximately $100,000 to NSC together with
certain other unsecured claims remaining. The cash payment is subject to a
contracted sale of substantially all fixed assets of PSI and formal approval of
the bankruptcy court. The sale has not occurred; therefore we are unable to
determine the final outcome of the lawsuit.
We filed a complaint in Maricopa County Superior Court in August 2002,
seeking $155,550 plus interest from E4World Corporation for breach of contract.
We were awarded a judgment of $179,000 in May 2003 against E4World Corporation.
We are now in the collection phase of this judgment, and, there is no assurance
that we will collect any of this judgment. Since our collection of this judgment
is uncertain, it is not reflected in our current financial statements. We
continue to assert our claim to secure assets held by E4World in a separate
legal matter.
Another lawsuit was resolved early this year. National Scientific
Corporation vs. Netmind was filed on or around August 29, 2002 in Maricopa
County Superior Court, seeking damages for failure to repay a $200,000 note. We
filed this lawsuit against Netmind, Inc. to recover an investment, plus damages.
Mr. Lou Ross assigned his right to certain sums as partial payment for an amount
we advanced to him in 1999. A final judgment of dismissal was entered on March
30, 2004.
From time to time in the normal course of business operations, we are
involved in other legal proceedings, none of which are expected to have a
material adverse affect on business operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted and traded on a limited and sporadic basis on
the OTC Bulletin Board operated by The NASDAQ Stock Market, Inc. under the
trading symbol "NSCT." The limited and sporadic trading does not constitute, nor
should it be considered, an established public trading market for our common
stock. We have 879 shareholders of record of our common stock as of September
30, 2004. The following table sets forth the high and low closing sale prices
for our common stock for the periods indicated, as reported by the OTC Bulletin
Board, NASDAQ Trading and Market Services.
MARKET FOR COMMON EQUITY HIGH LOW
------------------------------------------- -------- --------
FISCAL 2004
Fourth Quarter (through September 30, 2004) $ 0.160 $ 0.075
Third Quarter (through June 30, 2004) $ 0.190 $ 0.120
Second Quarter (through March 31, 2004) $ 0.200 $ 0.135
First Quarter (through December 31, 2003) $ 0.205 $ 0.130
FISCAL 2003
Fourth Quarter (through September 30, 2003) $ 0.210 $ 0.145
Third Quarter (through June 30, 2003) $ 0.225 $ 0.095
Second Quarter (through March 31, 2003) $ 0.170 $ 0.085
First Quarter (through December 31, 2002) $ 0.220 $ 0.065
FISCAL 2002
Fourth Quarter (through September 30, 2002) $ 0.160 $ 0.078
Third Quarter (through June 30, 2002) $ 0.205 $ 0.140
Second Quarter (through March 31, 2002) $ 0.265 $ 0.135
First Quarter (through December 31, 2001) $ 0.390 $ 0.220
DIVIDENDS
As of September 30, 2004, we have never declared or paid any cash dividends
on our common stock. Our board of directors has sole discretion to pay cash
dividends or other dividends or other distributions with respect to our common
stock based on our financial condition, results of operations, capital
requirements, contractual obligations and other relevant factors.
IMPACT OF THE "PENNY STOCK" RULES ON BUYING OR SELLING OUR COMMON STOCK
Trading in our common stock is subject to the "penny stock" rules. The SEC
has adopted regulations that generally define a penny stock to be any equity
security that has a market price of less than $5.00 per share. These rules
require that any broker-dealer who recommends our securities to persons other
than prior customers and accredited investors, must, before the sale, make a
special written suitability determination for the purchaser and receive the
purchaser's written agreement to execute the transaction. In addition, unless an
exception is available, the broker-dealer must deliver a disclosure schedule
explaining the penny stock market and the risks associated with trading in the
penny stock market prior to any transaction. Further, broker-dealers must
disclose commissions payable to both the broker-dealer and the registered
26
representative and current quotations for the securities they offer. The
additional burdens imposed upon broker-dealers by such requirements may
discourage them from transactions in our common stock, which could severely
limit the market price and liquidity of our securities.
DESCRIPTION OF SECURITIES
COMMON STOCK
As of December 27, 2004, we are authorized to issue up to 120,000,000
shares of common stock, par value $0.01 per share. As of December 27, 2004,
there were 84,350,657 shares of common stock outstanding. We had 877
shareholders of record of common stock as of December 27, 2004. Each holder of
common stock is entitled to one vote for each share held on all matters. Our
articles of incorporation and bylaws do not provide for cumulative voting in
elections of directors or any other matters brought before shareholder meetings.
The holders of our common stock are entitled to receive such dividends, if
any, as may be declared by our board of directors from time to time out of
legally available funds. The dividend rights of our common stock are junior to
any preferential dividend rights of any outstanding shares of preferred stock.
The holders of our common stock also are entitled to receive distributions upon
our liquidation, dissolution or winding up of our assets that are legally
available for distribution, after payment of all debt and other liabilities and
distribution in full of preferential amounts, if any, to be distributed to
holders of our preferred stock.
The holders of our common stock are not entitled to preemptive,
subscription, redemption or conversion rights. The rights, preferences and
privileges of holders of our common stock are subject to, and may be adversely
affected by, the rights of any series of preferred stock that we may designate
and issue in the future.
PREFERRED STOCK
Our board of directors is authorized by our articles of incorporation to
issue up to 4,000,000 shares of one or more series of preferred stock, par value
$0.10 per share. No shares of such preferred stock have been authorized for
issuance by our board of directors, and we have no present plans to issue any
such shares. In the event that the board of directors issues shares of serial
preferred stock, it may exercise its discretion in establishing the terms of
such preferred stock.
Our board of directors may determine the voting rights, if any, of the
series of preferred stock being issued, including the right to:
o vote separately or as a single class with the common stock and/or
other series of preferred stock;
o have more or less voting power per share than that possessed by the
common stock or other series of preferred stock; and
o vote on specified matters presented to the shareholders or on all of
such matters or upon the occurrence of any specified event or
condition.
If our company liquidates, dissolves or winds up, the holders of our
preferred stock may be entitled to receive preferential cash distributions fixed
by our board of directors when creating the particular preferred stock series
before the holders of our common stock are entitled to receive anything.
27
Preferred stock authorized by our board of directors could be redeemable or
convertible into shares of any other class or series of our stock.
The issuance of preferred stock by our board of directors could adversely
affect the rights of holders of the common stock by, among other things,
establishing preferential dividends, liquidation rights or voting powers. See
"Risk Factors" above.
STOCK OPTION PLAN
Our board of directors adopted the 2000 Stock Option Plan effective January
1, 2001. Our stockholders formally approved the 2000 Stock Option Plan on
February 14, 2001.
SUMMARY OF 2000 PLAN
The following is a summary of certain provisions of the 2000 Stock Option
Plan:
ADMINISTRATION
Either our board of directors or a committee appointed by our board of
directors may administer the 2000 Stock Option Plan.
ELIGIBILITY
NONQUALIFIED OPTIONS. Nonqualified options may be granted only to our
officers, directors, including our non-employee directors, employees and
advisors who, in the judgment of the committee, are responsible for our
management or our success and who, at the time of the granting of the
nonqualified options, are our officers, directors, employees or advisors.
INCENTIVE OPTIONS. Incentive stock options may be granted only to our
employees who, in the judgment of the committee or our board of directors, are
responsible for our management or our success and who, at the time of the
granting of the incentive stock option, are also our employees. No incentive
stock option may be granted under the 2000 Stock Option Plan to any individual
who would, immediately before the grant of such incentive stock option, directly
or indirectly, own more than 10% of the total combined voting power of all
classes of our capital stock unless: such incentive stock option is granted at
an option price not less than 110% of the fair market value of the shares on the
date the incentive stock option is granted; and such incentive stock option
expires on a date not later than five years from the date the incentive stock
option is granted.
OPTION PRICE
The purchase price as represented by our common stock offered under the
2000 Stock Option Plan must be at least 100% of the fair market value of our
common stock (if the option is an incentive stock option), or at least 25% of
the fair market value of our common stock at the time the option is granted (if
the option is a nonqualified option), or such higher purchase price as may be
determined by the committee or our board of directors at the time of grant. If,
however, we grant an incentive stock option to an individual who would,
immediately before the grant, directly or indirectly own more than 10% of the
total combined voting power of all of our classes of stock, the purchase price
of the shares of our common stock covered by such incentive stock option may not
be less than 110% of the fair market value of such shares on the day the
incentive stock option is granted. As the price of our common stock is currently
28
quoted on the OTC Bulletin Board, the fair market value of our common stock
underlying options granted under the 2000 Stock Option Plan will be the last
closing sale price of our common stock on the day the options are granted. If
there is no market price for our common stock, then our board of directors and
the committee may, after taking all relevant facts into consideration, determine
the fair market value of our common stock.
EXERCISE OF OPTIONS
An option holder under the 2000 Stock Option Plan may exercise his or her
option in whole or in part as provided under the terms of the grant, but in no
event shall an option be exercisable after the expiration of ten years from the
grant date. An option holder may not exercise any option after the option holder
ceases to be one of our employees except in the case of disability or death. Our
committee may, however, extend the right of exercise up to three months after
the date of termination of the option holder's employment with us. If we
terminate an option holder's employment by reason of disability, the committee
or our board of directors may extend the exercise period for a specified period,
generally one year, following the date of termination of the option holder's
employment. If an option holder dies while in our employ and the option holder
has not fully exercised his or her options, the options may be exercised in
whole or in part at any time within one year after the option holder's death by
the executors or administrators of the option holder's estate or by any person
or persons who acquired the option directly from the option holder by bequest or
inheritance.
In the event of the death of an employee or consultant while in our employ,
the committee or our board of directors is authorized to accelerate the
exercisability of all outstanding options under the 2000 Stock Option Plan.
Under the 2000 Stock Option Plan, we may grant one or more options to an
individual, as long as the aggregate fair market value of the shares covered by
incentive options exercisable for the first time during any calendar year shall
not exceed $100,000.
ACCELERATION AND EXERCISE UPON CHANGE OF CONTROL
All option holders' unvested options automatically will become exercisable
in the event of a change of control of our company as defined in the 2000 Stock
Option Plan.
PAYMENT FOR OPTION SHARES
An option holder may exercise his or her options by delivering written
notice to us at our principal office setting forth the number of shares with
respect to which the option is to be exercised, together with cash or certified
check payable to us for an amount equal to the option price of such shares. We
may not issue any shares underlying an option grant until full payment has been
made of all amounts due. We will deliver a certificate or certificates
representing the number of shares purchased as soon as practicable after payment
is received. Our board of directors or the committee may, in its discretion,
permit the holder of an option to pay all or a portion of the exercise price by
a simultaneous sale of our common stock to be issued upon exercise of an option
pursuant to a brokerage or similar arrangement.
TERMINATION OF THE 2000 STOCK OPTION PLAN
The 2000 Stock Option Plan will terminate on December 1, 2010, unless our
board of directors terminates the 2000 Stock Option Plan prior to its expiration
29
date. Any option outstanding under the 2000 Stock Option Plan at the time of
termination shall remain in effect until the option is exercised or expires.
AMENDMENT OF THE 2000 STOCK OPTION PLAN
Our board of directors may at any time modify or amend the 2000 Stock
Option Plan without obtaining the approval of our shareholders as it shall deem
advisable to comply with Section 422 of the Internal Revenue Code or Rule 16b-3
of the Securities and Exchange Act of 1934, as amended, or in any other respect.
TRANSFERABILITY OF OPTIONS
An option holder may not assign any option under the 2000 Stock Option Plan
other than by will or the laws of descent and distribution or if our board of
directors or the committee agrees otherwise.
ISSUANCE AND RESERVATION OF SHARES
As of September 30, 2004, we have issued options to purchase an aggregate
of 3,709,257 shares of our common stock. We have reserved the right to issue a
total of 7,000,000 shares of our common stock for issuance under the 2000 Stock
Option Plan, although our Board currently plans to limit issuances of options to
4,000,000 for the immediate future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
OVERVIEW
Our business focuses on the research, development and sale of location
tools used to track or monitor people or objects such as vehicles or other
mobile equipment. We also own devices and designs that are used in the
semiconductor and electronics industries.
From 1996 to 2002, we engaged primarily in developing devices and designs
that are used in the semiconductor and electronics industries. This resulted in
a number of U.S. patents, but did not produce any significant amount of revenue.
Additionally, during the period from 2000 to 2001 we engaged in the business of
distributing electronic and other semiconductor-related products to customers in
Asia and the United States in order to generate revenue. In 2001, we
discontinued those activities because they did not produce the profit margins we
had originally expected.
In 2002, we began to focus on applications of electronic devices in the
location tools market. We also began to decrease our focus on semiconductor
designs and devices, due primarily to difficult market conditions in the
semiconductor industry. We plan to continue our focus on location tools for the
foreseeable future.
Our first shipment and sale of our location tools began with the sale and
shipment of our Followit(TM) product in August 2002.
In December of 2002, we entered into an agreement with Electroconnect of
Scotland to produce a prototype and then manufacture our Gotcha!(R) product.
This agreement is based on us paying for units as ordered, and does not require
minimum purchase amounts.
In December 2002, we entered into an agreement with FutureCom Global, Inc.
(FCG) of Arizona to assist us in the marketing and distribution of our location
30
tools. The term of the agreement is two years and it is renewable for up to one
additional year. The agreement allows FCG to market our Followit(TM),
StarPilot(TM), and Gotcha!(R) products through media and trade shows, as well as
through networks of sales representatives in a variety of consumer marketplaces,
including general retail. The agreement may be expanded to include stocking of
our products by FCG. FCG currently provides some stocking for our Gotcha!(R)
line of products. The agreement does not require minimum purchase amounts.
Our sales during the two fiscal years ending September 30, 2004, have
consisted largely of sales of our Gotcha!(R) child safety product through
FutureCom Global, and to a lesser extent of our GPS related products, including
IBUS(TM) to Verify Systems and early prototype versions of the TrakJack(TM)
product to Positus Corp. During this period, we have generally seen a gradual
increase in the total sales on a quarter-to-quarter basis, although we can make
no assurance that this trend will continue into any future periods.
PATENTS AND PROPRIETARY RIGHTS
We currently hold U.S. patents on eight devices and designs and have
several domestic patent applications pending. Most of our patent work is focused
on protection in the United States today, due to the high cost of acquiring and
maintaining patents in other markets. We plan to continue to develop our
existing patented technologies as well as develop new performance-enhancing
devices and designs for use in the semiconductor, electronics and location
industries. Our business plan contemplates that we will generate revenue by
entering into strategic joint venture licensing agreements, manufacturing
agreements, development agreements, distribution and marketing agreements and
other arrangements with firms and/or entities that will either incorporate our
technologies into their product offerings or sell them directly to their
customers.
RESULTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 2004 AND 2003
We generated $77,994 and $63,579 of revenue for the fiscal years ending
September 30, 2004 and 2003, respectively. Sales for the year ended September
30, 2004 represent the sale and delivery of product introductions from NSC's
Gotcha!(R), WiFi Tracker(TM), and Followit(TM) lines.
Gross profit decreased to $22,397 in fiscal 2004 from $37,731 in fiscal
2003.
Costs and expenses decreased to $952,635 in fiscal 2004 from $981,098 in
fiscal 2003.
Salaries and benefits, of administration and marketing personnel decreased
to $393,308 in fiscal 2004, from $438,244 in 2003.
Research and development expenditures increased to $253,257 for the fiscal
year ended September 30, 2004, from $84,301 for the previous fiscal year as we
continued to engineer and develop new location tools.
Stock compensation decreased to $45,421 in fiscal 2004 from $291,658 in
fiscal 2003. The most significant factor in the decrease is a result of a
reduction in Director's compensation. In fiscal 2003 the majority of the stock
compensation expense related to the issuance of vested options to employees and
consultants at an exercise price that was below the then-current market value.
These options were granted in order to conserve operating cash.
31
Other expenses increased in fiscal 2004 to $260,649 from $149,245 in fiscal
2003 as a result of increases in insurance costs, marketing expenses, filing
fees, and legal expenses. The 2003 total was reduced by a one time event of
approximately $150,000 after we came to a definitive settlement agreement with a
service firm resulting in the elimination of approximately $150,000 of
short-term liability previously owed by the company.
We have focused an increasingly significant amount of our time and energy
on development of new sources of revenue through the building of new distributor
and customer relationships. This has included increased attendance at trade
shows, increased expenditures on promotional literature, Internet advertising
and promotion through website listings, on-site customer product demonstrations,
and other marketing related activities intended to foster customer acquisition.
We have also spent and plan to continue to spend resources on the development of
strategic partnerships with other technology firms to assist our marketing
efforts. We will continue to research and implement innovative ways to take its
technology expertise and products to market, across our entire portfolio of
semiconductor and electronics-related devices.
