U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to ________
Commission File Number: 0-30786
NIGHTHAWK SYSTEMS, INC
----------------------
(Exact name of small business issuer as specified in its charter)
Nevada 87-0627349
------ ----------
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
10715 Gulfdale, Suite 200
San Antonio, TX 78216
----------------------
(Address of principal executive offices)
210 341-4811
------------
(Issuer's telephone number)
__________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
As of August 12, 2005 there were 40,521,194 shares of common stock, par value
$.001 per share, of the registrant issued and outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
INDEX
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited)
Report of Independent Registered Public Accounting Firm 2
Condensed consolidated balance sheet as of June 30, 2005 3
Condensed consolidated statements of operations for the
three and six month periods ended June 30, 2005 and 2004 4
Condensed consolidated statement of stockholders'
deficit for the six months ended June 30, 2005 5
Condensed consolidated statements of cash flows for
the six months ended June 30, 2005 and 2004 6
Notes to condensed consolidated financial statements 8
Item 2 Management's Discussion and Analysis or Plan of Operation 17
Item 3 Controls and Procedures 24
Part II OTHER INFORMATION
Item 1 Legal Proceedings 25
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 3 Defaults Upon Senior Securities 25
Item 4 Submissions of Matters to a Vote of Security Holders 25
Item 5 Other Information 25
Item 6 Exhibits and Reports on Form 8-K 26
Signatures and Certifications 27
PART I - FINANCIAL INFORMATION
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Nighthawk Systems, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Nighthawk Systems, Inc. and subsidiary as of June 30, 2005, the related
condensed consolidated statements of operations for the three-month and
six-month periods ended June 30, 2005 and 2004, the condensed consolidated
statement of stockholders' deficit for the six-month period ended June 30, 2005,
and the condensed consolidated statements of cash flows for the six-month
periods ended June 30, 2005 and 2004. These interim condensed consolidated
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with accounting principles generally
accepted in the United States of America.
GHP HORWATH, P.C.
Denver, Colorado
August 17, 2005
NIGHTHAWK SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 2005
ASSETS
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,927
Accounts receivable, net of allowance for doubtful accounts of $750. . . . . . 26,920
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88,908
Prepaids . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143,920
------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . 279,675
------------
Furniture, fixtures and equipment, net. . . . . . . . . . . . . . . . . . . . . . . 11,877
Intangible and other assets. . . . . .. . . . . . . . . . . . . . . . . . . . . . . 14,762
------------
$ 306,314
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 339,701
Accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331,658
Line of credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,792
Notes payable:
Related parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,736
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,347,582
------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . 2,053,469
------------
Long-term liabilities:
Convertible debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72,014
------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.001 par value; 5,000,000 shares authorized; 5,000 issued
and outstanding; liquidation preference. . . . . . . . . . . . . . . . . . . . $12,500
Common stock; $0.001 par value; 200,000,000 shares authorized;
39,021,194 issued and outstanding . . . . . . . . . . . . . . . . . . . . . . . 39,022
Additional paid- in capital . . . . . . . . . . . . . . . . . . . . . . . . . . 5,046,227
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,916,918)
------------
Total stockholders' deficit. . . . . . . . . . . . . . . . . . . . . (1,819,169)
------------
$ 306,314
============
The accompanying notes are an integral part of these financial statements
Nighthawk Systems, Inc.
Condensed Consolidated Statements of Operations
Three months ended June 30, Six months ended June 30,
2005 2004 2005 2004
----------------------------- ---------------------------
Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 98,372 $ 161,387 $ 269,594 $ 264,225
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . 85,099 108,057 189,623 180,623
----------------------------- ---------------------------
Gross profit. . . . . . . . . . . . . . . . . . . . . . . . . 13,273 53,330 79,971 83,602
Selling, general and administrative expenses . . . . . . . . . . . 588,040 264,865 1,149,700 540,945
----------------------------- ---------------------------
Loss from operations. . . . . . . . . . . . . . . . . . . . . (574,767) (211,535) (1,069,729) (457,343)
Interest expense:
Related parties . . . . . . . . . . . . . . . . . . . . . . . 148 2,227 839 5,600
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 358,381 38,571 489,008 56,589
----------------------------- ---------------------------
Total interest expense. . . . . . . . . . . . . . . . . . 358,529 40,798 489,847 62,189
----------------------------- ---------------------------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (933,296) (252,333) (1,559,576) (519,532)
Less: preferred stock dividends. . . . . . . . . . . . . . . . . . (221) (197) (440) (197)
----------------------------- ---------------------------
Net loss to common stockholders. . . . . . . . . . . . . . . . . . $ (933,517) $(252,530) $(1,560,016) $ (519,729)
============================= ===========================
Net loss per basic and diluted common share. . . . . . . . . . . . $ (0.03) $ (0.01) $ (0.04) $ (0.02)
============================= ===========================
Net loss to common stockholders per basic and diluted common share $ (0.03) $ (0.01) $ (0.04) $ (0.02)
============================= ===========================
Weighted average common shares outstanding - basic and diluted . . 37,249,225 25,911,034 35,501,257 25,434,668
The accompanying notes are an integral part of these financial statements.
Nighthawk Systems, Inc.
