U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to ________
Commission File Number: 0-30786
NIGHTHAWK SYSTEMS, INC
----------------------
(Exact name of small business issuer as specified in its charter)
Nevada 87-0627349
------ ----------
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
10715 Gulfdale, Suite 200
San Antonio, TX 78216
----------------------
(Address of principal executive offices)
210 341-4811
------------
(Issuer's telephone number)
__________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
As of August 14, 2006 there were 74,420,053 shares of common stock, par value
$.001 per share, of the registrant issued and outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
INDEX
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited)
Condensed consolidated balance sheet as of June 30, 2006 2
Condensed consolidated statements of operations for the
three and six month periods ended June 30, 2006 and 2005 3
Condensed consolidated statement of stockholders'
deficit for the six months ended June 30, 2006 4
Condensed consolidated statements of cash flows for
the six months ended June 30, 2006 and 2005 5
Notes to condensed consolidated financial statements 7
Item 2 Management's Discussion and Analysis or Plan of Operation 11
Item 3 Controls and Procedures 15
Part II OTHER INFORMATION
Item 1 Legal Proceedings 16
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 16
Item 3 Defaults Upon Senior Securities 16
Item 4 Submissions of Matters to a Vote of Security Holders 16
Item 5 Other Information 16
Item 6 Exhibits and Reports on Form 8-K 16
Signatures and Certifications 17
-1-
PART I - FINANCIAL INFORMATION
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 2006
ASSETS
Current assets:
Cash $ 18,713
Accounts receivable, net of allowance for doubtful accounts of $456 156,311
Inventories 137,842
Prepaids 690,115
------------
Total current assets 1,002,981
------------
Furniture, fixtures and equipment, net 19,918
Intangible and other assets 19,548
------------
$ 1,042,447
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 249,429
Accrued expenses 306,479
Line of credit 19,792
Notes payable:
Related parties 13,471
Other 340,439
------------
Total current liabilities 929,610
------------
Long-term liabilities:
Convertible debt 2,539,983
------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.001 par value; 5,000,000 shares authorized; 5,000 issued
and outstanding; liquidation preference $ -
Common stock; $0.001 par value; 200,000,000 shares authorized;
71,452,553 issued and outstanding 71,453
Additional paid- in capital 7,500,641
Accumulated deficit (9,999,240)
------------
Total stockholders' deficit (2,427,146)
------------
$ 1,042,447
============
The accompanying notes are an integral part of these financial statements
-2-
Nighthawk Systems, Inc.
Condensed Consolidated Statements of Operations
Three months ended June 30, Six months ended June 30,
2006 2005 2006 2005
----------------------- ---------------------------
Revenue $ 252,139 $ 98,372 $ 393,526 $ 269,594
Cost of goods sold 165,480 85,099 264,292 189,623
----------------------- ---------------------------
Gross profit 86,659 13,273 129,234 79,971
Selling, general and administrative expenses 554,155 588,040 1,311,375 1,149,700
----------------------- --------------------------
Loss from operations (467,496) (574,767) (1,182,141) (1,069,729)
Interest expense:
Related parties 647 148 1,331 839
Other 165,418 358,381 765,770 489,008
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Total interest expense 166,065 358,529 767,101 489,847
----------------------- ---------------------------
Net loss (633,561) (933,296) (1,949,242) (1,559,576)
Less: preferred stock dividends (221) (440)
----------------------- ---------------------------
Net loss to common stockholders $ (633,561) $(933,517) $(1,949,242) $(1,560,016)
======================= ===========================
Net loss per basic and diluted common share $ (0.01) $ (0.03) $ (0.03) $ (0.04)
======================= ===========================
Net loss to common stockholders per basic and diluted common share $ (0.01) $ (0.03) $ (0.03) $ (0.04)
======================= ===========================
Weighted average common shares outstanding - basic and diluted 68,696,251 37,249,225 63,486,951 35,501,257
The accompanying notes are an integral part of these financial statements.
-3-
Nighthawk Systems, Inc.
