FILED PURSUANT TO RULE 424(B)(5)
FILE NO. 333-120179
PROSPECTUS
NIGHTHAWK SYSTEMS, INC.
OFFERING UP TO 52,864,500 COMMON SHARES
This prospectus relates to the resale of up to 2,614,500 shares of our common
stock pursuant to a Special Warrant sale to individual accredited investors, the
resale of up to 48,250,000 shares of our common stock by Dutchess Private
Equities Fund, II, LP pursuant to a Debenture Agreement, a warrant and an
Investment Agreement, and the resale of up to 2,000,000 shares of our common
stock by U.S. Euro Securities, Inc. pursuant to the Investment Agreement. We
have received cash proceeds from the sale of the Special Warrants and the
issuance of the convertible debentures under the Debenture Agreement with
Dutchess, and expect to receive cash proceeds from any "puts" pursuant to the
Investment Agreement we have entered into with Dutchess. All costs associated
with this registration will be borne by us.
Dutchess, First Associates and U.S. Euro Securities are "underwriters" within
the meaning of the Securities Act of 1933, as amended, in connection with the
resale of our common stock under the Investment Agreements. In connection with
the Debenture Agreement, U.S. Euro Securities received a cash commission of 5%
and 100,000 shares of our restricted common stock. In connection with the
Investment Agreement, U.S. Euro Securities will receive a cash commission of 5%
of cash provided under the agreement and 2,000,000 shares of common stock, which
are being registered under this prospectus. In connection with the Special
Warrants, First Associates received a cash commission of 8%, or $18,592, of the
gross proceeds from the sale of the Special Warrants and 12.5% of the amount of
Special Warrants sold for a total number of Special Warrants for First
Associates of 145,250.
The shares of common stock are being offered for sale by the selling
stockholders at prices established on the Over-the-Counter Bulletin Board or in
negotiated transactions during the term of this offering. Our common stock is
quoted on the Over-the-Counter Bulletin Board under the symbol NIHK.OB. On May
24, 2006, the last reported closing sale price of our common stock was $0.06 per
share.
THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK.
YOU SHOULD PURCHASE SECURITIES ONLY IF YOU CAN AFFORD A COMPLETE LOSS.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
You should rely only on the information provided in this prospectus or any
supplement to this prospectus and information incorporated by reference. We have
not authorized anyone else to provide you with different information. Neither
the delivery of this prospectus nor any distribution of the shares of common
stock pursuant to this prospectus shall, under any circumstances, create any
implication that there has been no change in our affairs since the date of this
prospectus.
Neither the Securities and Exchange Commission nor any state securities
regulator has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. It is a criminal offense to make any
representation to the contrary.
The date of this prospectus is May 25, 2006.
TABLE OF CONTENTS
PROSPECTUS SUMMARY 1
RISK FACTORS 4
USE OF PROCEEDS 7
DETERMINATION OF OFFERING PRICE 8
DILUTION 8
SELLING SECURITY HOLDERS 8
PLAN OF DISTRIBUTION 9
LEGAL PROCEEDINGS 10
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS 11
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 11
INTEREST OF NAMED EXPERTS AND COUNSEL 13
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS 13
DESCRIPTION OF BUSINESS 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION 17
DESCRIPTION OF PROPERTY 23
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 24
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 24
EXECUTIVE COMPENSATION
FINANCIAL STATEMENTS F-1 - F-25
<PAGE?
PROSPECTUS SUMMARY
The following information is a summary of the prospectus and it does not contain
all of the information you should consider before making an investment decision.
You should read the entire prospectus carefully, including the financial
statements and the notes relating to the financial statements.
OUR COMPANY
We design and manufacture intelligent remote monitoring and power control
products that are easy to use, inexpensive and can remotely control virtually
any device from any location. Our products save consumers and businesses time,
effort and expense by eliminating the need for a person to be present when and
where an action needs to be taken. Currently, most commercial control
applications utilize telephone lines, which tether the system to a single
location and have associated installation and monthly charges. Our wireless
products eliminate installation costs and monthly charges for telephone lines.
This wireless application also allows businesses and consumers to remotely
control unmanned or remote locations that may operate on traditional electrical
power, or solar or battery generated power. By utilizing existing wireless
technology, we give our users the flexibility to move their application from
place to place, without re-engineering their network.
Active applications for our intelligent products include, but are not limited
to:
- - Rebooting unmanned computer stations;
- - Remote switching of residential power;
- - Managing power on an electrical grid;
- - Activation/deactivation of alarm and warning devices;
- - Displaying or changing a digital or printed message or warning signs;
- - Turning pumps on or off; and
- - Turn on heating or cooling equipment.
Our proprietary, wireless products are easily integrated into third-party
products, systems and processes. They allow for intelligent control by
interpreting instructions sent via paging and satellite media, and executing the
instructions by 'switching' the electrical current that powers the device,
system or process. Our intelligent products can be activated individually or in
pre-defined groups for specified time periods with a simple click of a mouse or
by dialing a telephone number.
We are a publicly traded company, which trades on the Over-the-Counter bulletin
Board of the National Quotation Service under the ticker symbol "NIHK.OB"
HOW TO CONTACT US
Our executive offices are located at 10715 Gulfdale, Suite 200, San Antonio,
Texas 78216. Our phone number is 210-341-4811. Our manufacturing facility is
located at 8300 East Pacific Place, Suite 204, Denver, Colorado 80231. Our
website address is www.nighthawksystems.com. Information contained on our
website does not constitute part of this report and our website address should
not be used as a hyperlink to our website.
SALES BY OUR SELLING STOCKHOLDERS
This prospectus relates to the resale of up to 2,614,500 shares of our common
stock pursuant to a Special Warrant sale to individual accredited investors, the
resale of up to 48,250,000 shares of our common stock by Dutchess pursuant to a
Debenture Agreement, a warrant and an Investment Agreement, and the resale of up
to 2,000,000 shares of our common stock by U.S. Euro Securities pursuant to the
Investment Agreement.
The table below sets forth the shares that we are registering pursuant to the
Registration Statement to which this prospectus is a part:
Stockholder Number of Shares
- --------------------------------------------- ------------------
Dutchess Private Equities Fund II, LP 48,250,000 shares (1)
U.S. Euro Securities 2,000,000 shares
Christopher Vorberg 1,100,000 shares
Rod Saville 600,000 shares
Douglas Hunter 500,000 shares
Fraser Hindson 124,000 shares
First Associates 290,500 shares (2)
Total common stock being registered 52,864,500 shares
(1) For the purpose of determining the number of shares subject to registration
with the Securities and Exchange Commission, we have assumed that we will issue
not more than 40,000,000 shares pursuant to the exercise of our put right under
the Investment Agreement, although the number of shares that we will actually
issue pursuant to that put right may be more than or less than 40,000,000,
depending on the trading price of our common stock. We currently have no intent
to exercise the put right in a manner that would result in our issuance of more
than 40,000,000 shares, but if we were to exercise the put right in that manner,
we would be required to file a subsequent registration statement with the
Securities and Exchange Commission and for that registration statement to be
deemed effective prior to the issuance of any such additional shares. Under our
Debenture Agreement with Dutchess, we are also required to register for resale
four times the number of shares (2,000,000) that the $250,000 in convertible
debentures would be convertible into based upon the conversion price when we
signed the Debenture Agreement of $0.125 per share. Therefore, we are
registering 8,000,000 shares of our common stock for resale in connection with
the future conversion of the convertible debentures with Dutchess. We are also
registering 250,000 shares of our common stock pursuant to a warrant issued to
Dutchess which gives them the right to purchase 250,000 shares of our common
stock for $0.125 per share for a period of five years.
(2) Our Special Warrant offering included an option for First Associates to
purchase an additional 12.5%, or 145,250, of the total number of Special
Warrants sold. Each Special Warrant is convertible into one share of our common
stock and one common stock purchase warrant to purchase a share of our common
stock for $0.30 per share. We sold 1,162,000 Special Warrants and First
Associates has not exercised its right to purchase any Special Warrants.
1
THE OFFERING
Common stock offered 52,864,500 shares
Use of proceeds We will not receive any proceeds from the
sale by the selling stockholders of our
common stock. We expect to receive cash
proceeds from any "puts" pursuant to
the Investment Agreement we have entered
into with Dutchess. The proceeds from
our exercise of the put right pursuant to
the Investment Agreement will be used
for working capital and general corporate
expenses, expansion of internal operations,
and potential acquisition costs. See "Use
of Proceeds."
Symbol for our common stock Our common stock trades on the
OTCBB Market under the symbol "NIHK.OB"
OUR CAPITAL STRUCTURE AND SHARES ELIGIBLE FOR FUTURE SALE
Shares of common stock outstanding as of November 18, 2004 30,622,518(1)
Shares of common stock potentially issuable upon
exercise of the put right to Dutchess Private Equities Fund II 40,000,000
Shares of common stock issuable upon conversion of Convertible Debentures 8,000,000
by Dutchess Private Equities Fund II
Shares of common stock issuable upon exercise of a warrant
By Dutchess Private Equities Fund II 250,000
Shares of common stock issuable upon exercise of Special Warrants 2,614,500
----------
Total 81,487,018
(1) Assumes no:
-Exercise of vested options to purchase 1,280,534 shares of common stock
outstanding as of November 18, 2004 under the Nighthawk Systems, Inc. 2003
Stock Option Plan.
- Conversion of $150,000 convertible note into 750,000 shares as of November
18, 2004.
- - Exercise of outstanding vested warrants to purchase common stock at
November 18, 2004, as follows:
Holder Shares of Common Stock Exercise Price Expiration Date
- ----------------- ---------------------- -------------- ---------------
Private Placement 75,000 .20 11/05/2004
- ----------------- ---------------------- -------------- ---------------
Private Placement 150,000 .20 11/06/2004
- ----------------- ---------------------- -------------- ---------------
Private Placement 2,857,143 .07 03/31/2005
- ----------------- ---------------------- -------------- ---------------
Private Placement 150,000 .25 04/01/2005
- ----------------- ---------------------- -------------- ---------------
Private Placement 25,000 .25 06/06/2005
- ----------------- ---------------------- -------------- ---------------
Private Placement 300,000 .25 11/07/2005
- ----------------- ---------------------- -------------- ---------------
Private Placement 600,000 .25 12/01/2005
- ----------------- ---------------------- -------------- ---------------
Private Placement 333,333 .25 01/16/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 40,000 .25 01/18/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 100,000 .25 01/19/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 40,000 .25 01/22/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 60,000 .25 02/18/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 200,000 .25 02/23/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 55,000 .25 03/04/2006
- ----------------- ---------------------- -------------- ---------------
Private Placement 30,000 .25 03/25/2006
- ----------------- ---------------------- -------------- ---------------
Note Conversion 375,000 .25 06/30/2006
- ----------------- ---------------------- -------------- ---------------
Note Conversion 739,423 .25 08/23/2006
- ----------------- ---------------------- -------------- ---------------
Total 6,129,899
- ----------------- ----------------------
2
THE SPECIAL WARRANT OFFERING
We completed our Special Warrant Offering on June 30, 2004. This prospectus
relates to the resale of up to 2,614,500 shares of our common stock by selling
shareholders who may acquire the shares pursuant to the sale of Common Stock
Units. Under the terms of those sales, we sold Special Warrants for $0.20. Each
Special Warrant is convertible into a single share of our common stock and a
purchase warrant entitling the holder to purchase an additional share of our
common stock for $0.30. The Special Warrants may be exercised at any time before
the expiration date, which is defined as the earlier of:
(a) five business days following the date on which we receive the last of
(i) the SEC declares this registration statement effective, and (ii) the final
prospectus is filed with the SEC and
(b) August 10, 2005
THE DEBENTURE OFFERING
This prospectus also relates to the resale of up to 8,250,000 shares of our
common stock by Dutchess, who will become a stockholder pursuant to our
Debenture Agreement. Under the Debenture Agreement, Dutchess paid us $250,000.
Dutchess also received a common stock purchase warrant entitling them to
purchase up to 250,000 shares of common stock at a price of $0.125 per share.
The warrant expires on August 10, 2009.
We will pay an 8%annual coupon on the unpaid principal amount of the debentures.
Prior to the SEC declaring the registration statement effective for the shares
underlying the debentures, we will make mandatory prepaid payments, in advance,
on the coupon in the amount of one-twelfth of the annual payment, per month,
pursuant to each tranche. These coupon payments began on August 15th, 2004, and
all subsequent coupon payments are due on the fifteenth calendar day of each
month thereafter.
When the SEC has declared the Registration Statement effective, we must pay the
coupon at the time of each conversion until the principal amount hereof is paid
in full or has been converted into shares of our registered common stock. The
interest paid in common stock, shall be delivered to Dutchess, or per Dutchess'
instructions, within three business days of the date of conversion. The
debentures are subject to automatic conversion at the end of three years from
the date of issuance at which time all debentures outstanding will be
automatically converted.
THE INVESTMENT AGREEMENT
This prospectus also relates to the resale of up to 40,000,000 shares of our
common stock by Dutchess, who will become a stockholder pursuant to our
Investment Agreement. Under the Investment Agreement, we are allowed to "put" to
Dutchess up to $10,000,000. We shall not be entitled to submit a put notice
until after the previous put has been completed. The purchase price for the
common stock identified in the put notice shall be equal to 95% of the lowest
closing best bid price of the common stock during the five consecutive trading
day period immediately following the date of our notice to them of our election
to put shares.
As part of the Investment Agreement with Dutchess, we paid a commission to U.S.
Euro Securities, of 2,000,000 shares of our common stock. These shares are also
being registered under this prospectus.
We can only put shares to Dutchess under the Investment Agreement when we meet
the following conditions:
- - A registration statement has been declared effective and remains effective
for the resale of the common stock subject to the Equity Line of Credit;
- - Our common stock has not been suspended from trading for a period of five
consecutive trading days and we have not have been notified of any pending
or threatened proceeding or other action to delist or suspend our common
stock;
- - We have complied with our obligations under the Investment Agreement and
the Registration Rights Agreement;
- - No injunction has been issued and remains in force, or action commenced by
a governmental authority which has not been stayed or abandoned,
prohibiting the purchase or the issuance of our common stock; or
- - The issuance of the common stock will not violate any shareholder approval
requirements of any exchange or market where our securities are traded. The
Investment Agreement will terminate when any of the following events occur:
- - Dutchess Private Equities Fund has purchased an aggregate of $10,000,000 of
our common stock; or
- - 36 months after the SEC declares this registration statement effective.
3
RISK FACTORS
An investment in our common stock involves a high degree of risk. You should
carefully consider the following risk factors, other information included in
this prospectus and information in our periodic reports filed with the SEC. If
any of the following risks actually occur, our business, financial condition or
results of operations could be materially and adversely affected, and you may
lose some or all of your investment.
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF LOSSES SINCE INCEPTION AND IF WE CONTINUE TO INCUR LOSSES,
THE PRICE OF OUR SHARES CAN BE EXPECTED TO FALL.
We expect to continue to incur losses in the foreseeable future as we expend
substantial resources on sales, marketing and research and development of our
products. From the effective date of our reverse merger in February 2002 up to
the end of the second quarter of fiscal year 2005, we have incurred losses. If
we continue to incur losses, the price of our shares can be expected to fall. We
may continue to incur substantial and continuing net losses beyond the next six
months. We may never generate substantial revenues or reach profitability.
OUR INDEPENDENT ACCOUNTANTS HAVE ISSUED A GOING CONCERN OPINION AND IF WE CANNOT
OBTAIN ADDITIONAL FINANCING, WE MAY HAVE TO CURTAIL OPERATIONS AND MAY
ULTIMATELY CEASE TO EXIST.
Our auditors, GHP Horwath, PC, included an explanatory paragraph in their Report
of Independent Registered Public Accounting Firm on our December 31, 2004
consolidated financial statements indicating that there is substantial doubt
about our ability to continue as a going concern. We will require additional
funds in the future, and any independent auditors report on our future financial
statements may include a similar explanatory paragraph if we are unable to raise
sufficient funds or generate sufficient cash from operations to cover the cost
of our operations. The existence of the explanatory paragraph may adversely
affect our relationship with prospective customers, suppliers and potential
investors, and therefore could have a material adverse effect on our business,
financial condition and results of operations.
OUR CONTINUED EXISTENCE IS DEPENDENT UPON OUR ABILITY TO RAISE ADDITIONAL
CAPITAL, WHICH MAY NOT BE READILY AVAILABLE.
There is currently limited experience upon which to assume that our business
will prove financially profitable or generate more than nominal revenues. From
inception, we have generated funds primarily through the sale of securities. We
may not be able to continue to sell additional securities. We expect to raise
funds in the future through sales of our debt or equity securities until a time,
if ever, that we are able to operate profitably. We may not be able to obtain
funds in this manner or on terms that are beneficial to us. Our inability to
obtain needed funding can be expected to have a material adverse effect on our
operations and our ability to achieve profitability. If we fail to generate
increased revenues or fail to sell additional securities you may lose all or a
substantial portion of your investment.
WE DEPEND ON CERTAIN CUSTOMERS AND IF WE LOSE ONE OF OUR SIGNIFICANT CUSTOMERS,
OUR REVENUES MAY SUBSTANTIALLY DECREASE AND OUR BUSINESS MAY FAIL.
During 2004, three customers accounted for approximately 26%, 20% and 12% of
sales, respectively. During 2003, two customers accounted for approximately 47%
and 31% of sales, respectively. The same customers represented the largest
percentage of sales in both 2004 and 2003. If either of these two customers stop
generating orders for us altogether, and we are unable to obtain comparable
orders from other customers, our revenues would decrease and our business could
fail.
OUR DEPENDENCE ON PROPRIETARY TECHNOLOGY AND A LIMITED ABILITY TO PROTECT OUR
INTELLECTUAL PROPERTY MAY ADVERSELY AFFECT OUR ABILITY TO COMPETE IN THE MARKET.
We currently have two patent applications pending. We plan to file additional
patent applications for future products or services, although we may not do so,
or they might not be approved. Our success is dependent in part on our ability
to obtain and maintain patent protection for our products, maintain trade secret
protections and operate without infringing the patent or proprietary rights of
others. A successful challenge to our ownership of our technology could
materially damage our business prospects. Our patent pending applications may
not be granted to us. We may not be able to develop additional products that are
patentable. Any patents issued to us may not provide us with any commercial
advantage. Any of our products may infringe on the patent rights of others. If
any of our products are found to infringe on any other patents, we may not be
able to obtain licenses to continue and manufacture and license these products
or we may have to pay damages as a result of an infringement. Even if our patent
applications are approved, the commercial application of the product may not
result in any profits to us.
4
WE DEPEND ON KEY PERSONNEL AND OUR BUSINESS COULD BE ADVERSELY AFFECTED IF THEY
WERE TO DEPART.
Our success depends to a significant degree upon the continued contributions of
our key management, marketing, service and related product development and
operational personnel. Our business requires a highly skilled management team.
The technical nature of our products requires an engineer proficient in the
provision of wireless systems and controlling electrical switches. Additionally,
we require a person with the understanding of the potential applications for our
products to a multitude of industries ranging from the electric utility industry
to the information technology industry. Two employees, Eric Berg and Myron
Anduri, are particularly valuable to us because they possess specialized
knowledge about our company and operations and both have specialized skills for
our operations making them very difficult to replace. Doug Saathoff currently
serves as our Chief Executive Officer, and has experience in raising capital for
small cap companies and providing financial oversight that is vital to our
ongoing success. We do not currently have employment agreements with Messrs.
Anduri, Berg and Saathoff that prohibit them from competing with us upon
termination of their employment. Our business may not be successful if, for any
reason, any of these officers ceased to be active in our management.
THE LIMITED PUBLIC MARKET FOR OUR SHARES MAY MAKE IT DIFFICULT TO TRANSFER OUR
SHARES.
Although our stock is traded on the over-the-counter bulletin board, there is
limited trading in our stock and thus no established market for our securities.
Holders of our stock may find it difficult to trade their shares until a time
that there is a more established market for our securities.
WE DO NOT ANTICIPATE DECLARING ANY DIVIDENDS IN THE FORESEEABLE FUTURE AND MAY
NEVER DO SO.
We anticipate that, following the completion of this offering and for the
foreseeable future, earnings, if any, will be retained for the development of
our business and will not be distributed to shareholders as cash dividends. The
declaration and payment of cash dividends, if any, by us at some future time
will depend upon our results of operations, financial condition, cash
requirements, future prospects, limitations imposed by credit agreements or
senior securities and any other factors deemed relevant by our Board of
Directors.
RISKS RELATED TO OUR INDUSTRY
WELL-FUNDED COMPETITORS COULD ENTER THE MARKET WITH SIMILAR PRODUCTS AND, IF WE
CAN NOT EFFECTIVELY COMPETE, OUR BUSINESS MAY FAIL.
To our knowledge, we are the only company to develop and market an easy to use
"plug and play" intelligent wireless remote control device. While we have
extensive knowledge of utilizing a paging network to provide remote control
services, we are not the only company with this knowledge. If another company
enters the market, we may have to lower our prices to compete which could
adversely affect our revenues. We may also have to increase our costs to
differentiate our products. Even if we lower our prices or differentiate our
products, we may not be able to compete effectively. If we can not compete
effectively, our business may fail.
