10QSB 1 v050019_10-qsb.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (MARK ONE) |X| Quarterly Report Pursuant to Section 13 or 15(d) of Securities Exchange Act of 1934 For the quarterly period ended June 30, 2006 |_| Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______ to _______. Commission file number 814-00631 HOMELAND SECURITY CAPITAL CORPORATION (Name of small business issuer in its charter) Delaware 59-2050585 (State or Other Jurisdiction of Incorporation (I.R.S. Employer or Organization) Identification No.) 4100 N. Fairfax Drive, #1150 Arlington, VA 22203 (Address of principal executive offices) (Zip code) (703) 528-7073 (Issuer's Telephone Number, Including Area Code) 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 |_| No |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Check whether the registrant filed all documents and reports required to be filed by Sections 12, 13 or 15(d)of the Exchange Act subsequent to the distribution of securities under a plan confirmed by a court. |_| Yes |_| No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: There were 4,155,380,536 par value $.001 per share, shares of common stock outstanding as of August 14, 2006. Transitional Small Business Disclosure Format: Yes |_| No |X| PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The accompanying interim condensed consolidated financial statements and notes to the consolidated financial statements for the interim periods as of June 30, 2006 and for the three and six months ended June 30, 2006 and 2005, are unaudited. The accompanying interim unaudited financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States for interim financial statements and pursuant to the requirements for reporting on Form 10-QSB and Article 10 of Regulation S-B. Accordingly, these inteim unaudited financial statements do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Form 10-K of the Company as of and for the year ended December 31, 2005. Certain June 30, 2005 balances have been reclassified to conform to the June 30, 2006 financial statement presentation. 1 HOMELAND SECURITY CAPITAL CORPORATION Consolidated Balance Sheets
June 30, 2006 December 31,2005 ------------- ---------------- (unaudited) ASSETS Cash $ 646,280 $ 1,094,061 Accounts receivable 3,404,003 -- Inventories 52,776 -- Costs in excess of billings on uncompleted contracts 515,449 -- Other current assets 172,893 144,657 ------------ ------------ Total current assets 4,791,401 1,238,718 ------------ ------------ Fixed assets, net 206,232 24,306 Deferred officers' compensation 240,000 -- Deferred financing costs - net 447,780 -- ------------ ------------ Total assets $ 5,685,413 $ 1,263,024 ============ ============ Liabilities and Stockholders' Equity Accounts payable $ 1,107,841 $ 384,792 Judgments and defaults payable 44,000 44,000 Accrued interest 129,810 64,911 Billings in excess of costs on uncompleted contracts 523,681 -- Derivative liability 2,674,923 -- Other current liabilities 134,232 4,601 ------------ ------------ Total current liabilities 4,614,487 498,304 Convertible debentures - related party, net of $2,996,667 discount 1,003,333 -- Convertible debentures, net -- 222,500 ------------ ------------ 1,003,333 222,500 ------------ ------------ Total liabilities 5,617,820 720,804 ------------ ------------ Commitments and contingencies -- -- Minority interest in consolidated subsidiaries 205,499 -- Stockholders' Equity (deficit) Preferred stock Series F 100,000 100,000 Preferred stock Series G 100,000 -- Common stock, $.001 par value, 20,000,000,000 shares authorized, 4,155,380,536 and 4,397,728,539 shares issued and outstanding, respectively 4,155,381 4,397,729 Additional paid-in capital 42,556,343 41,822,550 Accumulated deficit (47,049,630) (45,778,059) ------------ ------------ Total stockholders' equity (deficit) (137,906) 542,220 ------------ ------------ Total liabilities and stockholders' equity (deficit) $ 5,685,413 $ 1,263,024 ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements 2 HOMELAND SECURITY CAPITAL CORPORATION Consolidated Statements of Operations (unaudited)
Three Months Three Months Six Months Six Months Ended Ended Ended Ended June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005 -------------- -------------- -------------- ------------- Sales $ 2,053,707 $ -- $ 2,741,737 $ -- -------------- -------------- -------------- ------------ Cost of sales Materials 888,314 -- 1,268,560 -- Labor 278,001 539,099 Other -- -- 123,727 -- Total cost of sales 1,166,315 -- 1,931,386 -- -------------- -------------- -------------- ------------ Gross profit on sales 887,392 -- 810,351 -- General and administrative expenses 1,273,635 192,239 2,329,966 392,920 -------------- -------------- -------------- ------------ Operating income (loss) (386,243) (192,239) (1,519,615) (392,920) Other income (expense) Amortization of debt