Condensed Consolidated Statement of Stockholders' Deficit
Six months ended June 30, 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, including commissions 15,421,729 15,422 1,290,533 1,305,955
Common stock issued as incentive for notes payable 3,778,666 3,779 273,871 277,650
Common stock issued for consulting services 4,925,000 4,925 232,075 237,000
Conversion of accrued liabilities to common stock 850,000 850 34,150 35,000
Amortization of beneficial conversion feature on notes payable 199,600 199,600
Vesting of employee options 5,976 5,976
Net loss (1,949,242) (1,949,242)
------------ ------------ ------------ ------------ ------------
Balances, June 30, 2006 71,452,553 $ 71,453 $ 7,500,641 $(9,999,240) $(2,427,146)
============ ============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
-4-
Nighthawk Systems, Inc.
Condensed Consolidated Statements of Cash Flows
Six months ended June 30,
2006 2005
------------ ------------
Cash flows from operating activities:
Net loss $(1,949,242) $(1,559,576)
------------ ------------
Adjustments to reconcile net loss to net cash used in operating activities:
Bad debt expense 309 1,648
Depreciation and amortization 4,848 3,163
Vesting of employee options 5,976 -
Loan discounts and warrants 133,789 198,013
Beneficial conversion feature 199,600 -
Common stock issued for consulting services 177,000 23,025
Common stock issued for interest 88,109 -
Shares issued as incentives on notes payable 224,624 133,908
Note payable issued for consulting 49,700 -
Amortization of prepaid consulting expense - 212,124
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (73,414) 17,186
Increase in inventories (57,965) (62,199)
Decrease in prepaids 18,744 26,810
Decrease in other assets and liabilities - (1,020)
Decrease in accounts payable (35,820) (82,553)
Increase in accrued expenses 22,173 149,434
------------ ------------
Total adjustments 757,673 619,539
------------ ------------
Net cash used in operating activities of continuing operations (1,191,569) (940,037)
------------ ------------
Cash flows from investing activities:
Purchases of furniture, fixtures and equipment (11,338) (1,973)
------------ ------------
Net cash used in investing activities (11,338) (1,973)
------------ ------------
Cash flows from financing activities:
Proceeds from notes payable, related parties - 567
Payments on notes payable, related parties (923) (1,233)
Proceeds from notes payable, other 1,135,000 1,113,500
Payments on notes payable, other (3,662) (573,818)
Net proceeds from the sale of common stock, and the exercise of puts and warrants - 361,803
------------ ------------
Net cash provided by financing activities 1,130,415 900,819
------------ ------------
Net (decrease) increase in cash (72,492) (41,191)
Cash, beginning balance. 91,205 61,118
------------ ------------
Cash, ending balance $ 18,713 19,927
============ ============
-5-
Condensed Consolidated Statements of Cash Flows
(continued)
Supplemental disclosures of cash flow information:
2006 2005
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Cash paid for interest $ 16,528 $ 49,722
========== ==========
Supplemental disclosure of non-cash investing and financing activities:
Common shares issued as payments on notes payable, including commissions $1,312,280
==========
Common shares issued as incentives for notes payable $ 277,650 $ 168,500
========== ==========
Common shares issued for prepaid consulting agreements $ 207,500
==========
Conversion of accrued expenses to common stock $ 35,000 $ 56,620
========== ==========
Conversion of notes payable and accrued interest to common stock
Notes payable $ 155,590
Accrued interest 6,960
----------
Total amount converted $ 162,550
==========
Preferred stock dividends issued in common stock $ 440
==========
-6-
NIGHTHAWK SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 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
wireless power control products that enable simultaneous activation or
de-activation of multiple assets or systems on demand. Nighthawk's installed
customer base includes major electric utilities, internet service providers and
fire departments in over 40 states. Nighthawk's products also enable custom
message display, making them ideal for use in traffic control and emergency
notification situations.
Nighthawk products enable customers to wirelessly extend their reach, allowing
them to turn on, off or reboot remotely located equipment at any time, from
anywhere. Expensive truck rolls and third-party service contracts are no longer
required with Nighthawk products in place. 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 $1.9 million during the six
month period ended June 30, 2006 and had a stockholders' deficit of
approximately $2.4 million as of June 30, 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.