IF THE COSTS OF CELLULAR SERVICE DECREASE, WE MAY HAVE TO ADAPT OUR PRODUCTS FOR
CELLULAR TECHNOLOGY WHICH WOULD INCREASE OUR COSTS AND ADVERSELY AFFECT OUR
GROSS PROFITS.
While paging is a very low cost telecommunications medium that enjoys extensive
geographic coverage both in the United States and abroad, cellular service now
has vast geographic reach as well. Moreover, while the costs of using cellular
service for remote control currently are significantly higher than paging,
cellular costs may eventually come down to an affordable price for remote
control. In this case, to remain competitive, we would have to expend resources
to adapt our products for cellular technology, or develop or acquire a cellular
product of our own.
WE ARE DEPENDENT UPON THIRD-PARTY SUPPLIERS FOR PAGING AND SATELLITE SERVICES
AND MAY BE UNABLE TO FIND ALTERNATIVE SUPPLIERS.
We rely on other companies to supply key components of our network
infrastructure, including paging carriers and satellite providers, both of which
are critical to our ability to provide remote control services to our customers.
We have only a few long-term agreements governing the supply of many of paging
services and are dependent upon a third party for several of the other paging
services that serve our customers. Additionally, we have only one contract with
a satellite carrier. If we were unable to continue to obtain these services, at
a commercially reasonable cost, it would adversely affect our business,
financial condition and results of operations.
IF OUR PRODUCTS FAIL TO GAIN WIDESPREAD MARKET ACCEPTANCE, OUR ABILITY TO
GENERATE SUFFICIENT REVENUES OR PROFIT MARGINS WILL BE LIMITED.
There may not be sufficient demand for our products to enable us to become
profitable. We do not know whether any of our products will be sold in
sufficient numbers to provide enough revenues to cover operating expenses. In
addition, if the electric utility industry develops alternative conservation or
load control devices, it could have an adverse effect on our sales.
5
RISKS RELATED TO THIS OFFERING
OUR STOCK PRICE IS VOLATILE AND YOU MAY NOT BE ABLE TO SELL YOUR SHARES FOR
HIGHER THAN WHAT YOU PAID.
Our common stock is quoted on the "OTC - Bulletin Board Service" under the
symbol "NIHK.OB." The market price of our common stock has been and is likely to
continue to be highly volatile and subject to wide fluctuations due to various
factors, many of which may be beyond our control, including: annual variations
in operating results; announcements of technological innovations or new
software, services or products by us or our competitors; and changes in
financial estimates and recommendations by securities analysts. In addition,
there have been large price and volume fluctuations in the stock market, which
have affected the market prices of securities of many technology and services
companies, often unrelated to the operating performance of these companies.
These broad market fluctuations, as well as general economic and political
conditions, may adversely affect the market price of our common stock. In the
past, volatility in the market price of a company's securities has often led to
securities class action litigation. This litigation could result in substantial
costs and diversion of our attention and resources, which could have a material
adverse effect on our business, financial condition and operating results.
EXISTING STOCKHOLDERS MAY EXPERIENCE SIGNIFICANT DILUTION FROM THE SALE OF
SECURITIES PURSUANT TO OUR INVESTMENT AGREEMENT WITH DUTCHESS.
The sale of shares pursuant to our Investment Agreement with Dutchess may have a
dilutive impact on our stockholders. As a result, our net income per share could
decrease in future periods and the market price of our common stock could
decline. In addition, the lower our stock price is at the time we exercise our
put option, the more shares we will have to issue to Dutchess to draw down on
the full equity line with Dutchess. If our stock price decreases, then our
existing stockholders would experience greater dilution. At a stock price of
$0.12 or less, we would have to issue all 40,000,000 shares registered under
this offering in order to draw down on the full equity line.
DUTCHESS WILL PAY LESS THAN THE THEN-PREVAILING MARKET PRICE OF OUR COMMON STOCK
WHICH COULD CAUSE THE PRICE OF OUR COMMON STOCK TO DECLINE.
Our common stock to be issued under our agreement with Dutchess will be
purchased at a 5% discount to the lowest closing best bid price during the five
days immediately following our notice to Dutchess of our election to exercise
our put right. Dutchess has a financial incentive to sell our common stock
immediately upon receiving the shares to realize the profit between the
discounted price and the market price. If Dutchess sells our shares, the price
of our stock could decrease. If our stock price decreases, Dutchess may have a
further incentive to sell the shares of our common stock that it holds. The
discounted sales under our agreement with Dutchess could cause the price of our
common stock to decline.
WE WILL NEED TO RAISE ADDITIONAL FUNDING AND IF WE ISSUE SUBSTANTIAL AMOUNTS OF
COMMON STOCK, CURRENT STOCKHOLDERS MAY EXPERIENCE DILUTION AND OUR STOCK PRICE
MAY DECREASE.
We will need to raise additional funding to implement our business plan. As a
result, we may issue substantial amounts of common or preferred stock. Sales of
substantial amounts of common stock could have a material dilutive effect on
shareholders. Additionally, it may be necessary to offer warrants or other
securities to obtain strategic relationships or to raise additional capital. All
of these issuances will dilute the holdings of existing shareholders thereby
reducing the holder's percentage ownership and possibly lowering the price of
our common stock.
WE MUST COMPLY WITH PENNY STOCK REGULATIONS THAT COULD EFFECT THE LIQUIDITY AND
PRICE OF OUR STOCK.
The SEC has adopted rules that regulate broker-dealer practices in connection
with transactions in "penny stocks." Penny stocks generally are equity
securities with a price of less than $5.00, other than securities registered on
certain national securities exchanges or quoted on NASDAQ, provided that current
price and volume information with respect to transactions in these securities is
provided by the exchange or system. Prior to a transaction in a penny stock, a
broker-dealer is required to:
- - deliver a standardized risk disclosure document prepared by the SEC;
- - provide the customer with current bid and offer quotations for the penny
stock;
- - explain the compensation of the broker-dealer and its salesperson in the
transaction;
- - provide monthly account statements showing the market value of each penny
stock held in the customer's account;
- - make a special written determination that the penny stock is a suitable
investment for the purchaser and receive the purchaser's executed
acknowledgement of the same; and
- - provide a written agreement to the transaction.
These requirements may have the effect of reducing the level of trading activity
in the secondary market for our stock. Because our shares are subject to the
penny stock rules, you may find it more difficult to sell your shares.
6
USE OF PROCEEDS
Up to 2,614,500 shares of common stock covered by this prospectus will be sold
by selling shareholders, who will receive the shares pursuant to the conversion
of Special Warrants and the exercise of the underlying common stock purchase
warrants. The selling shareholders will receive all of the proceeds from such
sales. We received $232,400 from the sale of 1,162,000 Special Warrants, and
paid $43,625 in related expenses. First Associates received a warrant to
purchase 145,250 Special Warrants in return for sponsoring the placement of the
Special Warrants. We will receive the proceeds from the exercise price of the
warrant by First Associates and from the exercise of any of the common stock
purchase warrants, if they are exercised. The warrants can be exercised for
$0.30 per share of common stock and expire two years from their date of
issuance. If First Associates converts their warrant, and all of the common
stock purchase warrants are exercised, we will receive $421,225 in gross cash
proceeds. We do not know if we will receive any proceeds from the warrant issued
to First Associates in the near future, nor do we expect to receive proceeds
from the exercise of the common stock purchase warrants at $0.30 in the near
future because, as of November 18, 2004, the closing price of our stock was
$0.125.
Up to 8,000,000 shares of common stock covered by this prospectus will be sold
by Dutchess, who will receive all of the proceeds from such sales. We received
$250,000 in proceeds from the sale of convertible debentures.
Up to 250,000 shares of common stock covered by this prospectus will be sold by
Dutchess, who will receive the shares pursuant to the exercise of warrants
issued by us along with the convertible debentures. Dutchess will receive all of
the proceeds from such sales. We will receive the proceeds from the exercise of
the warrants. The warrants can be exercised for $0.125 per share of common stock
and expire on August 10, 2009. If all of the warrants are exercised, we will
receive $31,250 in proceeds.
Up to 40,000,000 shares of common stock covered by this prospectus will be sold
by Dutchess, who will receive all of the proceeds from such sales. However, we
could receive up to $10,000,000 in proceeds from the sale of our common shares
pursuant to our Investment Agreement with Dutchess.
For illustrative purposes, we have set forth below our intended use of proceeds
for the range of net proceeds received or expected to be received subsequent to
June 30, 2004. The gross proceeds shown below consist of $31,250 from the
Dutchess warrants, and a range of proceeds from the Investment Agreement. The
gross proceeds shown below do not include proceeds from the issuance of any
additional Special Warrants at $0.20 or from the exercise of the common stock
warrants underlying the Special Warrants at $0.30, because those prices are well
above our recent closing stock prices. Estimated expenses of the Offering
include a 5% commission on the proceeds from the Debenture Agreement and the
Investment Agreement.
Proceed if 100% Proceeds if 50% Proceeds if 25% Proceeds if 10%
of Investment of Investment of Investment of Investment
Agreement Agreement Agreement Agreement
Priority Sold Sold Sold Sold
Gross Proceeds $10,031,250 $5,031,250 $2,531,250 $1,031,250
Estimated expenses of the Offering 525,000 275,000 150,000 75,000
---------------- ---------------- ---------------- ----------------
Net proceeds $9,506,250 $4,756,250 $2,381,250 $956,250
================ ================ ================ ================
Working capital and general
corporate expenses 1st $3,000,000 $2,500,000 $2,000,000 $900,000
Expansion of internal operations 2nd $2,000,000 $1,000,000 $381,250 $56,250
Potential acquisition costs(1) 3rd $4,506,250 $1,256,250 $- $-
---------------- ---------------- ---------------- ----------------
$9,506,250 $4,756,250 $2,381,250 $956,250
================ ================ ================ ================
<FN>
(1) From time to time we evaluate opportunities to make acquisitions of assets
or businesses that we believe would help us
achieve our goal of profitability, but we are not currently planning any
material acquisitions.
Proceeds of the offering which are not immediately required for the purposes
described above will be invested in United States government securities,
short-term certificates of deposit, money market funds and other high-grade,
short-term interest-bearing investments.
DETERMINATION OF OFFERING PRICE
The selling stockholders may sell shares in any manner at the current market
price or through negotiated transactions with any person at any price.
DILUTION
Our net tangible book value as of June 30, 2004 was ($1,001,870), or ($0.04) per
share of common stock. Net tangible book value per share is determined by
dividing our tangible book value (total tangible assets less total liabilities)
by the number of outstanding shares of our common stock. Net tangible book value
as of June 30, 2004 is calculated by subtracting our net intangible asset of
$8,658 from net total book value (total assets less total liabilities) of
($993,212). Since this offering is being made solely by the selling stockholders
and none of the proceeds will be paid to us, our net tangible book value will be
unaffected by this offering. Our net tangible book value, however, will be
impacted by the common stock to be issued to Dutchess Private Equities Fund II
under the Debenture Agreement and Investment Agreement, and to any additional
purchasers of Special Warrants and their underlying common stock purchase
warrants. The amount of dilution resulting from share issuances to Dutchess will
be determined by our stock price at or near the time of the conversion of the
debentures by Dutchess or the put of shares to Dutchess by us. The amount of
dilution resulting from share issuances to purchasers of Special Warrants will
depend on how many additional Special Warrants are sold by us and how many of
the underlying common stock purchase warrants are exercised. The following
example shows the dilution to new investors assuming i) no additional sales of
Special Warrants and no exercises of the underlying common stock purchase
warrants; ii) The conversion of all $250,000 convertible debentures at $0.09
which is based on our closing bid price of $0.12 on October 29, 2004; iii) the
exercise of 250,000 warrants at $0.125 issued with the convertible debentures,
and iv) the issuance of 100%, 50%, 25% and 10% of the 40,000,000 shares of
common stock to Dutchess Private Equities Fund at an assumed offering price of
$0.13 per share which is based on the closing price of our common stock on
October 29, 2004 of $0.14 adjusted for the 5% discount at which we will issue
shares under our agreement with Dutchess Private Equities Fund. The discount is
defined as 95% of the lowest closing bid price of our common stock during the
five consecutive trading day period immediately following our notice to Dutchess
Private Equities Fund of our election to exercise our put rights.
Using the above assumptions, less $25,000 of offering expenses and 5% cash
commission, our pro forma net tangible book value as of June 30, 2004 would have
been as follows:
7
Pro Forma Effects of Dilution from Offering:
Assumed percentage of shares issued 100% 50% 25% 10%
Number of shares issued (in millions) 40 20 10 4
Assumed public offering price per share $0.13 $0.13 $0.13 $0.13
Stock discount recognized as interest expense $363,333 $223,333 $153,333 $111,333
Net tangible book value per share before this offering ($0.04) ($0.04) ($0.04) ($0.04)
Net tangible book value after this offering $3,932,547 $1,545,548 $352,049 ($364,050)
Net tangible book value per share after this offering $0.06 $0.03 $0.01 ($0.01)
Dilution of net tangible book value per share to new investors $0.12 $0.11 $0.11 $0.9
Increase in net tangible book value per share to existing
shareholders $0.10 $0.07 $0.05 $0.03
You should be aware that there is an inverse relationship between our stock
price and the number of shares to be issued under the Debenture Agreement and
the Investment Agreement to Dutchess. That is, as our stock price declines, we
would be required to issue a greater number of shares under the Debenture
Agreement for a conversion and under the Investment Agreement for a given
advance. This inverse relationship is demonstrated by the table below, which
shows the number of shares to be issued under the Debenture Agreement at a price
of $0.09 per share and the Investment Agreement at a price of $0.13 per share,
and 25%, 50% and 75% discounts to those prices.
% discount 0% 25% 50% 75%
Offering price(1) $0.13 $0.10 $0.07 $0.03
Conversion price(2) $0.09 $0.07 $0.05 $0.02
No of shares(3) 10,769,231 14,358,974 21,538,462 43,076,923
No of shares(4) 2,777,778 3,703,704 5,555,556 11,111,111
Total outstanding(5) 40,080,697 44,596,366 53,627,705 80,721,722
% outstanding(6) 34% 41% 51% 67%
<FN>
(1) Represents sales price under Investment Agreement.
(2) Represents conversion price under Debenture Agreement.
(3) Represents the number of shares of common stock to be issued at the prices
set forth in the table to generate $1.4 million in gross proceeds under the
Investment Agreement.
(4) Represents the number of shares of common stock to be issued at the prices
set forth in the table upon conversion of $250,000 in convertible debentures.
(5) Represents the total number of shares of common stock outstanding after the
issuance of the shares from (3) and (4) above, assuming no issuance of any other
shares of common stock.
(6) Represents the shares of common stock to be issued as a percentage of the
total number shares of common stock outstanding (assuming no exercise or
conversion of any options, warrants or other convertible securities).
SELLING SECURITY HOLDERS
Based upon information available to us as of November 18, 2004, the following
table sets forth the names of the selling stockholders, the number of shares
owned, the number of shares registered by this prospectus and the number and
percent of outstanding shares that the selling stockholders will own after the
sale of the registered shares, assuming all of the shares are sold. The
information provided in the table and discussions below has been obtained from
the selling stockholders. The selling stockholders may have sold, transferred or
otherwise disposed of, or may sell, transfer or otherwise dispose of, at any
time or from time to time since the date on which they provided the information
regarding the shares beneficially owned, all or a portion of the shares of
common stock beneficially owned in transactions exempt from the registration
requirements of the Securities Act of 1933. As used in this prospectus, "selling
stockholder" includes donees, pledgees, transferees or other
successors-in-interest selling shares received from the named selling
stockholders as a gift, pledge, distribution or other non-sale related transfer.
Beneficial ownership is determined in accordance with Rule 13d-3(d) promulgated
by the Commission under the Securities Exchange Act of 1934. Unless otherwise
noted, each person or group identified possesses sole voting and investment
power with respect to the shares, subject to community property laws where
applicable.
8
Percentage
Owned
Ownership Before Offering Shares Being Offered Shares after the Offering (1) After the
Offering(2)
---------------------------- ----------------------- ----------------------------- --------------
Dutchess Private Equities
Fund II, LP (3) 0 48,250,000 0 0%
312 Stuart St., Third Floor
Boston, MA 02116
U.S. Euro Securities 2,100,000 2,000,000 100,000 *
330 Washington Blvd,, Ste 706
Marina del Rey, CA 90292 (5)
Christopher Vorberg 1,420,000 1,100,000(4) 320,082 1%
7671 Abercrombie Drive,
Richmond, British Columbia, Canada
Rod Saville 600,000 600,000(4) 0 0%
7987 Wentworth Drive SW,
Calgary, Alberta, Canada
Douglas Hunter 544,000 500,000(4) 44,000 *
1420 Joliet, Ave., SW,
Calgary, Alberta, Canada
Fraser Hindson 179,000 124,000(4) 55,000 *
5099 Topaz Place,
Richmond, British Columbia, Canada
First Associates 0 290,500(4) 0 0
Suite 500, Bentall Five,
550 Burrard St.
Vancouver, BC V6C 2B5 (6)
<FN>
* Less than 1%
(1)The numbers assume that the selling stockholder have sold all of the
shares offered hereby prior to completion of this offering.
(2)Based on 30,622,518 shares outstanding as of November 18, 2004.
(3)Michael Novielli and Douglas Leighton are the Managing Members of
Dutchess Capital Management, LLC, which is the General Partner of
Dutchess Private Equities Fund II, LP.
(4)Shares that may be acquired pursuant to our Special Warrant offering. Our
Special Warrant offering resulted in the issuance of 1,162,000 Special
Warrants to accredited investors, and an option to First Associates
Allowing them to purchase an additional 12.5 percent, or 145,250, of the
Total number of Special Warrants sold. Each Special Warrant is convertible
into one share of our common stock and one common stock purchase warrant
to purchase a share of our common stock for $0.30 per share. The number
of shares reflects the underlying shares for both the Special Warrant and
the purchase warrant.
(5)The principals of U.S. Euro Securities are Michael R. Fugler, Chairman, and
Ray Dowd, President.
(6)The principals of First Associates are William Packham, Chairman and Chief
Executive Officer, and Stuart R. Raftus, President and Chief Operating
Officer.
PLAN OF DISTRIBUTION
The selling stockholders will act independently of us in making decisions with
respect to the timing, manner and size of each sale. The selling stockholders
may sell the shares from time to time:
- - in transactions on the Over-the-Counter Bulletin Board or on any national
securities exchange or U.S. inter-dealer system of a registered national
securities association on which our common stock may be listed or quoted at
the time of sale; or
- - in private transactions and transactions otherwise than on these exchanges
or systems or in the over-the-counter market;
- - at prices related to prevailing market prices, or
- - in negotiated transactions, or
- - in a combination of these methods of sale; or
- - any other method permitted by law.
The selling stockholders may be deemed underwriters. The selling stockholders
may effect these transactions by offering and selling the shares directly to or
through securities broker-dealers, and these broker-dealers may receive
compensation in the form of discounts, concessions or commissions from the
selling stockholders and/or the purchasers of the shares for whom these
broker-dealers may act as agent or to whom the selling stockholders may sell as
principal, or both, which compensation as to a particular broker-dealer might be
in excess of customary commissions.
Dutchess Private Equities Fund, II, First Associates and U.S. Euro Securities
and any broker-dealers who act in connection with the sale of our shares will be
deemed to be "underwriters" within the meaning of the Securities Act, and any
discounts, concessions or commissions received by them and profit on any resale
of the shares as principal will be deemed to be underwriting discounts,
concessions and commissions under the Securities Act.
9
On or prior to the effectiveness of the registration statement to which this
prospectus is a part, we will advise the selling stockholders that they and any
securities broker-dealers or others who may be deemed to be statutory
underwriters will be governed by the prospectus delivery requirements under the
Securities Act. Under applicable rules and regulations under the Securities
Exchange Act, any person engaged in a distribution of any of the shares may not
simultaneously engage in market activities with respect to the common stock for
the applicable period under Regulation M prior to the commencement of this
distribution. In addition and without limiting the foregoing, the selling
security owners will be governed by the applicable provisions of the Securities
and Exchange Act, and the rules and regulations thereunder, including without
limitation Rules 10b-5 and Regulation M, which provisions may limit the timing
of purchases and sales of any of the shares by the selling stockholders. All of
the foregoing may affect the marketability of our securities.
On or prior to the effectiveness of the registration statement to which this
prospectus is a part, we will advise the selling stockholders that the
anti-manipulation rules under the Securities Exchange Act may apply to sales of
shares in the market and to the activities of the selling security owners and
any of their affiliates. We have informed the selling stockholders that they may
not:
- - engage in any stabilization activity in connection with any of the shares;
- - bid for or purchase any of the shares or any rights to acquire the shares,
- - attempt to induce any person to purchase any of the shares or rights to
acquire the shares other than as permitted under the Securities Exchange Act; or
- - effect any sale or distribution of the shares until after the prospectus shall
have been appropriately amended or supplemented, if required, to describe the
terms of the sale or distribution.
We have informed the selling stockholders that they must affect all sales of
shares in broker's transactions, through broker-dealers acting as agents, in
transactions directly with market makers, or in privately negotiated
transactions where no broker or other third party, other than the purchaser, is
involved.