offering costs (43,332) -- (72,220) (40,529) Beneficial conversion feature - convertible debentures -- (53,709) -- (242,988) Amortization of debt discounts (290,000) -- (483,333) -- Interest expense (51,934) (9,374) (90,535) (68,112) Settlement of debt 13,276 (156,408) 13,276 32,038 Minority interest in loss of consolidated subsidiary (8,654) -- 60,225 -- Other income (expense) 1,240,660 39,944 820,631 39,944 -------------- -------------- -------------- ------------ Total other income (expense) 860,016 (179,547) 248,044 (279,647) -------------- -------------- -------------- ------------ Net income (loss) attributable to common stockholders $ 473,773 $ (371,786) $ (1,271,571) $ (672,567) ============== ============== ============== ============ Income (loss) per common share, basic and diluted Net income (loss) per common share attributable to common stockholders - basic $ 0.00 $ 0.00 $ 0.00 $ 0.00 ============== ============== ============== ============ - diluted $ 0.00 $ -- $ -- $ -- ============== ============== ============== ============ Weighted average shares outstanding - basic 4,144,179,071 4,428,073,650 4,167,858,917 491,955,173 ============== ============== ============== ============ - dliuted 4,435,012,404 -- -- -- ============== ============== ============== ============
The accompanying notes are an integral part of these condensed consolidated financial statements 3 HOMELAND SECURITY CAPITAL CORPORATION Consolidated Statements of Cash Flows (unaudited)
Six Months Six Months Ended Ended June 30, 2006 June 30, 2005 ------------- ------------- Cash flows from operating activities: Net loss $(1,271,571) $ (672,567) Adjustments to reconcile net loss to net cash used in operating activities: Settlement of debt (11,514) (181,901) Stock issued for payment of expenses 271,216 -- Depreciation and amortization 21,065 5,600 Beneficial conversion - convertible notes -- 242,988 Amortization of debt discount (321,744) -- Amortization of debt offering costs 72,220 40,529 Changes in operating assets and liabilities: Accounts Receivable (3,277,316) -- Inventories (52,776) -- Other assets (670,373) (150,215) Accounts payable 723,050 (50,083) Judgments and defaults payable -- (103,774) Accrued interest 76,413 (310,020) Other current liabilities 653,312 6,039 ----------- ----------- Net cash provided by (used in) operating activities (3,788,018) (1,173,404) Cash flows from investing activities: Purchase of fixed assets (202,991) -- Increase in other assets (240,000) -- Minority interest in consolidated subsidiaries 205,499 -- Proceeds from liquidation of Yorkville Advisors Management, LLC -- 5,240,000 ----------- ----------- Net cash provided by (used in) investing activities (237,492) 5,240,000 Cash flows from financing activities: Proceeds from convertible debentures - related party 4,000,000 -- Cost of convertible debentures - related party (430,000) -- Conversion of convertible debentures (222,500) -- Common stock issued for convertible debentures 230,229 Payments on notes payable -- (1,542,500) Payments on notes payable - related party -- (1,265,000) Acquisition of treasury stock -- (417,967) ----------- ----------- Net cash used in financing activities 3,577,729 (3,225,467) Net increase (decrease) in cash (447,781) 841,129 Cash, beginning of period 1,094,061 1,863 ----------- ----------- Cash, end of period $ 646,280 $ 842,992 =========== =========== Cash paid for: Interest $ 17,410 $ 302,040 =========== =========== Taxes $ -- $ -- =========== ===========
The accompanying notes are an integral part of these condensed consolidated financial statements 4 HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Changes in Stockholders' Equity For the six months ended June 30, 2006
Total Common Stock Additional Stockholders' Preferred -------------------------- Paid- Accumulated (Deficit) Stock Shares Amount In Capital Deficit Equity --------- ------------- ---------- ----------- ------------ ------------- Balance December 31, 2005 $100,000 4,397,728,539 $4,397,729 $41,822,550 $(45,778,059) $ 542,220 Issuance of preferred stock Series G 100,000 710,000 810,000 Exchanged for common stock (450,000,000) (450,000) (360,000) (810,000) Conversion of debentures to common 157,651,997 157,652 72,577 230,229 Value of vested stock options 271,216 271,216 Issuance of common stock for fees 50,000,000 50,000 40,000 90,000 Net loss (unaudited) (1,271,571) (1,271,571) ------------ ----------- Balance, June 30, 2006 $200,000 4,155,380,536 $4,155,381 $42,556,343 $(47,049,630) $ (137,906) ======== ============= ========== =========== ============ ===========