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. 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 six-month
period ending June 30, 2006, please see Note 4 - 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.
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 responsible for 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.
-7-
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 Peregrine
Control Technologies, Inc. (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").
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 June 30, 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 June 30, 2006, is approximately $14,323.
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.
-8-
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 June 30, 2006, the Company had approximately $156,311 in accounts
receivable, net of the allowance for doubtful accounts. Approximately $79,004
of this balance was from two customers, $57,763 of which was collected
subsequent to June 30, 2006.
During the three months ended June 30, 2006, two customers accounted for
approximately 24% and 12% of total revenue, respectively. During the three
months ended June, 2005, one customer accounted for approximately 46% of total
revenue.
During the three months ended June 30, 2006, three suppliers accounted for
approximately 76% 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 June 30, 2006.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs include materials and equipment costs associated
with the formulation, design, construction and testing of new product
prototypes. These costs also include contract labor and salaries, wages and
other related costs of personnel engaged in the research and development
activities. During the three month period ending June 30, 2006, the Company
incurred approximately $60,000 in research and development costs related to the
development of a two-way wireless product for the utility industry. These costs
are included in selling, general and administrative expenses in the accompanying
financial statements.
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.
-9-
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 each of the periods presented in the
accompanying financial statements, the effect of the inclusion of dilutive hares
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 June 30, 2006, notes payable consist of the following:
Related parties:
Note payable, officer; unsecured; interest at prime rate plus 5.5% (12.24% at June 30, 2006); due on demand $ 9,554
Note payable, officer; unsecured; interest at 23.99%, revolving 3,917
----------
$ 13,471
==========
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 15,439
-----------
$ 340,439
===========
Long Term:
Convertible debenture, 5% interest rate, due December, 2010 $ 500,000
Convertible debenture, 10% interest rate, due December, 2009 1,360,263
Convertible debenture, 10% interest rate, due March, 2011 179,720
Convertible debenture, 10% interest rate, due April, 2011 165,000
Convertible debenture, 10% interest rate, due May, 2011 130,000
Convertible debenture, 10% interest rate, due June, 2011 205,000
----------
$2,539,983
==========
1) Based on recurring 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.
-10-
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. During the six-month period
ended June 30, 2006, Dutchess exercised on put notice valued at $5,280 to pay
down the debenture, and was issued 69,480 shares as a result. The debenture
contains a clause calling for an early redemption penalty of 20%.
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 Company recorded $2,751
in interest expense during the six month period ending June 30, 2006 related to
the beneficial conversion feature of the debenture. 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 $48,300
for the debenture, which is secured by put notices. The Company recorded $1,444
in interest expense during the six month period ending June 30, 2006 related to
the beneficial conversion feature of the debenture. The debenture contains a
clause calling for an early redemption penalty of 20%.
On June 15, 2006, Dutchess loaned the Company $205,000 in exchange for a
convertible debenture that is due June 15, 2011. Dutchess was issued 1,010,000
incentive shares of unregistered common stock valued by the Company at $47,470
for the debenture, which is secured by put notices. The Company recorded $1,139
in interest expense during the six month period ending June 30, 2006 related to
the beneficial conversion feature of the debenture. The debenture contains a
clause calling for an early redemption penalty of 20%.
In addition to the activity discussed about, during the six month period ending
June 30, 2006, Dutchess exercised puts valued at $737,832 to pay off four notes
and one debenture, plus all related interest, that had been outstanding at
December 31, 2005, and exercised puts valued at $59,573 to pay down a debenture
that had been outstanding at December 31, 2005. Dutchess was issued 14,661,608
shares as a result of these transactions. The Company recorded $121,039 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 $46,331 in interest expense related
to the beneficial conversion feature of debentures outstanding during the
period. The Company also paid $30,405 in cash, issued 760,121 shares of stock
valued at $30,405 and accrued an additional $6,325 in commissions due to a third
party as a result of puts exercised by Dutchess during the period.
Subsequent to June 30, 2006, Dutchess has exercised four puts valued at $98,975
in order to pay down the debentures issued in December 2005 and March 2006. The
Company issued Dutchess 2,392,500 shares of common stock as a result.