The selling stockholders may indemnify any broker-dealer that participates in
transactions involving the sale of the shares against certain liabilities,
including liabilities arising under the Securities Act. Any commissions paid or
any discounts or concessions allowed to any broker-dealers, and any profits
received on the resale of shares, may be deemed to be underwriting discounts and
commissions under the Securities Act if the broker-dealers purchase shares as
principal.
In the absence of the registration statement to which this prospectus is a part,
certain of the selling stockholders would be able to sell their shares only
pursuant to the limitations of Rule 144 promulgated under the Securities Act.
We engaged U.S. Euro Securities as our placement agent with respect to the
securities to be issued under the Equity Line of Credit. To our knowledge U.S.
Euro Securities has no affiliation or business relationship with Dutchess
Private Equities Fund II. U.S. Euro Securities is our exclusive placement agent
in connection with the Investment Agreement. We agreed to pay U.S. Euro
Securities 5% of the Put Amount on each draw. The Placement Agent agreement
terminates when our Investment Agreement with Dutchess Private Equities Fund II
terminates pursuant to the terms of that Investment Agreement.
We engaged First Associates as the underwriter with respect to the Special
Warrants. To our knowledge, First Associates has no affiliation with Dutchess
Private Equities Fund, II. First Associates received a cash commission of 8%, or
$18,592, of the gross proceeds from the sale of the Special Warrants and 12.5%
of the amount of Special Warrants sold for a total number of Special Warrants
for First Associates of 145,250.
LEGAL PROCEEDINGS
In May 2003, the Company was sued by a former Board member, Charles McCarthy,
seeking recovery for the value of 350,000 shares, or $209,500, and $120,000 due
his law firm under a retainer agreement between the Company and his firm.
McCarthy had previously signed a settlement agreement with the Company in which
he agreed to cancel all potential claims against the Company and its directors
in return for 150,000 unregistered shares trading at a value of $0.60 or higher.
In October 2004 we reached an agreement with him to settle the case for $55,000.
Under the Settlement Agreement and Release, we made a cash payment to McCarthy
of $10,000 during October 2004, a cash payment of $15,000 in January 2005 and
the remaining balance was settled in the October of 2005.
The Company, along with the current officers and board members and several
former directors, were sued by Lawrence Brady, a former director of the Company,
and his son Mark Brady, who served for a period of time as Chief Financial
Officer, for, among other things, breach of contract for unlawful termination
and failure to provide stock allegedly promised. The alleged breaches and other
claims all stem from their service as director of the Company and Chief
Financial Officer, respectively, for part of 2001 and part of 2002. The Company
denied the allegations. Further, The Company counter-sued the Bradys for non
- -performance and breach of fiduciary duties. Pursuant to a court order, dated
June 23, 2005, the judge terminated the Brady's lawsuit, dismissing it,
outright. In July of 2005, in an effort to bar the Bradys from raising these
issues in the future, the Company engaged in a mutual release of all claims and
issued a total of 250,000 shares of unregistered stock and $10,000 to Lawrence
Brady, Mark Brady and their counsel.
10
Certain claims and lawsuits have arisen against the Company in its normal course
of business. The Company believes that such claims and lawsuits have not had,
and will not have, a material adverse effect on the Company's financial
position, cash flow or results of operations.
DIRECTORS, EXECUTIVE OFFICERS, SIGNFICANT EMPLOYEES AND CONTROL PERSONS
The following persons are executive officers and directors of the Company:
H. DOUGLAS SAATHOFF, 43 - CHIEF EXECUTIVE OFFICER, CHIEF FINANCIAL OFFICER
H. Douglas "Doug" Saathoff, CPA, joined the Company as its full-time Chief
Financial Officer on January 1, 2003 after serving in that capacity on a
part-time consulting basis beginning in October 2002. On March 26, 2003, he was
promoted to the position of Chief Executive Officer. Prior to joining the
Company, he served as Chief Financial Officer for ATSI Communications, Inc.
(AMEX: AI), from June 1994 through July 2002 and as a Board Member of ATSI's
publicly traded subsidiary, GlobalSCAPE, Inc. (GSCP.OB) from April 1997 through
June 2002. During his tenure at ATSI, he was directly responsible for
establishing and monitoring all accounting, financial, internal reporting and
external reporting functions, and had primary responsibility for fundraising
efforts. ATSI raised over $60 million in debt and equity financing from both
individuals and institutions during Doug's tenure, and moved from the Canadian
OTC market to the U.S. OTC market and eventually to a listing on the American
Stock Exchange in February 2000. ATSI grew from San Antonio-based start-up with
11 employees to an international operation with in excess of 500 employees and
operations in the U.S., Mexico, Costa Rica, Guatemala and El Salvador with
annual revenues in excess of $60 million. He was instrumental in the acquisition
of subsidiaries and customer bases, as well as the divestiture of GlobalSCAPE in
June 2002. Prior to joining ATSI, Doug served as the Accounting Manager,
Controller and Financial Reporting Manager for U.S. Long Distance Corp. from
1990 to 1993. While at USLD he was responsible for supervising all daily
accounting functions, developing internal and external financial reporting of
budgeted and actual information, and for preparing financial statements for
shareholders, lending institutions and the Securities and Exchange Commission.
Doug also served as Senior Staff Accountant for Arthur Andersen & Co. where he
planned, supervised and implemented audits for clients in a variety of
industries, including telecommunications, oil & gas and financial services. Doug
graduated from Texas A&M University with a Bachelor of Business Administration
degree in Accounting.
MYRON ANDURI, 49 - PRESIDENT
Mr. Anduri joined the Company in January 2000 and was promoted to President in
December 2003 from his previous position as Vice President of Sales. From 1999
to 2000 he was Vice President-New Business Development for Kyocera Solar Inc. of
Scottsdale, Arizona. While with Kyocera, he worked to develop new market areas
for the company's solar power products. From 1997 to 1999 he served as Vice
President- Telecommunications Division, a $21 million international unit, where
he managed all sales and engineering efforts. From 1993-1997 Mr. Anduri was
Senior Vice President-Marketing and Sales for Photocomm Inc. a Nasdaq-traded
company based in Scottsdale Arizona, which was ultimately acquired by Kyocera in
1997. He also served as Vice President-Industrial Division of Photocomm from
1989-1993 and was the Rocky Mountain Regional Manager from 1987-89. Mr. Anduri
holds a BA in Economics from Colorado State University.
MAX POLINSKY, 47 - CHAIRMAN OF THE BOARD
Mr. Polinsky was elected a member of the Board in April 2002 and is a member of
our audit committee. He is a director and principal of Venbanc, Inc., an
investment and merchant bank located in Winnipeg, Manitoba Canada that he
founded with a partner in 1994. Venbanc specializes in the structuring and
financing of start-up companies and provides follow-up financial and management
advisory assistance. It has successfully funded and taken public several
companies in Canada and the United States in the past ten years. Prior to this
Mr. Polinsky was the general manager of City Machinery Ltd., a nationwide power
transmission parts distributor with offices across Canada. He began his career
as a stockbroker at Canarim Investment Corp. (now Canaccord Capital) in 1982.
Mr. Polinsky graduated with honors from the University of Manitoba with a degree
in Business Administration, Finance Major.
PATRICK A. GORMAN, 40 - BOARD MEMBER
Mr. Gorman was elected a member of the Board in April 2002, and is a member of
the compensation committee. He is the managing director of Gorman and
Associates, Inc., a strategic consulting firm for corporate and government
affairs. Since its inception, the company has been dedicated to being the
preeminent business development firm for companies seeking to do business with
the Fortune 500 as well as the advisory firm of choice in understanding the
federal government in Washington, D.C. Mr. Gorman's focus at Gorman and
Associates, Inc. includes law and the legislative process, communications,
government relations, and operations. Over the last 10 years, he has advised
corporations, NGOs, non-profits, and individuals on issues pertaining to
criminal law, the environment, telecommunications, international trade, fund
raising, community development, media relations, and alternative dispute
resolution. Mr. Gorman is a member of the Advisory Board of New Media
Strategies, Inc., an Internet service provider focused on public relations,
communications, and viral marketing. Mr. Gorman is also a Board member of the
Echo Hill Campership Fund, a local non-profit whose mission is to send the
neediest, very low-income, inner-city youths to camp on the Chesapeake Bay. Mr.
Gorman is admitted to practice law in Maryland and the District of Columbia and
has successfully appeared at the administrative, district, circuit, and
appellate court levels.
On November 26, 2003, each member of the Board of Directors was elected for a
one-year term or until their successor shall have been elected and qualified.
11
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
BENEFICIAL OWNERS OF MORE THAN 5% OF NIGHTHAWK SYSTEMS, INC. COMMON STOCK
TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP PERCENT OF CLASS
Common stock Steven Jacobson 4,005,317(a)(b) 7.9%
6600 E Hampden Ave
3rd Floor
Denver, CO 80224
Common stock Myron Anduri 3,208,149 (c) 6.5%
P.O. Box 1051
Fairplay, CO 80440
NOTES:
(a) Based on historical information and the fact that no Section 16 filings were
completed by Mr. Jacobson during 2005, although Company management has reason to
believe that Mr. Jacobson sold shares during 2005. Includes 300,000 shares under
options which are vested or vest within 60 days, and 1,875,317 shares held under
in an irrevocable voting agreement with Myron Anduri which was executed on
September 8, 2003 and which will survive for a period of five years from that
date. See Note (d) below.
(b) Based on historical information and the fact that no Section 16 filings were
completed by Mr. Jacobson during 2005, although Company management has reason to
believe that Mr. Jacobson sold shares during 2005. Includes 550,000 shares held
in a trust that expires on 6/11/06 for Aaron Guth and 550,000 shares held in a
trust that expires on 3/31/09 for Adam Guth. Steve Jacobson acts as trustee for
both trusts, and has all rights afforded any shareholder, including voting
rights, until the trusts expire.
(c) Includes 431,416 shares and 250,000 under warrants and options,
respectively, which are exercisable within 60 days. Also includes 1,875,317
shares held under an irrevocable voting agreement with Steve Jacobson which was
executed on September 8, 2003 and which will survive for a period of five years
from that date. Pursuant to this agreement, Mr. Anduri has the right to vote the
proxy of said shares on all matters submitted to a vote of the shareholders with
the single exception of votes on any proposal to change fifty one percent (51%)
or more of the ownership of the Company. Mr. Anduri receives no economic
benefits from the shares subject to this Voting Agreement.
SECURITY OWNERSHIP OF MANAGEMENT
TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP PERCENT OF CLASS
Common stock Max Polinsky 925,000 (a) 2.0%
138 Portage Ave. East, Ste. 406
Winnipeg, Manitoba R2COA1
Common stock Patrick Gorman 675,000 (b) 1.4%
1666 K Street NW, Ste 500
Washington, D.C. 20006
Common stock H. Douglas Saathoff 948,324 (c) 2.0%
25106 Callaway
San Antonio, Tx 78258
Common stock Myron Anduri 3,208,149 (d) 6.5%
PO Box 1051
Fairplay, CO 80440
Common stock Directors and officers as a group 5,756,473 10.8%
<FN>
NOTES:
(a) Includes 200,000 shares that are owned by Venbanc, Inc., of which Mr.
Polinsky is a partner, and 575,000 shares under options exercisable within 60
days.
(b) Includes 575,000 shares under options exercisable within 60 days.
(a) Includes 500,000 shares under options exercisable within 60 days.
(d) Includes 431,416 shares and 250,000 under warrants and options,
respectively, which are exercisable within 60 days. Also includes 1,875,317
shares held under an irrevocable voting agreement with Steve Jacobson which was
executed on September 8, 2003 and which will survive for a period of five years
from that date. Pursuant to this agreement, Mr. Anduri has the right to vote the
proxy of said shares on all matters submitted to a vote of the shareholders with
the single exception of votes on any proposal to change fifty one percent (51%)
or more of the ownership of the Company. Mr. Anduri receives no economic
benefits from the shares subject to this Voting Agreement. Based on historical
information and the fact that no Section 16 filings were completed by Mr.
Jacobson during 2005, although Company management has reason to believe that Mr.
Jacobson sold shares during 2005.
12
DESCRIPTION OF COMMON STOCK
Our Certificate of Incorporation authorizes us to issue 50,000,000 shares of
common stock, par value $.001 per share. The number of shares of common stock
issued and outstanding on November 18, 2004 was 30,622,518 shares. We do not
have enough authorized shares to issue all of the shares on this registration
statement. We intend to hold a special meeting for the purpose of increasing our
authorized shares.
VOTING RIGHTS. The holders of shares of common stock are entitled to one vote,
either in person or by proxy, per share on each matter submitted to a vote of
stockholders. At each election of Directors, every stockholder entitled to vote
in such election shall have the right to vote in person or by proxy the number
of shares owned by him or it for as many persons as there are directors to be
elected and for whose election he or it has the right to vote, but the
shareholder shall have no right to accumulate his or its votes with regard to
such election. Holders of Common Stock have no preemptive or other rights to
subscribe for shares.
DIVIDEND POLICY. All shares of common stock are entitled to receive when, as and
if declared by our Board of Directors, out of the funds legally available
thereof, the dividends payable in cash, common stock, or otherwise.
INTEREST OF NAMED EXPERTS AND COUNSEL
No expert or counsel within the meaning of those terms under Item 509 of
Regulation S-B will receive a direct or indirect interest in our company or was
a promoter, underwriter, voting trustee, director, officer, or employee. No
expert has any contingent based agreement with us or any other interest in or
connection to us.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The consolidated balance sheet as of December 31, 2005 and the related
consolidated statements of operations, stockholders' deficit and cash flows for
each of the years in the two-year period ended December 31, 2005 included in
this Prospectus, have been audited by GHP Horwath, P.C., independent registered
public accounting firm, as stated in their report appearing herein.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article X of our Amended and Restated Articles of Incorporation and Bylaws state
every person who was or is a party or is threatened to be made a party to or is
involved in any action, suit or proceeding, whether civil, criminal,
administrative or investigative, by reason of the fact that he or a person of
whom he is the legal representative is or was a director or officer of the
corporation or is or was serving at the request of the corporation or for its
benefit as a director or officer of another corporation, or as its
representative in a partnership, joint venture, trust or other enterprise, shall
be indemnified and held harmless to the fullest extent legally permissible under
the General Corporation Law of the State of Nevada from time to time against all
expenses, liability and loss (including attorneys' fees, judgments, fines and
amounts paid or to be paid in settlement) reasonably incurred or suffered by him
in connection therewith. The expenses of officers and directors incurred in
defending a civil or criminal action, suit or proceeding must be paid by the
corporation as they are incurred and in advance of the final disposition of the
action, suit or proceeding upon receipt of an undertaking by or on behalf of the
director or officer to repay the amount if it is ultimately determined by a
court of competent jurisdiction that he is not entitled to be indemnified by the
corporation. Such right of indemnification shall be a contract right which may
be enforced in any manner desired by such person. Such right of indemnification
shall not be exclusive of any other right which such directors, officers or
representatives may have or hereafter acquire and, without limiting the
generality of such statement, they shall be entitled to their respective rights
of indemnification under any bylaw, agreement, vote of stockholders, provision
of law or otherwise, as well as their rights under this Article.
The Board of Directors may cause the corporation to purchase and maintain
insurance on behalf of any person who is or was a director or officer of the
corporation, or is or was serving at the request of the corporation as a
director or officer of another corporation, or as its representative in a
partnership, joint venture, trust or other enterprise against any liability
asserted against such person and incurred in any such capacity or arising out of
such status, whether or not the corporation would have the power to indemnify
such person.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons in accordance
with the provisions contained in our Certificate of Incorporation and By-laws,
Nevada law or otherwise, we have been advised that, in the opinion of the
Securities and Exchange Commission, this indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. If a
claim for indemnification against such liabilities (other than the payment by us
of expenses incurred or paid by a director, officer or controlling person in the
successful defense of any action, suit, or proceeding) is asserted by such
director, officer or controlling person, we will, unless in the opinion of our
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by us is
against public policy as expressed in the Securities Act and we will follow the
court's determination.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve risks and
uncertainties. We generally use words such as "believe," "may," "could," "will,"
"intend," "expect," "anticipate," "plan," and similar expressions to identify
forward-looking statements, including statements regarding our expansion plans.
You should not place undue reliance on these forward-looking statements. Our
actual results could differ materially from those anticipated in the
forward-looking statements for many reasons, including the risks described in
our "Risk Factor" section and elsewhere in this report. Although we believe the
expectations reflected in the forward-looking statements are reasonable, they
relate only to events as of the date on which the statements are made, and our
future results, levels of activity, performance or achievements may not meet
these expectations. Moreover, neither we nor any other person assumes
responsibility for the accuracy and completeness of the forward-looking
statements. We do not intend to update any of the forward-looking statements
after the date of this document to conform these statements to actual results or
to changes in our expectations, except as required by law.
13
DESCRIPTION OF BUSINESS
GENERAL
Nighthawk Systems, Inc. ("Nighthawk" or "the Company") designs and manufactures
intelligent remote power control products that are easy to use, inexpensive and
can remotely control virtually any device from any location. Utilizing our
proprietary Nighthawk control board, we have designed a series of 'plug and
play' devices for certain common customer applications that are ready to use
upon purchase, so they are easily installed by anyone, regardless of technical
ability, and are also easily integrated into third-party products, systems and
processes. They allow for intelligent control by interpreting instructions sent
via paging and satellite media, and execution of the instructions by 'switching'
the electrical current that powers the device, system or process. Our
intelligent products can be activated individually, in pre-defined groups, or en
masse, and for specified time periods with a simple click of a mouse or by
dialing a telephone number.
Our products have been uniquely designed and programmed to be simple and ready
to use upon purchase by anyone, almost anywhere, at affordable prices. As such,
it is the Company's goal to have its products become commonplace, accepted and
used by businesses and consumers alike in their daily routines. If our 'plug and
play' devices do not fit a desired application, the Nighthawk control board can
be customized to fit into or alongside other devices that need to be controlled.
We save consumers and businesses time, effort and expense by eliminating the
need for a person to be present when and where an action needs to be taken. By
utilizing existing wireless technology, we give our users the flexibility to
move their application from place to place, without re-engineering their
network. Currently, most commercial control applications utilize telephone or
Internet connections, which tether the system to a single location and have
associated installation and monthly charges. Our products make companies more
profitable by eliminating installation costs and monthly charges for telephone
or Internet connections, and allow control of unmanned or remote locations that
operate on traditional electrical power, solar or battery generated power.
Effective February 1, 2002, the Company acquired 100% of the issued and
outstanding shares of Peregrine Control Technologies, Inc. ("PCT") in exchange
for 14,731,200 post reverse split shares of the Company's common stock. In
conjunction with the acquisition and the change in focus of the Company's
business, the Company changed its name to Peregrine, Inc. on January 10, 2002
and later to Nighthawk Systems, Inc. on April 29, 2002. Prior to the acquisition
of PCT, the Company had conducted a reverse split of its shares on a 1:100
basis, and had 4,600,256 shares outstanding. The acquisition was recorded as a
reverse acquisition, with PCT being the accounting survivor.
PCT was originally incorporated as a Colorado company in 1992, and operated as a
family-owned business specializing in paging repair. Through knowledge gained in
the operation of the business, the Company began developing a specialized
circuit board that could receive paging signals and switch electrical power. In
its simplest form, the technology gave the user the ability to turn devices "on"
or "off" from or to remote sites. Through limited marketing, the Company was
able to solve specific control problems for both large and small companies
through customization of the original circuit board.
As of the date of this report, the Company has nine full time employees.
MISSION STATEMENT
To become the premier provider of intelligent, wireless remote power control
products and services that allow businesses and consumers to save time and money
through more efficient management of resources.
THE MARKETPLACE
The controls industry is characterized by companies that sell remote asset
management and tracking systems and related products. It is the Company's belief
that there is almost no limit to the size of the remote control market; the
application of remote control is limited only by one's imagination. Companies
both large and small are seeking ways to save money and lower the risk of
liability by replacing processes that require human intervention with processes
that can be controlled remotely without on-site human intervention. Today, the
remote control of physical assets and processes is performed primarily through
the use of telephone and Internet based systems. However, these connections are
expensive, requiring high monthly fees, and more importantly, they restrict the
remote control to the availability of the physical connection between the person
operating the remote control and the asset to be controlled. In contrast,
Nighthawk's products are wireless and can therefore be operated from any
location, without our device being connected to a telephone line or Internet
connection. This means that the asset does not have to be tethered to a fixed
location in order to be accessed. Moreover, Nighthawk's products are designed to
work with a variety of wireless media including paging and satellite-based
systems. Almost any device that runs off of an electrical current, whether
battery, solar or line generated, can be controlled by a Nighthawk device. The
Company has identified primary markets (Utilities, Emergency Management and
IT/Telecommunications), as well as secondary markets (Irrigation, Outdoor
Advertising, Oil/Gas and Security) for its products.
14
TECHNOLOGY AND PRODUCTS
Nighthawk products have been in service for over seven years. The Company's
installed customer base includes major electric utilities, internet service
providers and fire departments in over 40 states. Customers using Nighthawk
products today include the Naval Air Warfare Center - Weapons Division, Mercury
Online Solutions, PECO Energy, Denver Fire Department, and Internet America. The
primary distinguishing feature of all Nighthawk products that is not shared by
its competitors across the various markets is its proprietary firmware and
software, which together provide the intelligence for our solutions. The
Company's products are shipped ready for use and are pre-programmed before
shipment to the customer.