The accompanying notes are an integral part of these condensed consolidated financial statements 5 HOMELAND SECURITY CAPITAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2006 Overview Homeland Security Capital Corporation (formerly Celerity Systems, Inc.) (the "Company" or "HMSC"), a Delaware corporation, is a consolidator in the fragmented homeland security industry. The Company is focused on long-term value by taking controlling interests in and developing its subsidiary companies through superior operations and management. The Company intends to acquire businesses that provide homeland security product and service solutions, growing organically and through acquisitions. The targets are emerging companies that are generating revenues from promising security products and services but face challenges in scaling their businesses to capitalize on the opportunities in the homeland security industry. Prior to changing its focus, the Company was a closed-end management investment company that was initially formed to design, develop, integrate, install, operate and support interactive video services hardware and software ("interactive video") systems. On June 3, 2003, the Company elected to become a Business Development Company ("BDC") that is regulated under the Investment Company Act of 1940, as amended ("Investment Company Act"). A BDC is an investment company designed to assist eligible portfolio companies with capital formation and which are required to offer, and many times do render, substantial and continuing management advice. As contemplated by this election, the Company materially changed its business plan to primarily seek investments in developing companies that offer attractive investment opportunities. However, at its stockholders' meeting on December 30, 2005, the Company approved the withdrawal of the Company's election as a BDC and the Company changed its focus to the homeland security industry. 1. Presentation of Unaudited Interim Financial Statements On May 20, 2003, the Company formed a subsidiary, Celerity Systems, Inc., a Nevada corporation, ("Celerity NV"). The assets and liabilities related to the Company's existing interactive video business were transferred to Celerity NV for 100% of the common stock. As this subsidiary is not an investment company, between June 3, 2003 and December 31, 2005, it is not consolidated with the parent company. During its designation as a BDC, the Company's principal investment was a minority ownership interest in Yorkville Advisors Management, LLC ("Yorkville"). In accordance with Article 6 of Regulation S-X under the Securities Act of 1933, as amended (the "Securities Act") and Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company does not consolidate portfolio company investments in which the Company has a controlling interest. However, for periods after December 31, 2005, the Company will consolidate controlled companies. The results of operations for the three and six months ended June 30, 2005 reflect the Company's results as a BDC. Accounting principles used in the preparation of the financial statements between June 3, 2003 and December 31, 2005 are different than those of prior or subsequent periods and, therefore, the financial position and results of operations of these periods are not directly comparable. The primary differences in accounting principles relate to the carrying value of investments. At its annual meeting on December 30, 2005, the stockholders passed a resolution to withdraw the Company's election as a BDC under Section 54 of the Investment Company Act. The termination of the Company's BDC status occurred on January 5, 2006. Financial statements for periods subsequent to December 31, 2005 will be prepared on the basis used prior to becoming a BDC. 2. Stock-Based Compensation In December 2005, the Company issued to directors and an officer of the Company options to purchase 796,000,000 shares of common stock par value $0.001 per share (the "Common Stock") in the future. In February 2006, the Company issued 60,000,000 options to a contractor and 10,000,000 options to an employee of the Company to purchase shares of Common Stock of the Company in the future. 6 Of the options granted in December 2005 and February 2006, options to purchase 290,833,333 shares of Common Stock vested during the six month period ended June 30, 2006 and the Company recorded $271,217 as compensation expense related to the vesting of these options. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2005 and 2006; risk-free interest rate of 4.4%, volatility between 426% and 456% and expected lives of ten years. 3. Investment in Celerity Systems, Inc. (A Nevada corporation) Celerity NV had no operations for the six months ended June 30, 2006 or for the six months ended June 30, 2005. Because of lack of sales of systems and consequent lack of operating profits, the Company's directors decided in September 2004 to cease operations and dispose of the remaining business and related assets. Accordingly, the Company entered into a sales agreement with Escent Systems, Inc. whereby the Company transferred all the assets and business plus $15,000 for working capital in return for a 25% equity position in Escent Systems, Inc. Since the net assets of Celerity NV had been written to nil, there was no further loss recorded on the transaction. Because of the lack of operations and uncertainty of continued operations, Celerity NV has not assigned any value to the investment. 