Condensed Consolidated Statements of Stockholders' Deficit
Six months ended June 30, 2005
Preferred Stock Common stock
-------------- -------------- Additional paid Special Accumulated
Shares Amount Shares Amount in capital Warrants deficit Total
-----------------------------------------------------------------------------------------------
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, and puts
and warrants exercised for cash 2,276,610 2,277 359,526 361,803
Common stock issued as incentive
on notes payable 900,000 900 167,600 168,500
Common stock and options issued
for consulting and other services 1,200,000 1,200 229,325 230,525
Conversion of accrued liabilities
to common stock 313,100 313 56,307 56,620
Conversion of notes payable and
accrued interest to common stock. 1,400,000 1,400 161,150 162,550
Series A preferred dividend . . . 2,487 2 (2) -
Exercise of Special Warrants. . . 969,750 970 187,805 (188,775) -
Net loss. . . . . . . . . . . . (1,559,576) (1,559,576)
-----------------------------------------------------------------------------------------------
Balances, June 30, 2005. . . . . . . 5,000 $ 12,500 39,021,194 $ 39,022 $5,046,227 $ - $ (6,916,918) $(1,819,169)
===============================================================================================
The accompanying notes are an integral part of these financial statements
Nighthawk Systems, Inc.
Condensed Consolidated Statements of Cash Flows
Six months ended June 30,
2005 2004
----------- ----------
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(1,559,576) $(519,532)
----------- ----------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . 3,163 3,854
Bad debt expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,648
Amortization of loan discounts and warrants . . . . . . . . . . . . . . . . . . . 198,013 -
Common stock and options issued for consulting and other services . . . . . . . . 23,025 73,660
Common stock and warrants issued for interest . . . . . . . . . . . . . . . . . . - 34,500
Amortization of shares issued as incentives on notes payable. . . . . . . . . . . 133,908 -
Amortization of shares issued for prepaid consulting. . . . . . . . . . . . . . . 212,124 -
Changes in assets and liabilities, net of business acquisition:
Decrease (increase) in accounts receivable. . . . . . . . . . . . . . . . . . . . 17,186 (11,357)
(Increase) in inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . (62,199) (39,189)
Decrease in prepaids. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,810 -
Decrease in other assets and liabilities. . . . . . . . . . . . . . . . . . . . . (1,020) (2,198)
(Increase) decrease in accounts payable . . . . . . . . . . . . . . . . . . . . . (82,553) 11,801
Increase in accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . 149,434 35,313
------------ ----------
Total adjustments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619,539 106,384
------------ ----------
Net cash used in operating activities of continuing operations . . . . . . . . . . . (940,037) (413,148)
------------ ----------
Cash flows from investing activities:
Purchases of furniture, fixtures and equipment. . . . . . . . . . . . . . . . . . (1,973) -
------------ ----------
Net cash used in investing activities. . . . . . . . . . . . . . . . . . . . . . . . (1,973) -
------------ ----------
Cash flows from financing activities:
Cash overdraft. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (3,902)
Proceeds from the sale of preferred stock . . . . . . . . . . . . . . . . . . . . - 12,500
Proceeds from notes payable, related parties. . . . . . . . . . . . . . . . . . . 567 25,516
Payments on notes payable, related parties. . . . . . . . . . . . . . . . . . . . (1,233) (34,655)
Proceeds from notes payable, other. . . . . . . . . . . . . . . . . . . . . . . . 1,113,500 25,000
Payments on notes payable, other. . . . . . . . . . . . . . . . . . . . . . . . . (573,818) (10,404)
Payments on other related party payable . . . . . . . . . . . . . . . . . . . . . - (25,000)
Proceeds from the issuance of special warrants. . . . . . . . . . . . . . . . . . - 188,775
Net proceeds from the sale of common stock, and the exercise of puts and warrants 361,803 237,350
------------ ----------
Net cash provided by financing activities. . . . . . . . . . . . . . . . . . . . . . 900,819 415,180
------------ ----------
Net (decrease) increase in cash. . . . . . . . . . . . . . . . . . . . . . . . . . . (41,191) 2,032
Cash, beginning balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61,118 -
------------ ----------
Cash, ending balance $ 19,927 2,032
============ ==========
Condensed Consolidated Statements of Cash Flows
(continued)
Supplemental disclosures of cash flow information:
2005 2004
-------- -------
Cash paid for interest . . . . . . . . . . . . . . . . . . . . . . . . . $ 49,722 $17,222
======== =======
Supplemental disclosure of non-cash investing and financing activities:
Common shares issued as incentives for notes payable . . . . . . . . . . $168,500
========
Common shares issued for prepaid consulting agreements . . . . . . . . . $207,500
========
Conversion of accrued expenses to common stock . . . . . . . . . . . . . $ 56,620
========
Conversion of notes payable and accrued interest to common stock
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . $155,590 $71,640
Accrued interest. . . . . . . . . . . . . . . . . . . . . . . . . . . 6,960 8,876
-------- -------
Total amount converted . . . . . . . . . . . . . . . . . . . . . . . . . $162,550 $80,516
======== =======
Preferred stock dividends issued in common stock . . . . . . . . . . . . $ 440 $ 197
======== =======
NIGHTHAWK SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2005 AND 2004
(unaudited)
1. Organization, going concern, results of operations and management's plans
Organization
Nighthawk Systems, Inc. ("the Company") designs and manufactures intelligent
remote power control products that are easy to use, inexpensive and can remotely
control virtually any device from any location. The Company's proprietary,
wireless products are ready to use upon purchase, so they are easily installed
by anyone, regardless of technical ability, and are also easily integrated into
third-party products, systems and processes. They allow for intelligent control
by interpreting instructions sent via 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 $1.38 million during the year
ended December 31, 2004 and a net loss of approximately $1.56 million during the
six months ended June 30, 2005. The Company had a stockholders' deficit and
working capital deficiency of approximately $1.24 million and $1.04 million,
respectively, as of December 31, 2004 and $1.82 million and $1.77 million
respectively, as of June 30, 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 a sales and marketing plan.
ADDITIONAL BORROWINGS AND EQUITY FUNDRAISING:
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 the third quarter of 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 the six months ended June 30, 2005, Dutchess loaned the company a total
of $1,113,500 in the form of notes payable. The notes have no stated interest
rate but have a face amount greater than the funded amount. This difference is
recognized as interest expense over the life of the loan. Under the terms of
the notes, Dutchess is also issued incentive shares, which are recorded as
prepaid interest and expensed over the life of the loan.