Nighthawk's plug and play products, and the applications they are typically
utilized for, are as follows:
Utilities
CEO700: Remote power connect/disconnect of customers by electric utilities
PT1-LC: Load control programs utilized by electric utilities
Emergency Management
FAS8: Firehouse automation. Upon receiving a 911 dispatch, the FAS8 will
simultaneously print instructions, activate alarms, turn on lights, turn off
stoves, open bay doors and activate outdoor flashing lights within firehouses.
EA1: In-building alerting, including alarm activation and message display AL100:
remote public alerting
IT/Telecommunications
NH100: Rebooting or on/off applications to single devices like servers and
routers
NH8: Rebooting or on/off applications for up to 8 individually controlled
devices
Using the proprietary Nighthawk control board, Nighthawk's products can be and
have been modified to fit many custom applications such as traffic control
signage and irrigation control. If a device needs to be turned on or off, we can
typically develop a product to do it.
Through innovative product engineering and software, Nighthawk's products
typically utilize a common paging signal found virtually worldwide. Paging is
often used because it is very secure, inexpensive, and easy to use. Customers
can choose to source their own paging service or Nighthawk will arrange for the
service directly. The Company also offers Windows-based software packages that
enable customers to activate the remote control units from a PC. Paging, when
combined with Nighthawk's proprietary firmware and software, allows for a "group
call" feature whereby a user can access multiple sites at the same time using a
single paging number. This exponentially increases the functionality and ease of
use of the products. It is important to note that the Company's products can be
adapted to function with any wireless, or wireline-based, communications medium.
In September 2003, the Company signed an agreement to become a value-added
reseller for Orbcomm, a low-earth orbit ("LEO") satellite system. This
relationship expands Nighthawk's coverage beyond the reach of paging and
cellular systems and allows the Company to offer global solutions for companies
that have global needs. Additionally, satellite technology enables Nighthawk's
products to be used in conjunction with monitoring equipment due to the two-way
communication capability. Unlike paging, which allows for one-way communication,
satellite communications allow the customer to get confirmation from the device
that the control has been effectuated or that the flow, for example, of liquids
being monitored has been shut off or turned on, as the case may be.
In January 2006, we announced that the Company had signed both a value-added
reseller agreement and a joint marketing agreement with Verizon Wireless. The
agreements allow Nighthawk to bundle access to Verizon Wireless's network with
Nighthawk products, and also calls for the two companies to collaborate on joint
marketing opportunities. Verizon Wireless operates an extensive paging network
throughout the United States. Verizon Wireless has agreed to provide airtime
access to Nighthawk on that network on a wholesale basis, allowing Nighthawk to
mark up the service if it wishes and sell Verizon Wireless airtime to its
customers, who then utilize the Verizon Wireless network to communicate with
their Nighthawk devices. The two companies are also working together to identify
customers that may be able to utilize the Verizon Wireless network to
communicate with Nighthawk's control devices.
The Company completes the assembly of its products at its Denver, Colorado
facility. The Company sub-contracts for assembly of various components, and
utilizes several vendors for parts that do not require assembly. Parts and
sub-assembly services are widely available. During the final assembly process,
individual units are programmed depending on their destination or customer
requirements, tested, and then shipped to the customer for installation.
In July 2003, the Company sold back the assets and liabilities it had acquired
from Vacation Communication, Inc. in September 2001 to the original owners of
Vacation Communication, Inc. The assets disposed of in the sale consisted
primarily of a retail paging customer base. The Company now purchases wholesale
paging services from paging carriers, including Vacation Communication, Inc.,
for regional, nationwide and international coverage. The Company utilizes these
paging carriers to offer paging services to customers that buy Nighthawk
products, but do not have their own private paging networks. Several customers
own their own private paging networks and, hence, do not require Nighthawk to
arrange for their paging services.
15
PATENTS PENDING
The Company has two patent applications pending at the U.S. Patent Office: one
is titled "Remote Disconnect Systems for Utility Meters" and is for whole house
disconnect systems, and the second is titled "Paging Remote Disconnect Systems"
and is for the remote wireless control for turning on and off electrical and
telephonic lines.
Under the first patent application, the user dials a pager number that is
pre-programmed into the unit. The paging service then transmits a signal to a
radio frequency ("RF") receiver in the module. The signal is then decoded and
sent to a processor. The processor then causes a relay to open or close in
accordance with the decoded signal in order to connect or disconnect the
electrical power.
Under the second application, a user simply plugs the power cord or
telecommunication line of their device, such as a computer or appliance, into
the outlet of the module. The user is then able to dial a pager number that is
pre-programmed. The paging service then transmits a signal to an RF receiver in
the module. The signal is then decoded and sent to a processor. The processor
then causes a relay to open or close in accordance with the decoded signal in
order to activate the power supply or to turn the power off to the electronic
device or to connect or disconnect the telecommunications line.
COMPETITION
We have one primary distinguishing feature that is not shared by our competitors
in our markets, our proprietary firmware and software, which together provide
intelligent solutions for our customers.
Utility competition. The Company has several competitors for its CEO700 remote
power disconnect system. BLP Technologies makes a device that is very similar to
the CEO700 which also utilizes paging frequencies for activation. The Company
competes with BLP Technologies directly for utility projects where either the
location of the utility's customers or directives of the utility dictate that
paging technology must be used for remote connect/disconnect of customers. If we
are able to secure our patent titled "Remote Disconnect Systems for Utility
Meters", we may be able to preclude BLP from providing services using their
product, which is called X-PulseTM . Carina Technology, Inc. makes a utility
meter that it reports is capable of reading a meter and/or remotely
disconnecting service utilizing cellular technology. Cellular technology/service
is generally more expensive than paging technology/service, but affords the
utility the ability to communicate to and from the meter and disconnect device.
This would allow the user to connect/disconnect service to a customer, and take
a meter reading as well.
Rebooting competition: rebooting of computers, routers and other digital
equipment has historically utilized telephone lines or Internet-based technology
to access the product. Companies such as DataProbe, Inc., Western Telematic,
Inc. and American Power Conversion Corp. make devices that utilize these forms
of technology to communicate to their devices. To our knowledge, we are the only
company that offers paging-based rebooting units. Our units are competitively
priced in comparison to alternative products, and offer the distinct advantage
of being wireless, thus allowing the units to be moved from place to place
without moving lines and incurring installation charges. Our products also offer
an 'out of band' solution, meaning that our customers utilize a separate
(paging) network, instead of their own existing network, to reboot devices
within their own network.
Emergency Management competition: this is an emerging market that has not yet
developed product standards and therefore there is no identified competition as
of the date of this report. Historically, the Company has provided equipment
that has been used for activating signs for departments of transportation,
in-station firehouse alerting which includes message printout, and activating
civil defense sirens. The Company believes that its existing technology is
well-suited for in-building and in-house emergency alerting in combination with
alerting of first responders.
Wireless competition. Wireless remote control through the use of radio signals
has historically been performed utilizing private system data radios, cellular
telephones, or satellite-based systems. While our technology can be modified to
utilize any of these wireless media, our core expertise has been in the use of
paging. This medium, combined with our proprietary technology, allows for a high
level of security, the lowest overall cost and greatest control flexibility.
Only a handful of small, undercapitalized companies utilize paging for this
purpose. To our knowledge, we are the only company emphasizing paging technology
that manufactures a product that is ready-to-use upon receipt.
SALES AND DISTRIBUTION
The Company believes that it has the opportunity to meet current demand for
applications of its technology within specific markets, and to create
opportunities in many other markets as well. Despite historically having little
or no marketing resources to target these markets, customers in our targeted
markets have found that the Company's technology successfully meets their needs.
As such, Nighthawk will focus significant direct, and supplier-based, sales
efforts in these industries.
Nighthawk's intelligent products attach to existing customer hardware and act as
a "brain", receiving wireless instructions sent from a remote location, allowing
the hardware to perform as instructed. As mentioned above, Nighthawk's products
are typically set up to receive these instructions via a paging protocol, which
allows for secure, reliable and low cost operation. Nighthawk products literally
serve as the "intelligence" between the wireless service medium and the hardware
that must perform the desired action. As such, we believe substantial
opportunities exist to partner with wireless service providers as well as
hardware manufacturers and dealers, each of which stand to gain from the use of
Nighthawk's products. The Company will also attempt to establish itself as a
supplier of products to paging and other wireless service providers, and
establish dealer networks in a number of markets, including, but not limited to,
computer controls, utilities, irrigation, traffic control, and wide area
notification.
16
During 2005, the Company hired its first full time sales staff. This staff now
consists of one inhouse sales person who handles incoming customer inquiries and
makes outbound sales calls, as well as a full time account executive who calls
on potential customers. In addition, the Company announced in January 2006 that
it had signed a joint marketing agreement with Verizon Wireless. Under this
agreement, the companies will collaborate to identify, pursue and close mutually
beneficial business opportunities, and Verizon Wireless sales personnel will
introduce Nighthawk Systems products to new and existing customers.
EMPLOYEES
As of December 31, 2005, we had nine full time employees. We believe our
relations with all of our employees are good.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD LOOKING STATEMENTS
Discussions and information in this document, which are not historical facts,
should be considered forward-looking statements. With regard to forward-looking
statements, including those regarding the potential revenues from increased
sales, and the business prospects or any other aspect of Nighthawk Systems, Inc.
("the Company"), actual results and business performance may differ materially
from that projected or estimated in such forward-looking statements. The Company
has attempted to identify in this document certain of the factors that it
currently believes may cause actual future experience and results to differ from
its current expectations. Differences may be caused by a variety of factors,
including but not limited to, adverse economic conditions, entry of new and
stronger competitors, inadequate capital and the inability to obtain funding
from third parties.
The following information should be read in conjunction with the Company's
audited financial statements for the years ended December 31, 2005 and 2004.
GENERAL
The Company's financial results include the accounts of Nighthawk Systems, Inc.
(formerly Peregrine, Inc.) and its subsidiary, Peregrine Control Technologies,
Inc. ("PCT"). Effective February 1, 2002, the two companies were brought
together under common management through an acquisition in which Peregrine, Inc.
acquired all of the outstanding shares of PCT. Because Peregrine, Inc. issued
more shares to acquire PCT than it had outstanding just prior to the
acquisition, the transaction was accounted for as a reverse acquisition of
Peregrine, Inc. by PCT. Peregrine, Inc. subsequently changed its name to
Nighthawk Systems, Inc.
The Company designs and manufactures intelligent remote monitoring and power
control products that are easy to use, inexpensive and can remotely control
virtually any device from any location. Our proprietary, wireless products are
ready to use upon purchase, so they are easily installed by anyone, regardless
of technical ability, and are also easily integrated into third-party products,
systems and processes. They allow for intelligent control by interpreting
instructions sent via paging and satellite media, and executing the instructions
by 'switching' the electrical current that powers the device, system or process.
Our intelligent products can be activated individually, in pre-defined groups,
or en masse, and for specified time periods with a simple click of a mouse or by
dialing a telephone number.
Our products have been uniquely designed and programmed to be simple and ready
to use upon purchase by anyone, almost anywhere, at affordable prices. As such,
it is the Company's goal to have its products become commonplace, accepted and
used by businesses and consumers alike in their daily routines.
We save consumers and businesses time, effort and expense by eliminating the
need for a person to be present when and where an action needs to be taken. By
utilizing existing wireless technology, we give our users the flexibility to
move their application from place to place, without re-engineering their
network. Currently, most commercial control applications utilize telephone
lines, which tether the system to a single location and have associated
installation and monthly charges. Our products make companies more profitable by
eliminating installation costs and monthly charges for telephone lines, and
allow for remote control of unmanned or remote locations that may operate on
traditional electrical power, or solar or battery generated power.
Active applications for our intelligent products include, but are not limited
to:
- - Rebooting digital network components
- - Remote switching of residential power
- - Managing power on an electrical grid
- - Activation/deactivation of alarm and warning devices
- - Displaying or changing a digital or printed message or warning sign
- - In-station firehouse alerting
- - Turning irrigation systems on or off
- - Turning heating or cooling equipment on or off
17
Companies both large and small are seeking ways to save money and lower the risk
of liability by replacing processes that require human intervention with
processes that can be controlled remotely without on-site human intervention.
Today, the remote control of industrial or commercial assets and processes is
performed mainly through the use of telephone-line or Internet-based systems.
Opportunities exist for companies that provide intelligent wireless solutions,
as telephone lines are expensive and limited in availability and function, and
Internet-based solutions are not always available or desirable. Nighthawk's
products are wireless, and can be designed to work with a variety of wireless
media. They often offer an 'out of band' control solution - they function on a
different network than the item to be turned on or off. The number of
applications for wireless remote control is virtually limitless. The Company has
identified primary markets (Utility, IT Professional, Traffic Control), as well
as secondary markets (Irrigation, Outdoor Advertising, Oil/Gas, Security) for
its products.
COMPARISON OF YEARS ENDED DECEMBER 31, 2005 AND 2004
REVENUE
The components of revenue, including revenues from discontinued operations, and
their associated percentages of total revenues, for the fiscal years ended
December 31, 2005 and 2004 are as follows:
YEARS ENDED DECEMBER 31,
--------------------------------
2005 2004
----------- -----------
Product Revenues
- ----------------------
Nighthawk NH100 & NH8 $ 119,078 23% $ 186,492 31%
PT1 LC 1,120 - 64,536 11%
PT 1000 & PT Boards 118,483 22% 99,256 16%
CEO 700 157,470 30% 197,508 32%
Hydro 1 76,975 15% - -
Other product 5,651 1% 11,938 2%
Freight 5,468 1% 6,848 1%
----------- ----- ----------- ----
Total product revenues 484,245 92% 566,578 93%
Airtime sales 44,444 8% 43,602 7%
----------- ----- ----------- ----
Total revenues $ 528,689 100% $ 610,180 100%
=========== ===== =========== ====
Revenues from continuing operations are made up of product sales and airtime
billed to customers for Nighthawk Systems, Inc. products. Revenues from
continuing operations declined $81,491 or 13% between years. The Company's
revenues have historically been dependent on a handful of customers who have
each placed a large order. These contracts originated in 2002, and production
under these contracts stretched into 2004. In 2004, approximately $135,000 of
the Company's rebooting product revenues were generated by a single customer.
While this customer continued to order equipment throughout 2005, revenues from
this customer declined to approximately $33,000 during 2005. During 2004, two
customers accounted for approximately $140,000 of the total CEO 700 revenues for
the year. These two customers did not account for any CEO 700 revenues during
2005. During 2004, one customer accounted for almost all of the approximately
$65,000 in revenues from the sale of PT1 LC load control boards. During 2005,
the Company did not market this product, and generated only $1,120 in revenues
from the product. Decreases from the culmination of these three projects was
offset partially by the approximately $76,000 sale of Hydro1 irrigation control
units as part of a government-funded project in the state of New Mexico early in
2005. While the Company anticipates that it may sell more Hydro1 irrigation
control units in the future, it anticipates that such sales will remain 'project
oriented' until and unless it decides to dedicate significant marketing and
sales dollars to this product.
In an effort to generate additional business from new customers, the Company
sought financing during 2004 which culminated in our funding relationship with
Dutchess Private Equities, II, L.P. ("Dutchess"). Using funding from this
source, the Company hired its first full time sales staff consisting of two
people early in 2005. Throughout 2005, the sales staff was charged with
generating new business opportunities for the Company's core products, the NH100
rebooting device and the CEO700 whole house disconnect device. It also launched
a new website during 2005 which allows potential customers to send contact
information and product inquiries directly to the Company via the Internet. Even
though the Company did not actively market its rebooting devices during 2005, if
results from the one major customer are excluded from both 2004 and 2005, sales
of this product actually increased from year to year. New rebooting customers
were added, primarily within the Wireless Internet Service Provider industry.
During 2005, in spite of long sales cycles typically associated with electric
utilities, the Company added over a dozen new utilities to its CEO700 customer
base. More importantly, these efforts have lead to larger potential sales
opportunities within the electric utility industry. As of December 31, 2005, the
Company had submitted bids on over $6.0 million in potential product sales
within the industry, and was in contact with entities that are planning large
deployments over the next 18 months.
During 2005, the Company continued selling it's PT1000 control boards to
customers for a variety of applications, including sign control for various
departments of transportation. The Company also sold several units to fire
departments for in-house fire station alerting. This resulted in an increase in
PT1000 board sales between years of approximately $19,000.
Cost of goods sold declined approximately $69,000, or 16% between years, and
decreased as a percentage of product revenues from 72% in 2004 to 70% in 2005.
As a result, the Company's gross margin increased from 28% in 2004 to 30% in
2005. While lower production volumes between years caused the decrease in
overall cost of goods sold, the Company's gross profit declined only 7% from
$171,707 in 2004 to $159,358 in 2005. Sales of the Hydro1, a relatively higher
margin product, in 2005, as well as changes made to the Company's NH100
rebooting product contributed to the increased gross margin between years. The
Company sold no Hydro1 irrigation control units during 2004, and the Company
enhanced the design of its core rebooting product so that it is less expensive
to produce during 2005.
18
Selling, general and administrative ("SG&A) expenses increased approximately
$636,000, approximately 48%, from 2004 to 2005. During 2005, the Company spent
approximately $300,000 on public relations services in an effort to increase
investor awareness of the Company, and to promote sales of the Company's
products. The Company's ability to receive funding from its primary funding
source under agreements signed in August 2004 is dependent on both the price and
trading volume of its common stock. As such, the Company spent more money on
public relations efforts during 2005 than it did in 2004. The Company also spent
approximately $285,000 more on salaries and wages during 2005 than it did in
2004. The Company hired a corporate controller who was employed during the first
9 months of the year before he resigned, and then hired a Vice President/General
Manager in early October 2005. In addition, as mentioned above, the Company
hired its first full time sales staff during 2005 that was employed throughout
the year, and also contracted for marketing help throughout 2005. The Company
spent approximately $175,000 more on sales and marketing efforts during 2005
than it did during 2004.
Related party interest expense decreased $42,601 between years because the
Company converted almost all related party debt to common stock during 2004.
Other interest expense increased approximately $711,000 between years due to
borrowings between the Company and its primary funding partner, Dutches Private
Equities. During 2005, Dutchess loaned the company net cash proceeds of
$1,460,633 in the form of short-term promissory notes and long-term convertible
debentures. The promissory notes have no stated interest rate but have a face
amount greater than the funded amount. The notes are recorded by the Company at
the discounted amount, and the difference between the face and funded amount is
recognized as interest expense over the life of the loan. During 2005, the
Company recognized approximately $292,000 in non-cash expense in amortizing
these differences. Outstanding principal balances on promissory notes that
matured during the year were rolled into new promissory notes or debentures,
plus a 10% penalty on the face amount of the note that expired. During 2005, the
Company recognized approximately $239,000 in such penalties, which it recorded
as interest expense. The convertible debentures carry interest rates of 10%.
Dutchess also received incentive shares on all new cash proceeds loaned to the
Company. These incentive shares are recorded as prepaid interest and expensed
over the life of the loan. During 2005, the Company amortized approximately
$241,000 in incentive fees , which was also included in interest expense.
Airtime sales were approximately $44,000 during both years presented. Airtime
access to communicate to the Company's control devices represents a source of
recurring revenue to the Company unless the customer arranges for such service
on their own. The Company typically bills for airtime access on a prepaid,
quarterly basis. Even though the Company continued to add new customers during
2005, airtime billed to those customers was offset by revenues lost when the
Company's largest rebooting customer had its own asset management contract
suspended with a large company and therefore no longer needed airtime to service
that company.
The net loss for 2005 was $2,692,656, or $0.07 per share as compared to a net
loss of $1,377,395, or $0.05 per share in 2004. The increased net loss and net
loss per share was principally the result of non-cash interest expense
associated with the Company's funding with Dutchess during 2005, as well as
public relations efforts during the year. The addition of sales and marketing
personnel and related activities also contributed to the increase.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
Revenue recognition
Revenue from product sales is recognized when all significant obligations of the
Company have been satisfied. Revenues from equipment sales are recognized either
on the completion of the manufacturing process, or upon shipment of the
equipment to the customer, depending on the Company's contractual obligations.
The Company occasionally contracts to manufacture items, bill for those items
and then hold them for later shipment to customer-specified locations. There
were no bill and hold items at December 31, 2005. Revenue related to airtime
billing is recognized when the service is performed. Some customers pre-pay
airtime on a quarterly or annual basis and the pre-paid portion is recorded as
deferred revenue. Deferred revenue, included in accrued liabilities on the
balance sheet at December 31, 2005, is approximately $12,200.
Stock-based compensation
We believe that stock-based compensation is a critical accounting policy that
affects our financial condition and results of operations. Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation defines a fair-value based method of accounting for stock-based
employee compensation plans and transactions in which an entity issues its
equity instruments to acquire goods or services from non-employees, and
encourages but does not require companies to record compensation cost for
stock-based employee compensation plans at fair value. The Company has chosen to
continue to account for employee stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB No. 25") and related
interpretations.