4. Investment in Sagamore Holdings, Inc. In September 2004, the Company entered into a business development agreement with Sagamore Holdings, Inc. ("Sagamore') with an effective date of October 4, 2004. The Company received 7,500,000 shares of Sagamore common stock as consideration for its agreement to provide future services regarding capital formation and management advise. The Company has reviewed the valuation of the Sagamore stock using fair value, and, based on the liquidation preference of the preferred stockholder, management has considered the value of the stock as nil. Also, the Company has rendered no specific services in 2006 or 2005. There have been no events or circumstances occurring in the six months ended June 30, 2006 that would change the valuation. Accordingly, the Board of Directors has continued to include the value of the Sagamore stock in its financial statements as nil and has not recognized any revenue from the transaction. 5. Investment in Yorkville Advisors Management, LLC. On December 1, 2003, the Company purchased a minority interest in Yorkville, which is the investment manager of a private equity fund that is a principal holder of equity securities of the Company. The purchase price amounted to $5,240,000. In 2005, the Company was informed that Yorkville was in the process of an orderly liquidation of its business. Under the terms of a Preferential Rights Agreement, the Company's membership interest in Yorkville has been converted into a new class with certain preferential rights and shall receive consideration equal to the original purchase price less certain debt of approximately $1,500,000 due to an affiliated company of Yorkville. The Company received this consideration in full and in cash by May 3, 2005. 7 6. Acquisition of Nexus Preferred Shares On February 8, 2006, the Company entered into a Series A Convertible Preferred Stock Purchase Agreement (the "Purchase Agreement") with Nexus Technologies Group, Inc. ("Nexus"). Pursuant to the Purchase Agreement, the Company purchased 3,400,000 shares of Nexus Series A Convertible Preferred Stock (the "Nexus Preferred Shares") for an aggregate purchase price of $3,400,000. The Company also committed to purchase an additional 6,400,000 Nexus Preferred Shares, in one or more transactions, at a purchase price of $1.00 per share at any time prior to February 8, 2008. Each Nexus Preferred Share accrues dividends cumulatively at the rate of eight percent (8%) per annum and is convertible into one (1) share of the Nexus common stock at any time by the Company, subject to adjustment for stock dividends, stock splits, and similar events. Each Nexus Preferred Share is entitled to one vote as if converted into Nexus common stock. The holders of the outstanding Nexus Preferred Shares, as a class, have the right to elect a majority of the board of directors of Nexus. Each Nexus Preferred Share has a liquidation preference of $1.00 per share plus any accrued and unpaid dividends. The following is an unaudited condensed statement of operations for the six months ended June 30, 2006 showing the combined results of operations of the Company and Nexus as though the Company had acquired the Nexus Preferred Shares on January 1, 2006: Pro Forma HMSC Nexus Adjustments Pro Forma ------------ ----------- ----------- ----------- Sales $ -- $ 2,741,737 $ 2,741,737 Net loss $ (1,271,571) $ (704,090) $60,225 $(1,915,436) Net loss per share 0.00 0.00 -- 0.00 Since the Company operated during 2005 as a BDC with an entirely different business strategy and had no meaningful operations for the six months ended June 30, 2005, we believe that it would not provide a meaningful comparison to provide a pro forma unaudited condensed statement of operations showing the combined results of operations of the Company and Nexus as though the Company had acquired the Nexus Preferred Shares on January 1, 2005. 7. Investment in Nexus Technology Group On February 8, 2006, Nexus, a subsidiary of the Company, completed its acquisition of Corporate Security Solutions, Inc., a Pennsylvania corporation ("CSS") pursuant to the terms of an Agreement and Plan of Merger (the "Merger Agreement"), dated February 8, 2006, by and among Nexus, CSS, CSS Acquisition, Inc. and certain other persons named therein. Pursuant to the Merger Agreement, CSS Acquisition, Inc., a wholly owned subsidiary of Nexus, merged with and into CSS (the "Merger") with CSS surviving the Merger. The stockholders of CSS received an aggregate of 3,675,000 shares of Nexus common stock in exchange for all of the issued and outstanding CSS common stock. Of these shares, 3,000,000 are deemed restricted stock and are subject to vesting and performance provisions. Upon the effectiveness of the Merger, the Company maintained of Nexus with control with its 82.1% of the voting power of Nexus. 