On July 6, 2006, Dutchess loaned the Company $135,000 in exchange for a
convertible debenture that is due July 6, 2011. Dutchess was issued 575,000
incentive shares of unregistered common stock valued by the Company at $28,750
for the debenture, which is secured by put notices. The debenture contains a
clause calling for an early redemption penalty of 20%.
5. STOCKHOLDERS' DEFICIT
COMMON STOCK
During the six month period ending June 30, 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 prepaids related to one of the
contracts as of June 30, 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.
ITEM 2. 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
-11-
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.
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 $15,800.
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.
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.
-12-
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2006 AND JUNE 30, 2005
The components of revenue and their associated percentages of total revenues,
for the three months ended June 30, 2006 and 2005 are as follows:
Three months ended June 30,
2006 2005 $ Change % Change
------------------- ------------------- ---------- --------
Revenues:
Rebooting products $ 34,646 14% $ 21,002 21% $ 13,644 65%
Logic boards 18,610 7% 14,144 15% $ 4,466 32%
Utility products 163,827 65% 47,590 48% $ 116,237 244%
Emergency notification products 20,351 8% - 0% $ 20,351 n/a
Hydro 1 - - 0% $ - n/a
Airtime sales 9,082 4% 13,556 14% $ (4,474) -33%
Other product 3,652 1% 1,282 1% $ 2,370 185%
Freight 1,971 1% 798 1% $ 1,173 147%
----------- ---------- -----------
Total revenues $ 252,139 100% $ 98,372 100% $ 153,767 156%
=========== ========== ===========
Revenues for the three-month period ended June 30, 2006 were $252,139 as
compared to $98,372 for the corresponding period of the prior year, an increase
of 156% between periods. Sales of each of Company's core products increased
between the periods presented, and the Company also produced revenues from the
sale of emergency notification products during the 2006 period. The products,
sold mainly to firehouses for in-station alerting, were not yet being sold
during the prior year period. During 2005, the Company hired its first fulltime
sales staff, and began proactively marketing its products for the first time. In
2006, the Company added an in-house sales coordinator. These additions have
produced more frequent contact with both new and existing customers, which has
resulted in an increased level of product sales. Airtime revenues decreased
approximately $4,500 between periods. Recurring monthly airtime revenues from
the Company's largest customer declined in July 2005 when that customer lost its
own remote monitoring contract with a customer, and airtime access to more than
2,400 rebooting units was canceled.
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 increased by $80,381 or 94% to $165,480 for
the three months ended June 30, 2006 from $85,099 for the corresponding period
of the prior year but decreased as a percentage of revenues between the periods
from 94% in 2005 to 66% in 2006. As a result, the Company's gross margin
increased between the periods from 13% to 34%. This improvement in gross margins
is attributable to the increase in products produced during the 2006 period as
compared to the 2005 period, which led to volume discounts for parts and
in-house production efficiencies. The increase in revenues assisted in covering
fixed overhead charges at the Company's assembly facility in Denver, Colorado.
Selling, general and administrative expenses for the three months ended June 30,
2006 decreased by $33,885 or 6% to $554,155 from $558,040 for the three-month
period ended June 30, 2005. The Company incurred one-time expenses of
approximately $60,000 during the second quarter of 2005 for the settlement of
lawsuit and legal fees associated with that suit. No such fees were incurred
during the second quarter of 2006, but the Company did spend approximately
$60,000 during the second quarter of 2006 on the development of a new product
for the utility market that has two-way wireless capability. These development
costs offset the decrease in legal expenses between quarters. The Company
expects to begin marketing the new product during the quarter ending September
30, 2006. The Company also spent less on public relations efforts during the
second quarter of 2006 than it did during the second quarter of 2005.