During the six months ended June 30, 2005, the Company exercised six (6) puts to
Dutchess totaling 1,276,610 shares for net proceeds of $222,726. Of the total
proceeds, $125,633 was used to repay portions of previously issued notes to
Dutchess and $67,838 went to the Company.
On March 9, 2005, Dutchess exercised 250,000 warrants at $0.125 each, for total
proceeds of $31,250, $15,000 of which was applied to outstanding notes and
accrued interest.
The Company used the proceeds from the notes, puts and warrants to fund its
operating cash flow deficits and to repay outstanding notes and accrued interest
and penalties to Dutchess.
For more information on the transactions with Dutchess, please see Note 5, Notes
payable.
Although no assurance may be given that it will be able to do so, the Company
expects to be able to continue to access funds under this arrangement to help it
fund near-term and long-term sales and marketing efforts, and to cover cash flow
deficiencies.
THE SALES AND MARKETING PLAN FOR 2005 INCLUDES THE FOLLOWING:
- Hiring sales and marketing personnel. The Company increased its sales
force in the first quarter of 2005 with experienced salespeople with the goal of
effectively targeting existing and new markets.
- Product marketing including print media and attendance at trade shows.
This method has proved the most effective for the Company to date, and it plans
to increase its presence in these areas to attract new customers.
- An improved Internet presence. The Company launched a new website in May
2005 to improve content and to make the site more friendly to search engines.
The Company has plans to add e-commerce functionality at a future date.
- Leveraging existing customer relationships by up-selling new products or
fully integrating systems with the Company's products.
- The establishment of distribution and dealer networks. Through an
effective dealer network, the Company can increase awareness in its products and
utilize a dealer's sales force to actively promote its products.
- New applications in irrigation control, civil defense and emergency
management. The current product design can be altered with little cost to the
Company to be effectively implemented into a wide array of fields. Through the
commitment of funding, the Company can now research all possible applications
and begin to market directly to new customers.
- The development and launch of a product designed to be used for multiple
purposes by consumers.
In addition to the marketing and sales objectives, the Company has identified
the following strategic goals for 2005:
- Joint ventures with wireless service providers and equipment
manufacturers.
- The identification of complementary products and companies for potential
acquisition.
The accompanying financial statements do not include any adjustments relating to
the recoverability and classification of assets or the amounts of liabilities
that might be necessary should the Company be unsuccessful in implementing these
plans, or otherwise be unable to continue as a going concern.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements, which
include the accounts of Nighthawk Systems, Inc. and its subsidiary PCT
(collectively referred to herein as "the Company"), have been prepared in
accordance with accounting principles generally accepted in the U.S. for interim
financial information. In the opinion of management, all adjustments (consisting
of only normal recurring items), which are necessary for a fair presentation
have been included. The results for interim periods are not necessarily
indicative of results that may be expected for any other interim period or for
the full year. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-KSB for 2004 filed with the Securities and
Exchange Commission (the "SEC").
3. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenue from product sales is recognized when all significant obligations of the
Company have been satisfied. Revenues from equipment sales are recognized
either on the completion of the manufacturing process, or upon shipment of the
equipment to the customer, depending on the Company's contractual obligations.
The Company occasionally contracts to manufacture items, bill for those items
and then hold them for later shipment to customer-specified locations. The
Company had no bill and hold sales at December 31, 2004 or June 30, 2005.
Revenue related to airtime billing is recognized when the service is performed.
Some customers pre-pay airtime on a quarterly or annual basis and the pre-paid
portion is recorded as deferred revenue. Deferred revenue, included in accrued
expenses on the balance sheet at June 30, 2005, is approximately $6,300.
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 June 30, 2005, the Company had approximately $26,900 in accounts
receivable, net of the allowance for doubtful accounts. Approximately $17,300
of this balance, or 64%, was from four customers. Each balance was collected
subsequent to June 30, 2005.
During the three month period ended June 30, 2005, two customers accounted for
approximately 45% of total revenue. During the six month period ended June 30,
2005, two customers accounted for approximately 44% of total revenue.
During the three and six month periods ended June 30, 2005, the Company's
largest supplier accounted for approximately 55% and 49%, respectively, of the
Company's purchases of pre-manufactured component materials.
INVENTORIES
Inventories consist of parts and pre-manufactured component materials and
finished goods. Inventories are valued at the lower of cost or market using the
first-in, first-out (FIFO) method.
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.
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 three and six month periods
ended June 30, 2005 and the year ended December 31, 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.
RECLASSIFICATIONS
Certain amounts reported in the consolidated financial statements for the three
and six months ended June 30, 2004 have been reclassified to conform to the June
30, 2005 presentation.
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 2004 and the first six months of 2005, no compensation expense was
recognized in either of the periods. 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:
Three months ended June 30, Six months ended June 30,
---------------------------------------------------------
2005 2004 2005 2004
----------------------------- ---------------------------
Net loss applicable to common stockholders:
As reported . . . . . . . . . . . . . . . . . $ (933,517) $ (252,530) $(1,560,016) $(519,729)
Total stock-based employee compensation expense
determined under fair value based method for
all employee awards, net (6,148) (3,341) (12,296) (6,795)
------------- ----------- ----------- ----------
Pro forma net loss. . . . . . . . . . . . . . $ (939,665) $ (255,871) $(1,572,312) $(526,524)
============= =========== ============ ==========
Net loss per share:
As reported:
Basic and diluted . . . . . . . . . . . . . . . $ (0.03) $ (0.01) $ (0.04) $ (0.02)
Pro forma:
Basic and diluted $ (0.03) $ (0.01) $ (0.04) $ (0.02)
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 Three months ended June 30, Six months ended June 30,
2005 2004 2005 2004
---------------------------- --------------------------
Dividend yield. . . . . . 0.00% 0.00% 0.00% 0.00%
Expected volatility . . . 1.31 1.122 1.31 1.122
Risk-free interest rate . 4.50% 4.50% 4.50% 4.50%
Expected life in years 2 years 3 years 2 years 3 years
The weighted average fair value at date of grant for options granted during the
first quarter of 2005 was $0.132 per share using the above assumptions. There
were no options granted to employees during the first and second quarters of
2004 or the second quarter of 2005.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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.