8. Series G Preferred Stock On February 6, 2006, the Company entered into an Investment Agreement with Cornell Capital Partners, LP, pursuant to which the Company exchanged with Cornell Capital Partners 1,000,000 shares of Series G Convertible Preferred Stock (the "Series G Preferred Shares") for 450,000,000 shares of the Company's Common Stock owned by Cornell Capital Partners. Each share of Series G Preferred Shares may be converted, at Cornell Capital Partners' discretion, into 450 shares of the Common Stock. The Series G Preferred Shares are senior in rank to all Common Stock and all series of preferred stock of the Company. Each share of Series G Preferred Share has a liquidation preference of $0.10 plus any accrued and unpaid dividends. The holders of Series G Preferred Shares are not entitled to receive any dividends. The Company paid a $10,000 structuring fee to Yorkville in connection with the transaction. In connection with the Investment Agreement, the Company entered into an Investor Registration Rights Agreement with the Cornell Capital Partners pursuant to which the Company agreed to file a registration statement covering the resale of shares of Common Stock issuable upon the conversion of the Series G Preferred Shares. The Company also filed a Certificate of Designation with the State of Delaware amending its Certificate of Incorporation to include the rights and terms of the Series G Preferred Shares. 8 9. Sale of Convertible Debentures On February 6, 2006, the Company entered into a Securities Purchase Agreement with Cornell Capital Partners, which provided for the purchase by Cornell Capital Partners of a Convertible Debenture (the "Debenture") in the amount of $4,000,000, which debenture is convertible into Common Stock. The conversion price of the Debenture shall be equal to the lesser of (1) $0.01 or (2) a ten percent discount to the lowest daily volume weighted average price of the Common Stock for the thirty days preceding conversion. Cornell Capital Partners is entitled to convert the Debenture at a conversion price into Common Stock, provided that Cornell Capital Partners cannot convert into shares of Common Stock that would cause Cornell Capital Partners to own more than 4.9% of the issued and outstanding Common Stock. The Debenture has an interest at rate of 5% per annum and the principal amount will be payable on the third anniversary of the effective date of the Debenture. If the Common Stock is trading below the conversion price, the Company may redeem the Debenture at any time upon the payment of a redemption premium equal to twenty percent of the amounts redeemed. Pursuant to a Security Agreement between the Company and Cornell Capital Partners, the Company's obligations under the Debenture are secured by a pledge of all of its assets. Pursuant to the Securities Purchase Agreement, the Company paid a commitment fee of $400,000 and $20,000 in structuring fees and diligence fees, all to Yorkville. Accordingly, the Company received net proceeds of approximately $3,580,000 upon issuance of the Debenture. The Company has also issued to Cornell Capital Partners 50,000,000 shares of Common Stock pursuant to this transaction. In connection with the Securities Purchase Agreement, the Company entered into an Investor Registration Rights Agreement with Cornell Capital Partners pursuant to which the Company agreed to file a registration statement covering the resale of shares of Common Stock issuable upon the conversion of the Debenture. In accordance with EITF-00-19 and SFAS 150, and because there is no explicit limit on the number of shares that are to be delivered upon exercise of the conversion feature, the Company is not able to assert that it will have sufficient authorized and unissued shares to settle the conversion option. As a result, the conversion feature will be accounted for as a derivative liability, with the fair value recorded in earnings each period. 10. Income or Loss Per Share Basic and diluted imcome or loss per share were computed by dividing net income or loss attributable to Common Stock by the weighted average number of common shares outstanding during each period. 11. Long-term Debt The long-term debt of the Company includes the following items: June 30, 2006 December 31, 2005 ------------- ----------------- 5% convertible debentures - 2004 $ - 0 - $222,500 5% convertible debentures - 2006 1,003,333 - 0 - ---------- -------- Long-term debt less current maturities $1,003,333 $222,500 ========== ======== During the six months ended June 30, 2006, $222,500 in face value of convertible debentures plus accrued interest of $19,243 were presented for conversion, accordingly, 157,651,997 shares of Common Stock were issued. 