Interest expense decreased $192,462 or 54% between the three-month periods
presented. During 2005, the Company borrowed funds on a monthly basis from
Dutchess under short-term notes. The value of any associated loan discounts or
incentive shares was expensed over the term of the notes. In addition, if the
notes were not paid off prior to maturity, the Company incurred penalties when
the matured notes were rolled into new note balances. During the second quarter
of 2005, the Company recognized approximately $132,000 in non-cash expenses
related to the amortization of these loan discounts, approximately $84,000 in
non-cash expenses related to incentive shares and approximately $86,000 in
penalties on late payments of Dutchess notes. While the Company has continued to
borrow funds from Dutchess on a monthly basis, all amounts outstanding
throughout the second quarter of 2006 are under debentures that mature four to
five years from their date of issuance. Any associated expenses for loan
discounts and incentive shares on these notes are amortized over the life of the
note, resulting in smaller amounts of interest expense recorded by the Company
on a monthly basis.
-13-
The net loss to common shareholders for the three-month period ended June
30,2006 was $633,561 compared to $933,517 for the three-month period ended June
30, 2005, an improvement of 31%. The decrease in net loss was due primarily to
increased sales and production of the Company's products that produced
additional gross margin dollars, combined with a reduction in expenses for
public relations campaign and reduction in interest expense related to Dutchess
notes and debentures. The net loss per common share for the quarter ended June
30, 2006 was ($0.01) as compared to (0.03) for the previous year's quarter. The
improvement was the result of the lower net loss, and the increase in the
weighted average number of shares outstanding from period to period, primarily
due to the issuance of shares to Dutchess which were utilized to reduce the
amount outstanding under notes and debentures held by Dutchess.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2006 AND JUNE 30, 2005
The components of revenue and their associated percentages of total revenues,
for the six months ended June 30, 2006 and 2005 are as follows:
Six months ended June 30,
2006 2005 $ Change % Change
------------------- ------------------- ---------- --------
Revenues:
Rebooting products $ 81,716 21% $ 42,606 16% $ 39,110 92%
Logic boards 36,075 9% 39,997 15% $ (3,922) -10%
Utility products 211,825 54% 78,815 29% $ 133,010 169%
Emergency notification products 38,166 10% - 0% $ 38,166 n/a
Hydro 1 - 76,750 28% (76,750) n/a
Airtime sales 17,127 4% 27,789 10% $ (10,662) -38%
Other product 5,044 1% 1,637 1% $ 3,407 208%
Freight 3,573 1% 2,000 1% $ 1,573 79%
---------- ----------- ----------
Total revenues $ 393,526 100% $ 269,594 100% $ 123,932 46%
========== =========== ==========
Revenues for the six-month period ended June 30, 2006 were $396,526 as compared
to $269,594 for the corresponding period of the prior year, an increase of 46%
between periods. Sales of two of the Company's core products (Rebooting and
Utility) increased between the periods presented, and the Company also produced
revenues from the sale of emergency notification products during the 2006
period. During 2005, the Company began selling its PT1000 logic boards to
wireless integrators for use in firehouse alerting. During the latter half of
2005, the Company produced a new product, the FAS8 Firehouse Alerting System,
based on the specific needs of fire departments. As such, in many instances the
Company sold the FAS8 solution to fire departments during 2006 instead of the
PT1000 logic board that it had sold them in prior years. The Company continues
to sell the PT1000, it's most versatile product, for use in a wide variety of
applications. During 2005, the Company hired its first fulltime sales staff, and
began proactively marketing its products for the first time. In 2006, the
Company added an in-house sales coordinator. These additions have produced more
frequent contact with both new and existing customers, which has resulted in an
increased level of product sales. During the six months ended June 30, 2005, one
customer, who purchased the Company's Hydro 1 product, represented approximately
28% 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.
Airtime revenues decreased 38%, or $10,662 between the two periods presented.
Recurring monthly airtime revenues from the Company's largest customer declined
in July 2005 when that customer lost its own remote monitoring contract with a
customer, and airtime access to more than 2,400 rebooting units was canceled.
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 increased by $74,669 or 94% to $264,292 for
the six months ended June 30, 2006 from $189,623 for the corresponding period of
the prior year but decreased as a percentage of revenues between the periods
from 70% in 2005 to 67% in 2006. As a result, the Company's gross margin
increased between the periods from 30% to 33%. This improvement in gross margins
is attributable to the increase in products produced during the 2006 period as
compared to the 2005 period, which led to volume discounts for parts and
in-house production efficiencies. The increase in revenues assisted in covering
fixed overhead charges at the Company's assembly facility in Denver, Colorado.