4. 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 and this person is an accredited investor. No underwriters were
involved in the sale.
5. NOTES PAYABLE
At June 30, 2005, notes payable consist of the following:
Related parties:
Note payable, officer; unsecured; interest at prime . . . . . . . . . . . $ 9,824
rate plus 5.5% (10.75% at June 30, 2005); due on demand
Note payable, officer; unsecured; interest at 23.99%, revolving . . . . . . 4,912
----------
$ 14,736
==========
Other:
Convertible note payable to stockholder, 8% interest . . . . . . . . . . . $ 160,000
rate, in default as of the date of this report (1)
Notes payable to stockholder, 8% interest rate, in . . . . . . . . . . . . 165,000
default as of the date of this report (1)
Unsecured note with a financial institution, 15.99% . . . . . . . . . . . . 21,694
interest rate, revolving
Note payable, $586,200 face amount, no stated interest 586,200
rate but with an implied annual rate of 387.95%, due June 7, 2005 (2)
Note payable, $120,000 face amount, no stated interest
rate but with an implied annual rate of 73.70%, due December 12, 2005 (2) 104,571
Note payable, $240,000 face amount, no stated interest
rate but with an implied annual rate of 71.55%, due December 19, 2005 (2) 207,926
Note payable, $120,000 face amount, no stated interest
rate but with an implied annual rate of 65.16%, due January 8, 2006 (2) 102,191
---------
$ 1,347,582
=========
Long Term:
Convertible debenture, 8% interest rate, due August 10, 2007 (2) $ 72,014
=========
1) The Company is currently in discussions with Mr. Revesz, the holder of
the notes that are in default as of the date of this report. In April 2004, the
Company reached an agreement with Tomas Revesz, a former board member, under
which, in return for an additional $25,000 in borrowings and the extension of
the maturity dates of three notes to July 31, 2004, the Company granted the
creditor a secured position in the assets of the Company.
2) On April 7, 2005, Dutchess loaned the Company $488,500. The note had no
stated interest rate but had a face amount of $586,200 and matured on June 7,
2005. A portion of the proceeds of this loan was used to repay the note dated
December 3, 2004 with a face amount of $300,000, which matured on April 3, 2005.
Under the terms of the note, Dutchess was issued 250,000 incentive shares of
common stock. The Company recorded the fair value of these incentive shares as
prepaid interest, and will expense their value over the term of the note.
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
implied annual rate of interest is 387.95%. The note was repaid on July 8, 2005
with a partial use of the proceeds of a new note.
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 matures on December 12,
2005. Under the terms of the note, Dutchess was issued 100,000 incentive shares
of common stock. The Company recorded the fair value of these incentive shares
as prepaid interest, and will expense their value over the term of the note.
The implied annual rate of interest is 73.70%.
On May 19, 2005, Dutchess loaned the Company $200,000. The note had no stated
interest rate but had a face amount of $240,000 and matures on December 19,
2005. A portion of the proceeds of this loan was used to repay the note dated
January 18, 2005 with a face amount of $270,000, which matured on May 18, 2005.
Under the terms of the note, Dutchess was issued 200,000 incentive shares of
common stock. The Company recorded the fair value of these incentive shares as
prepaid interest, and will expense their value over the term of the note. The
implied annual rate of interest is 71.55%.
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 matures on January 8, 2006.
Under the terms of the note, Dutchess was issued 100,000 incentive shares of
common stock. The Company recorded the fair value of these incentive shares as
prepaid interest, and will expense their value over the term of the note. The
implied annual rate of interest is 65.16%.
On July 8, 2005, Dutchess loaned the Company $795,154. The note had no stated
interest rate but had a face amount of $820,154 and matures on February 8, 2006.
A portion of the proceeds of this loan was used to repay the note dated April 7,
2005 with a face amount of $586,200, which matured on June 7, 2005. Under the
terms of the note, Dutchess was issued 285,000 incentive shares of common stock.
The Company recorded the fair value of these incentive shares as prepaid
interest, and will expense their value over the term of the note.
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.
Under the terms of the note, Dutchess was issued 285,000 incentive shares of
common stock. The Company recorded the fair value of these incentive shares as
prepaid interest, and will expense their value over the term of the note.
During the period from January 1, 2005 through June 30, 2005, the Company
exercised six (6) puts to Dutchess totaling 1,276,610 shares for proceeds of
$222,726 less commissions of $9,673. Of the total proceeds, $125,633 was used
to repay portions of previously issued notes to Dutchess and $67,838 went to the
Company.
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.
Also during the period from January 1, 2005 through June 30, 2005, Dutchess
elected to convert a total of $162,550 of the 36-month convertible note for
1,400,000 shares of the Company's common stock.
During the period from July 1, 2005 through August 1, 2005, Dutchess elected to
convert a total of $51,767 of the 36-month convertible note for 680,000 shares
of the Company's common stock.
6. STOCKHOLDERS' DEFICIT
PREFERRED STOCK
Preferred stock dividends of $440 were accrued in the form of a stock dividend
equal to 2,487 shares of common stock of the Company during the six months ended
June 30, 2005.
