UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
COMMISSION FILE NO. 0-30786
NIGHTHAWK SYSTEMS, INC.
-----------------------
(Exact name of registrant as specified in its charter)
NEVADA 87-0627349
------ ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
10715 GULFDALE, STE 200
SAN ANTONIO, TEXAS 78258
(210) 341-4811
--------------
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $0.001
PAR VALUE
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.
Registrant's revenues for its most recent fiscal year were $528,689.
The aggregate market value of the voting and non-voting common stock held by
non-affiliates based on the closing price on April 13, 2006 was $6,047,196.
As of April 14, 2006 there were 67,191,074 shares of common stock, par value
$.001 per share, of the registrant issued and outstanding.
Transitional Small Business Disclosure Format Used (Check one): Yes No
TABLE OF CONTENTS
PART I
Item 1. Description of Business 3
Item 2. Description of Property 7
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters 9
Item 6. Management's Discussion and Analysis or Plan of Operation 10
Item 7. Financial Statements 16
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 16
Item 8A. Controls and Procedures 16
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(A) of the Exchange Act of 1934 18
Item 10. Executive Compensation 19
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 20
Item 12. Certain Relationships and Related Transactions 21
Item 13. Exhibits, Financial Statements and Reports on Form 8-K 22
Item 14. Principal Accountant Feeds and Services 22
Signatures and Certifications
2
PART I
ITEM 1. 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.
3
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.
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
4
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.
5
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.
6
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.
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..
ITEM 2. 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.
7
ITEM 3. 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.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a shareholder vote in 2004. However, the
Company held a special shareholders' meeting on January 6, 2005 to vote to
increase the number of authorized common shares. The results are as follows:
1. To approve an amendment to the Amended and Restated Articles of
Incorporation of Nighthawk Systems, Inc. to increase the number of authorized
shares of our common stock from 50,000,000 to 200,000,000
VOTES FOR VOTES AGAINST ABSTENTIONS
17,833,098 1,585,559 102,600
8
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) 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.
(b) Security Holders
The number of record holders of our common stock at year-end 2005 was 197
according to our transfer agent. This figure excludes an indeterminate number of
shareholders whose shares are held in "street" or "nominee" name.
(c) Dividends
There have been no cash dividends declared or paid since the inception of the
company, and no cash dividends are contemplated in the foreseeable future. The
company may consider a potential dividend in the future in either common stock
or the stock of future operating subsidiaries.
(d) Sales of Unregistered Securities
In 2003, we sold 1,575,000 shares of common stock to seven investors for cash at
a weighted average price of $0.17 per share. Warrants to purchase 1,575,000
shares of common stock at an exercise price of $0.25 per share were also
included in these sales. We did not publicly offer the securities and the
investors were all accredited investors. No underwriters were involved in the
sales.
Between January 1, 2004 and March 31, 2004, we sold 858,333 shares of common
stock to nine investors for cash at a price of $0.15 per share. Warrants to
purchase 858,333 shares of common stock at an exercise price of $0.25 per share
were also included in these sales. We did not publicly offer the securities and
the investors were all accredited investors. No underwriters were involved in
the sales.
Between May 31, 2004 and June 15, 2004, we sold 1,162,000 Special Warrants to
five investors for cash at a price of $0.20 per Special Warrant. Each Special
Warrant is convertible into one share of our common stock and one warrant to
purchase a share of our common stock at an exercise price of $0.30 per share.
First Associates Investments, Inc. was the underwriter in this offering. They
received a commission of 8% of the total proceeds raised and the right to
purchase 12.5% of the amount of the Special Warrants sold in the offering, or
142,250 Special Warrants.
9
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. 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 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 and this person is an accredited investor. No
underwriters were involved in the sale.
The securities described immediately above were issued to investors in reliance
upon an exemption from the registration requirements of the Securities Act of
1933, as set forth in Section 4(2) under the Securities Act of 1933 and Rule 506
of Regulation D promulgated thereunder relative to sales by an issuer not
involving any public offering, to the extent an exemption from such registration
was required. All purchases of the securities described immediately above this
paragraph represented to us in connection with their purchase that they were
accredited investors and were acquiring the shares for investment purposes only
and not for distribution, that they could bear the risks of the investment and
could hold the securities for an indefinite period of time. The purchasers
received written disclosures that the securities had not been registered under
the Securities Act of 1933 and that any resale must be made pursuant to a
registration statement or an available exemption from such registration. Each
participant in the offering or offerings described above was given access to
full and complete information regarding us, together with the opportunity to
meet with our officers and directors for purposes of asking questions and
receiving answers in order to facilitate such participant's independent
evaluation of the risks associated with the purchase of our securities.
ITEM 6. 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.
10
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
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.
11
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.
12
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.
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.
13
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.
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 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. 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.
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.
14
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.
Subsequent to December 31, 2005, Dutchess has provided the Company with $635,000
in cash proceeds in return for the issuance of $684,000. The Company has also
issued 13,226,916 shares to Dutchess as a result of the exercise of 14 puts,
which reduced outstanding debt owed to Dutchess by $1,262,243.
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
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.
15
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.
ITEM 7. FINANCIAL STATEMENTS
The audited consolidated balance sheet of the Company as of December 31, 2004
and related consolidated statements of operations, stockholders' deficit and
cash flows for the years ended December 31, 2004 and 2003 are included,
following Item 14, in sequentially numbered pages numbered F-1 through F-19. The
page numbers for the financial statement categories are as follows:
INDEX PAGE
----- ----
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheet as of December 31, 2005 F-2
Consolidated Statements of Operations for the Years Ended
December 31, 200 and 2004 F-3
Consolidated Statements of Stockholders' Deficit for the Years Ended
December 31, 2005 and 2004 F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2005 and 2004 F-5
Notes to Consolidated Financial Statements F-7
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES
The Company's management, including the Company's principal executive 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 year ended December 31, 20045 the
period covered by the Annual Report on Form 10-KSB. Based upon that evaluation,
the Company's principal executive and financial officer has concluded that the
disclosure controls and procedures were effective as of December 31, 2005 to
provide reasonable assurance that material information relating to the Company
is made known to management including the CEO/CFO.