12. Stock Buyback Program In September 2004, the Board of Directors authorized the Company to establish a stock buyback program whereby the Company would acquire up to 500,000,000 shares of its Common Stock over a twelve month period from the open market at favorable prices. There was no obligation to acquire any specific number of shares or purchase at any specific price. At December 31, 2004, the Company had acquired 226,843,599 shares at a cost of $561,334 and from January through March 2005, the Company acquired 87,180,000 shares at a cost of $228,321. The acquisitions have been accounted for as treasury stock. The funding was provided primarily through a short term note of $500,000 from a related party through December 2004. In the three month period ended March 31, 2005, the purchases were funded from proceeds from the liquidation of its Yorkville investment. When the buyback program was complete, the Company retired all shares acquired under the program. 9 13. Judgments and Defaults Payable In January 2002, the Company terminated the Equity Line of Credit entered into on September 14, 2001 due to delays in getting related shares registered and in order to pursue other types of financing arrangements. As a result, the Company does not have an effective registration statement including common shares to be issued in connection with certain debentures issued in 2001 and the first quarter of 2002 under the 1999 Line of Credit Agreement, entered into with Cornell Capital Partners. The Company is required to pay liquidated damages in the form of increased interest on the convertible debentures as a result of not filing an effective registration statement for these debentures at a rate of 2% of the principle plus interest per month. The liability for liquidated damages has been accrued at its maximum amount. The Company has remaining accrued liquidated damages of $36,000 at June 30, 2006 and 2005. In 2003, Del Rio Enterprises sued the Company for non-payment of services rendered. During 2003, a judgment was rendered against the Company in the amount of $8,000. This amount has been accrued at June 30, 2006. 14. Common Stock During the six months ended June 30, 2006, the Company issued 50,000,000 shares of Common Stock valued at $90,000 in partial payment for costs of issuance on its 5% convertible debenture. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Introductory Statements Forward-Looking Statements and Associated Risks. This Report contains forward-looking statements. Such forward-looking statements include statements regarding, among other things, (a) our projected sales and profitability, (b) our growth strategies, (c) anticipated trends in our industry, (d) our future financing plans, (e) our anticipated needs for working capital, (f) our lack of operational experience, and (g) the benefits related to ownership of our common stock. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend," or "project" or the negative of these words or other variations on these words or comparable terminology. These forward-looking statements are based largely on our company's expectations and are subject to a number of risks and uncertainties, including those described in "Business Risk Factors" of our Form 10-K for the year ended December 31, 2005. Actual results could differ materially from these forward-looking statements as a result of changes in trends in the economy and our company's industry, demand for our products, competition, reductions in the availability of financing and availability of raw materials, and other factors. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this Report will in fact occur as projected. Overview Homeland Security Capital Corporation (together with any subsidiaries shall be referred to as the `Company,' `we,' `us' and `our') was incorporated in Delaware on August 12, 1997, and is located in Arlington, Virginia. The Company focuses on the acquisition and development of homeland security businesses. The Company's original business was to develop and manufacture, at third party plants, digital set top boxes and digital video servers for the interactive television and high speed Internet markets. On June 3, 2003, the Company elected to become a business development company ("BDC"), to be regulated pursuant to Section 54 of the Investment Company Act of 1940, as amended (the "Investment Company Act"). A business development company is an investment company designed to assist eligible portfolio companies with capital formation and management advice. The Company then changed its business plan to primarily seek investments in developing companies. On December 30, 2005, at a special stockholders meeting (the "Special Meeting"), the