19
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R "Share-Based Payment", which addresses the accounting for share-based
payment transactions. SFAS 123R eliminates the ability to account for
share-based compensation transactions using APB 25, and instead, generally
requires that such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123R will be effective for small
business issuers as of the beginning of the first interim or annual reporting
period that begins after December 15, 2005. SFAS No. 123R offers the Company
alternative methods of adopting this standard. The Company has not yet
determined which alternative method it will use. Depending upon the number and
terms of options that may be granted in future periods, the implementation of
this standard could have a material impact on the Company's financial position
and results of operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD-LOOKING STATEMENTS
Discussions and information in this document, which are not historical facts,
should be considered forward-looking statements. With regard to forward-looking
statements, including those regarding the potential revenues from increased
sales, and the business prospects or any other aspect of Nighthawk Systems,
Inc.'s business, actual results and business performance may differ materially
from that projected or estimated in such forward-looking statements. Nighthawk
Systems, Inc. ("the Company") has attempted to identify in this document certain
of the factors that it currently believes may cause actual future experience and
results to differ from its current expectations. Differences may be caused by a
variety of factors, including but not limited to, adverse economic conditions,
entry of new and stronger competitors, inadequate capital and the inability to
obtain funding from third parties.
The following information should be read in conjunction with the unaudited
condensed consolidated financial statements included herein which are prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information.
GENERAL
The Company designs and manufactures intelligent remote monitoring and power
control products that are easy to use, inexpensive and can remotely control
virtually any device from any location. Our proprietary, wireless products are
ready to use upon purchase, so they are easily installed by anyone, regardless
of technical ability, and are also easily integrated into third-party products,
systems and processes. They allow for intelligent control by interpreting
instructions sent via paging and satellite media, and executing the instructions
by 'switching' the electrical current that powers the device, system or process.
Our intelligent products can be activated individually, in pre-defined groups,
or en masse, and for specified time periods with a simple click of a mouse or by
dialing a telephone number.
Our products have been uniquely designed and programmed to be simple and ready
to use upon purchase by anyone, almost anywhere, at affordable prices. As such,
it is the Company's goal to have its products become commonplace, accepted and
used by businesses and consumers alike in their daily routines.
We save consumers and businesses time, effort and expense by eliminating the
need for a person to be present when and where an action needs to be taken. By
utilizing existing wireless technology, we give our users the flexibility to
move their application from place to place, without re-engineering their
network. Currently, most commercial control applications utilize telephone
lines, which tether the system to a single location and have associated
installation and monthly charges. Our products make companies more profitable by
eliminating installation costs and monthly charges for telephone lines, and
allow for remote control of unmanned or remote locations that may operate on
traditional electrical power, or solar or battery generated power.
Applications for our intelligent products include, but are not limited to:
- - Rebooting remotely located computer equipment
- - Remote switching of residential power
- - Managing power on an electrical grid
- - Activation/deactivation of alarm and warning devices
- - Displaying or changing a digital or printed message or warning sign
- - Turning pumps on or off
- - Turning heating or cooling equipment on or off
Companies both large and small are seeking ways to save money and lower the risk
of liability by replacing processes that require human intervention with
processes that can be controlled remotely without on-site human intervention.
Today, the remote control of industrial or commercial assets and processes is
performed mainly through the use of telephone-line based systems. Opportunities
exist for companies that provide intelligent wireless solutions, as telephone
lines are expensive and limited in availability and function. Nighthawk's
products are wireless, and can be designed to work with a variety of wireless
media. The number of applications for wireless remote control is virtually
limitless. The Company has identified primary markets (Utility, IT Professional,
Traffic Control), as well as secondary markets (Irrigation, Outdoor Advertising,
Oil/Gas, Security) for its products.
During 2005, the Company hired its first full-time personnel that were dedicated
only to developing sales channels and sales opportunities Throughout 2005, the
sales staff was charged with generating new business opportunities for the
Company's core products, the NH100 rebooting device and the CEO700 whole house
disconnect device. It also launched a new website during 2005 which allows
potential customers to send contact information and product inquiries directly
to the Company via the Internet.
20
Even though the Company did not actively market its rebooting devices during
2005, if results from the one major customer are excluded from both 2004 and
2005, sales of this product actually increased from year to year. New rebooting
customers were added, primarily within the Wireless Internet Service Provider
industry. During 2005, in spite of long sales cycles typically associated with
electric utilities, the Company added over a dozen new utilities to its CEO700
customer base. More importantly, these efforts have lead to larger potential
sales opportunities within the electric utility industry. As of December 31,
2005, the Company had submitted bids on over $6.0 million in potential product
sales within the industry, and was in contact with entities that are planning
large deployments over the next 18 months.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue from product sales is recognized when all significant obligations of the
Company have been satisfied. Revenues from equipment sales are recognized either
on the completion of the manufacturing process, or upon shipment of the
equipment to the customer, depending on the Company's contractual obligations.
The Company occasionally contracts to manufacture items, bill for those items
and then hold them for later shipment to customer-specified locations. There
were no bill and hold items at March 31, 2005. Revenue related to airtime
billing is recognized when the service is performed. Some customers pre-pay
airtime on a quarterly or annual basis and the pre-paid portion is recorded as
deferred revenue. Deferred revenue, included in accrued expenses on the balance
sheet at March 31, 2005, is approximately $13,073.
STOCK-BASED COMPENSATION
We believe that stock-based compensation is a critical accounting policy that
affects our financial condition and results of operations. Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation defines a fair-value based method of accounting for stock-based
employee compensation plans and transactions in which an entity issues its
equity instruments to acquire goods or services from non-employees, and
encourages but does not require companies to record compensation cost for
stock-based employee compensation plans at fair value. The Company has chosen to
continue to account for employee stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB No. 25") and related
interpretations.
The Financial Accounting Standards Board ("FASB") issued SFAS No. 123R
"Share-Based Payment", which addresses the accounting for share-based payment
transactions. SFAS 123R eliminates the ability to account for share-based
compensation transactions using APB 25, and instead, generally requires that
such transactions be accounted and recognized in the statement of operations
based on their fair value. SFAS No. 123R offers the Company alternative methods
of adopting this standard. The Company has not yet determined which alternative
method it will use. Depending upon the number and terms of options that may be
granted in future periods, the implementation of this standard could have a
material impact on the Company's financial position and results of operations.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2006 AND MARCH 31, 2005
REVENUE
The components of revenue and their associated percentages of total revenues,
for the three months ended March 31, 2006 and 2005 are as follows:
Quarterly period ended March 31,
----------------------------
2006 2005 Change % Change $
------------- ------------- ------------- -------------
Revenues:
Rebooting products $ 47,070 33% $ 21,604 13% 118% $ 25,466
Logic boards 17,465 12% 25,853 15% (32%) (8,338)
Utility products 47,998 34% 31,225 18% 54% 16,773
Emergency notification products 17,815 13% - - n/a 17,815
Hydro 1 - - 76,750 45% n/a (76,750)
Airtime sales 8,045 6% 14,233 8% (43%) (6,188)
Other product 1,392 1% 355 0% 292% 1,037
Freight 1,602 1% 1,202 1% 33% 400
------------- ------------- ------------- -------------
Total revenues $141,387 100% $171,222 100% (17%) $(29,835)
Revenues for the three-month period ended March 31, 2006 were $141,387 as
compared to $171,222 for the corresponding period of the prior year, a decrease
of 17% between periods. During the three months ended March 31, 2005, one
customer, who purchased the Company's Hydro 1 product, represented approximately
46% of the Company's total revenue. This sale was made as part of a
stated-funded project in New Mexico, and the Company has not marketed or sold
Hydro 1's since that time. The Company does not consider the Hydro 1 to be part
of its portfolio of products that it markets and sells on an ongoing basis.
Sales of the Company's core products (rebooting, utility, emergency notification
and logic boards) increased 67% between the periods due to the marketing and
sales efforts launched by the Company during 2005. Sales of the Company's
rebooting products more than doubled, as the Company began focusing on selling
to Wireless Internet Service Providers. Sales of utility products increased 18%
as the Company added new customers to its base during 2005 and the first three
months of 2006. Utility customers typically order product on a test basis, and
then reorder on a recurring basis if they are pleased with the product's
performance. Sales of the Company's logic boards decreased between the periods
presented, but during 2005 the Company began selling FAS8 firehouse alerting
systems. Fire departments began buying the FAS8 instead of using the Company's
PT1000 logic boards for their station alerting. The decrease in sales of logic
boards of approximately $8,000 was more than offset by approximately $18,000 in
sales of FAS8's.
21
Cost of goods sold includes parts and pre-manufactured components used to
assemble our products as well as allocated overhead for production personnel and
facilities costs. Cost of goods sold decreased by $5,712 or 5% to $98,812 for
the three months ended March 31, 2006 from $104,524 for the corresponding period
of the prior year but increased as a percentage of revenues between the periods
from 61% in 2005 to 70% in 2006. As a result, the Company's gross margin
decreased between the periods from 39% to 30%. This decrease is almost entirely
due to the sale of the higher margin Hydro 1 units during the first quarter of
2005.
Selling, general and administrative expenses for the three months ended March
31, 2006 increased by $195,560 or 35% to $757,220 from $561,660 for the
three-month period ended March 31, 2005. This increase was due to the
recognition of approximately $180,000 in noncash expenses from unregistered
stock issuances to public relations firms.
Interest expense increased $469,718 or 358% between the three-month periods
presented. The increase was due to interest expense related to the Dutchess
notes and debentures, several which were paid off during the first quarter of
2006 prior to their maturity date. When this occurs, the Company expenses any
unamortized discount associated with the debt being paid off, as well as any
unamortized beneficial conversion expense, any unamortized expense associated
with incentive shares issued with the debt, and any early redemption penalties.
During the first quarter of 2006, the Company recognized interest expense of
approximately $153,000 related to the beneficial conversion feature of
debentures, as well as approximately $192,000 in interest expense related for
the value of incentive shares issued to Dutchess in exchange for money loaned to
the Company. The Company also recognized approximately $77,000 in interest
expense during the period in early redemption penalties on debentures that were
paid off during the period.
The net loss to common shareholders for the three-month period ended March 31,
2006 was $1,315,681 compared to $626,499 for the three-month period ended March
31, 2005. The increase in net loss was due primarily to increased expenses for
public relations campaigns, and interest expense related to Dutchess notes and
debentures.
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred a net loss of approximately $2.7 million during the year
ended December 31, 2005 and had a stockholders' deficit and working capital
deficiency of approximately $2.5 million and $500,000, respectively, as of
December 31, 2005. The Company's financial statements for the three months ended
March 31, 2006 have been prepared on a going concern basis, which contemplates
the realization of assets and the settlement of liabilities and commitments in
the normal course of business. The Company incurred a net loss of approximately
$1.3 million during the quarter ended March 31, 2006 and had a stockholders'
deficit and working capital deficiency of approximately $2.1 million and $57,000
respectively, as of March 31, 2006.
The Report of the Company's Independent Registered Public Accounting Firm on the
Company's financial statements as of and for the year ended December 31, 2005
includes a "going concern" explanatory paragraph which means that the auditors
expressed substantial doubt about the Company's ability to continue as a going
concern.
Although no assurance can be given that such plans will be successfully
implemented, management's plans to address these concerns include:
- - Raising working capital through additional borrowings.
- - Raising equity funding through sales of the Company's common stock.
- - Implementation of the Company's sales and marketing plans.
During the quarter ended March 31, 2006, cash used in operating activities was
approximately $605,000. Net proceeds from the issuance of a note and debentures
to Dutchess were $615,000. Major cash outlays during the quarter were
approximately $187,000 for public relations efforts, $171,000 for
payroll/employee benefits, $81,000 for inventory, $68,000 for consulting expense
and $39,000 for sales and marketing efforts.
In August 2004, the Company signed a financing arrangement with Dutchess Private
Equities, II, L.P. ("Dutchess") under which the Company received $250,000 in
exchange for a convertible debenture during August 2004. The Company also signed
an investment agreement under which Dutchess agreed to purchase up to $10.0
million in common stock from the Company, at the Company's discretion, over the
next three years, subject to certain limitations including the Company's then
current trading volume. Although the amount and timing of specific cash
infusions available under the entire financing arrangement cannot be predicted
with certainty, the arrangement represents a contractual commitment by Dutchess
to provide funds to the Company.
22
During 2005, Dutchess provided the Company with $1,461,133 in net cash proceeds
in return for convertible debentures and promissory notes totaling $2,621,469.
During the twelve months ended December 31, 2005, the Company also exercised
seventeen (17) puts to Dutchess that produced cash proceeds of $342,477, of
which $245,384 was used to repay outstanding notes and accrued interest, in
exchange for the issuance of 3,819,654 shares. On March 9, 2005, Dutchess
exercised 250,000 warrants at $0.125 each, for total proceeds of $31,250,
$15,000 of which was applied to outstanding notes and accrued interest.
The aforementioned funding from Dutchess was used to fund the cash shortfall
generated from operations during 2005 of approximately $1.6 million.
The Company issued 12,615,074 shares to Dutchess during the quarter ended March
31, 2006 which was used to pay down $1,216,193 in debt during the period.
Until the Company is able to generate positive cash flows from operations in an
amount sufficient to cover its current liabilities and debt obligations as they
become due, it will remain reliant on borrowing funds from or selling equity to
Dutchess or other parties to meet those obligations. Although the amount and
timing of specific cash infusions available under the entire financing
arrangement cannot be predicted with certainty, the arrangement represents a
contractual commitment by Dutchess to provide funds to the Company.
The aforementioned funding from Dutchess was used to fund the cash shortfall
generated from operations during 2005 of approximately $1.6 million.
Although no assurance may be given that it will be able to do so, the Company
expects to be able to continue to access funds under this arrangement to help it
fund near-term and long-term sales and marketing efforts, and to cover cash flow
deficiencies.
During 2005, the Company hired its first full-time personnel that were dedicated
only to developing sales channels and sales opportunities. The Company also
developed new or enhanced existing products in order to better penetrate
targeted markets. As a result, as of December 31, 2005, the Company had
developed a pipeline of potential sales opportunities that included in excess of
$6,000,000 for which it had submitted formal bids. No assurance may be given
that the Company will be successful in winning these bids or growing revenues
based on the pipeline of opportunities.
The Company's strategic initiatives for 2006 include:
- - Capitalize on existing enterprise sales opportunities
- - Cultivate and capitalize on indirect sales channels
- - Enhance our marketing effort to support direct and indirect sales channels
- - Bundle our products with ancillary products and services to enhance revenue
opportunities
- - Develop and sell a device that functions on multiple wireless protocols
- - Form an advisory board with relevant industry expertise and relationships
- - Execute on a strategic acquisition that is scalable and complementary to our
existing business
DESCRIPTION OF PROPERTY
The Company's sales and operations departments are in leased facilities located
at 8200 East Pacific Place, Suite 204, Denver, Colorado. The lease for this
facility expired on March 2002, but the Company has maintained use of the
facilities on a month-to-month basis since that time. The leased property
consists of approximately 2400 square feet, for which the Company pays $1,650
per month. It consists of office space and a manufacturing floor. The Company's
executive offices are located in 679 square feet of leased office space at 10715
Gulfdale, Suite 200, San Antonio, Texas. The Company leases the space at a
monthly rate of $815.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
At a meeting of the Board of Directors held on March 26, 2003, the Board
accepted the resignation of Steve Jacobson as chief executive officer, but
remained as an employee of the Company. On July 9, 2003, Steve Jacobson resigned
as a member of the Company's board of directors. On September 8, 2003, the
Company entered into a separation agreement with Steve Jacobson under which,
among other things, he agreed to a) resign as an employee of the Company; b)
return 545,454 shares of stock held by him to the Company in payment of the
$118,629 he owed the Company as of that date; and c) transfer voting rights for
shares owned or held in trust by him to Myron Anduri, an employee of the Company
for five years. Under the agreement, the Company agreed to issue Steve Jacobson
450,000 options to purchase shares of the Company's common stock at $0.22 per
share, with such options vesting over a three-year period at a rate of 150,000
shares per year. As a result of the transaction, the Company recorded an
additional $39,933 in compensation expense to Steve Jacobson for amounts owed by
him to the Company upon his resignation. The Company retired the 545,454 shares
returned to the Company under the agreement.
During 2004, the Company entered into an agreement with Steve Jacobson in which
it allowed him to transfer up to 600,000 shares of his stock, which he was
contractually restricted from selling under his separation agreement until June
2005, to various consultants who had agreed to perform services for the Company.
As of December 31, 2004, 200,000 of these shares had been distributed to a
consultant and the Company recognized $20,000 in consulting expenses related to
this transaction. The remaining 400,000 shares were not distributed, and are not
included in the issued and outstanding shares of the Company as of December 31,
2004. As part of the agreement, the Company agreed to replace Mr. Jacobson's
600,000 shares with 730,000 shares of stock that would not be eligible for
resale until November 2005. The Company recorded $13,000 in consulting expense
associated with this agreement. In addition, the Company amended Mr. Jacobson's
separation agreement to allow him to sell 50,000 shares of common stock in each
of the months of March, April, May and June 2005.
23
On December 19, 2003 the Company entered into a settlement and release agreement
with a former director, Herb Jacobson, and his wife. Under terms of the
agreement, Mr. & Mrs. Jacobson and the Company agreed to dismiss any and all
claims against each other in return for, among other things, payment of a total
of $25,000 over a four-month period from the Company to Mr. Jacobson. The
Company paid this amount during 2003 and 2004. In addition, Mr. and Mrs.
Jacobson, along with their son Steven Jacobson, agreed to refrain from selling,
transferring, conveying or otherwise disposing of their remaining share
ownership for a period of eighteen months subsequent to selling an aggregate of
850,000 shares. As a result of the agreement, the Company recorded a gain of
$23,912 due to a reduction in the amount previously recorded by the Company as
owed to Mr. Jacobson.
In August 2004, in an effort to improve its working capital position, the
Company issued 558,007 shares of common stock and warrants to purchase 558,007
common shares at $0.20 per share to an individual and a company in exchange for
approximately $88,700 in notes payable plus accrued interest owed them by the
Company. The individual is a business partner of the Company's Chairman, Max
Polinksy, and the company is affiliated with the father of Mr. Polinksy. Based
on calculations using Black-Scholes, the fair value of the warrants issued to
the two parties was $29,079. This amount is reflected in interest expense and
additional paid-in capital for the period ended December 31, 2004.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market for Common Equity
From July 8, 2002 through May 23, 2003, our common stock traded on the Over the
Counter Bulletin Board ("OTCBB") under the symbol "NIHK". From May 27, 2003
until November 25, 2003 our stock was traded on the pink sheets under the same
symbol, after which our stock resumed trading on the OTCBB. The CUSIP number is
65410X-10-4. Knight Securities, L.P., Schwab Capital Markets, L.P. and ACAP
Financial, Inc. are among the most active market makers for the stock. From
February 1, 2002 through July 8, 2002, our common stock traded on the OTCBB
under the symbol "PGRN." Prior to February 1, 2002, the stock traded on the
OTCBB under the symbol "LSIM".
The following is a table of the high and low bid prices of our stock for each of
the four quarters of the fiscal years ended December 31, 2005 and 2004, and the
first quarter of fiscal 2006:
QUARTER ENDED HIGH LOW QUARTER ENDED HIGH LOW
- -------------- ---- --- ------------- ---- ---
March 31, 2006 0.14 0.04
December 31, 2005 0.09 0.03 December 31, 2004 0.23 0.09
September 30, 2005 0.14 0.06 September 30, 2004 0.25 0.12
June 30, 2005 0.23 0.12 June 30, 2004 0.38 0.20
March 31, 2005 0.27 0.14 March 31, 2004 0.35 0.18
These quotations reflect interdealer prices, without retail mark-up, mark-down
or commission and may not represent actual transactions.
EXECUTIVE COMPENSATION
The following table sets forth the aggregate compensation paid by us for
services rendered during the periods indicated:
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM PAYOUTS
COMPENSATION AWARDS
OTHER ANNUAL RESTRICTED SECURITIES UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION ($) STOCK AWARD ($) OPTIONS/SARS (#) PAYOUTS($) COMPENSATION ($)
- --------------------------- ---- ------- ------- ---------------- --------------- -------------------- ---------- ----------------
H. Douglas Saathoff,
Chief Executive Officer (a) 2005 $115,000 $13,500 - - - - -
2004 $120,000 $ - - - 500,000 - -
2003 $115,000 $ - - - - - -
Myron Anduri, President (b) 2005 $115,000 $ - - - - - -
2004 $120,000 $ - - - 250,000 - -
2003 $ 84,125 $ - - - - - -
NOTES:
(a) H. Douglas Saathoff was named the Chief Executive Officer in March 2003.
(b) Myron Anduri was named President in December 2003. In 2004, Mr. Anduri was
given 181,416 shares of the Company's common stock in exchange for $22,276 in
debt he had incurred on the Company's behalf and for which the Company had
recognized a liability to Mr. Anduri.
24
NAME NUMBER OF SECURITIES PERCENT OF TOTAL
OPTIONS/SARS GRANTED TO EMPLOYEES UNDERLYING OPTIONS GRANTED EXERCISE OR BASE PRICE ($/SH) EXPIRATION DATE
- ------------------------------------------------------------------------------------------------------------------
No options or stock appreciation rights were granted to executive officers of
the registrant in 2004 or 2005.