COMMON STOCK
The Company held a special shareholders' meeting on January 6, 2005 where an
amendment to the Amended and Restated Articles of Incorporation of Nighthawk
Systems, Inc. was approved to increase the number of authorized shares of our
common stock from 50,000,000 to 200,000,000.
During the first quarter of 2005, the Company issued 463,100 shares for
consulting and other services, of which 175,000 shares were issued to a business
partner of the Company's Chairman to settle a $20,000 liability for consulting
services performed and expensed in 2004.
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 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.
During the second quarter of 2005, the Company issued 250,000 shares of common
stock to Prospect Hunter, Inc. for marketing services for a period of one year
beginning in April 2005.
Also during the second quarter of 2005, the Special Warrant holders exercised
their right to 969,750 shares of the Company's common stock. 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.
7. SUBSEQUENT EVENTS
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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD-LOOKING STATEMENTS
Discussions and information in this document, which are not historical facts,
should be considered forward-looking statements. With regard to forward-looking
statements, including those regarding the potential revenues from increased
sales, and the business prospects or any other aspect of Nighthawk Systems,
Inc.'s business, actual results and business performance may differ materially
from that projected or estimated in such forward-looking statements. Nighthawk
Systems, Inc. ("the Company") has attempted to identify in this document certain
of the factors that it currently believes may cause actual future experience and
results to differ from its current expectations. Differences may be caused by a
variety of factors, including but not limited to, adverse economic conditions,
entry of new and stronger competitors, inadequate capital and the inability to
obtain funding from third parties.
The following information should be read in conjunction with the unaudited
condensed consolidated financial statements included herein which are prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information.
GENERAL
The Company designs and manufactures intelligent remote monitoring and power
control products that are easy to use, inexpensive and can remotely control
virtually any device from any location. Our proprietary, wireless products are
ready to use upon purchase, so they are easily installed by anyone, regardless
of technical ability, and are also easily integrated into third-party products,
systems and processes. They allow for intelligent control by interpreting
instructions sent via paging and satellite media, and executing the instructions
by 'switching' the electrical current that powers the device, system or process.
Our intelligent products can be activated individually, in pre-defined groups,
or en masse, and for specified time periods with a simple click of a mouse or by
dialing a telephone number.
Our products have been uniquely designed and programmed to be simple and ready
to use upon purchase by anyone, almost anywhere, at affordable prices. As such,
it is the Company's goal to have its products become commonplace, accepted and
used by businesses and consumers alike in their daily routines.
We save consumers and businesses time, effort and expense by eliminating the
need for a person to be present when and where an action needs to be taken. By
utilizing existing wireless technology, we give our users the flexibility to
move their application from place to place, without re-engineering their
network. Currently, most commercial control applications utilize telephone
lines, which tether the system to a single location and have associated
installation and monthly charges. Our products make companies more profitable
by eliminating installation costs and monthly charges for telephone lines, and
allow for remote control of unmanned or remote locations that may operate on
traditional electrical power, or solar or battery generated power.
Applications for our intelligent products include, but are not limited to:
- Rebooting remotely located computer equipment
- Remote switching of residential power
- Managing power on an electrical grid
- Activation/deactivation of alarm and warning devices
- Displaying or changing a digital or printed message or warning sign
- Turning pumps on or off
- Turning heating or cooling equipment on or off
Companies both large and small are seeking ways to save money and lower the risk
of liability by replacing processes that require human intervention with
processes that can be controlled remotely without on-site human intervention.
Today, the remote control of industrial or commercial assets and processes is
performed mainly through the use of telephone-line based systems. Opportunities
exist for companies that provide intelligent wireless solutions, as telephone
lines are expensive and limited in availability and function. Nighthawk's
products are wireless, and can be designed to work with a variety of wireless
media. The number of applications for wireless remote control is virtually
limitless. The Company has identified primary markets (Utility, IT
Professional, Traffic Control), as well as secondary markets (Irrigation,
Outdoor Advertising, Oil/Gas, Security) for its products.
The Company has historically had minimum funds available to it to support its
operations and has been largely dependent on private equity placements with
accredited investors to fund its negative cash flows. As such, the Company's
ability to fund and sustain sales and marketing efforts was very limited. In
August 2004, the Company signed a financing arrangement with Dutchess Private
Equities, II, L.P. Under the terms of the amended arrangement, the Company
received a total of $250,000 under a debenture during the three-month period
ended September 30, 2004. The Company also signed an investment agreement under
which, subsequent to the December 2004 effectiveness of its SB-2 registration
statement filed with the Securities and Exchange Commission ("SEC"), 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.
As is more fully explained in Liquidity and Capital Resources below, the Company
began utilizing this investment agreement in December 2004 and continued to
utilize this agreement in the first half of 2005 in order to implement a sales
and marketing effort designed to stimulate revenue growth. This sales and
marketing plan for 2005 includes the following:
- Hiring sales and marketing personnel. The Company increased its sales
force in the first quarter of 2005 with experienced salespeople with the goal of
effectively targeting existing and new markets.
- Product marketing including print media and attendance at trade shows.
This method has proved the most effective for the Company to date, and it plans
to increase its presence in these areas to attract new customers.
- An improved Internet presence. The Company launched a new website in May
2005 to improve content and to make the site more friendly to search engines.
The Company has plans to add e-commerce functionality at a future date.
- Leveraging existing customer relationships by up-selling new products or
fully integrating systems with the Company's products.
- The establishment of distribution and dealer networks. Through an
effective dealer network, the Company can increase awareness in its products and
utilize a dealer's sales force to actively promote its products.
- New applications in irrigation control, civil defense and emergency
management. The current product design can be altered with little cost to the
Company to be effectively implemented into a wide array of fields. Through the
commitment of funding, the Company can now research all possible applications
and begin to market directly to new customers.