stockholders of the Company voted to amend the Certificate of Incorporation of the Company to change the name to `Homeland Security Capital Corporation' and voted to withdraw the Company's election as a BDC. Accordingly, the Company has changed its business plan to primarily seek acquisition of companies that provide homeland security products and services. The Company is seeking to build consolidated enterprises through the acquisition and integration of multiple businesses in the homeland security industry. We will seek to create long-term shareholder value by taking controlling interests in companies that provide homeland security products and services and helping them develop through superior operations, management and acquisitions. Our value creation strategy is designed to foster significant growth at our platform companies by providing leadership and counsel, capital support and financial expertise, strategic guidance and operating discipline, access to best practices and industry knowledge. We are targeting emerging companies in fragmented sectors of the homeland security industry. These target companies are generating revenues from promising security products and services but face challenges in scaling their businesses to capitalize on opportunities in the homeland security industry. As part of the Company's new business strategy, the Company acquired a majority interest in Nexus Technologies Group, Inc. ("Nexus") on February 8, 2006 through the purchase of $3.4 million in preferred stock of Nexus. Nexus is a mid-Atlantic security integrator for the corporate and governmental security markets. Based in Hawthorne, N.Y., Nexus' subsidiaries began operations in 2001. Nexus specializes in non-proprietary integrated security solutions, including access control, alarm, video, communication, perimeter protection and bomb and metal detection security systems. Where applicable in this annual report, references to the `Company,' `we,' `us' and `our' shall include Nexus. Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that are complex and those that require significant judgments and estimates in the preparation of our financial statements, including valuation of our investments. Management relies on historical experience and on other assumptions believed to be reasonable under the circumstances in making its judgment and estimates. Actual results could differ materially from those estimates. 11 Revenue Recognition - Nexus recognizes revenues on its security system installation and integration contracts using the percentage of completion method. 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 revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair Value of Financial Instruments - The carrying amount of items included in working capital approximates fair value because of the short maturity of those instruments. The carrying value of the Company's debt approximates fair value because it bears interest at rates that are similar to current borrowing rates for loans of comparable terms, maturity and credit risk that are available to the Company. Debt Offering Costs - Debt offering costs are related to private placements and are being amortized on a straight line basis over the term of the related debt, most of which is in the form of convertible debentures. Should conversion occur prior to the stated maturity date the remaining unamortized cost is expensed. Investment Valuation - Investments in equity securities are recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation, respectively. The fair value of investments that have no ready market, are determined in good faith by management, and approved by the Board of Directors, based upon assets and revenues of the underlying investee companies as well as general market trends for businesses in the same industry. Because of the inherent uncertainty of valuations, management's estimates of the values of the investments may differ significantly from the values that would have been used had a ready market for the investments existed and the differences could be material. Income Taxes - The Company accounts for income taxes using the asset and liability method, whereby deferred tax assets and liabilities are determined based upon the differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance related to the deferred tax assets is also recorded when it is more likely than not that some or all of the deferred tax asset will not be realized. Results of Operations Three Months Ended June 30, 2006 Compared With the Three Months Ended June 30, 2005 Revenues For the three months ended June 30, 2006, the Company had sales of $2,053,707 consisting of fees earned by Nexus on security systems installation and integration contracts. The Company had no sales for the three month period ended June 30, 2005. The increase in sales is due to the implementation