Max Polinsky received 150,000 shares in return for serving as Chairman of the
Board through his term ending November 13, 2003. Patrick Gorman received 100,000
shares for serving as a board member through his term ending November 13, 2003.
Both Mr. Polinsky and Mr. Gorman were granted 75,000 options to purchase common
shares at a price of $0.22 per share in return for one year of service on the
board beginning November 13, 2003. On December 8, 2004, both Mr. Polinsky and
Mr. Gorman were granted 500,000 options to purchase common shares at a price of
$0.09 per share in return for services rendered.
EMPLOYMENT CONTRACTS
We do not have employment contracts with our executive officers.
STOCK OPTION PLANS
Nighthawk Systems, Inc. 2003 Stock Option Plan (the "Plan") authorized the
issuance of a maximum of 5,000,000 shares of common stock. Of that amount,
3,435,000 shares of common stock authorized to be issued under the Plan are
subject to outstanding options already granted under the Plan and 935,000 are
available for future grants thereunder. Participation in the Plan is limited to
those employees, directors and consultants of the Company and its subsidiaries
who are believed by the Board to be in a position to make a substantial
contribution to our success.
NUMBER OF SECURITIES REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER EQUITY COMPENSATION
NUMBER OF SECURITIES TO BE ISSUED UPON WEIGHTED AVERAGE EXERCISE PRICE PLANS (EXCLUDING SECURITIES
PLAN CATEGORY EXERCISE OF OUTSTANDING OPTIONS OF OUTSTANDING OPTIONS REFLECTED IN COLUMN (A)
- -----------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Nighthawk Systems,
Inc. 2003 Stock
Option Plan
approved by
security holders 3,435,000 $ 0.16 935,000
- -----------------------------------------------------------------------------------------------------------------------------------
ADDITIONAL INFORMATION
Our common stock is registered with the SEC under section 12(g) of the
Securities Exchange Act of 1934. We file with the SEC periodic reports on Forms
10-KSB, 10-QSB and 8-K, and proxy statements, and our officers and directors
file reports of stock ownership on Forms 3, 4 and 5. We intend to send annual
reports containing audited financial statements to our shareholders.
Additionally, we filed with the Securities and Exchange Commission a
registration statement on Form SB-2 under the Securities Act of 1933 for the
shares of common stock in the offering, of which this prospectus is a part. This
prospectus does not contain all of the information in the registration statement
and the exhibits and schedules that were filed with the registration statement.
For further information we refer you to the registration statement and the
exhibits and schedules that were filed with the registration statement.
Statements contained in this prospectus about the contents of any contract or
any other document that is filed as an exhibit to the registration statement are
not necessarily complete, and we refer you to the full text of the contract or
other document filed as an exhibit to the registration statement. A copy of the
registration statement and the exhibits and schedules that were filed with the
registration statement may be inspected without charge at the Public Reference
Room maintained by the Securities and Exchange Commission at 450 Fifth Street,
N.W., Washington, D.C. 20549, and copies of all or any part of the registration
statement may be obtained from the Securities and Exchange Commission upon
payment of the prescribed fee. Information regarding the operation of the Public
Reference Room may be obtained by calling the Securities and Exchange Commission
at 1-800-SEC-0330.
The Securities and Exchange Commission maintains a web site that contains
reports, proxy and information statements, and other information regarding
registrants that file electronically with the SEC. The address of the site is
www.sec.gov.
25
FINANCIAL STATEMENTS
INDEX
------
PAGE
------
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheet as of December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Statements of Operations for the Years Ended December 31, 2004 and 2003. . . . . . F-3
Consolidated Statements of Stockholders' Deficit for the Years Ended December 31, 2004 and 2003 F-4
Consolidated Statements of Cash Flows for the Years Ended December 31, 2004 and 2003. . . . . . F-5
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
Board of Directors
Nighthawk Systems, Inc.
We have audited the accompanying consolidated balance sheet of Nighthawk
Systems, Inc. and subsidiary ("the Company") as of December 31, 2005, and the
related consolidated statements of operations, stockholders' deficit and cash
flows for each of the years in the two-year period ended December 31, 2005.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by the 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Nighthawk Systems,
Inc. and subsidiary as of December 31, 2005, and the results of their operations
and their cash flows for each of the years in the two-year period ended December
31, 2005, in conformity with accounting principles generally accepted in the
United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company reported a net loss of
approximately $2.7 million during the year ended December 31, 2005, and has a
stockholders' deficit and working capital deficiency of approximately $2.5
million and $500,000, respectively, at December 31, 2005. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans with regard to these matters are also described in Note 1.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
GHP HORWATH, P.C.
Denver, Colorado
March 17, 2006, except for the last paragraph of Note 11 as to which the date is
April 14, 2006
F-1
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2005
ASSETS
Current assets:
Cash $ 91,205
Accounts receivable, net of allowance for doubtful accounts of $750 83,205
Inventories 79,877
Prepaids 645,534
------------
Total current assets 899,821
------------
Furniture, fixtures and equipment, net 13,431
Intangible and other assets 19,549
------------
$ 932,801
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 290,249
Accrued expenses 277,579
Line of credit 19,792
Notes payable:
Related parties 14,394
Other 805,036
------------
Total current liabilities 1,407,050
------------
Long-term liabilities:
Convertible debt 2,064,836
------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding -
Common stock; $0.001 par value; 200,000,000 shares authorized; 46,477,158 issued and outstanding 46,477
Additional paid- in capital 5,464,436
Accumulated deficit (8,049,998)
------------
Total stockholders' deficit (2,539,085)
------------
$ 932,801
============
<FN>
The accompanying notes are an integral part of these financial statements.
F-2
NIGHTHAWK SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
2005 2004
------------ ------------
Revenue $ 528,689 $ 610,180
Cost of goods sold 369,331 438,473
------------ ------------
Gross profit 159,358 171,707
Selling, general and administrative expenses 1,947,420 1,311,824
------------ ------------
Loss from operations (1,788,062) (1,140,117)
Interest expense
Related parties 2,055 44,656
Other 902,539 191,978
------------ ------------
Net loss (2,692,656) (1,376,751)
Less: preferred stock dividends (440) (644)
------------ ------------
Net loss to common stockholders $(2,693,096) $(1,377,395)
============ ============
Net loss to common stockholders per basic and diluted common share $ (0.07) $ (0.05)
============ ============
Weighted average common shares outstanding - basic and diluted 39,094,751 27,674,693
<FN>
The accompanying notes are an integral part of these financial statements.
F-3
Nighthawk Systems, Inc.
Consolidated Statements of Stockholders' Deficit
Years ended December 31, 2005 and 2004
Preferred Stock Common stock
--------------- ------------------- Additional Special Accumulated
Shares Amount Shares Amount paid-in capital Warrants deficit Total
------ ------ ---------- -------- --------------- -------- ----------- ------------
Balances, December 31, 2003 - $ - 24,320,902 $ 24,321 $ 2,855,289 $ - $(3,980,591) $(1,100,981)
Common stock and warrants issued and
options exercised for cash 1,488,333 1,488 235,863 188,775 426,126
Common stock and options issued for
consulting and other services 2,345,000 2,345 323,228 325,573
Common stock issued for interest 61,875 62 12,312 12,374
Conversion of notes payable to
common stock and warrants 1,439,423 1,440 311,413 312,853
Preferred stock issued for cash 5,000 12,500 - 12,500
Warrants issued for cash 18,750 18,750
Common stock issued for
placement fees & incentives 350,000 350 37,150 37,500
Beneficial conversion feature
of convertible debt 92,465 92,465
Common stock issued for
investment agreement placement fee 2,000,000 2,000 (2,000) -
Cancellation of shares (50,000) (50) 50 -
Series A preferred dividend 3,714 4 (4) -
Net loss (1,376,751) (1,376,751)
------ ------ ---------- -------- --------------- -------- ----------- ------------
Balances, December 31, 2004 5,000 $12,500 31,959,247 $ 31,960 $ 3,884,516 $188,775 $(5,357,342) $(1,239,591)
Common stock issued for exercise of
Dutchess puts and warrants, including
commissions 4,105,616 4,070 358,079 362,185
Common stock and warrants issued for cash 750,000 750 116,750 117,500
Common stock issued as incentive
on notes payable 3,777,500 3,777 333,498 337,275
Common stock and options issued for
consulting and other services 1,200,000 1,200 235,175 236,375
Common stock issued as settlement
of lawsuit 250,000 250 22,250 22,500
Conversion of accrued liabilities
to common stock 313,100 313 56,307 56,620
Conversion of debenture and accrued
interest to common stock 2,761,958 2,762 252,228 254,990
Series A preferred dividend 2,487 2 (2) -
Conversion of Series A Preferred
stock to common stock (5,000) (12,500) 50,000 50 12,450 -
Exercise of Special Warrants 1,307,250 1,307 187,468 (188,775) -
Amortization of beneficial conversion
feature on notes payable 5,717 5,717
Net loss (2,692,656) (2,692,656)
------ ------ ---------- -------- --------------- -------- ----------- ------------
Balances, December 31, 2005 - $ - 46,477,158 $ 46,477 $ 5,464,436 $ - $(8,049,998) $(2,539,085)
====== ====== ========== ======== =============== ======== =========== ============
F-4
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
TWELVE MONTHS ENDED DECEMBER 31,
2005 2004
------------ ------------
Cash flows from operating activities:
Net loss $(2,692,656) $(1,376,751)
------------ ------------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 6,438 7,707
Bad debt expense 1,861 380
Common stock issued for consulting and other services 258,250 205,775
Beneficial conversion feature 5,717 92,465
Common stock and warrants issued for interest 14,365 78,658
Common stock issued as placement fee on notes payable - 37,500
Common stock issued as settlement for lawsuit 22,500 -
Note payable issued for consulting 8,283 -
Loan discounts and warrants 327,032 15,104
Notes payable issued for penalty interest 251,636 -
Shares issued as incentives on notes payable 275,142 -
Stock options issued for consulting services 13,875 119,798
Changes in assets and liabilities, net of business acquisition:
(Increase) in accounts receivable (39,312) (4,217)
Decrease (increase) in inventories (53,168) 48,620
Decrease (ncrease) in prepaids 10,329 (105,407)
Increase in intangible and other assets (5,807) (5,084)
Increase (decrease) in accounts payable (132,005) 29,716
Increase in accrued expenses 84,869 3,852
------------ ------------
Total adjustments 1,050,005 524,867
------------ ------------
Net cash used in operating activities of continuing operations (1,642,651) (851,884)
------------ ------------
Cash flows from investing activities:
Purchases of furniture, fixtures and equipment (6,802) -
------------ ------------
Net cash used in investing activities (6,802) -
------------ ------------
Cash flows from financing activities:
Cash overdraft - (3,902)
Proceeds from the sale of preferred stock - 12,500
Proceeds from notes payable, related parties - 26,261
Payments on notes payable, related parties (1,008) (36,318)
Proceeds from notes payable, other and warrants 1,461,133 585,000
Payments on notes payable, other (21,410) (71,664)
Payments on other related party payable - (25,000)
Proceeds from sale of note 3,000
Proceeds from exercise of warrants 31,250
Proceeds from exercise of puts, net of commissions 89,075
Proceeds from the issuance of special warrants - 188,775
Proceeds from the sale of common stock 117,500 237,350
------------ ------------
Net cash provided by financing activities 1,679,540 913,002
------------ ------------
Net increase in cash 30,087 61,118
Cash, beginning balance 61,118 -
------------ ------------
Cash, ending balance $ 91,205 $ 61,118
============ ============
F-5
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
TWELVE MONTHS ENDED DECEMBER 31,
(CONTINUED)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
2005 2004
------------ ------------
Cash paid for interest $ 38,717 $ 26,228
============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common shares issued as incentives for notes payable, other $ 337,275
============
Common shares and options issued for prepaid consulting agreements $ 236,375
============
Conversion of accrued expenses to common stock $ 56,620
============
Conversion of Series A preferred stock to common stock $ 12,500
============
Conversion of Special Warrants to common stock $ 188,775
============
Common shares issued as payments on notes payable, other $ 245,384
============
Common shares issued for commissions on puts $ 5,568
============
Conversion of notes payable and accrued interest to common stock
Notes payable $ 240,625 $ 224,390
Accrued interest 14,365 22,179
------------ ------------
Total amount converted $ 254,990 $ 246,569
============ ============
Preferred stock dividends issued in common stock $ 440 $ 644
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
F-6
NIGHTHAWK SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
1. ORGANIZATION, GOING CONCERN, RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS
ORGANIZATION
Nighthawk Systems, Inc. ("Nighthawk" or "the Company") designs and manufactures
intelligent remote power control products that are easy to use, inexpensive and
can remotely control virtually any device from any location. The Company's
proprietary, wireless products are ready to use upon purchase, so they are
easily installed by anyone, regardless of technical ability, and are also easily
integrated into third-party products, systems and processes. They allow for
intelligent control by interpreting instructions sent via paging and satellite
media, and executing the instructions by 'switching' the electrical current that
powers the device, system or process. Nighthawk's intelligent products can be
activated individually, in pre-defined groups, or en masse, and for specified
time periods with a simple click of a mouse or by dialing a telephone number.
GOING CONCERN, RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS
The Company incurred a net loss of approximately $2.7 million during the year
ended December 31, 2005 and had a stockholders' deficit and working capital
deficiency of approximately $2.5 million and $500,000, respectively, as of
December 31, 2005. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Although no assurance can be given that
such plans will be successfully implemented, management's plans to address these
concerns include:
1. Raising working capital through additional borrowings.
2. Raising equity funding through sales of the Company's common stock.
3. Implementation of the Company's sales and marketing plans.
In August 2004, the Company signed a financing arrangement with Dutchess Private
Equities, II, L.P. ("Dutchess") under which the Company received $250,000 in
exchange for a convertible debenture during August 2004. The Company also signed
an investment agreement under which Dutchess agreed to purchase up to $10.0
million in common stock from the Company, at the Company's discretion, over the
next three years, subject to certain limitations including the Company's then
current trading volume. Although the amount and timing of specific cash
infusions available under the entire financing arrangement cannot be predicted
with certainty, the arrangement represents a contractual commitment by Dutchess
to provide funds to the Company.
From August 2004, when Dutchess first provided funding to the Company, through
December 31, 2005, Dutchess provided the Company with $1,960,633 in net cash
proceeds in return for convertible debentures and promissory notes totaling
$2,621,469. During the twelve months ended December 31, 2005, the Company also
exercised seventeen (17) puts to Dutchess that produced cash proceeds of
$342,477, of which $245,384 was used to repay outstanding notes and accrued
interest, in exchange for the issuance of 3,819,654 shares. On March 9, 2005,
Dutchess exercised 250,000 warrants at $0.125 each, for total proceeds of
$31,250, $15,000 of which was applied to outstanding notes and accrued interest.
For more information on the transactions with Dutchess, please see Note 7 -
Notes payable, Note 8 - Stockholders' deficit, and Note 11 - Subsequent events.
Although no assurance may be given that it will be able to do so, the Company
expects to be able to continue to access funds under this arrangement to help it
fund near-term and long-term sales and marketing efforts, and to cover cash flow
deficiencies.
F-7
During 2005, the Company hired its first full-time personnel that were dedicated
only to developing sales channels and sales opportunities. The Company also
developed new or enhanced existing products in order to better penetrate
targeted markets. As a result, as of December 31, 2005, the Company had
developed a pipeline of potential sales opportunities that included in excess of
$6,000,000 for which it had submitted quotes at customers' requestsNo assurance
may be given that the Company will be successful in winning these bids or
growing revenues based on the pipeline of opportunities.
The Company's strategic initiatives for 2006 include:
- - Capitalize on existing enterprise sales opportunities
- - Cultivate and capitalize on indirect sales channels
- - Enhance our marketing effort to support direct and indirect sales channels
- - Bundle our products with ancillary products and services to enhance revenue
opportunities
- - Develop and sell a device that functions on multiple wireless protocols
- - Form an advisory board with relevant industry expertise and relationships
- - Execute on a strategic acquisition that is scalable and complementary to our
existing business
The accompanying financial statements do not include any adjustments relating to
the recoverability and classification of assets or the amounts of liabilities
that might be necessary should the Company be unsuccessful in implementing these
plans, or otherwise be unable to continue as a going concern.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenue from product sales is recognized when all significant obligations of the
Company have been satisfied. Revenues from equipment sales are recognized either
on the completion of the manufacturing process, or upon shipment of the
equipment to the customer, depending on the Company's contractual obligations.
The Company occasionally contracts to manufacture items, bill for those items
and then hold them for later shipment to customer-specified locations. The
Company had no bill and hold sales at December 31, 2005 or December 31, 2004.
Revenue related to airtime billing is recognized when the service is performed.
Some customers pre-pay airtime on a quarterly or annual basis and the pre-paid
portion is recorded as deferred revenue. Deferred revenue, included in accrued
expenses on the balance sheet at December 31, 2005, is approximately $12,200.
PROVISION FOR DOUBTFUL ACCOUNTS
The Company reviews accounts receivable periodically for collectibility and
establishes an allowance for doubtful accounts and records bad debt expense when
deemed necessary.
CONCENTRATIONS
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of trade accounts receivable. Receivables arising
from sales to customers are not collateralized and, as a result, management
continually monitors the financial condition of its customers to reduce the risk
of loss. At December 31, 2005, the Company had approximately $83,200 in accounts
receivable, net of the allowance for doubtful accounts. Approximately $39,106 of
this balance, or 47%, was from three customers. Each balance was collected
subsequent to December 31, 2005.
During 2005, two customers accounted for approximately 12% and 15% of total
revenue, respectively. During 2004, three customers accounted for approximately
26%, 20% and 12% of sales, respectively.
During 2005, the Company's single largest supplier accounted for approximately
54% of the Company's purchases of pre-manufactured component materials. During
2004, the Company's three largest suppliers accounted for approximately 47%, 11%
and 11%, respectively, of the Company's purchases of pre-manufactured component
materials. As the pre-manufactured components are a crucial integral component
of the Company's product, the loss of one or more of the Company's major
suppliers may have an adverse effect on the Company's ability to maintain
production of their products on a cost effective basis in the future.
F-8
INVENTORIES
Inventories consist of parts and pre-manufactured component materials and
finished goods. Inventories are valued at the lower of cost or market using the
first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is recorded using the
straight-line method over the estimated useful lives of five to seven years.
Maintenance and repairs are expensed as incurred and improvements are
capitalized. Upon sale or retirement of assets, the cost and related accumulated
depreciation or amortization is eliminated from the respective accounts and any
resulting gains or losses are reflected in operations.
INTANGIBLE ASSETS
Intangible assets include patent costs and are stated at cost. If the patents
are granted, the Company will then begin to amortize the patents over the
shorter of the lives of the patents or the estimated useful lives using the
straight-line method. The Company reviews these and any other long-lived assets
for impairment whenever events or changes in circumstances indicate their
carrying amounts may not be recoverable. Recoverability of an asset to be held
and used is measured by a comparison of the carrying amount of the asset to
future undiscounted cash flows expected to be generated by the asset. If the
asset is considered to be impaired, the impairment to be recognized is measured
by the amount by which the carrying amount of the asset exceeds the fair value
of the asset. Based on its review, management does not believe that any
impairment of intangible or other long-lived assets exists at December 31, 2005.
ADVERTISING
Advertising costs are expensed as incurred. For the years ended December 31,
2005 and 2004, advertising costs were approximately $9,600 and $9,200,
respectively.
INCOME TAXES
Deferred tax assets and liabilities are recorded for the estimated future tax
effects of temporary differences between the tax basis of assets and liabilities
and amounts reported in the accompanying balance sheets, and for operating loss
and tax credit carry forwards. The change in deferred tax assets and liabilities
for the period measures the deferred tax provision or benefit for the period.
Effects of changes in enacted tax laws on deferred tax assets and liabilities
are reflected as adjustments to the tax provision or benefit in the period of
enactment. The Company's deferred tax assets have been completely reduced by a
valuation allowance because management does not believe realization of the
deferred tax assets is sufficiently assured at the balance sheet date.
FINANCIAL INSTRUMENTS
The carrying amounts of cash, accounts receivable and accounts payable
approximate their fair values due to their short duration. Notes with floating
or fixed interest rates approximate their fair values based on market rate
information currently available to the Company. The fair values of notes with
related parties are not practicable to estimate based upon the related party
nature of the underlying transactions.
NET LOSS PER SHARE
Basic net loss per share is computed by dividing the net loss applicable to
common stockholders by the weighted-average number of shares of common stock
outstanding for the year. Diluted net loss per share reflects the potential
dilution that could occur if dilutive securities were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company, unless the effect of such inclusion would reduce
a loss or increase earnings per share. For the years ended December 31, 2005 and
2004, the effect of the inclusion of dilutive shares would have resulted in a
decrease in loss per share. Accordingly, the weighted average shares outstanding
have not been adjusted for dilutive shares.
USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect 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.
F-9
SHIPPING AND HANDLING FEES AND COSTS
The Company records shipping and handling fees billed to customers as revenue,
and shipping and handling costs incurred with the delivery of its products as
cost of sales. For the years ended December 31, 2005 and 2004, the Company
recognized approximately $5,468 and $6,900, respectively, as revenue from
shipping and handling fees. For the years ended December 31, 2005 and 2004, the
Company recognized approximately $6,700 and $4,300, respectively, in cost of
sales for shipping and handling fees.