16
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, as noted in previous filings,
throughout 2002 and until March 26, 2003, the Company's former Chief Executive
Officer was responsible for, among other duties, opening the mail, making
accounting entries, writing checks and producing financial reports.
Disbursements of cash and stock issuances were made during this time period that
were not substantiated as relating to Company business, or were made in error.
At the meeting of the Board of Directors held on March 26, 2003, the former
Chief Executive Officer resigned, and the Chief Financial Officer, H. Douglas
Saathoff, was appointed as his replacement by the board of directors.
Consequently, Mr. Saathoff held both the position of Chief Executive Officer and
Chief Financial Officer, but procedures were implemented subsequent to March 26,
2003 to segregate responsibilities in order to reduce the opportunities for a
single person to be in a position to both perpetrate and conceal errors or
irregularities in the normal course of business. In addition, the new Chief
Executive Officer and the board of directors initiated a process to establish
and implement a written policy on disclosure controls and procedures and hired a
corporate controller on January 1, 2005 to add additional oversight to the
accounting function. On April 12, 2005, the Board of Directors agreed that Mr.
Saathoff should no longer act as both Chief Executive Officer and Chief
Financial Officer. Mr. Saathoff relinquished his duties as Chief Financial
Officer as of April 12, 2005 and Daniel P. McRedmond, the Company's Corporate
Controller assumed the role of the Company's Principal Accounting and Financial
Officer. On September 28, 2005, Mr. McRedmond resigned as Corporate Controller
and he has not been replaced as of the filing of this report. As such, from
September 28, 2005 through the date of the filing of this report, Mr. Saathoff
has served as both the Company's principal executive and financial officer.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT OF 1934, AS AMENDED
The following persons are executive officers and directors of the Company:
H. Douglas Saathoff, 44 - 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.
17
Myron Anduri, 50 - 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, 48 - 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, 41 - 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.
18
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Nighthawk Systems, Inc. has adopted a code of ethics that applies to the
executive officers of the Company, including its Chief Executive Officer,
President and Principal Accounting and Financial Officer. A copy of the
Company's code of ethics is available on the Company's corporate website at
www.nighthawksystems.com, and will be provided free of charge to any person upon
--------------------
request. Requests may be made by phone at 210 341-4811.
ITEM 10. EXECUTIVE COMPENSATION
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 $22,276
in debt he had incurred on the Company's behalf and for which the Company had
recognized a liability to Mr. Anduri.
NAME NUMBER OF SECURITIES PERCENT OF TOTAL
OPTIONS/SARS GRANTED TO EMPLOYEES UNDERLYING OPTIONS GRANTED EXERCISE OR BASE PRICE ($/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.
19
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER MATTERS
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%
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.
20
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
-----------------------------------------------------------------------------------------------------------------------------------
ITEM 12. 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.
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.
21
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.
ITEM 13. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
EXHIBIT INDEX
(THOSE ATTACHED HERETO ARE SEQUENTIALLY NUMBERED)
Item 13(a)
EXHIBIT NO DESCRIPTION
----------- -----------
24 Power of Attorney is included on the signature page in this Annual Report
on this Form 10-KSB.
31.1 Rule 13a-14(a)/15d - 14(a) Certification of H. Douglas Saathoff, Chief
Executive Officer of Nighthawk Systems, Inc., filed herewith.
32.1 Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
(b) None
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
(1) Audit Fees:
Fees billed by GHP Horwath, P.C. for audit and review services for each of the
years ended December 31, 2005 and 2004 were $37,516 and $66,000, respectively.
(2) Audit-Related Fees:
During 2004, GHP Horwath, P.C. billed the Company $5,000 for services related to
the Company's Registration Statement on Form SB-2, and $750 for services related
to the Company's filing on
Form S-8
(3) Tax Fees:
GHP Horwath, P.C. did not bill the Company any tax fees during 2005 or 2004.
(4) All Other Fees:
GHP Horwath, P.C. did not bill the Company any other fees during 2005 or 2004.
(5) Audit Committee's Pre-Approval Policies and Procedures
(i) The audit committee of the board of directors approves the scope of
services and fees of the outside accountants on an annual basis, prior to
the beginning of the services.
(ii) The audit committee of the board of directors reviewed and approved 100% of
the fees for the services above.
22
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
============
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
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
============ ============
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.
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.
F-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 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
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.
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.
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.
F-11
Income tax benefit consists of the following:
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
==========
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.
F-14
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.
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.
F-15
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
============== ===============
(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.
F-16
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-17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this Amendment No. 1 to
the Annual Report on Form 10-KSB to be signed on its behalf by the undersigned,
thereunto duly authorized.
Date: April 14, 2006 NIGHTHAWK SYSTEMS, INC.
By: /s/ H. DOUGLAS SAATHOFF
--------------------------
H. Douglas Saathoff,
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints H. Douglas Saathoff his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
to sign any and all amendments to this Annual Report on Form 10-KSB and to file
the same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said attorney-in-fact
and agent full power and authority to do and perform each and every act and
thing requisite and necessary to be done in connection therewith, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, or any of them, shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Max Polinsky Director April 14, 2006
------------------
Max Polinsky
/s/ Patrick Gorman Director April 14, 2006
--------------------
Patrick Gorman