In addition, the gross margin for the six month period ended June 30, 2005 was
high relative to the number of products produced during the period because of
the one-time sale of the higher margin Hydro 1 units produced during that
period.
Selling, general and administrative expenses for the six months ended June 30,
2006 increased by $161,675 or 14% to $1,311,375 from $1,149,700 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 $277,254 or 57% between the six-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, 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. During the second quarter of 2006, interest expense
actually declined, as most short term notes from Dutchess had either been paid
off or had been rolled into long term debentures. These longer term arrangements
allow the Company to expense loan discounts and incentive shares over longer
periods of time, resulting in lower monthly interest accruals than shorter term
notes.
The net loss to common shareholders for the six-month period ended June 30,2006
was $1,949,242 compared to $1,560,016 for the six-month period ended June 30,
2005, an increase of 25%. Increased sales and gross profit was more than offset
by increases in expenses associated with public relations firms and the amount
of interest expense recorded during the first quarter of 2006 associated with
the early payoff of notes held by Dutchess. The net loss per common share for
the quarter ended June 30, 2006 was ($0.03) as compared to (0.04) for the
previous year's quarter. The improvement was the result of the increase in the
weighted average number of shares outstanding from period to period, primarily
due to the issuance of shares to Dutchess during the first quarter of 2006 which
were utilized to reduce the amounts outstanding under notes and debentures held
by Dutchess.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial statements for the six months ended June 30, 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 $1.9 million during
the six-month period ended June 30, 2006 and had a stockholders' deficit of
approximately $2.4 million as of June 30, 2006.
The Report of 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.
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. 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.
During the six month period ended June 30, 2006, net cash used in operating
activities was approximately $1.2 million. Net proceeds from the issuance of a
note and debentures to Dutchess during the period totaled $1,135,000. Major cash
outlays during the period were approximately $350,000 for payroll/employee
benefits, $302,000 for public relations efforts, $221,000 for inventory,
$144,000 for consulting expense, $72,000 for sales and marketing efforts, and
$60,000 for product development.
The Company issued 14,466,308 shares to Dutchess during the six-month period
ended June 30, 2006 which was used to pay down $1,332,826 in debt during the
period. Each note or debenture issued by the Company to Dutchess is secured by
put notices, which allow Dutchess to exercise puts in order to pay down on the
notes and debentures if they want to.
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.
-14-
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures:
The Company's management, including the Company's principal executive officer
and principal accounting and financial officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the
three-month period ended June 30, 2006, the period covered by the Quarterly
Report on Form 10-QSB. Based upon that evaluation, the Company's principal
executive officer and principal financial and accounting officer have concluded
that the disclosure controls and procedures were effective as of June 30, 2006
to provide reasonable assurance that material information relating to the
Company is made known to management including the CEO.
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting. However, on September 23, 2005, the Company's
Principal Accounting and Financial Officer, Daniel P. McRedmond, resigned as the
Company's Corporate Controller. As a result, the Company's Chief Executive
Officer, H. Douglas Saathoff, will serve as the Company's Principal Operating
and Principal Accounting and Financial Officer until Mr. McRedmond's successor
is hired.
-15-
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is in default on two loans from Mr. Revesz, a former board member,
as of the date of this report and is in discussions to extend the maturity dates
on those notes. In April 2004, the Company reached an agreement with Tomas
Revesz under which, in return for an additional $25,000 in borrowings and the
extension of the maturity dates of three notes to July 31, 2004, the Company
granted the creditor a secured position in the assets of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS
(a) Exhibits
31.1 Certification of H. Douglas Saathoff, Chief Executive Officer and Principal
Accounting and Financial Officer, pursuant to Rule 13A-14 or 15D-14 of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification pursuant to the 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
None
-16-
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NIGHTHAWK SYSTEMS, INC.
(Registrant)
Date: August 14, 2006 By: /s/ H. Douglas Saathoff
---------------------------
H. Douglas Saathoff,
Chief Executive Officer, Principal
Accounting and Financial Officer