In January, 2003 we initiated a restricted stock retainage program or plan
("Stock Retainage Program") to retain key staff during a period of financial
difficulty in calendar year 2002. Our board allocated approximately $150,000 in
restricted common stock from this Stock Retainage Program as a pool of shares of
our restricted common stock, to be granted to key employees at the direction of
the board for the year and the next, subject to NSC exceeding sales growth
objectives and expense control objectives in 2003. Failure to meet these
objectives under the plan would result in serious risk of forfeiture by staff of
some or all of these stock grants by all participants. All goals set were team
goals. The plan has been used as a tool to achieve salary deferral and other
salary concessions from the staff in order to retain key employees during this
period of fiscal hardship. The plan's sales goals were not met in calendar year
2003, although the plan was nonetheless largely successful in assisting to
retain key staff, even during this period of deferred or reduced salary. In
January of 2004, our board extended this program into 2004, and set new sales
growth objectives for the year at a level 50% higher than the previous year's
program, giving plan participants an additional year to fully earn these
previously outstanding restricted stock grants. No new shares were added to the
plan, although plan participants were able to convert some long-term back pay
into restricted stock at that time, if desired. All of the stock under this
program is restricted under SEC Section 144. As of September 30, 2004, none of
these grants have been fully earned, and they remain subject to substantial risk
of forfeiture.
We entered into an agreement in June 2003, to restructure our delinquent
outstanding debt and back pay to Mr. Lou Ross, a Director of NSC. NSC and Mr.
Ross aggregated the value of all sums currently owed by NSC to Mr. Ross. This
included notes executed of approximately $75,000, all salary deferred by Mr.
Ross in 2002 of approximately $8,300, and all cash board fees deferred in 2002
by Mr. Ross of approximately $3,000, for a total debt outstanding to Mr. Ross as
of June 11, 2003 of approximately $86,500. Mr. Ross agreed to accept one-half of
this amount, or $43,250, in restricted NSC common stock issued at the
then-current market price of $0.15 cents per share, for a total share grant to
Mr. Ross of 288,334 shares. Mr. Ross also agreed to convert the remaining
one-half of the total debt outstanding from NSC to him, or $43,250, into a
three-year interest free note, with no payments required of NSC until the end of
the three-year period, and which could be paid by NSC at any time before the
three-year period elapses with either cash or its common restricted stock or a
combination of cash and stock. With this agreement, NSC no longer has any
outstanding delinquent notes to Mr. Ross, and liabilities have been reduced by
$43,250.
32
Mr. Ross also agreed to take a reduction in his Director's fees for the
period from February 2003 to the end of the fiscal year ending in September
2003, and accept 50,000 shares of NSC restricted common stock in lieu of cash
for these board services, which was paid to him in stock on June 11, 2003. On
September 30, 2003, at the point of his resignation from the Board, Mr. Ross
surrendered all options contracts he had received from NSC, which included
options to purchase 1,000,000 shares of NSC common stock.
We expect to continue to increase our focus on sales and marketing of our
Location Tools(TM) products for the foreseeable future. This includes
significantly increased attendance at trade shows and other product marketing
events during the most recent quarters, as well as recent additional investment
in product promotion through new outreach programs with the trade press, using
new outside public relations resources. Partly as a result of these efforts and
others, revenues have begun to be generated from operations. It is thus possible
that we may emerge from its development stage status at sometime during the
coming year.
LIQUIDITY AND CAPITAL RESOURCES
NSC has not been profitable and has experienced a cash flow deficit from
operations due to its development stage and substantial on-going investment in
research and development efforts. Consequently, NSC has been dependent primarily
on the sale of equity to fund cash requirements.
As of September 30, 2004, NSC's cash and cash equivalents totaled $160,214
and total current assets were $267,650. NSC has recently initiated
product-marketing efforts after several years of research and development and
has not yet reached break even in terms of both cash flow and profitability. NSC
has long-term debt of $43,250 as of September 30, 2004. Total liabilities at
September 30, 2004 were $532,421.
We have an accumulated deficit of approximately $22.7 million as of
September 30, 2004 which includes approximately $10 million of non-cash
transactions, in fiscal years 2000 and 2001, for restricted common stock issued
as payment for research, consulting and capital formation expenses. A
substantial portion of the consulting expenses related to the issuance of one
million shares of common stock to Dr. Hashemi, our former Group President, as a
signing bonus on September 1, 2000. These shares were later returned to us. We
expect operating losses in the foreseeable future as we continue our efforts to
commercially exploit our portfolio of patents and develop commercial products.
Accumulated cash used in operating services from the Company's inception to
September 30, 2004 totaled approximately $7.8 million.
Cash used in operations was approximately $880,334 for the year ended
September 30, 2004 compared with approximately $702,560 for the year ended
September 30, 2003. The increase in cash used in operations resulted from fewer
salary deferrals, the addition of several new permanent employees and
contractors to support our efforts in the area of sales, marketing, product
engineering and development and to market our products.
We have financed our operations primarily through the sale of common stock,
granting of options, and warrants and through some debt financing. Those
activities since 2001 are summarized below.
In March 2001, we established a line of credit with Wells Fargo HSBC Trade
Bank totaling $500,000. The line of credit was collateralized with deposits at
Wells Fargo Bank. Borrowings under the line of credit bear interest at the prime
rate of Wells Fargo Bank, National Association. At September 30, 2001, there was
33
$430,000 outstanding under this line of credit. At September 30, 2002 the entire
line of credit had been repaid, and the line of credit had been terminated.
In May 2001, we entered into a common stock purchase agreement with
Coriander Enterprises Limited, a British Virgin Islands corporation, for the
future issuance and sale of shares of our common stock. A registration statement
filed with the Securities and Exchange Commission was declared effective on
October 11, 2001. This stock purchase agreement established an equity line of
credit. Under this arrangement, we at our sole discretion, were to make up to 24
draw down requests over a two year period, pursuant to which Coriander
Enterprises was obligated to purchase up to $24 million of our common stock, at
prices that will vary based upon the market price of the common stock. As of
August 2002, changes in the market price and/or trading volume of our common
stock have terminated our ability to draw down funds under the equity line of
credit.
On April 29, 2002 Mr. Lou Ross, Chairman of the Board, sold 240,000 shares
of common stock in the Company. The proceeds (net of sales commissions) of
$41,125 were loaned to the Company. The loan, which bears 6% interest per annum,
is payable in twelve monthly installments of $3,649 beginning October 29, 2002.
In July 2002, Mr. Lou Ross, Chairman of the Board, sold 260,000 shares of common
stock in the Company. The proceeds (net of sales commissions and approximately
$4,000 withheld by Mr. Ross for taxes) of approximately $34,000 were loaned to
the Company. The loan, which bears 6% interest per annum, is to be repaid in
twelve installments of $3,022 beginning February 28, 2003. This loan was
restructured in June of 2003 to a three-year non-interest bearing loan, with no
payments due until the end of the loan period. The Company has the option any
time during the loan period to pay this Note early.
During the fiscal years ending September 30, 2004 and 2003, NSC issued
160,084 and 946,270 shares, respectively, of NSC common stock to consultants in
lieu of cash compensation. During fiscal 2004, the Company granted 790,000
options to NSC consultants and employees to purchase shares of NSC's common
stock. The options granted had exercise prices ranging from $0.09 per share to
$0.16 per share. The exercise prices were generally below market on the date of
grant, and vested. We granted these options as a means of compensation to
consultants to conserve operating cash. During fiscal 2003, substantially all
option grants were issued to employees.
At September 30, 2004 there were 18,249,197 outstanding warrants to
purchase 18,249,197 shares of common stock, at prices ranging from $0.10 to
$0.75, with expiry dates from December 2004 to April 2011. There were 7,412,201
outstanding warrants at September 30, 2003, 412,201 of those warrants held by
Coriander Enterprises Limited expired during fiscal year 2004.
In November 2002, the Company commenced a private offering of restricted
common stock and common stock purchase warrants and raised approximately
$470,000 in cash and $30,000 in debt forgiveness from this effort. The Company
issued 11,625,000 shares of restricted common stock for the cash collected and
500,000 shares of restricted common stock for the forgiven debt, and granted
4,800,000 warrants to purchase common stock at a strike price of $0.30 and
200,000 warrants at a strike price of $0.50 per share. No underwriters were
involved in connection with this private placement. The sales and issuances of
the securities issued pursuant to the foregoing private placement are exempt
from registration under the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereof, and Rule 506 of Regulation D.
In June 2003, the Company commenced a private offering of restricted common
stock and common stock purchase warrants. The Company raised from this offering
34
in the fiscal year ending September 30, 2003, approximately $200,000 in cash,
and issued 2,500,000 shares of restricted common stock and granted 2,000,000
warrants to purchase common stock at exercise prices ranging from $0.35 and
$0.50 per share. The Company has continued to raise funds under this private
offering after September 30, 2003. From June 2003 through December 31, 2003, the
Company had raised a total of approximately $280,000 in cash from this effort,
and issued a total of 3,300,000 shares of restricted common stock and granted a
total of 2,400,000 warrants to purchase common stock at exercise prices ranging
from $0.35 to $0.75 per share. No underwriters were involved in connection with
this private placement. The sales and issuances of the securities issued
pursuant to the foregoing private placement are exempt from registration under
the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof, and
Rule 506 of Regulation D.
In January of 2004, we entered into a financing program with a U.S.
investment fund. The terms of this program include a six-month Note payable at
maturity in July 2004 for $160,000, at an effective annual interest rate of 13%.
The transaction also included 640,000 warrants good for three years to purchase
the Company's restricted stock, at $0.13 during the first and second year of the
warrant's lifetime, and $0.15 during the third and final year of the warrant's
lifetime. These warrants include anti-dilution provisions, as well as
registration rights in the event that we file an appropriate registration
statement with the SEC during the next three years. This $160,000 Note was
repaid in full in May of 2004.
During March 2004 we secured short-term loans in the aggregate principal
amount of $36,000. The interest rate on the loan was less than 10% plus minor
processing fees. The notes were repaid in full in April 2004.
On March 15, 2004, NSC commenced a private offering of restricted common
stock units through a placement agent. The offer consisted of one share of
common stock and a warrant to purchase three quarters of a share of common
stock. On June 14, 2004, we completed this private placement with aggregate
gross proceeds of approximately $1.1 million and issued 10,334,266 shares of
restricted common stock and warrants to purchase 7,750,700 shares of our common
stock at an exercise price of $0.11 per share. The warrants have a term of five
years, and include certain registration rights. After deducting commissions and
other expenses relating to the private placement, we received aggregate net
proceeds of approximately $972,864. Additional disbursements by the Company
related to the private placement further reduced the net proceeds to $935,044,
the majority of which was spent by September 30, 2004. We invested part of the
proceeds of the private placement to finance the continued development and
marketing of WiFi and RFID related Location Tools(TM) products. We used part of
the proceeds for expanded marketing and sales efforts, for further
commercialization of our other Location Tools(TM) product line, and for other
corporate purposes. The Units were sold to accredited investors pursuant to an
exemption from the registration requirements of the Securities Act of 1933 (the
"Act") and applicable state exemptions from registration. On June 24, 2004, we
filed a Registration Statement on Form SB-2 with the Securities and Exchange
Commission in connection to register the shares. The Securities and Exchange
Commission declared the Registration Statement effective on July 7, 2004.
We believe that our current cash position as of September 30, 2004,
including cash funds arising from the exercise of outstanding options, and
secured plant assets from legal settlements, from equity placement sales and
other capital raising efforts, product sales, and continued aggressive expense
management to be sufficient to continue operations for the next twelve months.
We also believe that we may be able to reduce outstanding liabilities through
35
negotiations with our creditors, or possibly negotiate to extend the payment
schedule for these debts. In the event these approaches do not provide us with
adequate working capital, we may be required to further curtail or reduce our
development activities, seek alternative funding sources, or seek protection
under reorganization laws.
ADDITIONAL FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS
IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS ANNUAL REPORT ON
FORM 10-KSB, THE FOLLOWING IMPORTANT FACTORS SHOULD BE CAREFULLY CONSIDERED IN
EVALUATING NSC AND ITS BUSINESS BECAUSE SUCH FACTORS CURRENTLY HAVE A
SIGNIFICANT IMPACT ON NSC'S BUSINESS, PROSPECTS, FINANCIAL CONDITION AND RESULTS
OF OPERATION.
AN INVESTMENT IN OUR COMMON STOCK IS VERY RISKY. YOU MAY LOSE THE ENTIRE AMOUNT
OF YOUR INVESTMENT.
Before you invest in shares of our common stock, you should be aware of
various risks, including those described below. You should carefully consider
these risk factors, together with all of the other information included in this
annual report, before you decide whether to purchase the shares of our common
stock. The risks set out below are not the only risks we face.
If any of the following risks occur, our business, financial condition and
results of operation could be materially and adversely affected. In such a case,
the trading price of our common stock could decline, and you may lose all or
part of your investment.
Keep these risk factors in mind when you read "forward-looking" statements
elsewhere in this annual report. These are statements that relate to our
expectations for future events and time periods. Generally, the words,
"anticipate," "expect," "intend" and similar expressions identify
forward-looking statements. Forward-looking statements involve risks and
uncertainties, and future events and circumstances could differ significantly
from those anticipated in the forward-looking statements.
RISKS RELATING TO OUR BUSINESS
WE HAVE EXPERIENCED SIGNIFICANT LOSSES AND WE MAY NEVER BE PROFITABLE.
We have generated nominal revenue and significant losses and negative cash
flows from our research and development endeavors since we began these
activities in 1996. As of September 30, 2004, we had an accumulated deficit of
$22,709,680. We had revenue for the fiscal year ended September 30, 2004 of
$77,994 and a net loss for the same fiscal year of $951,780. The future
profitability of our business will depend primarily on our ability to generate
revenues from the sale of our products and the licensing of our technology. If
our revenue grows at a slower rate than we anticipate or if our expenditures
exceed our expectations or cannot be adjusted to reflect slower revenue growth,
we may not achieve or sustain profitability. Our auditors have issued going
concern opinions on our financial statements for the fiscal years ending
September 30, 2004 and 2003.
OUR FUTURE SUCCESS IS HIGHLY DEPENDENT ON THE CONTINUED AVAILABILITY OF KEY
EMPLOYEES AND CONSULTANTS INCLUDING MICHAEL GROLLMAN AND GRAHAM CLARK.
Our success depends substantially on the continued services of our two
executive officers, Michael Grollman and Graham Clark. The loss of the services
36
of any of our executive officers or key employees could harm our business. Mr.
Grollman and Mr. Clark have entered into employment and non-compete agreements
with us, but the loss of their services would have a material adverse effect on
our business. In addition to Mr. Grollman and Mr. Clark, we employ or contract
with other engineers and scientists who may be also critical to our success,
especially Dr. El-Badawy El-Sharawy, who developed the majority of our
semiconductor patented products. Both Mr. Clark and Dr. El-Sharawy are foreign
nationals, and there is a risk that the Immigration and Naturalization Service
(INS) may at any time withdraw their permission to work in the United States for
us. Although our scientists and engineers have entered into confidentiality
agreements with us, most have not entered into non-compete agreements with us.
The loss of one or more of our research personnel could prevent or delay the
ongoing development of our products and services, which would materially and
adversely affect our business.
WE HAVE A LIMITED OPERATING HISTORY ON WHICH TO EVALUATE OUR BUSINESS OR
PROSPECTS.
We are a development stage company with limited revenue. Our business focus
changed in 2002 from semiconductor product licensing to development of location
tools and we have only a limited operating history on which you can base an
evaluation of our business and prospects, with only approximately $141,573 in
net revenue generated from this line of business for the two-years ending
September 30, 2004. Accordingly, our business prospects must be considered in
light of the risks, uncertainties, expenses and difficulties frequently
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets, such as the electronics and
wireless location tools services markets.
WE WILL REQUIRE ADDITIONAL FINANCING IN ORDER TO COMPLETE THE DEVELOPMENT OF OUR
PRODUCTS AND SERVICES AND OTHERWISE DEVELOP OUR BUSINESS OPERATIONS. SUCH
FINANCING MAY NOT BE AVAILABLE ON ACCEPTABLE TERMS, IF AT ALL.
We changed our business emphasis in 2002 and we do not know if our products
will achieve significant levels of market acceptance. We may encounter
unforeseen difficulties that may deplete our limited capital resources more
rapidly than anticipated.
We will likely be required to make significant product development
expenditures and spend additional money to maintain and expand our marketing
efforts. Although we recently completed a private offering that should provide
us with sufficient capital for the next twelve months, we may need to seek
additional equity financing in the future if our products do not generate
revenue or if our expenses are greater than expected. The timing and amount of
any capital requirements cannot be predicted at this time. We cannot be sure
that any financing will be available on acceptable terms, if at all. If such
financing is not available on satisfactory terms, we may be unable to continue,
develop or expand our business, develop new products or penetrate existing
markets at the rate desired and our ability to continue in business may be
jeopardized. If adequate financing is not available, we may be required to
terminate or significantly curtail our operations, or enter into arrangements
with collaborative partners or others that may require us to relinquish rights
to certain of our technologies, or potential markets that we would not otherwise
relinquish. This could have a negative impact on the value of your shares.