RECLASSIFICATIONS
Certain amounts reported in the consolidated financial statements for the year
ended December 31, 2004 have been reclassified to conform to the December 31,
2005 presentation.
SHARE-BASED PAYMENT TRANSACTIONS
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R "Share-Based Payment", which addresses the accounting for share-based
payment transactions. SFAS 123R eliminates the ability to account for
share-based compensation transactions using APB 25, and instead, generally
requires that such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123R will be effective for small
business issuers as of the beginning of the first interim or annual reporting
period that begins after December 15, 2005. SFAS No. 123R offers the Company
alternative methods of adopting this standard. The Company has not yet
determined which alternative method it will use. Depending upon the number and
terms of options that may be granted in future periods, the implementation of
this standard could have a material impact on the Company's financial position
and results of operations.
STOCK-BASED COMPENSATION
The Company has adopted Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). The provisions of SFAS
123 allow companies to either expense the estimated fair value of stock options
or to continue to follow the intrinsic value method set forth in Accounting
Principles Bulletin Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") but disclose the pro forma effects on net income (loss) had the fair
value of the options been expensed. The Company has elected to continue to apply
APB 25 in accounting for its employee stock option incentive plans.
Under APB 25, where the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation is recognized. As all employee options were issued at or above
market during 2005 and 2004, no compensation expense was recognized in either
year. If compensation expense for the Company's stock-based compensation plans
had been determined consistent with SFAS 123, the Company's net loss and net
loss per share including pro forma results would have been the amounts indicated
below:
YEAR ENDED DECEMBER 31,
-----------------------
2005 2004
-------------- ----------------
Net loss applicable to common stockholders:
As reported $ (2,692,656) $ (1,377,395)
Total stock-based employee compensation
expense determined under fair value
based method for all employee awards, net (20,265) (68,703)
-------------- ----------------
Pro forma net loss $ (2,672,391) $ (1,446,098)
============== ================
Net loss per share:
As reported:
Basic and diluted $ (0.07) $ (0.05)
Pro forma:
Basic and diluted $ (0.07) $ (0.05)
The pro forma effect on net loss may not be representative of the pro forma
effect on net income or loss of future years due to, among other things: (i) the
vesting period of the stock options and the (ii) fair value of additional stock
options in future years.
For the purpose of the above table, the fair value of each option grant is
estimated as of the date of grant using the Black-Scholes option-pricing model
with the following assumptions:
Black-Scholes Assumptions
2005 2004
Dividend yield 0.00% 0.00%
Expected volatility 1.117 - 1.31 1.167
Risk-free interest rate 4.50% 4.50%
Expected life in years 2 years 2 years
F-10
The weighted average fair value at date of grant for options granted during 2005
was $0.086 The fair value at grant date for options granted in 2004 was $0.055
per share using the above assumptions.
The weighted average fair value at date of grant for options granted during 2005
was $0.086 The fair value at grant date for options granted in 2004 was $0.055
per share using the above assumptions.
3. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following at December 31, 2005:
Equipment $ 37,108
Furniture and fixtures 3,378
Software 3,171
----------
43,657
Less accumulated depreciation (30,226)
----------
$ 13,431
==========
4. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office and warehouse space under month-to-month operating
leases in Denver, Colorado and San Antonio, Texas. Rent expense incurred for the
years ended December 31, 2005 and 2004 was approximately $29,600 each year.
LITIGATION
In April 2004, the Company, along with current officers, board members, and
several of the Company's former directors, were sued in the Colorado District
Court by a former director (Larry Brady) and former member of management (Mark
Brady, Larry's son) for, among other things, breach of contract for unlawful
termination and failure to provide stock allegedly promised during their service
as Company director and chief financial officer, respectively, for part of 2001
and part of 2002. The Company denied the allegations. Further, the Company
counter-sued the Bradys for non-performance and breach of fiduciary duties.
Pursuant to a court order, dated June 23, 2005, the judge terminated the Bradys'
lawsuit, dismissing it, outright. In July of 2005, in an effort to bar the
Bradys from raising these issues in the future, the Company engaged in a mutual
release of all claims and issued a total of 250,000 shares of unregistered
common stock and $10,000 to Lawrence Brady, Mark Brady, and their counsel. The
Company recognized $32,500 in expenses for the quarter ended June 30, 2005 in
relation to this settlement.
Certain claims and lawsuits have arisen against the Company in its normal course
of business. The Company believes that such claims and lawsuits have not had,
and will not have, a material adverse effect on the Company's financial
position, cash flow or results of operations.
5. INCOME TAXES
The Company accounts for income taxes using the liability method in accordance
with SFAS No. 109, Accounting for Income Taxes. The liability method provides
that the deferred tax assets and liabilities are recorded based on the
difference between the tax bases of assets and liabilities and their carrying
amount for financial reporting purposes, as measured by the enacted tax rates
and laws that will be in effect when the differences are expected to reverse.
Deferred tax assets are carried on the balance sheet with the presumption that
they will be realizable in future periods when pre-tax income is generated.
Predicting the ability to realize these assets in future periods requires a
great deal of judgment by management. In management's judgment, the Company
cannot predict with reasonable certainty that the tax assets resulting from
losses will be fully realized in future periods. SFAS No. 109 requires a
valuation allowance to reduce the deferred tax assets reported if, based on the
weight of the evidence, it is more likely than not that some portion or all of
the deferred tax assets will not be realized. After consideration of all of the
evidence, both positive and negative, management determined that a $2,739,000
valuation allowance at December 31, 2005 was necessary to reduce the deferred
tax assets to the amount that will more likely than not be realized. The change
in the valuation allowance for the current year is a net increase of $972,000.
At December 31, 2005, the Company has approximately $7.45 million of net
operating loss carryforwards, which expire from 2014 through 2025. The net
operating loss carryforwards include losses from the acquisition of PCT and may
be subject to certain restrictions in the future.
Income tax benefit consists of the following:
F-11
YEARS ENDED DECEMBER 31,
2005 2004
------------ ------------
Deferred tax benefit
Federal $ (868,000) $ (444,000)
State (134,000) (69,000)
------------ ------------
(1,002,000) (513,000)
Increase in valuation allowance 1,002,000 513,000
------------ ------------
$ - $ -
============ ============
The difference between the expected tax (benefit) computed at the Federal
statutory income tax rate of 34% and the effective tax rate for the years ended
December 31, 2005 and 2004 follows:
YEARS ENDED DECEMBER 31,
2005 2004
-------------- ---------------
AMOUNT % AMOUNT %
-------------------------------
Computed "expected" tax $(916,000) 34% $(469,000) 34%
State income taxes, net of federal
income tax benefit (88,000) 3% (46,000) 3%
Increase in valuation allowance 1,002,000 -37% 513,000 -37%
Non-deductible expenses and other 2,000 0% 2,000 0%
-------------------------------
$ - 0% $ - 0%
===============================
Significant deferred tax assets and liabilities represent the future impact of
temporary differences between the financial statement and tax bases of assets
and liabilities. The Company's deferred tax assets have been completely reduced
by a valuation allowance because management does not believe realization of the
deferred tax assets is sufficiently assured at the balance sheet date. The
deferred tax assets and associated valuation allowance are as follows:
YEARS ENDED DECEMBER 31,
2005 2004
------------- -------------
Deferred tax assets:
Net operating loss carry forwards $ 2,739,000 $ 1,737,000
Valuation allowance (2,739,000) (1,737,000)
------------- -------------
Net deferred tax assets $ - $ -
============= =============
6. LINE OF CREDIT
The Company has $19,792 outstanding at December 31, 2005 under a $20,000
unsecured line of credit with a bank. Borrowings under the line of credit bear
interest at an annual rate of 10.25% at December 31, 2005. Interest is due
monthly. The line of credit is guaranteed by three stockholders and an officer
of the Company.
F-12
7. NOTES PAYABLE
At December 31, 2005, notes payable consist of the following:
Related parties:
Note payable, officer; unsecured; interest at prime rate plus 5.5% (12.75 % at December 31, 2005);
due on demand $ 9,555
Note payable, officer; unsecured; interest at 23.99%, revolving 4,839
----------
14,394
==========
Other:
Convertible note payable to stockholder, 8% interest rate, in default as of the date of this
report, secured by all assets of the Company(1) $160,000
Notes payable to stockholder, 8% interest rate, in default as of the date of this report,
secured by all assets of the Company (1) $165,000
Unsecured note with a financial institution, 17.24% interest rate, interest and principal
due monthly through November 2008 19,102
Dutchess note payable, $156,000 face amount, no stated interest rate but with an implied
annual rate of 41.70%, due August 3, 2006 110,166
Dutchess note payable, $162,000 face amount, no stated interest rate but with an implied
annual rate of 36.68%, due September 1, 2006 54,916
Dutchess note payable, $150,000 face amount, no stated interest rate but with an implied
annual rate of 41.71%, due October 31, 2006 129,167
Dutchess note payable, $198,000 face amount, no stated interest rate but with an implied
annual rate of 41.09%, due December 12, 2006 166,685
----------
$ 805,036
==========
Long Term:
Dutchess convertible debenture, 10% interest rate, due October 3, 2010, implied annual rate of 13.5% $ 145,000
Dutchess convertible debenture, 5% interest rate, due December 1, 2010 500,000
Dutchess convertible debenture, 10% interest rate, due December 12, 2009 1,419,836
----------
$2,064,836
==========
<FN>
1) Based upon discussions with the shareholder, who is a former board member,
the Company does not expect to receive a notice of default and to have the notes
called by the holder. However, no assurance may be given that this will be the
case.
During 2005, Dutchess loaned the company net cash proceeds of $1,461,133 in the
form of short-term promissory notes and long-term convertible debentures. The
promissory notes have no stated interest rate but have a face amount greater
than the funded amount. The notes are recorded by the Company at the discounted
amount, and the difference between the face and funded amount is recognized as
interest expense over the life of the loan. Outstanding principal balances on
promissory notes that matured during the year were rolled into new promissory
notes or debentures, plus a 10% penalty on the face amount of the note that
expired. The convertible debentures carry interest rates of 10%. Dutchess also
received incentive shares on all new cash proceeds loaned to the Company. These
incentive shares are recorded as prepaid interest and expensed over the life of
the loan. As collateral for the promissory notes, Dutchess holds put notices
which it may exercise in order to pay down the note balances. The following
paragraphs describe activity during 2005 on notes and debentures between the
Company and Dutchess.
F-13
During the year, Dutchess was issued 2,761,958 shares of common stock in
exchange for converting the remaining $254,990 in outstanding principal and
interest on the $250,000 convertible debenture entered into during August 2004.
On January 18, 2005, Dutchess loaned the Company $225,000. The note had no
stated interest rate but had a face amount of $270,000 and matured on May 18,
2005. Dutchess was issued 250,000 incentive shares of unregistered common stock
for the note, which made the implied annual interest rate on the note 194.5%.
The Company made payments of $140,633 on this note before the remaining balance,
plus a $27,000 penalty, was rolled into a note dated May 19, 2005. See below.
On April 7, 2005, Dutchess loaned the Company $488,500 which generated net cash
proceeds of $157,000 to the Company. The remaining $331,000 borrowed under this
note was a rollover of promissory note dated December 3, 2004 with a face amount
of $300,000, which matured on April 3, 2005. The note had no stated interest
rate but had a face amount of $586,200 and matured on June 7, 2005. Dutchess was
issued 250,000 incentive shares of unregistered common stock for the note, which
made the implied interest rate on the note 121%. Dutchess also required the
Company to hire Edgarization, LLC for consulting services and Nighthawk issued
the consulting company 300,000 shares of common stock. The Company recorded the
fair value of these shares as prepaid consulting and will expense their value
over the term of the agreement. The Company made no payments on this note before
the face amount of the note, plus a penalty and penalty interest of $73,954 was
rolled into a note dated July 8, 2005. See below
On May 12, 2005, Dutchess loaned the Company $100,000. The note had no stated
interest rate but had a face amount of $120,000 and matured on December 12,
2005. Dutchess was issued 100,000 incentive shares of unregistered common stock
for the note, which made the implied annual interest rate 73.70%. The Company
made no payments on this note before the face amount of the note, plus a penalty
of $12,000 was rolled into a convertible debenture dated December 30, 2005. See
below.
On May 19, 2005, Dutchess loaned the Company $200,000 which generated net cash
proceeds of $43,633 to the Company. The remaining $156,367 borrowed under this
note was a rollover of the remaining principle balance outstanding on the note
dated January 18, 2005, plus a penalty of $27,000, described above. The note had
no stated interest rate but had a face amount of $240,000 and matured on
December 19, 2005. Dutchess was issued 200,000 incentive shares of unregistered
common stock for the note, which made the implied annual interest rate on the
note 71.55%. The Company made no payments on this note before the face amount of
the note, plus a penalty of $24,000 was rolled into a convertible debenture
dated December 30, 2005. See below.
On June 8, 2005, Dutchess loaned the Company $100,000. The note had no stated
interest rate but had a face amount of $120,000 and matured on January 8, 2006.
Dutchess was issued 100,000 incentive shares of unregistered common stock for
the note, which made the implied annual interest rate on the note 65.16%. The
Company made no payments on this note before the face amount of the note, plus a
penalty of $12,000 was rolled into a convertible debenture dated December 30,
2005. See below.
On July 8, 2005, Dutchess loaned the Company $795,154 which generated net cash
proceeds of $135,000 to the Company. The remaining $660,154 borrowed under this
note was a rollover of the remaining principle balance outstanding on the note
dated April 7, 2005, plus a penalty and penalty interest of $73,954, described
above. The note had no stated interest rate but had a face amount of $820,154
and was scheduled to mature on February 8, 2006. Dutchess was issued 285,000
incentive shares of unregistered common stock for the note, which made the
implied annual interest rate on the note 11.81%. The Company made no payments on
this note before the face amount of the note, plus a penalty of $82,015 was
rolled into a convertible debenture dated December 30, 2005. See below.
On August 3, 2005, Dutchess loaned the Company $130,000. The note had no stated
interest rate but had a face amount of $156,000 and matures on August 3, 2006.
Dutchess was issued 285,000 incentive shares of unregistered common stock for
the note, which makes the implied annual interest rate 41.7% . The Company made
$30,667 in payments against this note prior to December 31, 2005 through the
exercise of puts under its investment agreement.
On September 1, 2005, Dutchess loaned the Company $135,000. The note had no
stated interest rate but had a face amount of $162,000 and matures on September
1, 2006. Dutchess was issued 285,000 incentive shares of unregistered common
stock for the note, which makes the implied annual interest rate on the note
36.68%. The Company made $89,084 in payments against this note prior to December
31, 2005 through the exercise of puts under its investment agreement.
On October 3, 2005, Dutchess loaned the Company $145,000 under a convertible
debenture that matures on October 3, 2010. The debenture has a stated annual
interest rate of 10%. Dutchess was issued 362,500 incentive shares of
unregistered common stock for the note, which makes the implied annual interest
rate 13.5%. The Company did not make any payments against this debenture prior
to December 31, 2005.
On October 31, 2005, Dutchess loaned the Company $125,000. The promissory note
had no stated interest rate but had a face amount of $150,000 and matures on
10/31/06. Dutchess was issued 460,000 incentive shares of unregistered common
stock for the note, which makes the implied annual interest rate on the note
41.71%. The Company did not make any payments against this note prior to
December 31, 2005.
On December 12, 2005, Dutchess loaned the Company $165,000. The promissory note
had no stated interest rate but had a face amount of $198,000 and matures on
12/12/06. Dutchess was issued 1,200,000 incentive shares of unregistered common
stock for the note, which makes the implied annual interest rate on the note
41.09%. The Company did not make any payments against this note prior to
December 31, 2005.
F-14
On December 30, 2005, Dutchess converted the outstanding principle balances on
notes dated May 12, May 19, June 8 and July 8 2005, plus combined total
penalties of $130,015, into a $1,419,836 convertible debenture that matures
December 30, 2009. The debenture has a stated annual interest rate of 10%. No
incentive shares were issued for this debenture, and no payments were made
against the debenture prior to December 31, 2005.
Effective December 1, 2005, the Company entered into a twelve month consulting
agreement with Dutchess Advisors LLC, an entity affiliated with Dutchess, under
which Dutchess Advisors will advise the Company with respect to operations,
business strategy and capital structure. As compensation under the agreement,
Dutchess Advisors will receive cash compensation of $10,000 per month.
Additionally, Dutchess Advisors paid the Company $3,000 for a $500,000
convertible debenture that matures on December 1, 2005 and carries an annual
interest rate of 5%.
8. STOCKHOLDERS' DEFICIT
PREFERRED STOCK
The Company has authorized 5,000,000 shares of $0.001 par value, preferred
stock. At December 31, 2004 there were 5,000 shares of preferred stock issued
and outstanding. The Preferred Stock paid a 7% annual dividend, on a quarterly
basis, in the form of Company common stock and was converted into 50,000 common
shares of the Company on June 30, 2005. Preferred stock dividends of $440 were
accrued during the year which are payable in 2,487 shares of common stock of the
Company.
COMMON STOCK
The Company held a special shareholders' meeting on January 6, 2005 where an
amendment to the Amended and Restated Articles of Incorporation of Nighthawk
Systems, Inc. was approved to increase the number of authorized shares of our
common stock from 50,000,000 to 200,000,000.
During the first quarter of 2005, the Company sold 650,000 shares of common
stock to an investor for cash at a price of $0.15 per share for proceeds of
$97,500. Warrants to purchase 650,000 shares of common stock at an exercise
price of $0.25 per share were also included in the sale. We did not publicly
offer the securities for sale and the investor is an accredited investor. No
underwriters were involved in the sale.
During the second quarter of 2005, the Company sold 100,000 shares of common
stock to a business partner of the Company's Chairman for $20,000. We did not
publicly offer the securities for sale and this person is an accredited
investor. No underwriters were involved in the sale.
During the year ended December 31, 2005, Dutchess was issued 2,761,958 shares of
common stock in exchange for converting the remaining $254,990 in outstanding
principal and interest on the $250,000 convertible debenture entered into during
August 2004. The Company also issued 3,820,154 shares of common stock to
Dutchess for the exercise of 17 puts totaling $342,477 during the year under its
investment agreement with Dutchess. Of this total,$245,384 in cash proceeds were
used to pay down existing note balances, and the remaining $97,093 was used for
working capital purposes. Dutchess also exercised 250,000 warrants and received
250,000 shares of common stock in return for $31,250 in cash proceeds to the
Company. Of this total, $15,000 was used to pay down an existing note balance,
and the remainder was used by the Company for working capital purposes. A total
of 3,777,500 incentive shares of unregistered common stock were issued to
Dutchess during 2005 in return for notes and debentures entered into with the
Company during the year.
A total of 1,200,000 shares of common stock were issued during 2005 to
consultants and others in return for $230,525 in services, and 592,859 shares of
common stock were issued during 2005 in exchange for accrued liabilities of
$73,428.
During 2005, 1,307,250 common shares were issued upon the automatic conversion
the Special Warrants issued in 2004. The Special Warrants were sold in 2004 for
net proceeds of $188,775 and consisted of the right to one share of the
Company's common stock and one warrant to purchase a share of the Company's
common stock for $0.30. The warrants remain unexercised as of the date of this
report.
The Company recognized 5,717 of beneficial conversion feature as interest
expense during 2005 related to debentures held by Dutchess.
Common stock warrant transactions during 2005 and 2004 are summarized below:
WARRANTS WEIGHTED AVERAGE EXERCISE PRICE
-------- -------------------------------
Outstanding at December 31, 2003 3,879,000 $ 0.32
Granted 3,530,006 0.26
Exercised - -
Forfeited (2,304,000) 0.45
Other (a) 1,510,050 0.10
-------------- ---------------
Outstanding at December 31, 2004 6,615,056 0.19
Granted - -
Exercised 250,000 .13
Forfeited (1,075,000) .25
Other (a) (2,010,050) 0.10
-------------- ---------------
Outstanding at December 31, 2005 3,280,006 $ 0.27
============== ===============
F-15
(a) Based on an agreement signed in 2003, one warrant holder could exercise up
to $200,000 in warrants prior to March 31, 2005 at the lesser of $2.00 per share
or 50% of the consecutive 10-day average closing price prior to the election to
exercise the warrant. As of December 31, 2003, 500,000 warrants were included in
the total above. As of December 31, 2004, the holder had the right to exercise
up to 2,010,050 warrants at $0.0995 each, so 1,050,050 warrants were added as
outstanding. The agreement expired in 2005, so the entire balance of 2,010,050
was deducted from the totals during 2005.
9. RELATED PARTY TRANSACTIONS
During the year ended December 31, 2004, a business partner of the Company's
Chairman billed the Company $20,000 for consulting services. The liability was
settled for 175,000 shares of the Company's common stock in the first quarter of
2005. During the second quarter of 2005, the Company sold 100,000 shares of
common stock to this same individual for $20,000. We did not publicly offer the
securities for sale and this person is an accredited investor. No underwriters
were involved in the sale.
10. STOCK OPTIONS
Upon the reverse acquisition of Peregrine, Inc. on February 1, 2002, the 2000
Performance Stock Option Plan (the "Plan") of PCT was automatically terminated.