- The development and launch of a product designed to be used for multiple
purposes by consumers.
In addition to the marketing and sales objectives, the Company has identified
the following strategic goals for 2005:
- Joint ventures with wireless service providers and equipment
manufacturers.
- The identification of complementary products and companies for potential
acquisition.
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. The
Company had no bill and hold sales at December 31, 2004 or June 30, 2005.
Revenue related to airtime billing is recognized when the service is performed.
Some customers pre-pay airtime on a quarterly or annual basis and the pre-paid
portion is recorded as deferred revenue. Deferred revenue, included in accrued
expenses on the balance sheet at June 30, 2005, is approximately $6,300.
STOCK-BASED COMPENSATION
We believe that stock-based compensation is a critical accounting policy that
affects our financial condition and results of operations. Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation defines a fair-value based method of accounting for stock-based
employee compensation plans and transactions in which an entity issues its
equity instruments to acquire goods or services from non-employees, and
encourages but does not require companies to record compensation cost for
stock-based employee compensation plans at fair value. The Company has chosen to
continue to account for employee stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB No. 25") and related
interpretations.
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R "Share-Based Payment", which addresses the accounting for share-based
payment transactions. SFAS 123R eliminates the ability to account for
share-based compensation transactions using APB 25, and instead, generally
requires that such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123R will be effective for small
business issuers as of the beginning of the first interim or annual reporting
period that begins after December 15, 2005. SFAS No. 123R offers the Company
alternative methods of adopting this standard. The Company has not yet
determined which alternative method it will use. Depending upon the number and
terms of options that may be granted in future periods, the implementation of
this standard could have a material impact on the Company's financial position
and results of operations.
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2005 AND JUNE 30, 2004
Revenue
The components of revenue and their associated percentages of total revenues,
for the three months ended June 30, 2005 and 2004 are as follows:
THREE MONTHS ENDED JUNE 30,
---------------------------
2005 2004 CHANGE % CHANGE $
-------------------------------------------------
Revenues:
Rebooting Products:
NH100,NH1, NH2 & NH8 $ 21,002 21% $62,388 39% -66% $ (41,386)
Logic Boards: PT 1000,
PT1 LC & PT Boards 14,144 15% 47,618 30% -70% (33,474)
Utility Products: CEO 700 47,590 48% 41,174 25% 16% 6,416
Airtime sales 13,556 14% 10,207 6% 33% 3,349
Other products 1,282 1% - 0% n/a 1,282
Freight 798 1% - 0% n/a 798
-----------------------------------------------------
Total revenues $ 98,372 100% $ 161,387 100% -39% $ (63,015)
Revenues for the three-month period ended June 30, 2005 were $98,372 as compared
to $161,387 for the corresponding period of the prior year, a decrease of 39%
between periods. During the three months ended June 30, 2004, the Company sold
approximately $50,000 of its NH2 rebooting device to a single customer in
support of that customer's primary contract with AT&T Wireless. As a result of
the AT&T Wireless/Cingular merger, that customers' primary contract was
suspended subsequent to June 30, 2004. Because the Company did not have
customers to replace the lost demand, sales of the Company's rebooting devices
declined in the current quarter when compared to the quarter ended June 30,
2004. In an effort to improve the functionality of the NH2 and reduce its cost
of production, the Company replaced the NH2 with the NH100 in March 2005.
Although revenues from rebooting products shipped during the quarter ended June
30, 2005 were only approximately $21,000, the Company received additional
purchase orders during the quarter for approximately $60,000 of rebooting
devices. As of June 30, 2005, the Company was waiting on customer site
information before those units could be produced and shipped.
The Company hired two salesmen in February 2005. The initial focus of these
salesmen has been on selling the Company's 'plug and play' products for
rebooting and electric utility use. During the three months ended June 30,
2005, the Company shipped three orders for its CEO 700 utility product to one
customer. Revenues from these three orders represented approximately 32% of the
Company's total product revenues for the period. Overall sales of the Company's
utility products increased 16% between the periods presented.
Sales of the Company's logic boards, which must be engineered into systems and
are not considered 'plug and play' products, declined 70% between periods.
Airtime sales, which consist of recurring charges for access to customers'
units, increased 33% between periods due to the additional units sold during the
2005 period. As mentioned earlier, one of the Company's primary customers had
its account suspended by AT&T Wireless/Cingular. As a result, should AT&T
Wireless/Cingular choose not to continue its program with the Company's
customer, airtime revenues could decrease going forward.
Cost of goods sold includes parts and pre-manufactured components used to
assemble our products as well as allocated overhead for production personnel and
facilities costs. Cost of goods sold decreased by $22,958 or 21% to $85,099 for
the three months ended June 30, 2005 from $108,057 for the corresponding period
of the prior year and increased as a percentage of revenues between the periods
from 67% in the second quarter of 2004 to 87% in the second quarter of 2005. The
decrease in gross profit was due to lower sales volume and the decrease in gross
margin was due to poorer utilization of our productive capacity. During the
quarter ended June 30, 2005, allocated overhead for production and facilities
cost amounted to approximately $19,000.
Selling, general and administrative expenses for the three months ended June 30,
2005 increased by $323,175 or 122% to $588,040 from $264,865 for the three-month
period ended June 30, 2004. The Company spent approximately $138,000 in cash on
public relations and promotional activity to increase its exposure to potential
investors during the quarter ended June 30, 2005 as opposed to $0 during the
previous year's quarter. The Company incurred approximately $98,500 in non-cash
expenses in the second quarter of 2005 for consulting and other services. This
represents an increase of approximately $58,000 in non-cash expenses when
compared to the quarter ended June 30, 2004. During the 2005 period, the
Company incurred approximately $64,000 in cash expenses directly related to
sales and marketing efforts, including compensation for the two salesmen hired,
trade shows and travel costs. The Company also recognized $32,500 in expenses
during the quarter ended June 30, 2005 related to the settlement of a lawsuit.