WE RELY HEAVILY ON INTERNATIONAL THIRD PARTIES TO MANUFACTURE OUR PRODUCTS.
We currently lack the facilities to manufacture our products on a
commercial scale. If any of our customers require our location tools in
37
commercial quantities in the near term, we will have to rely on one or more
third-party contractors, some of which are outside the United States such as
Electroconnect, Ltd., to manufacture the products to satisfy the needs of such
customers. Reliance on one or more international third-party manufacturers
exposes us to the risk that delivery schedules cannot be met, and that we cannot
fulfill orders for some of our products in a timely way at the right price in
U.S. dollars. An example of a product we make outside the U.S. is our Gotcha!(R)
child safety product, which Electroconnect, Ltd makes for us in Scotland. This
risk includes the concern that:
o Third-party manufacturers might be unable to manufacture our products
in the volume and of the quality required to meet customers' needs;
o Our existing and future contract manufacturers may not perform as
agreed or may not remain in the contract manufacturing business for
the time required to supply our customers;
o If any third-party manufacturer makes improvements in the
manufacturing process for our products, we may not own, or may have to
share, the intellectual property rights to the innovation.
Each of these conditions could delay the shipments to our customers,
approvals required by regulatory authorities, and the commercialization of some
of our customers' products. These risks could also result in higher costs to the
customer or could deprive us of potential product revenues.
WE WILL NEED TO SIGNIFICANTLY INCREASE OUR SALES AND SUPPORT OPERATIONS.
We will need to create and substantially grow our direct and indirect sales
operations, both domestically and internationally, in order to create and
increase market awareness and sales of our products and services. For example,
our IBUS(TM) products will require us to gain significant new sales skills in
the education market. Our WiFi Tracker(TM) product will require us to gain new
skills in the healthcare market. The sale of our products and services will
require the engagement of sophisticated and highly knowledgeable sales
personnel. Similarly, the anticipated complexity of our products and services
and the difficulty of customizing them will require us to hire research and
development personnel and customer service and support personnel, highly trained
in hardware and software engineering. Competition between us and others to
retain qualified sales personnel, engineers, and scientists is intense due to
the limited number of available qualified candidates for such positions. Because
of our limited resources, many of our competitors are in a financial position to
offer potential employees greater compensation and benefits than those that we
may be able offer them.
RISKS RELATING TO OUR INDUSTRY
WE MAY BE HELD LIABLE FOR HARM CAUSED BY PRODUCTS THAT OUR CUSTOMERS USE.
Often times, our products are used to enhance the safety and security of
individuals and organizations because they provide real time information on
location. For example, our Gotcha!(R) is used to help keep track of children and
keep them safe in public places. Should these products fail to perform as
intended, or should these products directly or indirectly cause injuries or
illness to people, we may be required to incur substantial costs in defending
against claims and may be required to pay damages arising from these actions.
Although we have liability insurance and will try to limit our liability for
improper use of our products, such protections may not be sufficient to protect
us from the cost of such claims. Damages awarded in a product liability action
could be substantial and if damages exceed our insurance coverage, our financial
condition would be negatively affected.
38
SINCE MANY OF OUR PROSPECTIVE BUSINESS PARTNERS AND SUPPLIERS ARE SMALL
ELECTRONICS AND SOFTWARE COMPANIES, WE ARE AND WILL BE SUBJECT TO RISKS,
UNCERTAINTIES AND TRENDS THAT AFFECT THESE SMALL COMPANIES IN THESE INDUSTRIES.
For the foreseeable future, we will derive a substantial portion of our
revenue from selling our products in combination with software and hardware
products developed by other companies in areas complementary to our line of
business. These are sometimes other small technology companies. As a result, we
will be subject to risks and uncertainties that affect the electronic and
software industries and possible reduction and delays in research and
development expenditures by companies in these industries. For example, our GPS
products produce coordinates that are usually displayed on a map to be
meaningful. As a result, we have developed partnerships with mapping software
companies to help us display this data in ways useful to our customers. For
special mapping services such as this, we often deal with small privately-held
technology firms, such as Geotechnologies, Inc. for military and related
applications, or Verify Systems for school bus tracking software and mapping
applications. Although we take certain steps to locate secondary suppliers and
partners in each market where we depend on such small suppliers, we are often
dependant on these firms to supply us and our customers with key products in a
timely way. High costs and delays in product delivery by us to our customers
could be experienced as a result of supplier changeover if these suppliers do
not perform as we expect them to perform. Additionally, smaller firms that issue
us purchase orders for our products to include in offerings to their own
customers, such as Verify Systems for our IBUS(TM) product, may not have the
financial resources to meet the terms of their purchase orders should they be
unsuccessful in generating their own sales to their own customer base in a
timely way. These factors could negatively affect our delivery schedules and
potentially our financial results.
THE SEMICONDUCTOR AND ELECTRONICS MARKETS EXPERIENCE WIDER DEMAND AND PRICING
FLUCTUATIONS THAN MOST OTHER INDUSTRIES.
We may experience extreme cyclical fluctuations in the demand and supply
for our products, which may cause a decline in our sales or the prices of our
products and a corresponding decline in our revenues and profitability. For
example, our TMOS(R) memory products fall into a class of computer memory
products that often see annual price swings of over 50% or more in particular
lines of products, according to the reports issued by the Semiconductor Industry
Association over the last 10 years. We believe, based on reports from the
Semiconductor Industry Association and on the rate at which technologies in
these markets become popular, and then rapidly obsolete, that year-to-year price
swings in the semiconductor industry can be more extreme than in many other
industries. Should we be successful in licensing our semiconductor patented
designs at all, these kinds of extreme price swings could delay by several years
the development of revenue from these patented semiconductor products.
RISKS RELATING TO OUR TECHNOLOGY
SOME OF OUR WIRELESS TECHNOLOGY IS SUBJECT TO SUBSTANTIAL GOVERNMENT REGULATION.
The wireless electronics industry faces significant regulation by
governmental entities in the United States and other countries. The nature and
the extent to which these regulations apply to our customers will vary depending
on the nature of any of our customer's products. Most of the wireless products
developed by us will require regulatory approval by governmental agencies prior
to sale. In particular, radios we include in our products will require testing
39
and other approval procedures by the Federal Communications Commission ("FCC")
and by foreign regulatory authorities. Some of this work has been completed,
such as FCC approval of our Gotcha!(R) child safety product. In some cases, we
purchase pre-approved assemblies for use in our products that have existing FCC
approval for their radios, such as with our IBUS(TM) products. Other work
remains to be done for other products with the FCC before the products can be
sold to consumers, such as with the next version of our WiFi Tracker(TM)
product. The process of obtaining these approvals and the subsequent compliance
with appropriate federal and foreign statutes and regulations can be costly and
time consuming, and can cause significant delays in the sale of some of our
products.
WE MAY NOT BE ABLE TO LICENSE OR MAINTAIN ACCESS TO THE TECHNOLOGIES THAT WE
NEED TO CONDUCT OUR BUSINESS, SUCH AS GPS.
In addition to the technologies that we develop, we will rely heavily on
technologies that we license from other companies or institutions. We may not be
able to license technologies that we need in the future or we may be unable to
license such technologies on a commercially reasonable basis. In particular, we
depend on wireless technologies such as GPS that have been developed and are
owned by others. If we are unable to license the technologies we need in the
future, or to license or otherwise acquire such technologies on commercially
reasonable terms, we may experience increased costs (and, therefore, reduced
profits) or be unable to engage in certain activities that require those
technologies. In the case of GPS, we are dependant on the U.S. Department of
Defense to operate a large network of GPS satellites safely and at a low cost to
consumers into the future, without degrading the signal accuracy. Prior to the
year 2000, the Department of Defense degraded GPS accuracy for civilian uses on
a regular basis, and has reserved the right to do so again in the future,
without warning. Such an action by the Department of Defense could make our GPS
based products less accurate, and thus potentially less desirable to our
customers, and have a negative effect on our sales.
OUR SUCCESS WILL DEPEND ON OUR ABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY,
ESPECIALLY OUR LOCATION TOOLS PRODUCT DESIGNS.
Our rights to a substantial portion of our components products technology
are as the assignee of several United States patents and patent applications. We
also protect our intellectual property, especially for our location tools,
through the use of confidentiality agreements and other trade secret management
practices. We also hold U.S. trademarks, such as TMOS(R) and Gotcha!(R). In the
case of most of our patented electronic component products, we have a
contractual obligation to pay royalties to Dr. El-Badawy El-Sharawy in the event
that these products generate any royalties to us, in order to maintain these
rights of assignment. Our success will depend largely on our ability to protect
and exploit our intellectual property, to obtain additional patents for other
technologies and products, to defend patents once obtained, and maintain trade
secrets over time. Failure to do so may introduce domestic or foreign
competition that could significantly reduce our ability to generate sales at
acceptable margins.
RISKS RELATED TO OUR SECURITIES
OUR STOCK PRICE HAS BEEN VOLATILE AND WE EXPECT IT TO REMAIN VOLATILE, WHICH
COULD LIMIT INVESTORS' ABILITY TO SELL STOCK AT A PROFIT AT THE TIME OF THE
INVESTORS' CHOOSING.
We have a limited trading market for our common stock, and our common stock
has experienced price volatility in that market. In fiscal 2003, our stock price
40
ranged from a high of $0.225 to a low of $0.065 per share, and in fiscal 2004
our stock price ranged from a high of $0.205 to a low of $0.075. This price
volatility may substantially increase your risk of loss.
The volatile price of our stock makes it difficult for investors to predict
the value of their investment, to sell shares at a profit at any given time, or
to plan purchases and sales in advance. A variety of factors may affect the
market price of our common stock. These include, but are not limited to:
o announcements of technological innovations or new commercial products
by our competitors or us;
o developments concerning proprietary rights, including patents;
o regulatory developments in the United States and foreign countries;
o economic or other crises and other external factors;
o period-to-period fluctuations in our revenues and other results of
operations;
o changes in financial estimates by securities analysts; and
o sales of our common stock.
We will not be able to control many of these factors, and we believe that
period-to-period comparisons of our financial results will not necessarily be
indicative of our future performance.
In addition, the stock market in general, and the market for electronics
companies in particular, has experienced extreme price and volume fluctuations
that may have been unrelated or disproportionate to the operating performance of
individual companies. These broad market and industry factors may seriously harm
the market price of our common stock, regardless of our operating performance,
and may have a negative impact on your ability to sell shares of our stock.
OUR ARTICLES OF INCORPORATION ALLOW US TO SELL PREFERRED STOCK WITHOUT
SHAREHOLDER APPROVAL.
Our Board of Directors has the authority to issue up to 4,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any additional
vote or action by our shareholders. The rights of the holders of the common
stock will be subject to, and could be materially adversely affected by, the
rights of the holders of any preferred stock that may be issued in the future.
For example we could issue preferred stock that has superior rights to dividends
or is convertible into shares of common stock. This might adversely affect the
market price of the common stock.
TRADING OF OUR COMMON STOCK IS LIMITED.
Trading of our common stock is conducted on the National Association of
Securities Dealers' Over-the-Counter Bulletin Board, or "OTC Bulletin Board."
This adversely affects the liquidity of our common stock, not only in terms of
the number of shares that can be bought and sold at a given price, but also
through delays in the timing of transactions and reduction in security analysts'
and the media's coverage of us. This may result in lower prices for our common
stock than might otherwise be obtained and could also result in a larger spread
between the bid and ask prices for our common stock.
ITEM 7. FINANCIAL STATEMENTS
The financial statements of NSC are included (with an index listing all
such statements) in a separate financial section at the end of the Annual Report
on Form 10-KSB.
41
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 8A. CONTROLS AND PROCEDURES
Our management has responsibility for establishing and maintaining adequate
internal control over financial reporting for us. Our management uses a
framework for establishing these internal controls. This framework includes
review of accounting detailed records on at least a quarterly basis by multiple
senior officers of National Scientific, at least one of whom operates outside of
the corporate finance and accounting area, and one of whom operates within the
area of corporate finance and accounting. This review process includes review of
significant accounting records and source documents, such as general journal
entry records, accounts payable records, and monthly bank statement
reconciliations. Documentary records are kept of this review process.
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including its Chief Executive Officer
and Acting Chief Financial Officer and its President, of the effectiveness, as
of September 30, 2004, of the design and operation of the Company's disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that
evaluation, the Chief Executive Officer and Acting Chief Financial Officer and
its President concluded that the Company's disclosure controls and procedures
are effective.
There have been no changes in the our internal control over financial
reporting during the year ended September 30, 2004 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
The controls and procedures for our disclosure as well as our internal
controls over financial reporting are processes designed by, or under the
supervision of, the principal executive and principal financial officers, and
effected by the board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. We believe that a control system, no
matter how well designed and operated, cannot provide absolute assurance that
the objectives of the control system are met, and no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within a company have been detected. However, our Chief Executive Officer
and Acting Chief Financial Officer and its President have concluded that the
Company's disclosure controls and procedures and its internal controls and
procedures are effective at providing that reasonable level of assurance.
Our management believes that upon significant future growth in the number
of accounting transactions we process, perhaps within the next year, additional
review and enhancement of internal controls will be required. Our management is
planning to assign additional staff resources to assist with support for growth
in the internal controls area when the increase in transaction velocity dictates
this as a prudent step in order to maintain our effective level of internal
controls.
42
Our external auditors, Hurley and Company, have not issued an attestation
report on management's assessment of the Company's internal control over
financial reporting, as it is not yet required since the Company has less than
$75 million in "public float."
ITEM 8B. OTHER INFORMATION
Not Applicable.
43
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Directors hold office until the next succeeding annual meeting of
shareholders, and until their successors have been elected and qualified.
The directors, executive officers, significant employees and consultants of
National Scientific, their respective ages and positions with us are as follows:
NAME AGE POSITION
------------------- ----- ---------------------------------------
Michael A. Grollman 43 CEO, Chairman of the Board of Directors
Graham L. Clark 49 President, Director, Secretary
Gregory Szabo 51 Director (Outside)
DIRECTORS AND EXECUTIVE OFFICERS
MICHAEL A. GROLLMAN. Michael Grollman first became Chief Operation Officer
in October 2000. Mr. Grollman was named President in April 2001, Chief Executive
Officer in January of 2002, Chairman of the Board in December 2002, and Acting
Chief Financial Officer in June of 2003. From 1998 to September 2000, Mr.
Grollman served as Regional Service Director of MicroAge, Inc., a company that
provides customer-configured technology solutions to businesses. He served as
General Manager, Executive Vice President and Chief Technology Officer for
Advanced Information Systems from 1987 to 1998. Mr. Grollman received his
Bachelor of Science degree in chemistry from the State University of New York.
He received his MBA from Arizona State University.
GRAHAM L. CLARK. Graham Clark joined National Scientific in early 2001 as
general manager of the sales organization. He became Vice President of
Technology Applications & Sales for National Scientific in the spring of 2002, a
Director in August of 2002, and became Corporate Secretary in January of 2003.
Mr. Clark was named President of National Scientific in September of 2003. For
the two years immediately before joining National Scientific, Mr. Clark was the
General Manager of the Billet Precision Engineering Group, a privately held
manufacturing company providing custom engineering and manufacturing solutions
to the semiconductor industry and other related industries. Prior to his tenure
with Billet, he worked as Corporate General Manager for Amtech Systems, Inc. a
semiconductor equipment manufacturer. Six years prior, he was a founder and
senior partner of GC Technology, a private representative organization for
semiconductor capital equipment. Mr. Clark has a Bachelor of Science degree in
mechanical engineering from Paisley University in Scotland.
GREGORY SZABO joined National Scientific's board on October 1, 2003 as an
outside Director. Mr. Szabo serves on the Board's Audit and Compensation
Committees. Mr. Szabo served in various executive positions at Exten
Corporation, including President of Exten Corp. and CEO of MultiCell
Technologies, Inc. from approximately May 2000 to April 2004, where he was
responsible for public reporting, fund-raising for the corporation and overall
accountability for its subsidiaries, including revenue generation, intellectual
property protection and organizational development. Mr. Szabo was also a
director at Exten, a publicly traded company (OTC: MUCL.OB). Immediately before
joining Exten, Mr. Szabo was for a number of years President and CEO of Titan
Scan Corporation, a division of Titan Corporation, with subsidiaries in
44
sterilization, defense, software and communications. Mr. Szabo has held several
executive positions with Sunrise Medical Inc., a manufacturer and distributor of
numerous institutional and retail products. Mr. Szabo earned a BA in Psychology
from the University of Toledo and a MA in Management from the Drucker Graduate
School at Claremont University.