As such, no options were outstanding as of December 31, 2002. This option plan
was subsequently adopted by the Company's Board effective January 1, 2003. The
Plan provides for awards in the form of options, including incentive stock
options and non-qualified stock options. Under the plan, options granted vest at
a rate set by the board of directors or committee appointed by the board
directors, and options are exercisable up to 10 years from the date of grant at
not less than 100% of the fair value of the common stock on the date of grant.
If the option holder owns 10% or more of the Company's common stock, the options
are exercisable at not less than 110% of the fair value of the common stock on
the date of grant. At the Company's Annual Shareholders meeting held in November
2003, the shareholders approved a name change for the plan to the Nighthawk
Systems, Inc. 2003 Stock Option Plan and increased the number of shares eligible
for distribution under the plan to 5,000,000.
During 2004, 1,000,000 options, which vested immediately, were granted to the
Directors of the Company. Also during 2004, 630,000 options were granted for
consulting services, which vested immediately. The Company recognized $26,460 in
expenses related to the issuance of the options issued for consulting services.
During 2005, the Company granted a total of 550,000 options to employees vesting
in thirds over a three-year period, and an additional 100,000 options which
vested immediately during the year.
The following summarizes the stock option activity for the years ended December
31, 2005 and 2004:
OPTIONS WEIGHTED AVERAGE EXERCISE PRICE
------- -------------------------------
2004
Outstanding at beginning of year 2,285,000 $ 0.22
Options granted 1,630,000 0.11
Options exercised (630,000) 0.18
Options forfeited or expired (250,000) 0.22
-----------
Outstanding at end of year 3,035,000 0.17
===========
Options exercisable at year end 1,995,000 0.14
===========
Options available for
grant at end of year 1,335,000
===========
2005
Outstanding at beginning of year 3,035,000 $ 0.17
Options granted 650,000 0.14
Options exercised - -
Options forfeited or expired (250,000) 0.20
-----------
Outstanding at end of year 3,435,000 0.16
===========
Options exercisable at year end 2,615,000 0.16
===========
Options available for grant
at end of year 935,000
===========
11. SUBSEQUENT EVENTS
On January 9, 2006, Dutchess loaned the Company an additional $245,000. The
promissory note has no stated interest rate but has a face amount of $294,000
and matures on January 9, 2007. In connection with the note, Dutchess was issued
653,000 incentive shares of unregistered common stock.
On February 8, 2006, Dutchess loaned the Company an additional $205,000. The
convertible debenture bears an interest rate of 10% and matures on February 8,
2011. In connection with the note, Dutchess was issued 615,000 incentive shares
of unregistered common stock.
On March 16, 2006, Dutchess loaned the Company an additional $185,000. The
convertible debenture bears an interest rate of 10% and matures on March 16,
2011. In connection with the note, Dutchess was issued 444,000 incentive shares
of unregistered common stock.
During the period from January 1, 2006 through April 10, 2006, the Company
exercised fourteen (14) puts to Dutchess totaling 13,226,916 shares for proceeds
of $1,262,243. The proceeds were used to repay portions of previously issued
notes and debentures to Dutchess.
F-16
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 2006
ASSETS
Current assets:
Cash $ 109,900
Accounts receivable, net of allowance for doubtful accounts of $147 79,410
Inventories 160,832
Prepaids 639,127
------------
Total current assets 989,269
------------
Furniture, fixtures and equipment, net 19,908
Intangible and other assets 19,548
------------
$ 1,028,725
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 292,847
Accrued expenses 338,227
Line of credit 19,792
Notes payable:
Related parties 13,947
Other 381,322
------------
Total current liabilities 1,046,135
------------
Long-term liabilities:
Convertible debt 2,104,836
------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding -
Common stock; $0.001 par value; 200,000,000 shares authorized; 66,579,232 issued and outstanding 66,579
Additional paid- in capital 7,176,854
Accumulated deficit (9,365,679)
------------
Total stockholders' deficit (2,122,246)
------------
$ 1,028,725
============
<FN>
The accompanying notes are an integral part of these financial statements.
F-17
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
2006 2005
------------ ------------
Revenue $ 141,387 $ 171,222
Cost of goods sold 98,812 104,524
------------ ------------
Gross profit 42,575 66,698
Selling, general and administrative expenses 757,220 561,660
------------ ------------
Loss from operations (714,645) (494,962)
Interest expense:
Related parties 684 691
Other 600,352 130,627
------------ ------------
Total interest expense 601,036 131,318
------------ ------------
Net loss (1,315,681) (626,280)
Less: preferred stock dividends - (219)
------------ ------------
Net loss to common stockholders $(1,315,681) $ (626,499)
============ ============
Net loss per basic and diluted common share $ (0.02) $ (0.02)
============ ============
Net loss to common stockholders per basic and diluted common share $ (0.02) $ (0.02)
============ ============
Weighted average common shares outstanding - basic and diluted 58,219,769 33,733,867
<FN>
The accompanying notes are an integral part of these financial statements.
F-18
Nighthawk Systems, Inc.
Condensed Consolidated Statement of Stockholders' Deficit
Three months ended March 31, 2006
Common stock Additional
-------------------------- paid-in Accumulated
Shares Amount capital deficit Total
------------ ------------ ------------ ------------ ------------
Balances, December 31, 2005 46,477,158 $ 46,477 $ 5,464,436 $(8,049,998) $(2,539,085)
Common stock issued for Dutchess puts, net of commissions 12,615,074 12,615 1,142,768 1,155,383
Common stock issued as incentive for notes payable 1,712,000 1,712 147,168 148,880
Common stock issued for consulting services 4,925,000 4,925 232,075 237,000
Conversion of accrued expenses to common stock 850,000 850 34,150 35,000
Amortization of beneficial conversion feature on notes payable 153,269 153,269
Net loss (1,315,681) (1,315,681)
------------ ------------ ------------ ------------ ------------
Balances, March 31, 2006 66,579,232 $ 66,579 $ 7,173,866 $(9,365,679) $(2,122,246)
============ ============ ============ ============ ============
F-19
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31,
2006 2005
------------ ----------
Cash flows from operating activities:
Net loss $(1,315,681) $(626,280)
------------ ----------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 2,384 1,681
Employee options vested 2,988 -
Loan discounts and warrants 111,250 66,063
Beneficial conversion feature 153,269 -
Common stock issued for consulting services 177,000 15,000
Common stock issued for interest 88,109 -
Shares issued as incentives on notes payable 193,192 50,250
Note payable issued for consulting services 24,850 -
Amortization of prepaid consulting expense - 121,666
Changes in assets and liabilities:
(Increase) decrease in accounts receivable 3,795 (35,754)
(Increase) decrease in inventories (80,955) (9,976)
(Increase) decrease in prepaids (2,756) 23,596
Increase (decrease) in accounts payable 7,598 (38,739)
Increase in accrued expenses 29,841 24,275
------------ ----------
Total adjustments 710,565 218,062
------------ ----------
Net cash used in operating activities of continuing operations (605,116) (408,218)
------------ ----------
Cash flows from investing activities:
Purchases of furniture, fixtures and equipment (8,861) (1,973)
------------ ----------
Net cash used in investing activities (8,861) (1,973)
------------ ----------
Cash flows from financing activities:
Proceeds from notes payable, related parties - 339
Payments on notes payable, related parties (448) (550)
Proceeds from notes payable, other 635,000 225,000
Payments on notes payable, other (1,880) (127,765)
Payments on long term notes payable - (13,399)
Net proceeds from the sale of common stock, and the exercise of puts and warrants - 312,547
------------ ----------
Net cash provided by financing activities 632,672 396,172
------------ ----------
Net (decrease) increase in cash 18,695 (14,019)
------------ ----------
Cash, beginning balance 91,205 61,118
------------ ----------
Cash, ending balance $ 109,900 $ 47,099
============ ==========
F-20
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Supplemental disclosures of cash flow information: QUARTERLY PERIOD ENDED MARCH 31,
2006 2005
------------ ----------
Cash paid for interest $ 8,269 $ 18,312
============ ==========
Supplemental disclosure of non-cash investing and financing activities:
Common shares issued as payments on notes payable, other $ 1,205,334
============
Conversion of accrued expenses to common stock $ 35,000 $ 56,620
============ ==========
Conversion of notes payable and accrued interest to common stock
Notes payable $ 29,498
Accrued interest 1,752
----------
Total amount converted $ 31,250
==========
Preferred stock dividends issued in common stock $ 219
==========
<FN>
The accompanying notes are an integral part of these financial statements.
F-21
NIGHTHAWK SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(unaudited)
1. ORGANIZATION, GOING CONCERN, RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS
ORGANIZATION
Nighthawk Systems, Inc. ("the Company") designs and manufactures intelligent
remote power control products that are easy to use, inexpensive and can remotely
control virtually any device from any location. The Company's proprietary,
wireless products are ready to use upon purchase, so they are easily installed
by anyone, regardless of technical ability, and are also easily integrated into
third-party products, systems and processes. They allow for intelligent control
by interpreting instructions sent via wireless media, and executing the
instructions by 'switching' the electrical current that powers the device,
system or process. Nighthawk's intelligent products can be activated
individually, in pre-defined groups, or en masse, and for specified time periods
with a simple click of a mouse or by dialing a telephone number.
GOING CONCERN, RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS
The Company incurred a net loss of approximately $1.3 million during the quarter
ended March 31, 2006 and had a stockholders' deficit and working capital
deficiency of approximately $2.1 million and $57,000 respectively, as of March
31, 2006. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Although no assurance can be given that such
plans will be successfully implemented, management's plans to address these
concerns include:
- - Raising working capital through additional borrowings.
- - Raising equity funding through sales of the Company's common stock.
- - Implementation of the Company's sales and marketing plans.
During a prior year the Company signed a financing arrangement with Dutchess
Private Equities, II, L.P. ("Dutchess") under which the Company received
$250,000 in exchange for a convertible debenture during August 2004. The Company
also signed an investment agreement under which Dutchess agreed to purchase up
to $10.0 million in common stock from the Company, at the Company's discretion,
over the next three years, subject to certain limitations including the
Company's then current trading volume. Although the amount and timing of
specific cash infusions available under the entire financing arrangement cannot
be predicted with certainty, the arrangement represents a contractual commitment
by Dutchess to provide funds to the Company. Since entering into the arrangement
with Dutchess, the Company has utilized the arrangement to obtain enough cash to
cover its operating cash flow deficits on a monthly basis.
For more information on transactions with Dutchess during the three month period
ending March 31, 2006, please see Note 3 - Notes payable.
Although no assurance may be given that it will be able to do so, the Company
expects to be able to continue to access funds under this arrangement to help it
fund near-term and long-term sales and marketing efforts, and to cover cash flow
deficiencies.
The Company's strategic initiatives for 2006 include:
- - Capitalize on existing enterprise sales opportunities
- - Cultivate and capitalize on indirect sales channels
- - Enhance our marketing effort to support direct and indirect sales channels
- - Bundle our products with ancillary products and services to enhance revenue
opportunities
- - Develop and sell a device that functions on multiple wireless protocols
- - Form an advisory board with relevant industry expertise and relationships
- - Execute on a strategic acquisition that is scalable and complementary to our
existing business
The Report of the Company's Independent Registered Public Accounting Firm on the
Company's financial statements as of and for the year ended December 31, 2005
includes a "going concern" explanatory paragraph which means that the auditors
expressed substantial doubt about the Company's ability to continue as a going
concern. The accompanying financial statements do not include any adjustments
relating to the recoverability and classification of assets or the amounts of
liabilities that might be necessary should the Company be unsuccessful in
implementing these plans, or otherwise be unable to continue as a going concern.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements, which
include the accounts of Nighthawk Systems, Inc. and its subsidiary PCT
(collectively referred to herein as "the Company"), have been prepared in
accordance with accounting principles generally accepted in the U.S. for interim
financial information. In the opinion of management, all adjustments (consisting
of only normal recurring items), which are necessary for a fair presentation
have been included. The results for interim periods are not necessarily
indicative of results that may be expected for any other interim period or for
the full year. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-KSB for 2005 filed with the Securities and
Exchange Commission (the "SEC").
F-22
3. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenue from product sales is recognized when all significant obligations of the
Company have been satisfied. Revenues from equipment sales are recognized either
on the completion of the manufacturing process, or upon shipment of the
equipment to the customer, depending on the Company's contractual obligations.
The Company occasionally contracts to manufacture items, bill for those items
and then hold them for later shipment to customer-specified locations. The
Company had no bill and hold sales at December 31, 2005 or March 31, 2006.
Revenue related to airtime billing is recognized when the service is performed.
Some customers pre-pay airtime on a quarterly or annual basis and the pre-paid
portion is recorded as deferred revenue. Deferred revenue, included in accrued
expenses on the balance sheet at March 31, 2006, is approximately $13,073.
PROVISION FOR DOUBTFUL ACCOUNTS
The Company reviews accounts receivable periodically for collectibility and
establishes an allowance for doubtful accounts and records bad debt expense when
deemed necessary.
CONCENTRATIONS
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of trade accounts receivable. Receivables arising
from sales to customers are not collateralized and, as a result, management
continually monitors the financial condition of its customers to reduce the risk
of loss. At March 31, 2006, the Company had approximately $79,410 in accounts
receivable, net of the allowance for doubtful accounts. Approximately $34,000 of
this balance was from three customers, which was collected subsequent to March
31, 2006.
During the three months ended March 31, 2006, the Company had three individual
customers that accounted for approximately 36% of total revenue. Each of theses
three customers accounted for 10% to 14% of total revenue. During the three
months ended March 31, 2005, one customer accounted for approximately 46% of
total revenue.
During the three months ended March 31, 2006, three suppliers accounted for
approximately 67% of the Company's purchases of pre-manufactured component
materials.
INVENTORIES
Inventories consist of parts and pre-manufactured component materials and
finished goods. Inventories are valued at the lower of cost or market using the
first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is recorded using the
straight-line method over the estimated useful lives of five to seven years.
Maintenance and repairs are expensed as incurred and improvements are
capitalized. Upon sale or retirement of assets, the cost and related accumulated
depreciation or amortization is eliminated from the respective accounts and any
resulting gains or losses are reflected in operations.
INTANGIBLE ASSETS
Intangible assets include patent costs and are stated at cost. If the patents
are granted, the Company will then begin to amortize the patents over the
shorter of the lives of the patents or the estimated useful lives using the
straight-line method. The Company reviews these and any other long-lived assets
for impairment whenever events or changes in circumstances indicate their
carrying amounts may not be recoverable. Recoverability of an asset to be held
and used is measured by a comparison of the carrying amount of the asset to
future undiscounted cash flows expected to be generated by the asset. If the
asset is considered to be impaired, the impairment to be recognized is measured
by the amount by which the carrying amount of the asset exceeds the fair value
of the asset. Based on its review, management does not believe that any
impairment of intangible or other long-lived assets exists at March 31, 2006.
INCOME TAXES
Deferred tax assets and liabilities are recorded for the estimated future tax
effects of temporary differences between the tax basis of assets and liabilities
and amounts reported in the accompanying balance sheets, and for operating loss
and tax credit carry forwards. The change in deferred tax assets and liabilities
for the period measures the deferred tax provision or benefit for the period.
Effects of changes in enacted tax laws on deferred tax assets and liabilities
are reflected as adjustments to the tax provision or benefit in the period of
enactment. The Company's deferred tax assets have been completely reduced by a
valuation allowance because management does not believe realization of the
deferred tax assets is sufficiently assured at the balance sheet date.
F-23
NET LOSS PER SHARE
Basic net loss per share is computed by dividing the net loss applicable to
common stockholders by the weighted-average number of shares of common stock
outstanding for the year. Diluted net loss per share reflects the potential
dilution that could occur if dilutive securities were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company, unless the effect of such inclusion would reduce
a loss or increase earnings per share. For the quarter ended March 31, 2006 and
the year ended December 31, 2005, the effect of the inclusion of dilutive shares
would have resulted in a decrease in loss per share. Accordingly, the weighted
average shares outstanding have not been adjusted for dilutive shares.
USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect 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.
STOCK-BASED COMPENSATION
During the first quarter of fiscal 2006, the Company adopted the provisions of,
and accounts for stock-based compensation in accordance with, the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No. 123
- - revised 2004 ("SFAS 123R") "Share-Based Payment" which replaced Statement of
Financial Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25 ("APA 25"), "Accounting for
Stock Issued to Employees". Under the fair value recognition provisions of this
statement, stock-based compensation cost is measured at the grant date based on
the fair value of the award and is recognized as expense on a straight-line
basis over the requisite service period, which is the vesting period. The
Company elected the modified-prospective method, under which prior periods are
not revised for comparative purposes. The valuation provisions of SFAS 123R
apply to new grants and to grants that were outstanding as of the effective date
and are subsequently modified.
4. NOTES PAYABLE
At March 31, 2006, notes payable consist of the following:
Related parties:
Note payable, officer; unsecured; interest at prime rate plus 5.5% (12.24% at March 31, 2006); due on demand $ 9,554
Note payable, officer; unsecured; interest at 23.99%, revolving 4,393
-----------
$ 13,947
===========
Other:
Convertible note payable to stockholder, 8% interest rate, in default as of the date of this report (1) $ 160,000
Notes payable to stockholder, 8% interest rate, in default as of the date of this report (1) 165,000
Unsecured note with a financial institution, 17.24% interest rate, revolving 17,222
Note payable, $198,000 face amount, no stated interest rate but with an implied annual rate of 41.09%,
due December 12, 2006 (2) 39,100
-----------
$ 381,322
===========
Long Term:
Convertible debenture, 5% interest rate, due December, 2010 $ 500,000
Convertible debenture, 10% interest rate, due December, 2009 1,419,836
Convertible debenture, 10% interest rate, due March, 2011 185,000
-----------
$2,104,836
===========
<FN>
1) Based on discussions with the shareholder, who is a former board member,
the Company does not expect to receive a notice of default and to have the notes
called by the holder. However, no assurance may be give that this will be the
case.
On January 9, 2006, Dutchess loaned the Company $245,000. The note had no stated
interest rate but had a face amount of $294,000 and matured on January 9, 2007.
Dutchess was issued 653,000 incentive shares of unregistered common stock valued
by the Company at $45,710 for the note, which was secured by put notices. During
the three month period ending March 31, 2006, Dutchess exercised put notices
valued at $294,000 to pay off the note and was issued 3,477,247 shares of common
stock as a result.
On February 8, 2006, Dutchess loaned the Company $205,000 in exchange for a
convertible debenture that was due February 8, 2011. Dutchess was issued 615,000
incentive shares of unregistered common stock valued by the Company at $58,770
for the debenture, which was secured by put notices. The debenture contained a
clause calling for an early redemption penalty of 20%. During the three month
period ending March 31, 2006, Dutchess exercised put notices valued at $246,000
to pay off the debenture and the redemption penalty, and was issued 2,429,107
shares of common stock as a result. The Company recorded the redemption penalty
as interest expense, and also recorded $68,333 in interest expense during the
period related to the beneficial conversion feature of the debenture.
On March 16, 2006, Dutchess loaned the Company $185,000 in exchange for a
convertible debenture that is due March 16, 2011. Dutchess was issued 444,000
incentive shares of unregistered common stock valued by the Company at $44,400
for the debenture, which is secured by put notices. The debenture contains a
clause calling for an early redemption penalty of 20%.
F-24
In addition to the activity discussed about, during the three month period
ending March 31, 2006, Dutchess exercised puts valued at $540,358 to pay off
three notes and one debenture, plus all related interest, that had been
outstanding at December 31, 2005, and exercised puts valued at $135,835 to pay
down a note that had been outstanding at December 31, 2005. Dutchess was issued
6,708,720 shares as a result of these transactions. The Company recorded $98,500
in interest expense on these notes and debentures during the period, as well as
$83,908 in interest expense related to the beneficial conversion feature of the
debenture.
In total, the Company recognized a total of $153,269 in interest expense related
to the beneficial conversion feature of debentures outstanding during the
period.
On April 19, 2006, Dutchess loaned the Company $165,000 in exchange for a
convertible debenture that is due April 19, 2011. Dutchess was issued 366,666
incentive shares of unregistered common stock valued by the Company at $33,000
for the debenture, which is secured by put notices. The debenture contains a
clause calling for an early redemption penalty of 20%.
On May 17, 2006, Dutchess loaned the Company $130,000 in exchange for a
convertible debenture that is due May 17, 2011. Dutchess was issued 690,000
incentive shares of unregistered common stock valued by the Company at $41,400
for the debenture, which is secured by put notices. The debenture contains a
clause calling for an early redemption penalty of 20%.
Subsequent to March 31, 2006, Dutchess has exercised five puts valued at $97,288
in order to pay off the note due December 12, 2006, and to pay down the
debentures issued in December 2005 and March 2006. The Company issued Dutchess
1,414,713 shares of common stock as a result.
5. STOCKHOLDERS' DEFICIT
COMMON STOCK
During the quarterly period ending March 31, 2006, the Company issued 4,925,000
unregistered shares of common stock to consultants for services to be performed.
The Company recognized $177,000 in expense related to these contracts during the
period, and has recorded an additional $60,000 in prepaid expense related to one
of the contracts as of March 31, 2006. The Company also issued 850,000
unregistered shares of common stock to a consultant for $35,000 in services
rendered in 2004 and 2005.
F-25