Interest expense increased $319,810 or 829% between the three-month periods
presented. The increase was due primarily to interest expense related to the
Dutchess notes, some of which have no stated interest rate but have a repayment
amount greater than the funded amount. The Company recognizes the difference
between the face amount of the notes and the amounts actually received in cash
as interest expense over the life of the loans. In addition, the value of the
incentive shares issued in conjunction with the notes is recognized as interest
expense over the life of the loans. Penalties on late payment of notes and any
interest incurred during these periods are also recognized as interest expense.
In total, the Company recognized approximately $132,000 in non-cash expenses
related to the amortization of these loan discounts, approximately $84,000 in
non-cash expenses related to incentive shares and approximately $86,000 in
penalties on late payments of notes.
The net loss for the three-month period ended June 30, 2005 was $933,296
compared to $252,333 for the three-month period ended June 30, 2004. The
increase in net loss from continuing operations was due primarily to increased
non-cash expenses for consulting and other services, expenses related to
fundraising efforts, and increased non-cash interest expense from incentive
shares and the amortization of discounts on notes payable.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2005 AND JUNE 30, 2004
Revenue
The components of revenue and their associated percentages of total revenues,
for the six months ended June 30, 2005 and 2004 are as follows:
SIX MONTHS ENDED JUNE 30,
-------------------------
2005 2004 CHANGE % CHANGE $
--------------------------------------------------
Revenues:
Rebooting Products: NH100,
NH1, NH2 & NH8 $ 42,606 16% $119,246 45% -64% $ (76,640)
Logic Boards: PT 1000,
PT1 LC & PT Boards 39,997 15% 62,449 23% -36% (22,452)
Utility Products: CEO 700 78,815 29% 51,109 19% 54% 27,706
Hydro 1 76,750 28% - 0% n/a 76,750
Airtime sales 27,789 10% 20,373 8% 36% 7,416
Other product 1,637 1% 9,464 4% -83% (7,827)
Freight 2,000 1% 1,584 1% 26% 416
---------------------------------------------------
Total revenues $ 269,594 100% $ 264,225 100% 2% $ 5,369
Revenues for the six-month period ended June 30, 2005 were $269,594 as compared
to $264,255 for the corresponding period of the prior year, an increase of 2%
between periods. During the six months ended June 30, 2005, one customer, who
purchased the Company's Hydro I product, represented approximately 28% of the
Company's total revenue.
Cost of goods sold includes parts and pre-manufactured components used to
assemble our products as well as allocated overhead for production personnel and
facilities costs. Cost of goods sold increased by $9,000 or 5% to $189,623 for
the six months ended June 30, 2005 from $180,623 for the corresponding period of
the prior year and increased as a percentage of revenues between the periods
from 68% to 70%.
Selling, general and administrative expenses for the six months ended June 30,
2005 increased by $608,755 or 113% to $1,149,700 from $540,945 for the six-month
period ended June 30, 2004. The Company incurred approximately $235,000 in
non-cash expenses in the six-month period ended June 30, 2005 for consulting and
other services. This represents an increase of approximately $161,000 in
non-cash expenses when compared to the same period ended June 30, 2004. Other
SG&A expense increases from the six-month period ended June 30, 2004 to 2005
include: non-manufacturing related employee costs increased approximately
$57,000, the Company spent approximately $49,000 more on sales, marketing and
travel, incurred approximately $33,000 in settling a lawsuit, spent
approximately $51,000 more on legal fees and incurred approximately $263,000 in
expenses related to fundraising activity.
Interest expense increased $432,319 or 764% between the six-month periods
presented. The increase was due primarily to interest expense related to the
Dutchess notes, some of which have no stated interest rate but have a repayment
amount greater than the funded amount. The Company recognizes the difference
between the face amount of the notes and the amounts actually received in cash
as interest expense over the life of the loans. In addition, the value of the
incentive shares issued in conjunction with the notes is recognized as interest
expense over the life of the loans. Penalties on late payment of notes and any
interest incurred during these periods are also recognized as interest expense.
In total, the Company recognized approximately $198,000 in non-cash expenses
related to the amortization of these loan discounts, approximately $134,000 in
non-cash expenses related to incentive shares and approximately $86,000 in
penalties on late payments of notes.
The net loss for the six-month period ended June 30, 2005 was $1,559,576
compared to $519,532 for the six-month period ended June 30, 2004. The increase
in net loss from continuing operations was due primarily to increased non-cash
expenses for consulting and other services, increased fundraising expenditures,
and increased non-cash interest expense.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial statements for the six months ended June 30, 2005 have
been prepared on a going concern basis, which contemplates the realization of
assets and the settlement of liabilities and commitments in the normal course of
business. The Company incurred a net loss of approximately $1.38 million during
the year ended December 31, 2004 and a net loss of approximately $1.56 million
during the six months ended June 30, 2005. The Company had a stockholders'
deficit and working capital deficiency of approximately $1.24 million and $1.04
million, respectively, as of December 31, 2004 and $1.82 million and $1.77
million respectively, as of June 30, 2005.
The Report of Independent Registered Public Accounting Firm on the Company's
financial statements as of and for the year ended December 31, 2004 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.
During the six months ended June 30, 2005, cash used in operating activities was
approximately $940,000. The net loss of approximately $1.56 million for the
six-month period was partially offset by approximately $572,000 in non-cash
expenses and decreases in accounts receivable and prepaids and an increase in
accrued expenses. Uses of cash were increases in inventories as well as a
decline in accounts payable. Cash used in operating activities in the six-month
period ended June 30, 2004 was approximately $413,000. The net loss for the
period of approximately $520,000 was partially offset by approximately $112,000
in non-cash expenses and increase in accounts payable and accrued expenses.