SIGNIFICANT ADVISORS AND KEY EMPLOYEES
EL-BADAWY EL-SHARAWY, PH.D. Dr. El-Sharawy is a Senior Scientific
Consultant to us, starting with us in 1996. Dr. El-Sharawy is currently
Assistant Professor of Electrical Engineering at Arizona State University's
Telecommunications Research Center, Department of Electrical Engineering, and
has been there for over ten years. His expertise includes, but is not limited
to, microwave circuits, anistropic devices and applied electromagnetics. He is a
senior member of IEEE and is a recipient of the 1980 Egyptian Engineering
Syndicate Medal of Honor.
DAVID MANDALA. Mr. Mandala is our Chief Systems Architect. Mr. Mandala
serves as lead developer for several GPS tracking product lines and is
responsible for research & development, architecture, prototype creation and
client product presentations. Most recently prior to joining NSC Mr. Mandala led
a group of OLAP developers at Texas Instruments. Mr. Mandala previously worked
for NSC during 2002 and 2003. Prior to working for NSC he developed an on-line
lab infrastructure for embedded computer hardware and server systems for
DevelopOnline Corporation; he developed a number of database and courseware
packages for Linuxcare, Inc., and has also made significant technological
contributions to Ciba-Geigy, Dragon Medical Interactive Communications, and Sony
Corporation. Mr. Mandala received his formal electronics education while serving
in the United States Navy.
OSCAR QUADROS, CHARTERED ACCOUNTANT. Mr. Quadros is our controller, and
works for us on a part-time basis. He joined us in late 2002. He is a Fellow of
the Institute of Chartered Accountants in Ireland, and is a graduate of
University College Dublin, Ireland, with a Bachelor of Commerce, major in
Accounting and Economics. From August 1998 to June 2002, he was CFO/Controller
at A3T Incorporated & Axxis 3T Inc. of Scottsdale, Arizona. His 40 years of
experience in international accounting and finance include senior auditor roles
at Alexander MacLennan Trundell & Co., Public Accountants; Atkinson & Boyd,
Public Accountants; and as an audit manager at Coopers & Lybrand, Public
Accountants. He has also worked as a Director of Accounting at Canadelle Inc.
(Subsidiary of Sara Lee Corporation), Canada, and as Vice President
Finance/Controller at Jeno Neuman & Sons of Montreal, Canada.
SUSAN L. REGAN, ESQ. Ms. Regan has been part-time legal counsel for us
since 2002. Ms. Regan holds a Bachelor of Science degree from Heidelberg College
in Ohio, a Master's Degree in Planning and Resource Management from the
University of Alaska, and a Juris Doctorate from the Thomas M. Cooley School of
Law in Michigan. She is admitted to practice law in both Washington State and
the State of Arizona. She was in part-time private practice for the three years
prior to joining us. Previously she was employed with Standard Insurance Company
group legal department as an in house counsel.
KAREN A. FUHRE. Ms. Fuhre is responsible for investor relations for us, and
is involved as well in product marketing. She joined us in 2001. She is
responsible for investor communications, certain matters surrounding parts of
SEC compliance, and strategic planning. Ms. Fuhre is also responsible for our
web site, collateral materials, and media relations. Before joining us, Ms.
Fuhre spent approximately five years with FINOVA, a publicly traded commercial
45
lender, where she worked with the company's financial and informational
communications areas. Ms. Fuhre earned a Bachelor of Science Degree in Marketing
from Northwest Missouri State University and a Paralegal Certificate in Civil
Litigation from the University of San Diego.
ERIC HIMMER. Mr. Himmer is a full-time senior wireless design systems
engineer for us. Mr. Himmer has more than 25 years of systems and software
engineering and programming experience. He is responsible for developing and
designing tracking and other firmware and software used in many of the Company's
wireless location products such as WiFi Tracker(TM)and IBUS(TM). Before joining
NSC, Mr. Himmer was an embedded systems software engineer for GlobespanVirata,
Inc. (formerly Intersil) where he designed and developed IEEE 802.11 wireless
networking firmware and software systems in conjunction with hardware product
development. Prior to that, Mr. Himmer served as a systems programmer and
systems engineer for Datapoint Corporation for a number of years. Mr. Himmer has
a B.S. in Systems Engineering from the University of Arizona.
PAUL C. DAVIDSON. Mr. Davidson is a part-time embedded systems development
engineer for us. He has more than 20 years of software, hardware, and embedded
systems development experience. Mr. Davidson is responsible for implementing new
features within our location tools products. Prior to joining us Mr. Davidson
developed software, firmware, embedded systems, and device drivers for several
firms including C.S. & E. where he was Senior R&D Software Engineer & Team
leader and Hypercom Corporation where he was OS/R&D Team leader/Software
Engineer. His career experience also includes serving as V.P. of Engineering for
Advanced Video Technology, and Engineering Test Manager for Cal Omega Inc.
BOARD OF DIRECTORS
Our business is managed under the direction of the Board of Directors. The
Board meets on a regularly scheduled basis to review significant developments
affecting us and to act on matters requiring Board approval. It also holds
special meetings when an important matter requires Board action between
scheduled meetings. The Board met eight (8) times during fiscal 2004. Each
serving director attended 100% of the meetings held in 2004 by the Board and the
committees of the Board on which such director served. The Board of Directors
was made up of three members during substantially all of fiscal 2004. Michael A.
Grollman has been a director since November of 2000. Graham L. Clark has been a
director since August of 2002. Former director Mr. Lou Ross retired from the
board on September 30, 2003 for personal reasons, citing no conflicts with
management or board policy. Mr. Szabo joined the board on October 1, 2003.
Currently, our Board of Directors consists of three members, Michael A.
Grollman, Chairman, Graham L. Clark, Secretary, and Gregory Szabo. These Board
members were re-elected by shareholder vote in March 2004.
AUDIT COMMITTEE
Our Board's audit committee was established in December 2000. The audit
committee met three (3) times during calendar year 2004. Mr. Greg Szabo is
chairman of our audit committee as an outside director and financial expert, and
is currently its sole member. The audit committee has reviewed our financial
statements for the fiscal year ended September 30, 2004, as audited by Hurley &
Company, National Scientific's independent auditors. Hurley & Company has
discussed these financial statements with management and the audit committee.
AUDITOR
Our independent auditor is Hurley & Company, based in California. This firm
is licensed to practice public accounting by the State of California, and is
46
also registered with the Public Company Accounting Oversight Board. The senior
audit partner Mr. Michael Hurley is also licensed to practice public accounting
in Arizona. Our shareholders in each of the last three fiscal years have
ratified the use of this firm.
Hurley & Company billed us approximately $18,100 for the following
professional services: audit of the annual financial statements for the fiscal
year ended September 30, 2004, and review of the interim financial statements
included in quarterly reports on Form 10-QSB for the quarterly periods ended
December 31, 2003, March 31, 2004 and June 30, 2004.
During the last two fiscal years we have had no changes in or disagreements
with our auditors on accounting or financial disclosure.
ALL OTHER FEES
Hurley & Company billed us, approximately $1,500 for other services during
the fiscal year ended September 30, 2004 for audit services in connection with
the filing of a registration statement on Form SB-2 with the Securities and
Exchange Commission.
REVIEW OF AUDITED FINANCIAL STATEMENTS & REPORT OF THE AUDIT COMMITTEE
The audit committee has reviewed and discussed the audited financial
statements with management. The audit committee has discussed with the
independent auditors the matters required to be discussed by SAS 61. The audit
committee has received the written disclosures and the letter from the
independent accountants required by Independence Standards Board Standard No. 1
(Independence Standards Board Standard No. 1, Independence Discussions with
Audit Committees) and has discussed with the independent accountant the
independent accountant's independence. Based on the review and these
discussions, the audit committee recommended to the board of directors that the
audited financial statements be included in the company's Annual Report on Form
10-KSB for the last fiscal year for filing with the Commission.
FINANCIAL INFORMATION SYSTEMS DESIGN AND IMPLEMENTATION FEES AND OTHER
SERVICES
We did not engage Hurley & Company to provide services to us regarding
financial information systems design and implementation during the fiscal year
ended September 30, 2004. The Board of Directors has considered whether the
provision of non-audit services is compatible with maintaining Hurley &
Company's independence, and has decided not to secure such services from Hurley
& Company at this time in that area.
COMPENSATION COMMITTEE AND BOARD COMPENSATION
Our board's Compensation Committee was established in March 2003. The
Compensation Committee met once during calendar year 2003, and has met once so
far in calendar year 2004. Mr. Greg Szabo currently heads our Compensation
Committee as an outside director, and is currently its sole member. The
Compensation Committee approved the executive compensation plan for the fiscal
years ending September 30, 2003 and 2004, respectively.
Our board as a whole approves board member compensation. This plan was
approved by the Board originally in 2000, and was amended in the summer of 2003.
Currently, employees of National Scientific who also serve on the board receive
no additional compensation for board service. All newly appointed non-employee
directors appointed after the end of fiscal year 2002 will be provided with a
47
one-time grant of 20,000 shares of National Scientific restricted common stock
upon original appointment to the board. This stock will be subject to forfeiture
back to us should the Director for any reason not serve a full term on the board
at least up to the next annual meeting of shareholders.
Additionally, non-employee directors will also be paid $1,250 per board
meeting, which includes telephonic board meetings as well as face-to-face board
meetings. The $1,250 fee will be in the form of $250 cash and $1,000 of National
Scientific restricted common stock. The restricted common stock will be at risk
of forfeiture if the director does not serve his complete term. The fee will not
be paid for telephone conversations involving Board members or others where no
formal board meeting has been declared, or for normal committee meetings.
Non-employee directors will also be paid retrospectively a quarterly retainer of
10,000 options (as defined in the 2000 NSC Stock Option Plan) to purchase free
trading National Scientific common stock at the end of each fiscal quarter they
have served. The options will be immediately vested at point of grant, and will
be issued at an exercise price equal to the average closing price for our common
stock for that quarter. Non-employee directors who serve on a board committee,
such as the audit or compensation committees, will also be paid retrospectively
a quarterly additional retainer of 10,000 options, as defined in the 2000
National Scientific Stock Option Plan, to purchase free trading common stock.
The options will be immediately vested at point of grant, and will be issued at
an exercise price equal to the average closing price for National Scientific's
common stock for that quarter. Non-employee directors who serve on multiple
committees will be paid this bonus only once for general committee service,
however, as it is not paid for each committee of service. All directors are paid
any reasonable out of pocket expenses required to attend board meetings, such as
travel, if any.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our directors and executive officers, as well as persons beneficially owning
more than 10% of the our outstanding Common Stock, to file certain reports of
ownership with the Commission within specified time periods. Such officers,
directors, and shareholders are also required by Commission's rules to furnish
the Company with copies of all Section 16(a) forms they file.
Based solely on our review of such forms, all requirements received by it,
or written representations from certain reporting persons, we believe that
between October 1, 2002 and September 30, 2004, all Section 16(a) filing
requirements applicable to its officers, directors and 10% shareholders were
met.
CODE OF ETHICS
Our board adopted on July 28, 2004, a code of ethical conduct that applies
to our principal executive officers and principal financial officer. Its purpose
is to promote honest and ethical conduct, including the ethical handling of
actual or apparent conflicts of interest between personal and professional
relationships, full, fair, accurate, timely, and understandable disclosure in
reports and documents that a small business issuer files with, or submits to,
the Commission and in other public communications made by the small business
issuer, compliance with applicable governmental laws, rules and regulations; the
prompt internal reporting of violations of the code to an appropriate person or
persons identified in the code; and accountability for adherence to the code. A
copy of this code has been filed with the Securities and Exchange Commission. An
additional copy can be found on our website at WWW.NATIONAL-SCIENTIFIC.COM or by
writing to the Company and requesting one.
48
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information regarding annual and
long-term compensation for services rendered to us during the fiscal years ended
September 30, 2004, 2003, and 2002 to the Chief Executive Officer of National
Scientific, and other named executive officers who served us in fiscal year 2004
and whose total salary and non-cash compensation exceeded $100,000 for the
applicable fiscal periods. The table below includes salary earned and paid in
the fiscal year ended September 30, 2004.
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
----------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
------------------------------- ----------------------- -------
OTHER RESTRICTED SECURITIES
ANNUAL STOCK UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL FISCAL SALARY BONUS COMPENSATION AWARD(S) OPTIONS/ PAYOUT COMPENSATION
POSITION YEAR ($)(1) ($) ($) ($)(2) SARS (#) ($) ($)(3)
- ----------------------- ------ ------- ----- ------------ ---------- ---------- ------- ------------
Michael A. Grollman 2004 94,200 -- -- -- -- -- 70,800
CEO, Chairman (4) 2003 64,640 -- -- -- -- -- 70,360
2002 138,000 -- -- 78,750 -- -- 43,500
Graham L. Clark 2004 101,100 -- -- -- -- -- 41,400
President, Director (5) 2003 69,639 -- -- -- -- -- 50,360
2002 75,385 -- -- 63,000 -- -- 15,624
Lou L. Ross 2004 -- -- -- -- -- -- --
Former CEO & 2003 -- -- -- 17,650 -- -- --
Chairman (retired) (6) 2002 86,000 -- 12,700 4,500 -- -- --
Sam H. Carr 2004 -- -- -- -- -- -- --
Former CFO (7) 2003 -- -- 32,362 -- -- -- --
2002 160,275 -- 34,166 -- -- -- --
Gregory Szabo 2004 -- -- -- -- -- -- 2,250
Director (8)
- -------------------
(1) Unpaid wages in this table are subject to Agreements with listed persons
that allow for interest of approximately prime rate plus 2% accruing on
those unpaid wages until paid. These accruals for interest are shown as
approximate through fiscal year-end September 2004.
(2) Stock grants included in this column are for common stock valued at 90% of
the closing sales price for such shares on the date of grant. Closing sales
price at fiscal year end September 2004 was approximately $0.075 per share,
and closing sales price at fiscal year end September 2003 was approximately
$0.16 per share.
(3) Includes unpaid salary forgone at the election of executive officers
Grollman and Clark pursuant to a registrant program under which stock,
stock-based or other forms of non-cash compensation may be received by a
named executive in lieu of a portion of annual compensation earned in a
covered fiscal year.
49
(4) Salaries of $70,800, $70,360 and $43,500 were not paid in cash, but
deferred to a future period for fiscal years 2004, 2003 and 2002
respectively. Subsequent to September 30, 2002, Mr. Grollman exchanged
$10,000 of this deferred salary for a B Unit in our November 2002 Private
Placement Offering for 125,000 shares of restricted stock and 100,000
common stock purchase warrants exercisable at a price of $0.50 per share,
thus reducing 2002 unpaid wages for that year to $33,500. Other
Compensation for 2002 also includes $78,750 for common stock grants subject
to risk of forfeiture if calendar 2004 sales do not meet or exceed key
targets, and in exchange for salary reduction in calendar year 2003 of
$60,000 (See Note 2 above and Employment Agreements below). In December
2003 Mr. Grollman agreed to convert approximately $150,000 of his back pay
and accrued vacation pay to our restricted common stock, at a rate equal to
the then currently available private placement share price of $0.10 per
share. Mr. Grollman received this stock in January of 2004. Also subsequent
to fiscal 2004 year-end, Mr. Grollman deferred $6,000 of his October and
$5,000 of his November monthly salary of $15,000 to a future period. During
fiscal 2004 and up to November 2004, Mr. Grollman's share of contributions
to the Company's health insurance program of approximately $8,544 were
deducted from the balance of wages owing, leaving as of the end of November
2004, unpaid wages of approximately $55,090 accrued vacation pay of
approximately $15,816 and accrued interest on deferred salary of
approximately $8,998 for a combined total of approximately $79,904.
(5) Salaries of $41,400, $50,360 and $15,624 were not paid in cash, but
deferred to a future period for fiscal years 2004, 2003 and 2002
respectively. Subsequent to September 30, 2002, Mr. Clark exchanged $10,000
of deferred salary for a B Unit in our November 2002 Private Placement
Offering for 125,000 shares of restricted stock and 100,000 common stock
purchase warrants exercisable at a price of $0.50 per share. Other
compensation for 2002 also includes $63,000 for restricted common stock
grants subject to risk of forfeiture if 2004 sales do not meet or exceed
key targets (See Note 2 above and Employment Agreements below). Also
subsequent to September 30, 2004 year-end, Mr. Clark deferred $3,500 of his
October and $2,500 of his monthly salary of $12,500 to a future period.
During fiscal 2004 and up to November 2004, Mr. Clark's share of
contributions to the Company's health insurance program of approximately
$9,967 were deducted from the balance of wages owing, leaving as of the end
of November 2004, unpaid wages of approximately $87,574, accrued vacation
pay of approximately $22,263 and accrued interest on deferred salary of
approximately $8,047 for a combined total of approximately $117,884.
(6) Other Compensation for 2003 and 2002 includes common stock grants paid as
board service fees. Mr. Ross resigned as an employee in January of 2002 and
as a director in September 2003.
(7) Other Compensation for 2003 includes $32,362 of contractor fees for
services rendered in the six months to March 2003, of which approximately
$17,083 remains unpaid. For 2002 salary of $30,173 was not paid out in
cash, but deferred to a future period, and remains unpaid, including all
accrued vacation through July 2002, plus an estimated $1,500 in interest
through September 30, 2002. Other Compensation for 2002 includes $34,166 of
contractor fees for services rendered in August and September of 2002, of
which $21,337 remains unpaid. Subsequent to year ending September 2002,
$10,000 of other deferred contractor fees was exchanged by Mr. Carr for an
A Unit in the Company's November 2002 Private Placement Offering for
250,000 shares of restricted stock and 100,000 Common Stock purchase
warrants exercisable at a price of $.30 per share. Other Compensation in
2001 for Mr. Carr includes the value of options granted at an exercise
price below the market value of the stock on the date of grant. Mr. Carr
resigned in July 2002 as an employee and a director. (See Employment
Agreements below).
(8) Other Compensation for 2004 includes $2,250 for board fees.
50
LONG TERM INCENTIVE PLANS - AWARDS IN THE LAST FISCAL YEAR
The table below describes all Long Term Incentive Plans under which awards
were given to the named executive officers during the last fiscal year. These
awards fall under our employee stock retainage program.
LONG-TERM INCENTIVE PLANS - AWARDS IN LAST FISCAL YEAR
------------------------------------------------------
ESTIMATED FUTURE PAYOUTS UNDER NON-
PERFORMANCE OR STOCK PRICED-BASED PLANS
OTHER PERIOD -----------------------------------
NUMBER OF UNTIL
SHARES MATURATION OR THRESHOLD TARGET MAXIMUM
NAME (#)(1) PAYOUT ($ OR #) ($ OR #) ($ OR #)
- ----------------------- --------- -------------- --------- -------- --------
Michael A. Grollman (2) 1,250,000 Dec 2004
Graham L. Clark (3) 1,000,000 Dec 2004
- --------------
(1) All grants in this table are based on our fiscal year 2002 stock retainage
program. Our board implemented this program in September 2002, and shares
were granted at that time. Actual issuance of shares for the named
executive participants took place in January of 2003. Our board allocated
approximately $150,000 in common stock from this Stock Retainage Program
pool of shares, to be granted to key employees during the year, subject to
National Scientific exceeding sales growth objectives and expense reduction
objectives, and subject to the employees remaining with us through the next
15 months, or longer, if the awards were not earned after 15 months.
Failure to meet these objectives under the plan can result in the
forfeiture by staff of some or all of the stock grants by all participants.
These goals were the same for all plan participants, which included other
non-executives, as well the named executives. These goals were not met in
calendar year 2003. In January of 2004, our board extended this program
into 2004, and set new sales growth objectives for the year at a level 50%
higher than the previous year's program, giving plan participants an
additional year to fully earn this stock grant.
(2) Mr. Grollman was granted 750,000 shares of stock from this Stock Retainage
Program pool of shares, subject to National Scientific achieving in excess
of $400,000 in sales in calendar year 2004. Mr. Grollman was granted an
additional 500,000 shares of stock under this program, subject to sales
exceeding $1,500,000 for calendar year 2004.
(3) Mr. Clark was granted 500,000 shares of stock from our Stock Retainage
Program pool of shares discussed above, subject to National Scientific
achieving in excess of $400,000 in sales in calendar year 2004. Mr. Clark
was granted an additional 500,000 shares of stock under this program,
subject to sales exceeding $1,500,000 for calendar year 2004.
OPTION/SAR GRANTS AND EXERCISES OF OPTIONS/SAR GRANTS DURING LAST FISCAL YEAR
No individual grants of stock options (whether or not in tandem with SARs),
or freestanding SARs (including options and SARs that subsequently have been
transferred) were made during the fiscal year ending Septembers 30, 2004, to any
of the named executive officers, nor did any of the named executive officers
exercise any options or SAR grants during that period.
51
EMPLOYEE STOCK RETAINAGE PLAN
In September 2002, by unanimous vote, our board initiated a restricted
stock retainage program or plan ("Stock Retainage Program") to retain key staff
during a period of financial difficulty in calendar year 2002. The board
allocated approximately $150,000 in restricted common stock from this Stock
Retainage Program as a pool of shares of our restricted common stock, to be
granted to key employees at the direction of the board for the year and the
next, subject to National Scientific exceeding sales growth objectives and
expense control objectives in 2003. Failure to meet these objectives under the
plan would result in serious risk of forfeiture by staff of some or all of these
stock grants by all participants. All goals set were team goals. The plan has
been used as a tool to achieve salary deferral and other salary concessions from
the staff during this period of fiscal hardship, in order to retain key
employees during this period. The plan's sales goals were not met in calendar
year 2003, although the plan was nonetheless largely successful in assisting to
retain key staff, even during this period of deferred or reduced salary. In
January of 2004, our board extended this program into 2004, and set new sales
growth objectives for the year at a level 50% higher than the previous year's
program, giving plan participants an additional year to fully earn these
previously outstanding restricted stock grants. The board may extend this plan
into calendar year 2005 at its direction. No new shares were added to the plan
in 2004, although plan participants were able to convert some long-term back pay
into restricted stock at that time, if desired. As of the date of this report,
the plan currently covers officers Michael Grollman and Graham Clark, and
employees who are not officers including Oscar Quadros, Karen Fuhre, and Paul
Davidson. The plan has not been submitted to our shareholder's for approval. A
sample agreement for the plan is included as an exhibit to this report.
EMPLOYMENT AGREEMENTS
We engaged Mr. Grollman as an independent contractor from October 7, 2000
until November 30, 2000. He was paid $15,000 monthly for his services as an
independent contractor. Effective December 1, 2000, Mr. Grollman became an
employee of National Scientific under a one-year contract to serve as our Chief
Operating Officer. Mr. Grollman was named President in April 2001. The contract
automatically renews for additional one-year terms unless either party chooses
to terminate, and it remains in force through at least calendar year 2004. Mr.
Grollman's contract calls for an annual gross salary of $180,000, payable
semi-monthly. Also in accordance with the contract, on December 1, 2000, we
granted Mr. Grollman 100,000 shares of common stock; subject to risk of
forfeiture should Mr. Grollman not fulfill his employment agreement. Also on
December 1, 2000, we granted Mr. Grollman 500,000 vested options to purchase
common stock at the closing sales price of the common stock on December 1, 2000.
Additional option grants are included in Mr. Grollman's employment contract for
each whole dollar amount increase in the market value of our Common Stock. The
whole dollar amount increase is measured over a moving two-week average. For
each whole dollar amount attained between $1 and $15 inclusive, Mr. Grollman
will receive 75,000 options at the whole dollar amount option price. Mr.
Grollman is also entitled to additional options at various but declining levels
for increases in stock value up to $50 per Common Share. In the event of a
change in control or sale of substantially all the assets of National
Scientific, the employment agreement between Mr. Grollman and us automatically
terminates, and Mr. Grollman is to receive one hundred fifty percent (150%) of
the then current year's annual salary.
In January of 2002 Mr. Grollman agreed to defer 20% of his salary until
such a time as cash was more available, reducing his immediately payable cash
salary to $12,000 per month. For September, October, and November of 2002, Mr.
52
Grollman deferred 100% of his payable salary, reducing his immediately payable
cash salary to $0 per month. Mr. Grollman agreed from January 2003 through
December 2003 to reduce his total payable salary for the 2003 year to $120,000
per year. In addition to this reduction, during the year ended September 30,
2003 Mr. Grollman deferred $70,360 of his salary and was paid $64,640 in cash.
For the three months ending December 31, 2003, Mr. Grollman deferred $19,900 in
salary and was paid $10,100 in cash. For the fiscal year ended September 30,
2004 salary of $70,800 was not paid in cash, but deferred to a future period.
Also subsequent to fiscal 2004 year-end, Mr. Grollman deferred $6,000 of his
October and $5,000 of his November monthly salary of $15,000 to a future period.
For calendar year 2004, Mr. Grollman agreed to defer up to $30,000 of his
contracted pay as needed.
In September 2002, our board initiated a restricted stock retainage program
("Stock Retainage Program") to retain key staff during a period of financial
difficulty in calendar year 2002. The board allocated approximately $150,000 in
common stock from this Stock Retainage Program pool of shares, to be granted to
key employees during the year, subject to National Scientific exceeding sales
growth objectives and expense reduction objectives in 2003. Failure to meet
these objectives under the plan would result in the forfeiture by staff of this
entire stock grant by all participants. These goals were not met in calendar
year 2003. In January of 2004, our Board extended this program into 2004, and
set new sales growth objectives for the year at a level 50% higher than the
previous year's program, giving plan participants an additional year to fully
earn this stock grant. On August 19, 2003, a participant of the plan left us and
his grant of 800,000 shares were forfeited at the average market price per share
of $0.15. On September 30, 2003 the 800,000 shares of common stock resulting
from the forfeiture was allocated to the plan. We issued this stock under the
terms of the plan to several employees in 2004 who are not officers or directors
of National Scientific.
Mr. Grollman was granted 750,000 shares of stock from this Stock Retainage
Program pool of shares, subject to National Scientific achieving in excess of
$400,000 in sales in calendar year 2004. Mr. Grollman was granted an additional
500,000 shares of stock under this program, subject to sales exceeding
$1,500,000 for calendar year 2004.
In December 2003 Mr. Grollman agreed to convert approximately $150,000 of
his back pay and accrued vacation pay to our restricted common stock, at a rate
equal to the then currently available private placement share price of $0.10 per
share. Mr. Grollman received this stock in January of 2004.
Our board of directors is also considering granting approximately 500,000
additional options to Mr. Grollman in calendar year 2004 based on the
achievement of calendar year 2004 business objectives, including such areas as
product development and customer base development. The plan has been approved by
the board of directors, subject to availability of sufficient options in the
plan. These options have not been issued.
Mr. Clark was hired in December 2000 as manager of the sales organization.
His salary was $120,000 per year base salary, plus commission on sales. He
became Vice President of Technology Applications & Sales for us in September
2001, and a director and a corporate officer in August of 2002. In January of
2003, Mr. Clark entered into a one-year employment agreement with National
Scientific to serve as Vice President of Technology Applications & Sales. In
June of 2003 Mr. Clark was named President of National Scientific. The contract
automatically renews for additional one-year terms unless either party chooses
to terminate. Mr. Clark's contract provides for an annual gross salary of
$150,000, payable monthly. In the event of a change in control or sale of
substantially all our assets, the employment agreement between Mr. Clark and
53
National Scientific automatically terminates, and Mr. Clark is to receive fifty
percent (50%) of the then current year's annual salary.
For September, October, and November of 2002, Mr. Clark deferred 100% of
his payable salary, reducing his immediately payable cash salary to $0 per
month. During the year ended September 30, 2003 Mr. Clark deferred $50,360 of
his salary and was paid $69,640 in cash. During the year ended September 30,
2004 Mr. Clark deferred $41,400 of his salary and was paid $101,100 in cash.
Also subsequent to fiscal 2004 year-end, Mr. Clark deferred $3,500 of his
October and $2,500 of his monthly salary of $12,500 to a future period.
Mr. Clark was granted 500,000 shares of stock from our Stock Retainage
Program pool of shares discussed above, subject to National Scientific achieving
in excess of $400,000 in sales in calendar year 2004. Mr. Clark was granted an
additional 500,000 shares of stock under this program, subject to sales
exceeding $1,500,000 for calendar year 2004.
Our board of directors is also considering granting approximately 500,000
additional options to Mr. Clark in calendar year 2004 based on the achievement
of calendar year 2004 business objectives, including such areas as product
development and customer base development. The plan has been approved by the
board of directors, subject to availability of sufficient options in the plan.
These options have not been issued.
Throughout fiscal 2000, Mr. Ross was engaged as an independent contractor
for National Scientific. As such, Mr. Ross was paid a monthly fee of $9,500,
subject to cash availability. Effective December 1, 2001, Mr. Ross became an
employee of National Scientific. Throughout fiscal 2001 and continuing into
2003, Mr. Ross served without a written contract and was paid $9,500 monthly. In
addition, in connection with an equity transaction involving Mr. Ross and his
spouse in September 1999, the Board of Directors granted Mr. Ross the right to
receive 4% of our gross revenues. In partial consideration for the forgiveness
of this right to 4% of our future revenues, National Scientific agreed to issue
500,000 restricted shares of our common stock to Mr. Ross. The 500,000 shares
are subject to the terms of a Restricted Stock Award Agreement, which required
that the shares issued be released only when the market price of the stock
exceeds $2.50 per share.
Subsequent to fiscal year end 2001, National Scientific granted Mr. Ross
options to purchase an aggregate of 750,000 shares of common stock. The options
consist of ten separate groups of 75,000 shares each, whose exercise prices
range from $1 to $10 per share, which vest when the previous five day average
market price exceeds even dollar levels beginning with $1 per share through $10
per share. On September 30, 2003, these options were forfeited and returned to
us.
In February of 2002, Mr. Ross resigned as an employee of National
Scientific, and became a part-time contractor, paid at a rate of $10,000 per
month, of which 20% would be deferred until a future date. The term of the
agreement was two years and it required that Mr. Ross provide approximately 80
hours per month management-consulting services to us and serve as a director. In
July 2002 National Scientific and Mr. Ross amended the contract to eliminate
mandatory monthly minimum cash payments and minimum hours per month for on-going
consulting duties other than his responsibilities as a director. Under this
revised contract, Mr. Ross was paid a director's fee of $2,500 per month in our
restricted common stock. In February 2003 this contract was again revised, and
from February 2003 to September 30, 2003 Mr. Ross agreed to take a reduction in
his director's fees and accept 50,000 shares of common stock in lieu of cash for
board services for the entire six-month period. Mr. Ross retired from the board
54
on September 30, 2003. His major contract duties as a consultant with us ended
in February 2004, although some confidentiality provisions of this agreement
continue into 2005.
Mr. Carr served us as an independent contractor from October 15, 2000 until
November 30, 2000. He was paid $13,750 monthly for his services. Effective
December 1, 2000, Mr. Carr became employed under a one year contract to serve as
our Chief Financial Officer. The contract automatically renewed for additional
one-year terms unless either party elected to terminate. Mr. Carr's contract
provided for an annual gross salary of $180,000, payable semi-monthly. Also in
accordance with the contract, on December 1, 2000, we granted Mr. Carr 100,000
vested options to purchase common stock at a price equal to 25% of the closing
price per share on December 1, 2000. Also on December 1, 2000, we granted Mr.
Carr 500,000 vested options to purchase common stock at the closing sales price
of the shares on December 1, 2000. Additional option grants were included in Mr.
Carr's employment contract for each whole dollar amount increase in the market
value of our Common Shares. The whole dollar amount increase is measured over a
moving two-week average. For each whole dollar amount attained between $1 and
$15 inclusive, Mr. Carr would receive 75,000 options at the whole dollar amount
option price. Mr. Carr was also entitled to additional options at various but
declining levels for increases in stock value up to $50 per common share.
From January of 2002 through July of 2002, Mr. Carr deferred 20% of his
salary, subject to future cash availability, reducing his monthly salary cash
payments to $12,000 per month.
In July of 2002, Mr. Carr resigned as CFO and also as an employee and a
company director, and became a full-time non-employee contractor for us. He
signed a one-year contract, the terms of which were similar to his previous
company employment contracts, although all employee-related benefits were
eliminated, and his hourly rate of pay was changed to approximately $97 per
hour, or approximately $17,000 per month. In November 2002, National Scientific
and Mr. Carr amended this contract to eliminate mandatory monthly payments. Mr.
Carr was retained on this basis during the month of December 2002 to assist with
preparation of our annual report and other matters, for which he was paid
approximately $12,000 in cash. In January 2003 Mr. Carr and National Scientific
agreed to secure his services as a financial consultant for a minimum retainer
of ten hours per month at a rate of $120 per hour. This retainer agreement ended
on April 1, 2003.
In January 2003, we, under our Restricted Stock Retainage Plan initiated in
September 2002, issued 2,550,000 shares of common stock at an average price of
$0.06 or 90% of the price on the grant date of September 30, 2002. These grants
were provided originally to Michael Grollman, Graham Clark, David Mandala, and
Karen Fuhre. Mr. Mandala left the firm in mid-2003, and his shares under the
plan were reallocated to Oscar Quadros and Paul Davidson. These stock grants
were contingent upon National Scientific achieving sales targets for calendar
year 2003. Should these targets not be met, these shares would be forfeited, or
we and the employees involved in the program would elect to establish new goals
for calendar year 2004, in order to motivate the staff to perform and
simultaneously conserve cash resources during the next calendar year, using the
same stock grants, as yet unearned, as long term incentive.