Other uses of cash during the period were increases in accounts receivable and
inventories.
The Company purchased approximately $2,000 in computer equipment in the
six-month period ended June 30, 2005. There were no cash flows from investing
activity for the six-month period ended June 30, 2004.
Net cash provided by financing activities for the six-month period ended June
30, 2005 was approximately $901,000 and resulted primarily from the issuance of
notes payable to Dutchess, the sale of common stock and warrants and the
exercise of puts with Dutchess. The Company issued 2,276,610 shares of common
stock in return for approximately $362,000 in net cash proceeds during the
period. The Company also received $1,113,500 from Dutchess during the six-month
period in exchange for notes. These cash inflows were offset to some degree by
payments on notes payable of approximately $575,000 during the period. Net cash
provided by financing activity for the six-month period ended June 30, 2004 was
approximately $415,000 and resulted primarily from the sale of common stock,
preferred stock, special warrants and notes from related and other parties
offset by payments on notes payable and other related party payables.
Until the Company is able to generate positive cash flows from operations in an
amount sufficient to cover its current liabilities and debt obligations as they
become due, it will remain reliant on borrowing funds or selling equity to meet
those obligations. The Company had historically sold its equity securities
through private placements with various individuals. Raising funds in this
manner typically requires much time and effort to find new accredited investors,
and the terms of such an investment must be negotiated for each investment made.
Cash from these types of investments has historically been generated in amounts
of $50,000 or less, in an unpredictable manner, making it difficult to fund and
implement a broad-based sales and marketing program.
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 the third quarter of 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 the six months ended June 30, 2005, Dutchess loaned the company a total
of $1,113,500 in the form of notes payable. The notes have no stated interest
rate but have a face amount greater than the funded amount. This difference is
recognized as interest expense over the life of the loan. Under the terms of
the notes, Dutchess is also issued incentive shares, which are recorded as
prepaid interest and expensed over the life of the loan.
During the six months ended June 30, 2005, the Company exercised six (6) puts to
Dutchess totaling 1,276,610 shares for net proceeds of $222,726. Of the total
proceeds, $125,633 was used to repay portions of previously issued notes to
Dutchess and $67,838 went to the Company.
On March 9, 2005, Dutchess exercised 250,000 warrants at $0.125 each, for total
proceeds of $31,250, $15,000 of which was applied to outstanding notes and
accrued interest.
The Company used the proceeds from the notes, puts and warrants to fund its
operating cash flow deficits and to repay outstanding notes and accrued interest
and penalties to Dutchess.
For more information on the transactions with Dutchess, please see Note 5, Notes
payable.
Although no assurance may be given that it will be able to do so, the Company
expects to be able to continue to access funds under this arrangement to help it
fund near-term and long-term sales and marketing efforts, and to cover cash flow
deficiencies.
In the first six months of 2005, the Company identified sales and marketing
objectives and implemented a sales and marketing plan utilizing the Dutchess
financing agreement designed to stimulate revenue growth. This effort has
continued throughout 2005, and as of August 18, 2005, the Company has
established relationships and business opportunities that it believes will
result in increased sales and revenues in the future. While our customers have
identified needs that are substantial, our efforts have indicated that customers
are more likely to order our products in stages so that their installation and
utilization can be managed efficiently. Historical results have shown that once
customers have adopted the use of our products, they often order multiple times
thereafter in order to meet their overall needs. As such, and in order to avoid
the concentration of risk among only a few customers, the Company's approach for
the foreseeable future will be to obtain customers through test and trial
programs if necessary, in order to grow its overall customer base and increase
the likelihood of future sales to those same customers. Initial customer
contact is typically made through the use of lead generation programs offered by
third parties, attendance at trade shows, mailers to targeted lists, and direct
customer inquiries through our website.
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures:
The Company's management, including the Company's principal executive officer
and principal accounting and financial officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the
six-month period ended June 30, 2005, the period covered by the Quarterly Report
on Form 10-QSB. Based upon that evaluation, the Company's principal executive
officer and principal financial and accounting officer have concluded that the
disclosure controls and procedures were effective as of June 30, 2005 to provide
reasonable assurance that material information relating to the Company is made
known to management including the CEO.
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting. However, 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.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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.
These securities were issued to the investor 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. The
purchaser represented to us in connection with the purchase that; he is an
accredited investor and was acquiring the shares for investment purposes only
and not for distribution, that he could bear the risks of the investment and
could hold the securities for an indefinite period of time. The purchaser
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. The
participant in the offering 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 3. DEFAULTS UPON SENIOR SECURITIES
The Company is in default on two loans from Mr. Revesz, a former board member,
as of the date of this report. In April 2004, the Company reached an agreement
with Tomas Revesz under which, in return for an additional $25,000 in borrowings
and the extension of the maturity dates of three notes to July 31, 2004, the
Company granted the creditor a secured position in the assets of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS
(a) Exhibits
31.1 Certification of H. Douglas Saathoff, Chief Executive Officer, pursuant to
Rule 13A-14 or 15D-14 of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Daniel P. McRedmond, Principal Financial and Accounting
Officer, pursuant to Rule 13A-14 or 15D-14 of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification pursuant to the 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
None.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NIGHTHAWK SYSTEMS, INC.
(Registrant)
Date: August 22, 2005 By: /s/ H. Douglas Saathoff
H. Douglas Saathoff,
-------------------------
Chief Executive Officer
Date: August 22, 2005 By: /s/ Daniel P. McRedmond
Daniel P. McRedmond
------------------------
Principal Accounting and Financial Officer