During the fiscal years ending September 30, 2004 and 2003, we issued
160,084 and 946,270 shares, respectively, of our common stock to our consultants
in lieu of cash compensation. During fiscal 2004, we granted 790,000 options to
our consultants and employees to purchase shares of our common stock. The
options granted had exercise prices ranging from $0.09 per share to $0.16 per
share. The exercise prices were generally below market on the date of grant, and
55
vested. We granted these options as a means of compensation to consultants to
conserve operating cash. During fiscal 2003, substantially all option grants
were issued to employees.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth certain information, as of November 30, 2004,
concerning the beneficial ownership by (i) all current directors, (ii) each of
our named executive officers, (iii) each person known to us to be the beneficial
owner of more than five percent (5%) of our outstanding common stock, and (iv)
all of our directors and executive officers as a group. To our knowledge, all
persons listed in the table have sole voting and investment power with respect
to their shares, except to the extent that their respective spouses share
authority under applicable law.
NUMBER OF
COMMON SHARES PERCENT OF
BENEFICIALLY OUTSTANDING
NAME AND ADDRESS OF BENEFICIAL OWNER (1) OWNED (2) SHARES
- ---------------------------------------- ------------- -----------
Michael A. Grollman 4,066,000 (3) 4.8%
Graham L. Clark 1,451,667 (4) 1.7%
Gregory Szabo 157,240 (5) 0.2%
All executive officers and directors as
a group (3 persons) 5,674,907 6.7%
- -------------
(1) The business address for all directors and officers is c/o National
Scientific Corporation, 14505 North Hayden Road, Suite 305, Scottsdale,
Arizona 85260-6951.
(2) A person is deemed to be the beneficial owner of securities that can be
acquired within 60 days from the date set forth above through the exercise
of any option, warrant or right. Shares of Common Stock subject to options,
warrants or rights that are currently exercisable or exercisable within 60
days are deemed outstanding for computing the percentage of the person
holding such options, warrants or rights, but are not deemed outstanding
for computing the percentage of any other person. The amounts and
percentages are based upon the approximately 84,350,657 shares of Common
Stock outstanding as December 27, 2004.
(3) Includes 1,050,000 shares underlying currently exercisable stock options
and warrants, and 2,750,000 shares of restricted Common Stock subject to
substantial risk of forfeiture.
(4) Includes 326,667 shares underlying currently exercisable stock options and
warrants and 1,000,000 shares of restricted Common Stock subject to
substantial risk of forfeiture.
(5) Includes 80,000 shares underlying currently exercisable stock options and
warrants and 77,240 shares of restricted Common Stock subject to
substantial risk of forfeiture.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In October 2002, Mr. Lou Ross, the former Chairman of the Board, and a
Director until September 30, 2003, was paid for his services as an active member
of the board in shares of restricted common stock, in lieu of cash. The former
Chairman received 66,806 restricted common shares at an average price on the
date of grant of $0.11 per share.
56
In June 2003, we entered into an agreement to restructure and repay an
outstanding debt to Mr. Lou Ross, a Director of National Scientific. Together
with Mr. Ross, we aggregated the value of all sums we currently owed to Mr.
Ross. This included notes executed of approximately $75,000, all salary deferred
by Mr. Ross in 2002 of approximately $8,300, and all cash board fees deferred in
2002 by Mr. Ross of approximately $3,000, for a total amount payable to Mr. Ross
as of June 11, 2003 of approximately $86,500. Mr. Ross agreed to accept one-half
of this sum, or $43,250, in restricted common stock issued at the then-current
market price of $0.15 cents per share, for a total share grant to Mr. Ross of
288,334 shares. Mr. Ross also agreed to convert the remaining one-half of the
total debt outstanding from us to him, or $43,250, into a three-year interest
free note, with no payments required by us until the end of the three-year
period, and which could be paid by us at any time before the three-year period
elapses with either cash or its restricted common stock or a combination of cash
and stock. With this agreement, we no longer have any outstanding delinquent
notes to Mr. Ross, and our liabilities have been reduced by $43,250, though he
remains a significant stockholder of ours.
Mr. Ross also agreed to take a reduction in his Director's fees for the
period from February 2003 to the end of the fiscal year ending in September
2003, and to accept 50,000 shares of our restricted common stock in lieu of cash
for these board services, which was paid to him in stock on June 11, 2003. On
September 30, 2003, at the point of his resignation from the Board, Mr. Ross
surrendered all stock options he had received from us.
On September 30, 2002 we started a restricted Stock Retainage Program to
retain key staff during a period of financial difficulty with significant
periods of cash wage deferrals. We allocated approximately 3,350,000 shares with
a current market value of $150,000 from this Stock Retainage Program pool of
shares in fiscal 2002, to be granted to key personnel. Grants from this pool of
shares have been made to Michael Grollman, Graham Clark, Karen Fuhre, Oscar
Quadros, and Paul Davidson. As of the date of this report, none of these grants
have been fully earned, and they remain subject to substantial risk of
forfeiture.
WHERE YOU CAN FIND MORE INFORMATION
We file reports and other information with the U.S. Securities and Exchange
Commission. You may read and copy any document that we file at the SEC's public
reference facilities at 450 Fifth Street N.W., Room 1024, Washington, D.C.
20549. Please call the SEC at 1-800-732-0330 for more information about its
public reference facilities. Our SEC filings are also available to you free of
charge at the SEC's web site at www.sec.gov.
Copies of publicly available documents that we have filed with the SEC can
also be inspected and copied at the offices of the National Association of
Securities Dealers, Inc., 1735 K. Street, N.W., Washington, D.C. 20006.
You should only rely upon the information included in or incorporated by
reference into this annual report and the exhibits to the annual report. We have
not authorized anyone to provide you with additional or different information.
You should not assume that the information included in or incorporated by
reference into this annual report is accurate as of any date later than the date
on the front of the annual report.
We have not authorized any person to provide you with information different
from that contained or incorporated by reference in this annual report. The
information contained in this annual report is accurate only as of the date of
this report, regardless of the time of delivery of this annual report.
57
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
3.1 Articles of Incorporation(1)
3.2 Bylaws(2)
10.1 Employment Agreement between National Scientific Corporation and
Michael A. Grollman dated January 2001(4)
10.2 Employment Agreement between National Scientific Corporation and
Graham L. Clark dated January 2003(6)
10.3 NSC Consulting Agreement dated August 2001, and Amendments dated
August 2002 and July 2003, with Dr. El-Badawy El-Sharawy(6)
10.4 Amended and Restated 2000 Stock Option Plan(3)
10.5 Form of 2004 Stock Retainage Plan Agreement(6)
10.6 Agreement Regarding Management Consulting Services with Stanton
Walker of New York dated May 2003(6)
10.7 Agreement Regarding Distribution and Marketing of Gotcha!(R) Child
Safety Product and other products dated December 2002 with
FutureCom Global, Inc. (6)
10.8 Purchase Order from Verify Systems, Inc, dated March 2003 for
IBUS(TM) School Child Tracking Systems(5)
10.9 Letter of Understanding and Agreement dated April 2004 Regarding
Sales and Distribution of Verify School safety products, and an
Unlimited Software License with Anthony Grosso and CIS Services,
LLC(6)
10.10 Letter of Intent from Positus, Inc. dba Bike & Cycle Trak, dated
February 2003 for Design of Power Sports Tracking System(6)
10.11 Purchase Order from Positus, Inc. dba Bike & Cycle Trak, for Design
of Power Sports Tracking System dated March 2003(6)
14 Code of Ethics(7)
31 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
- --------------
(1) Incorporated by reference to the Registrant's Form 10-SB filed on or about
January 3, 2000.
(2) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended March 31, 2001 and filed on or about May 15, 2001.
(3) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended December 31, 2000 and filed on or about February 14, 2001.
(4) Incorporated by reference to the Registrant's Form 10-KSB for the year
ended September 30, 2000 and filed on or about December 19, 2000.
(5) Incorporated by reference to the Registrant's Form S-8 filed on or around
June 3, 2003.
(6) Incorporated by reference to the Registrant's Form SB2 filed on or around
June 24, 2004.
(7) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended June 30, 2004 and filed on or about August 16, 2004.
(b) Reports on Form 8-K
The Company filed one Report on Form 8-K on April 15, 2004 relating to the
initial closing of a private placement of its common stock units.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NATIONAL SCIENTIFIC CORPORATION
Date: March ___, 2005 By:
-------------------------------------------------
Director, Chief Executive Officer, Acting Chief
Financial Officer, and Chairman
By:
-------------------------------------------------
Director, President, and Secretary
By:
-------------------------------------------------
Director
59
NATIONAL SCIENTIFIC CORPORATION
AUDITED FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003 AND DEVELOPMENT STAGE
INDEX
PAGE
Report of Independent Registered Public Accounting Firm F-2
Balance Sheets (September 30, 2004 and 2003) F-3
Statements of Operations (Years Ended September 30, 2004, 2003
and Development Stage) F-4
Statements of Shareholders' Equity (Seven Years Ended
September 30, 2004, and Development Stage) F-5
Statements of Cash Flows (Years Ended September 30, 2004, 2003
and Development Stage) F-12
Notes to Financial Statements (Years Ended September 30, 2004, 2003
and Development Stage) F-13
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors,
National Scientific Corporation
We have audited the accompanying balance sheets of National Scientific
Corporation (a development stage Company) as of September 30, 2004 and 2003, and
the related statements of operations, changes in shareholders' equity (deficit)
and cash flows for each of the two years in the period ended September 30, 2004
and from September 30, 1997 (inception of development stage) to September 30,
2004. These financial statements are the responsibility of National Scientific
Corporation's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits 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 opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of National Scientific
Corporation as of September 30, 2004 and 2003, and the results of its operations
and its cash flows for each of the two years in the period ended September 30,
2004 and from September 30, 1997 (inception of development stage) to September
30, 2004 in conformity with accounting principles generally accepted in the
United States of America.
The accompanying financial statements have been prepared assuming that
National Scientific Corporation will continue as a going concern. As discussed
in Note 2 to the financial statements, National Scientific Corporation is in the
development stage, has not yet generated significant revenues, and is dependent
upon raising capital from investors. Additionally, National Scientific
Corporation has incurred aggregate losses during the past two years of over
$1,900,000 and has a total shareholders' deficit of over $200,000. These matters
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans concerning these matters are also described in Note
2. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
/s/ Hurley & Company
Granada Hills, CA
October 20, 2004
F-2
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
SEPTEMBER 30, 2004 AND 2003
2004 2003
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 160,214 $ 17,903
Trade receivables, net 25,797 28,200
Inventory 66,150 9,700
Other assets 15,489 16,926
------------ ------------
Total current assets 267,650 72,729
Property and equipment, net 21,021 32,081
Deposits 5,031 5,031
------------ ------------
$ 293,702 $ 109,841
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable $ 148,187 $ 185,725
Accrued expenses 340,984 457,695
Deposits -- 20,000
Notes payable, current -- 10,000
------------ ------------
Total current liabilities 489,171 673,420
Notes payable, net of current portion 43,250 43,250
------------ ------------
Total liabilities 532,421 716,670
Commitments and contingencies -- --
------------ ------------
Shareholders' equity (deficit):
Preferred stock, par value $0.10;
4,000,000 shares authorized, and
no shares issued and outstanding -- --
Common stock, par value $0.01;
120,000,000 shares authorized, and
shares issued and outstanding 84,330,669
and 70,633,819 at September 30, 2004 and
2003, respectively 843,307 706,338
Additional paid-in capital 21,627,654 20,444,733
Accumulated deficit (22,709,680) (21,757,900)
------------ ------------
Total shareholders' equity (deficit) (238,719) (606,829)
------------ ------------
$ 293,702 $ 109,841
============ ============
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-3
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003, AND DEVELOPMENT STAGE
DEVELOPMENT
2004 2003 STAGE
------------ ------------ ------------
Revenues $ 77,994 $ 63,579 $ 1,027,202
Cost of Sales 55,597 25,848 953,084
------------ ------------ ------------
Gross profit 22,397 37,731 74,118
Costs and expenses
Salaries and benefits 393,308 438,244 2,570,104
Research and development 253,257 84,301 3,966,392
Stock compensation 45,421 291,658 3,126,115
Consulting fees, related party -- 17,650 8,175,973
Other 260,649 149,245 2,667,952
------------ ------------ ------------
Total costs and expenses 952,635 981,098 20,506,536
------------ ------------ ------------
Loss from operations (930,238) (943,367) (20,432,418)
Other income (expense)
Interest and other income -- -- 178,972
Gain on settlement -- -- 89,403
Interest expense (21,542) (9,197) (55,810)
Loss on disposal of assets -- -- (30,960)
Loss on impairment of equipment -- -- (64,187)
------------ ------------ ------------
(21,542) (9,197) 117,418
------------ ------------ ------------
Loss before income taxes (951,780) (952,564) (20,315,000)
Income tax expense -- -- --
------------ ------------ ------------
Net loss $ (951,780) $ (952,564) $(20,315,000)
============ ============ ============
Net loss per common share, basic and diluted $ (0.01) $ (0.02)
============ ============ ============
Weighted average number of shares outstanding 78,212,528 62,758,349
============ ============ ============
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-4
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
---------------------- ---------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED
SHARES VALUE SHARES VALUE CAPITAL DEFICIT TOTAL
---------- --------- ------ ----- ------------ ------------ ---------
Balance, September 30, 2003 70,633,819 $ 706,338 -- $ -- $ 20,444,733 $(21,757,900) $(606,829)
Exercise of options 107,500 1,075 -- -- 8,600 -- 9,675
Stock Issued for services
Price per share ranged
$0.140 47,646 476 -- -- 5,527 -- 6,003
$0.155 33,000 330 -- -- 4,274 -- 4,604
$0.150 55,186 552 -- -- 7,726 -- 8,278
$0.160 24,252 243 -- -- 3,249 -- 3,492
Common stock options granted,
net -- -- -- -- 23,094 -- 23,094
Debt to equity swap 1,500,000 15,000 -- -- 135,000 -- 150,000
Private placement of
common stock
Shares issued for:
$0.100 1,100,000 11,000 -- -- 99,000 -- 110,000
$0.110 10,334,266 103,343 -- -- 831,701 -- 935,044
Stock retainage program 500,000 5,000 -- -- 64,750 -- 69,750
Stock returned to treasury (5,000) (50) -- -- -- -- (50)
Net loss -- -- -- -- -- (951,780) (951,780)
---------- --------- ------ ----- ------------ ------------ ---------
Balance, September 30, 2004 84,330,669 $ 843,307 -- $ -- $ 21,627,654 $(22,709,680) $(238,719)
========== ========= ====== ===== ============ ============ =========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-5
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
---------------------- ---------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED
SHARES VALUE SHARES VALUE CAPITAL DEFICIT TOTAL
---------- --------- ------ ----- ------------ ------------ ---------
Balance, September 30, 2002 51,587,062 $ 515,871 -- $ -- $ 19,517,719 $(20,805,336) $(771,746)
Stock issued for services
@ $0.17 946,270 9,462 -- -- 152,913 -- 162,375
Exercise of options 637,153 6,372 -- -- 22,686 -- 29,058
Stock options granted -- -- -- -- 60,733 -- 60,733
Debt equity swap 788,334 7,883 -- -- 66,232 -- 74,115
Private placement
@ $0.04 to $0.08 14,125,000 141,250 -- -- 528,750 -- 670,000
Stock retainage program 2,550,000 25,500 -- -- 95,700 -- 121,200
Net loss -- -- -- -- -- (952,564) (952,564)
---------- --------- ------ ----- ------------ ------------ ---------
Balance, September 30, 2003 70,633,819 $ 706,338 -- $ -- $ 20,444,733 $(21,757,900) $(606,829)
========== ========= ====== ===== ============ ============ =========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-6
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 2002, 2001 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
---------------------- ---------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED
SHARES VALUE SHARES VALUE CAPITAL DEFICIT TOTAL
---------- --------- ------ ----- ------------ ------------ -----------
Balance, September 30, 2001 47,367,498 $ 473,675 -- $ -- $ 18,766,775 $(18,921,847) $ 318,603
Stock issued for services
@ $0.306 100,000 1,000 -- -- 29,600 -- 30,600
Issuance of stock under
equity line of credit
@ $0.12 to $0.27 2,122,064 21,221 -- -- 393,603 -- 414,824
Exercise of warrants 770,500 7,705 -- -- 84,755 -- 92,460
Exercise of options 1,477,000 14,770 -- -- 154,762 -- 169,532
Loan repayment by officer (250,000) (2,500) -- -- (97,500) -- (100,000)
Grants of options and
warrants, net -- -- -- -- 185,724 -- 185,724
Net loss -- -- -- -- -- (1,883,489) (1,883,489)
---------- --------- ------ ----- ------------ ------------ -----------
Balance, September 30, 2002 51,587,062 $ 515,871 -- $ -- $ 19,517,719 $(20,805,336) $ (771,746)
========== ========= ====== ===== ============ ============ ===========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-7
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
---------------------- ---------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED
SHARES VALUE SHARES VALUE CAPITAL DEFICIT TOTAL
---------- --------- ------ ----- ------------ ------------ -----------
Balance, September 30, 2000 47,195,768 $ 471,958 -- $ -- $ 15,086,920 $(12,686,979) $ 2,871,899
Stock issued for services
Stock issued for services 100,000 1,000 -- -- 164,600 -- 165,600
@ $1.66
Stock issued for services 15,000 150 -- -- 23,070 -- 23,220
@ $1.55
Stock issued for services 5,000 50 -- -- 21,550 -- 21,600
@ $4.32
Stock issued for services 75,000 750 -- -- 98,475 -- 99,225
@ $1.32
Stock issued for services 10,000 100 -- -- 5,030 -- 5,130
@ $0.51
Exercise of warrants and
options 1,291,730 12,917 -- -- 1,278,813 -- 1,291,730
Amortization of stock
compensation -- -- -- -- 3,712,500 -- 3,712,500
Exchange for stock options (1,325,000) (13,250) -- -- (2,424,750) -- (2,438,000)
Common stock options
exercisable -- -- -- -- 800,567 -- 800,567
Net loss -- -- -- -- -- (6,234,868) (6,234,868)
---------- --------- ------ ----- ------------ ------------ -----------
Balance, September 30, 2001 47,367,498 $ 473,675 -- $ -- $ 18,766,775 $(18,921,847) $ 318,603
========== ========= ====== ===== ============ ============ ===========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-8
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
----------------------- ---------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED
SHARES VALUE SHARES VALUE CAPITAL DEFICIT TOTAL
---------- ---------- ------ ----- ------------ ------------ -----------
Balance, September 30, 1999 36,544,289 $ 365,443 -- $ -- $ 3,678,315 $ (4,111,680) $ (67,922)
Stock issued for services
Price per share ranged
$0.18 to $0.85 775,000 7,750 -- -- 397,620 -- 405,370
$1.74 to $2.70 606,797 6,067 -- -- 1,071,028 -- 1,077,095
$3.26 to $4.50 139,000 1,390 -- -- 457,884 -- 459,274
$5.12 to $6.92 236,832 2,369 -- -- 1,411,591 -- 1,413,960
$7.43 to $8.80 1,060,000 10,600 -- -- 7,929,921 -- 7,940,521
Exercise of warrants and
options 3,440,250 34,403 -- -- 3,151,997 -- 3,186,400
Private placement of
common stock
Shares issued for:
$0.11 2,430,000 24,300 -- -- 245,700 -- 270,000
$0.25 360,000 3,600 -- -- 86,400 -- 90,000
$0.40 975,000 9,750 -- -- 380,250 -- 390,000
Stock converted by
director's family
member 1,128,600 11,286 -- -- (11,286) -- --
Common stock to
collateralize
loan - retired (500,000) (5,000) -- -- -- -- (5,000)
Deferred stock
compensation -- -- -- -- (3,712,500) -- (3,712,500)
Net loss -- -- -- -- -- (8,575,299) (8,575,299)
---------- --------- ------ ----- ------------ ------------ -----------
Balance, September 30, 2000 47,195,768 $ 471,958 -- $ -- $ 15,086,920 $(12,686,979) $ 2,871,899
========== ========= ====== ===== ============ ============ ===========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-9
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
---------------------- ----------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED
SHARES VALUE SHARES VALUE CAPITAL DEFICIT TOTAL
---------- --------- ------ ------ ------------ ------------ -----------
Balance, September 30, 1998 25,331,849 $ 253,318 15,000 $1,500 $ 2,823,491 $ (3,167,225) $ (88,916)
Stock issued for services
Price per share ranged
$0.09 to $0.18 3,020,000 30,200 -- -- 528,239 -- 558,439
$0.20 to $0.29 145,000 1,450 -- -- 33,110 -- 34,560
Preferred stock offering -- -- 47,000 4,700 230,300 -- 235,000
Exercise of warrants and
options 496,000 4,960 -- -- 27,490 -- 32,450
Private placement of
common stock 400,000 4,000 -- -- 96,000 -- 100,000
Conversion of preferred to
common stock 6,200,000 62,000 (62,000) (6,200) (55,800) -- --
Common stock issued to
collateralize loan 500,000 5,000 -- -- -- -- 5,000
Stock converted by
director's family
member 451,440 4,515 -- -- (4,515) -- --
Net loss -- -- -- -- -- (944,455) (944,455)
---------- --------- ------ ------ ------------ ------------ -----------
Balance, September 30, 1999 36,544,289 $ 365,443 -- $ -- $ 3,678,315 $ (4,111,680) $ (67,922)
========== ========= ====== ====== ============ ============ ===========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-10
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 1998, 1997 AND DEVELOPMENT STAGE
COMMON STOCK PREFERRED STOCK
---------------------- ----------------
NUMBER NUMBER ADDITIONAL
OF PAR OF PAR PAID-IN ACCUMULATED DEVELOPMENT
SHARES VALUE SHARES VALUE CAPITAL DEFICIT STAGE TOTAL
---------- --------- ------ ------ ------------ ------------ ----------- ----------
Balance, October 1, 1997 17,847,292 $ 178,473 -- $ -- $ 2,160,780 $ (2,394,680) $ -- $ (55,427)
Stock issued for services 3,487,557 34,875 -- -- 335,473 -- -- 370,348
Private placement of
preferred stock -- -- 49,500 4,950 242,550 -- -- 247,500
Exercise of warrants
and options 547,000 5,470 -- -- 100,888 -- -- 106,358
Conversion of preferred
to common stock 3,450,000 34,500 (34,500) (3,450) (31,050) -- -- --
Contributed capital -- -- -- -- 14,850 -- -- 14,850
Net loss -- -- -- -- -- -- (772,545) (772,545)
---------- --------- ------ ------ ------------ ------------ ----------- ---------
Balance, September 30, 1998 25,331,849 $ 253,318 15,000 $1,500 $ 2,823,491 $ (2,394,680) $ (772,545) $ (88,916)
========== ========= ====== ====== ============ ============ =========== =========
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-11
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003 AND DEVELOPMENT STAGE
DEVELOPMENT
2004 2003 STAGE
------------ ------------ ------------
Cash flows from operating activities:
Net loss $ (951,780) $ (952,564) $(20,315,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Non cash transactions
Depreciation 13,134 12,926 78,330
Loss on disposal of assets -- -- 30,960
Impairment loss on equipment -- -- 64,187
Stock and options issued for services, net 45,421 344,308 11,628,133
Decrease (increase) in inventory (56,450) 5,216 (66,150)
(Increase) decrease in deferred offering costs -- -- (85,171)
Decrease (increase) in receivables 2,403 (26,569) 105,834
Decrease (increase) in other assets 1,437 (16,126) (11,580)
Increase (decrease) in accounts payable and accrued
expenses 65,501 (69,751) 738,627
------------ ------------ ------------
Net cash (used in) operating activities (880,334) (702,560) (7,831,830)
------------ ------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment (2,074) -- (155,766)
Repayment of loans -- -- 200,000
Proceeds from the sale of furniture and equipment -- -- 6,050
Loans issued -- -- (400,000)
------------ ------------ ------------
Net cash (used in) provided by investing activities (2,074) -- (349,716)
------------ ------------ ------------
Cash flows from financing activities:
Draws on the line of credit -- -- 430,000
Loan from (to) officer -- -- 65,079
Repayment of notes payable (10,000) -- (120,000)
Repayment of line of credit -- -- (430,000)
Repayment of capital lease obligations -- -- (1,819)
Proceeds from the exercise of options 9,675 29,058 208,265
Proceeds from the exercise of warrants -- -- 92,460
Proceeds from equity line of credit -- -- 414,824
Proceeds from the issuance of preferred stock -- -- 482,500
Deposits from private placement (20,000) 20,000 --
Proceeds from issuance of common stock 1,045,044 670,000 7,196,833
------------ ------------ ------------
Net cash provided by financing activities 1,024,719 719,058 8,338,142
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents 142,311 16,498 156,596
Cash and cash equivalents, beginning of period 17,903 1,405 3,618
------------ ------------ ------------
Cash and cash equivalents, end of period $ 160,214 $ 17,903 $ 160,214
============ ============ ============
Supplementary Disclosure of Cash Flow Information
Cash paid for interest $ 10,493 $ 3,000 $ 35,967
============ ============ ============
Cash paid for income taxes $ -- $ -- $ 50
============ ============ ============
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-12
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003 AND THE PERIOD OCTOBER 1, 1997
(INCEPTION OF DEVELOPMENT STAGE) THROUGH SEPTEMBER 30, 2004
SUMMARY OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During 1999, the Company issued 451,440 shares of restricted common stock
to a Director's family member in consideration of the family members' transfer
of 320,000 shares of unrestricted common stock to investors in connection with
the Company's private placement that year.
During fiscal year 2002, the Company's Board Chairman repaid a $100,000
loan by returning 250,000 shares of the Company's common stock valued at $0.40
per share.
During fiscal year 2003, the Company issued Mr. Lou Ross, 288,334 shares of
restricted common stock as part of its program to lower debt without expending
cash resources, in exchange for the forgiveness of $43,250 of debt, or one-half
of the total debt of $86,500 owed by the company to Mr. Ross. The debt forgiven
included various disclosed notes, salary deferred in 2002 and board fees
deferred in 2002. The shares were issued at an average market price per share of
$0.15. The Company also issued Mr. Ross 50,000 shares of restricted common stock
for reduced Director's fees for February 2003 through the end of this fiscal
year in September 2003. These shares were issued at an average market price per
share of $0.15.
SEE ACCOMPANYING INDEPENDENT AUDITORS' REPORT AND NOTES TO
FINANCIAL STATEMENTS, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
F-13
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting policies followed
by National Scientific Corporation (the "Company" or "us"). The policies conform
to accounting principles generally accepted in the United States of America,
which require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
a. OPERATIONS
The Company was incorporated in Texas on June 22, 1953 as American Mortgage
Company. On May 16, 1996, the Company changed its name to National Scientific
Corporation. During 1996, the Company acquired the operations of Eden Systems,
Inc. (Eden) as a wholly owned subsidiary. Eden was engaged in water treatment
and the retailing of cleaning products. Eden's operations were sold on October
1, 1997. As such, management now considers us as being in the development stage.
From September 30, 1997 through the year ended September 30, 2001, we aimed our
efforts in the research and development of semiconductor proprietary technology
and processes and in raising capital to fund its operations and research.
Beginning in calendar 2002, we focused our efforts on the development,
acquisition, enhancement and marketing of location device technologies. Our
revenue is derived from sales of electronic devices, recognized as the product
is delivered.
b. CASH EQUIVALENTS
Cash equivalents include money market accounts and other short-term
investments with an original maturity of three months or less.
c. INVENTORY
Inventories, primarily finished goods, are stated at the lower of cost or
market values. Cost is primarily determined on a FIFO (first-in, first-out)
basis.
d. PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and are being depreciated over
estimated useful lives of three to five years using the straight-line method.
e. ADVERTISING AND PROMOTION COSTS
Advertising and promotion costs, which totaled $53,239 in 2004 and $8,185
in 2003 are expensed as incurred.
F-14
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
f. STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES" and related interpretations as
permitted by SFAS 123 "Accounting for Stock-Based Compensation" as amended in
accounting for its employee stock options. Under APB 25, compensation expense is
measured as the excess, if any, of the quoted market price of the Company's
stock at the date of grant over the exercise price.
The following table illustrates the effect on net loss and loss per share
if the Company applied the fair value recognition provisions of SFAS 123 to
stock-based compensation:
2004 2003
----------- -----------
Net loss as reported $ (951,790) $ (952,564)
Deduct: total stock based
compensation expense as
determined under the fair
value method 31,500 50,360
----------- -----------
Pro forma net loss $ (983,290) $(1,002,924)
----------- -----------
Loss per share as reported (.01) (.02)
Loss per share, pro forma (.01) (.02)
As required by SFAS 123, as amended, the fair value of each grant is
estimated on the date of grant using the Black-Scholes option pricing method for
pro forma footnote disclosure with the following assumptions for all periods;
dividend yield of 0%, risk free interest rate of 5%, and expected option life of
10 years. Expected volatility was assumed to be 50% as of the date of issue.
g. INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases, including operating loss and tax credit carry-forwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect in deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized.
F-15
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
h. RESEARCH AND DEVELOPMENT / PATENTS
Both research and development and the costs associated with obtaining
patents and product development have been expensed as incurred. Patent costs are
expensed, since the Company has not yet developed products, which have gained
market acceptance.
i. NET LOSS PER SHARE
Net loss per share is computed by dividing the loss attributable to common
shareholders by the weighted average number of shares outstanding during the
period, which was 78,212,528 and 62,758,349 for the years ended September 30,
2004 and 2003, respectively. Stock options outstanding of 3,709,257 and warrants
outstanding of 18,249,197 are considered anti-dilutive and were not considered
in the calculation.
j. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has established new
pronouncements. The Company does not expect the adoption of these pronouncements
to have a material impact on its financial positions, results of operations or
cash flows. This includes SFAS 144 accounting for impairment and disposition of
long term assets.
In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46,
"CONSOLIDATION OF VARIABLE INTEREST ENTITIES." FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51, "CONSOLIDATED FINANCIAL
STATEMENTS," and applies immediately to any variable interest entities created
after January 31, 2003 and to variable interest entities in which an interest is
obtained after January 31, 2003. The Company holds no interest in variable
interest entities.
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." SFAS 149 clarifies the
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES." In particular, SFAS No. 149 clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a derivative
as described in SFAS No. 133. SFAS No. 149 also clarifies when a derivative
contains a financing component. SFAS No. 149 is generally effective for
derivative instruments entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. The company holds no
derivative instruments and does not engage in hedging activities.
In June 2003, the FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN
FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY." SFAS
No. 150 requires certain financial instruments that have both equity and
liability characteristics to be classified as a liability on the balance sheet.
SFAS No. 150 is effective for the first interim period beginning after June 15,
2003. The adoption of SFAS 150 did not have a material impact on the Company's
financial statements.
F-16
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
In December 2003, the FASB issued a revised Interpretation No. 46,
"CONSOLIDATION OF VARIABLE INTEREST ENTITIES." The interpretation clarifies the
application of Accounting Research Bulletin No. 51, "CONSOLIDATED FINANCIAL
STATEMENTS," to certain types of variable interest entities. The Company does
not expect the adoption of this interpretation to have any impact on its
financial statements.
2. DEVELOPMENT STAGE OPERATIONS
Although the Company has been in operation since 1996, management considers
NSC to be in the development stage. From September 30, 1997 through the year
ended September 30, 2001, the Company engaged its efforts in the research and
development of semiconductor proprietary technology and processes and in raising
capital to fund its operations and research. Beginning calendar 2002, the
Company focused its efforts toward the development, acquisition, enhancement and
marketing of location device technologies. Since its initiation of operations in
1996, the Company has not realized significant revenue, except for approximately
$882,000 generated through the export of electronic equipment, an isolated
event, which occurred in fiscal 2001.
The Company experienced significant operating losses during 2004 and 2003,
of $951,708 and $952,564 respectively, which raise substantial doubt about the
Company's ability to continue as a going concern. Of the total net operating
losses, approximately $45,000 and $292,000 are related to stock issued for
services and compensation in 2004 and 2003, respectively. Management believes
that its current cash position including cash funds arising from the exercise of
outstanding options, and secured plant assets from legal settlements, equity
private placement, product sales, and continued aggressive expense management to
be sufficient to continue operations for the next twelve months. We also believe
that we may be able to reduce outstanding liabilities through negotiations with
our creditors, or possibly negotiate to extend the payment schedule for these
debts. In the event these approaches do not provide us with adequate working
capital, we may be required to further curtail or reduce our development
activities, seek alternative funding sources, or seek protection under
reorganization laws.
The accompanying financial statements do not include any adjustments
relating to the recoverability and classification of the recorded asset amounts
or the amounts and classification of liabilities that might be necessary should
the Company be unable to continue in existence.
F-17
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
3. TRADE RECEIVABLES
Trade receivables are net of reserves:
2004 2003
---------- ----------
Trade receivables $ 35,797 $ 36,359
Less: reserves 10,000 8,159
---------- ----------
$ 25,797 $ 28,200
========== ==========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at September 30, 2004 and
2003:
2004 2003
---------- ----------
Computer equipment $ 60,880 $ 58,806
Office furniture 12,507 12,507
---------- ----------
73,387 71,313
Less: accumulated depreciation 52,366 39,232
---------- ----------
$ 21,021 $ 32,081
========== ==========
During fiscal 2002, the Company determined that the value of certain
computer and other equipment previously utilized in their San Jose office for
research and development was impaired. The Company recognized an impairment loss
of approximately $64,000.
F-18
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
5. EARNINGS PER SHARE
The following table reconciles weighted average shares outstanding to
amounts used to calculate basic and diluted earnings per share for fiscal years
2004 and 2003.
2004 2003
------------ ------------
Net (loss) $ (951,780) $ (952,564)
Weighted average shares:
Average shares outstanding 78,212,528 62,758,349
Effect of diluted shares -- --
------------ ------------
Average Shares outstanding,
adjusted for dilutive effect 78,212,528 62,758,349
------------ ------------
(Loss) per share - basic $ (0.01) $ (0.02)
============ ============
(Loss) per share - diluted $ (0.01) $ (0.02)
============ ============
Incremental common shares (not included in denominator of diluted earnings
per share because of their anti-dilutive nature):
2004 2003
------------ ------------
Employee options 3,709,257 3,329,757
Warrants 18,249,197 7,412,201
------------ ------------
Potential common equivalents 21,958,454 10,741,958
============ ============
If all currently outstanding potential common equivalents are exercised,
the Company would receive proceeds of approximately $7,000,000.
6. LEASE COMMITMENTS
On August 27, 2004 the Company signed a twenty-six month non-cancelable
operating lease agreement for an office in Scottsdale, Arizona, which expires on
October 31, 2006. The lease does not require any monthly payments in the first
two months. Thereafter, the lease requires monthly payments of $2,890 to $3,051
plus sales tax and contains no renewal or purchase options.
F-19
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
Future minimum lease obligations at September 30, 2003 are as follows:
Year ending September 30, Amount
------------------------- -------------
2005 $ 31,796
2006 36,452
2007 3,051
-------------
$ 71,299
=============
Rent expense for the years ended September 30, 2004 and 2003 was
approximately $60,000 and $64,000, respectively.
7. INCOME TAXES
Deferred income taxes consist of the following at September 30, 2004 and
2003:
2004 2003
------------ ------------
Tax Benefit of net operating loss
carry-forwards and start up costs $ 5,941,000 $ 5,779,000
Valuation allowance (5,941,000) (5,779,000)
------------ ------------
$ -- $ --
============ ============
A reconciliation of expected to actual taxes follows:
2004 2003
------------ ------------
Expected federal and state tax recovery
at 40% $ (380,000) $ (381,000)
Non-deductible stock compensation 18,000 117,000
------------ ------------
(362,000) (264,000)
Tax benefits not realized - valuation
allowance 362,000 264,000
------------ ------------
Realized tax benefit $ -- $ --
============ ============
The Company has recorded valuation allowances to offset the value of
deferred tax assets, since it has recorded losses from operations since 1996 and
the utilization of those assets is uncertain. During fiscal 2004 and 2003, the
valuation allowance increased by $362,000 and $264,000, respectively.
F-20
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
The Company has net operating loss carry-forwards of approximately
$15,600,000 at September 30, 2004, which may be used to offset future federal
taxable income through 2023 and state taxable income through 2009.
8. RELATED PARTY TRANSACTIONS
In October 2002, Mr. Lou Ross, the former Chairman of the Board, and a
Director until September 30, 2003, was paid for his services as an active member
of the board in shares of restricted common stock, in lieu of cash. The former
Chairman received 66,806 restricted common shares at an average price on the
date of grant of $0.11 per share.
As described in the Company's 10-KSB filing for the year ending September
30, 2003, and also in the Company's Proxy Statement for 2004 filed January 30,
2004, the Company's Board initiated on September 30, 2002 a restricted stock
retainage program ("Stock Retainage Program") to retain key staff during a
period of financial difficulty. The Company allocated approximately $150,000 in
restricted Common Stock from this Stock Retainage Program pool of shares in
fiscal 2002, to be granted to key employees during the year, subject to the
Company exceeding sales growth objectives and expense reduction objectives in
2003. Failure to meet these objectives under the plan would result in the
forfeiture by staff of this entire stock grant by all participants, unless new
objectives are approved by the board for calendar year 2004, in which case the
stock grant would remain with the participants but be subject to forfeiture by
participants until new objectives have been achieved in 2004. All stock grants
under this program were granted in September 2002 but shares were not finally
issued until January of 2003. All of the stock under this program is restricted
under SEC Section 144, and cannot be traded by the Stock Retainage Program
participants for at least one year from date of issue.
The Company CEO, Michael Grollman was granted 750,000 shares of stock from
this Stock Retainage Program pool of shares, subject to the Company achieving in
excess of $200,000 in sales in calendar year 2003, and subject to him accepting
a $60,000 per year pay reduction for the calendar year 2003, reducing his annual
payable salary to $120,000 per year for 2003. Mr. Grollman was granted an
additional 500,000 shares of stock under this program, subject to sales
exceeding $1,000,000 for calendar year 2003. The Company's President and
Director Graham Clark was granted 500,000 shares of stock from the Company's
Stock Retainage Program pool of shares discussed above, subject to the Company
achieving in excess of $200,000 in sales in calendar year 2003. Mr. Clark was
granted an additional 500,000 shares of stock under this program, subject to
sales exceeding $1,000,000 for calendar year 2003. The plan's sales goals were
not met in calendar year 2003, although the plan was nonetheless largely
successful in assisting to retain key staff, even during this period of deferred
or reduced salary. In January 2004, our board extended this program into 2004,
and set new sales growth objectives for the year at a level 50% higher than the
previous year's program, giving plan participants an additional year to fully
earn these previously outstanding restricted stock grants. No new shares were
added to the plan, although plan participants were able to convert some long
term back pay into restricted stock at that time The majority of the remaining
restricted stock allocated under this program was granted to other Company
F-21
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
staff, and is subject to substantially the same risk of forfeiture as the stock
granted to Grollman and Clark under the Program.
In January 2003, Mr. Lou Ross, was paid for his services as an active
member of the board in shares of restricted common stock, in lieu of cash. The
former Chairman received 54,464 restricted common shares at an average market
price on the date of grant of $0.14 per share. In June 2003, the Company issued
Mr. Lou Ross, 288,334 shares of restricted common stock as part of its program
to lower debt without expending cash resources, in exchange for the forgiveness
of $43,250 of debt, or one-half of the total debt of $86,500 owed by the Company
to Mr. Ross. The debt forgiven included various disclosed notes, salary deferred
in 2002 and board fees deferred in 2002. The shares were issued at an average
market price per share of $0.15. The Company also issued Mr. Ross 50,000 shares
of restricted common stock for reduced Director's fees for February 2003 through
the end of this fiscal year in September 2003. These shares were issued at an
average market price per share of $0.15.
The CEO and the President have employment contracts previously filed with
the SEC that include termination clauses that fully vest their ownership of
shares.
9. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made at a specific point in time and are based on
relevant market information and information about the financial instrument; they
are subjective in nature and involve uncertainties, matters of judgment and,
therefore, cannot be determined with precision.
These estimates do not reflect any premium or discount that could result
from offering for sale at one time the Company's entire holdings of a particular
instrument. Changes in assumptions could significantly affect the estimates.
Since the fair value is estimated as of September 30, 2004, the amounts
that will actually be realized or paid at settlement of the instruments could be
significantly different.
The carrying amount of cash and cash equivalents is assumed to be their
fair value because of the liquidity of these instruments. Accounts payable and
accrued expenses approximate fair value because of the short maturity of these
instruments.
F-22
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
10. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
As of September 30, 2004, the Company has a stock-based compensation plan
wherein officers and employees were granted stock options. The Company applies
APB 25 and related interpretations in accounting for the plan. Accordingly,
compensation expense is equal to the difference between the exercise price of
the options granted and the fair value of the common stock at the date of the
grant.
Under the above-mentioned 2000 Stock Option Plan, the purchase price must
be at least 100% of the fair market value of our common stock (if the option is
an incentive stock option), or at least 25% of the fair market value of our
common stock at the time the option is granted (if the option is a nonqualified
grant), or such higher price as may be determined by the Board of Directors at
the time of grant. If however, an incentive stock option is granted to an
individual who would, immediately before the grant, directly or indirectly own
more than 10% of the total combined voting power of all our classes of stock,
the purchase price of the shares of common stock covered by such incentive stock
option may not be less than 110% of the fair market value of such shares on the
day the incentive stock option is granted. As the price of the Company's common
stock is currently quoted on the OTC Bulletin Board, the fair market value of
the common stock underlying options granted under the 2000 Stock Option Plan
shall be the last closing sale price of the common stock on the day the options
are granted. If there is no market price for the common stock, then our Board of
Directors may, after taking all relevant facts into consideration, determine the
fair market value of the Company's common stock.
WEIGHTED WEIGHTED
NUMBER AVERAGE AVERAGE
OF EXERCISE FAIR
SHARES PRICE VALUE
--------- -------- --------
Options Outstanding, September 30, 2002 3,582,839 $ 1.97 $ 0.01
Granted 1,144,081 0.10 0.10
Exercised (637,153) 0.05 0.10
Canceled (760,010) 5.45 0.01
---------
Options Outstanding, September 30, 2003 3,329,757 $ 0.90 $ 0.06
---------
Options Outstanding September 30, 2003 3,329,757 $ 0.90 $ 0.06
Granted 790,000 0.13 0.04
Exercised (107,500) 0.09 0.09
Expired (303,000) 0.13 0.09
---------
Options Outstanding, September 30, 2004 3,709,257 $ 0.82 $ 0.02
=========
F-23
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
WARRANTS
The warrants outstanding as of September 30, 2004 are as follows:
NUMBER OF EXERCISE
SHARES PRICE EXPIRES
---------- -------- -------
Outstanding at September 30, 2002 412,201 $ 1.67 5/04
New issues 4,800,000 0.30 12/04
200,000 0.50 12/04
1,000,000 0.35 6/06
1,000,000 0.50 6/06
----------
Outstanding at September 30, 2003 7,412,201
Expired (412,201)
New issues 275,000 0.50 6/06
275,000 0.75 6/06
640,000 0.13 1/07
500,000 0.10 3/11
4,414,739 0.11 4/09
3,335,961 0.11 4/09
1,808,497 0.10 4/11
----------
Outstanding at September 30, 2004 18,249,197
==========
11. COMMITMENTS AND CONTINGENCIES
The Company was a defendant in a landlord-tenant lawsuit with a landlord of
leased property vacated by the Company in 2001 as part of its corporate
consolidation. The Company and the landlord negotiated a settlement in this
matter without admitting any wrongdoing. In order to fulfill the terms of this
settlement, NSC was to pay $10,000 in four installments by September 2004. The
amount due is included in notes payable on September 30, 2003. This $10,000 was
repaid in full during fiscal year 2004 in accordance with the settlement terms.
Mr. Lou Ross assigned his rights to certain amounts that may be recoverable
from NetMIND as partial payment for loan proceeds advanced to him in 1999 (see
Note 8 above). The Company has filed a suit against NetMIND to recover the
investment, plus damages. In April of 2003 the parties settled significant
portions of this suit, while other portions remain unsettled. Management is
unable to determine the outcome of the suit.
In January 2002, the Company initiated legal proceedings against Phoenix
Semiconductor, Inc. (PSI) for breach of contract. The Company was awarded a
judgment of approximately $179,000 in May 2003 against E4World Corporation.
However, there is no assurance that NSC will collect any of this amount. Since
collection of this judgment by NSC is uncertain, this positive judgment is not
reflected in NSC's current financial statements. The Company continues to press
its claim to secure assets held by E4World in a separate legal matter, although
F-24
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
there is no assurance that NSC will collect this claim, and thus this claim is
not shown in the NSC financial statements. The Company is from time to time
subject to claims and suits arising in the ordinary course of operations. In the
opinion of management, the ultimate resolution of such pending legal proceedings
will not have a material adverse effect on the Company's financial position,
results of operation or liquidity.
12. NOTES PAYABLE AND LONG TERM DEBT
As of September 30, 2004, all long-term debt consisted of the notes payable
following:
2004 2003
------------ ------------
Note payable to shareholder,
unsecured, non-interest
bearing, matures in 2006 $ 43,250 $ 43,250
Note payable, unsecured,
non-interest bearing,
payable in quarterly
installments of $2,500,
matures in 2004 -- 10,000
------------ ------------
Total notes 43,250 53,250
Current portion -- 10,000
------------ ------------
$ 43,250 $ 43,250
============ ============
The notes mature as follows:
Year ending September 30,
-------------------------
2004 $ -- $ 10,000
2005 -- --
2006 43,250 43,250
------------ ------------
$ 43,250 $ 53,250
============ ============
F-25
NATIONAL SCIENTIFIC CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
13. SUBSEQUENT EVENTS
In October 2004, we commenced a new strategic working relationship with
TurboWorx Inc. ("Turbo") regarding joint technology development and cooperative
marketing. The relationship was first memorialized in a Memorandum of
Understanding (MOU) in early November 2004. The two companies see benefit in
connecting NSC's location sensor technology to the computing engines developed
by TurboWorx. In November 2004, we entered into a Letter of Intent ("LOI") with
Turbo regarding a stock exchange transaction with Turbo, for an amount of stock
equal to less than 10% of the outstanding common stock of each company and the
payment of cash by Turbo to NSC. The LOI contemplated a due diligence process
prior to the share exchange, as well as a Securities Exchange Agreement (the
"Share Exchange Agreement") to memorialize the proposed exchange. As of the date
of this report, no Share Exchange Agreement has been completed. Completion of
the transaction is subject to completing a mutually satisfactory Share Exchange
Agreement and completion of due diligence by all parties. The LOI contemplates
us distributing to our shareholders approximately 50% of any Turbo stock we
receive under the proposed Share Exchange Agreement.
F-26
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
3.1 Articles of Incorporation(1)
3.2 Bylaws(2)
10.1 Employment Agreement between National Scientific Corporation and
Michael A. Grollman dated January 2001(4)
10.2 Employment Agreement between National Scientific Corporation and
Graham L. Clark dated January 2003(6)
10.3 NSC Consulting Agreement dated August 2001, and Amendments dated
August 2002 and July 2003, with Dr. El-Badawy El-Sharawy(6)
10.4 Amended and Restated 2000 Stock Option Plan(3)
10.5 Form of 2004 Stock Retainage Plan Agreement(6)
10.6 Agreement Regarding Management Consulting Services with Stanton
Walker of New York dated May 2003(6)
10.7 Agreement Regarding Distribution and Marketing of Gotcha!(R) Child
Safety Product and other products dated December 2002 with
FutureCom Global, Inc. (6)
10.8 Purchase Order from Verify Systems, Inc, dated March 2003 for
IBUS(TM) School Child Tracking Systems(5)
10.9 Letter of Understanding and Agreement dated April 2004 Regarding
Sales and Distribution of Verify School safety products, and an
Unlimited Software License with Anthony Grosso and CIS Services,
LLC(6)
10.10 Letter of Intent from Positus, Inc. dba Bike & Cycle Trak, dated
February 2003 for Design of Power Sports Tracking System(6)
10.11 Purchase Order from Positus, Inc. dba Bike & Cycle Trak, for Design
of Power Sports Tracking System dated March 2003(6)
14 Code of Ethics(7)
31 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
- ---------------------
(1) Incorporated by reference to the Registrant's Form 10-SB filed on or about
January 3, 2000.
(2) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended March 31, 2001 and filed on or about May 15, 2001.
(3) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended December 31, 2000 and filed on or about February 14, 2001.
(4) Incorporated by reference to the Registrant's Form 10-KSB for the year
ended September 30, 2000 and filed on or about December 19, 2000.
(5) Incorporated by reference to the Registrant's Form S-8 filed on or around
June 3, 2003.
(6) Incorporated by reference to the Registrant's Form SB2 filed on or around
June 24, 2004.
(7) Incorporated by reference to the Registrant's Form 10-QSB for the quarter
ended June 30, 2004 and filed on or about August 16, 2004.
60
EXHIBIT 31
CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER AND
ACTING CHIEF FINANCIAL OFFICER
PURSUANT TO 15 U.S.C. 78M(A) OR 78O(D)
(SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002)
I, Michael A. Grollman, certify that:
(1) I have reviewed this Annual Report on Form 10-KSB of National Scientific
Corporation;
(2) Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the small business issuer as of, and for, the periods presented in this
report;
(4) The small business issuer's other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the small business issuer and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the small
business issuer, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the small business issuer's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the small business issuer's
internal control over financial reporting that occurred during the
small business issuer's most recent fiscal quarter (the small business
issuer's fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect,
the small business issuer's internal control over financial reporting;
and
(5) The small business issuer's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the small business issuer's auditors and the audit
committee of the small business issuer's board of directors (or persons
performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the small business issuer's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the small business issuer's
internal control over financial reporting.
- --------------------------------------------
Michael A. Grollman
Chairman, Chief Executive Officer,
and Acting Chief Financial Officer
March ___, 2005
2
EXHIBIT 32
CERTIFICATE OF CHIEF EXECUTIVE OFFICER AND ACTING CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18 U.S.C. 1350)
The undersigned, Michael A. Grollman, Chairman of the Board of Directors, Chief
Executive Officer and Acting Chief Financial Officer of National Scientific
Corporation (the "Company"), has executed this certification in connection with
the filing with the Securities and Exchange Commission of the Company's Annual
Report on Form 10-KSB for the fiscal year ended September 30, 2004 (the
"Report"). The undersigned hereby certifies that:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial results of operations of the Company.
IN WITNESS WHEREOF, the undersigned has executed this certificate as of the ____
day of March, 2005.
- --------------------------------------------
Michael A. Grollman
Chairman, Chief Executive Officer,
and Acting Chief Financial Officer