of the Company's new business strategy of acquiring and integrating businesses that provide homeland security products and services. Cost of goods sold For the three months ended June 30, 2006, cost of sales was $1,166,315 consisting of materials, labor and other costs incurred by Nexus associated with security systems installation and integration contracts. The Company had no cost of sales for the three months ended June 30, 2005. The increase in cost of sales is due to the implementation of the Company's new business strategy of acquiring and integrating businesses that provide homeland security products and services. General and administrative expenses General and administrative expenses for the three months ended June 30, 2006 were $1,273,635 compared to $192,239 for the three months ended June 30, 2005. The increase of $1,081,396 or 562% in general and administrative expenses is primarily due to general and administrative expenses that were incurred in the acquisition of Nexus. The increase consisted of additional professional fees of $38,125 for the acquisition of Nexus, additional personnel costs of $701,138, increases in facility and insurance expenses of $188,085 and general administrative costs of $154,048. These costs and other expenses were incurred in connection with the Company's change in business strategy for the three month period. 12 Other income and expense The Company had net other income of $860,016 for the three months ended June 30, 2006 compared to net other expenses of $(179,547) for the three months ended June 30, 2005 for an increase of $1,039,563 or 579%. Income was increased by a positive change in the derivative valuation of $1,194,955, settlement of trade payables of $169,684 and interest income of $5,761. Other income and expense was decreased by increases in interest expense of $42,560, amortization of debt discounts of $236,291, amortization of debt offering costs of $43,332 and recording of minority interest in the consolidated Nexus subsidiaries of $8,654. Net income (loss) As a result of the foregoing, the Company recorded a net income of $473,773 for the three months ended June 30, 2006 compared to a net loss of $371,786 for the three months ended June 30, 2005. This represents an increase in the net income of $845,559 or 227%. Six Months Ended June 30, 2006 Compared With the Six Months Ended June 30, 2005 Revenues For the six months ended June 30, 2006, the Company had sales of $2,741,737, consisting of fees earned by Nexus on security systems installation and integration contracts. The Company had no sales for the six month period ended June 30, 2005. The increase in sales is due to the implementation of the Company's new business strategy of acquiring and integrating businesses that provide homeland security products and services. Cost of goods sold For the six months ended June 30, 2006, cost of sales was $1,931,386, consisting of materials, labor and other costs incurred by Nexus associated with security systems installation and integration contracts. The Company had no cost of sales for the six months ended June 30, 2005. The increase in cost of sales is due to the implementation of the Company's new business strategy of acquiring and integrating businesses that provide homeland security products and services. General and administrative expenses General and administrative expenses for the six months ended June 30, 2006 were $2,329,966 compared to $392,920 for the six months ended June 30, 2005. The increase of $1,937,046 or 493% in general and administrative expenses is primarily due to general and administrative expenses that were incurred in the acquisition of Nexus. The increase consisted of additional professional fees of $242,089 for the acquisition of Nexus, additional personnel costs of $1,255,457, increases in facility and insurance expenses of $184,604 and general administrative costs of $254,896. These costs and other expenses were incurred in connection with the Company's change in business strategy for the six month period. Other income and expense The Company had net other income of $248,044 for the six months ended June 30, 2006 compared to net other expenses of $(279,647) for the six months ended June 30, 2005 for an increase of $527,691 or 189%. Income was increased by a positive change in the derivative valuation of $805,077, recording a minority interest in the loss of the consolidated Nexus subsidiary of $60,225, and interest income of $15,554. Other income and expense was decreased by increases in interest expense of $22,423, amortization of debt discounts of $240,345, amortization of debt offering costs of $31,691, a reduction in the settlement of trade payables of $18,762 and a reduction in investment income of $39,944. Net loss As a result of the foregoing, the Company recorded a net loss of $1,271,571 for the six months ended June 30, 2006 and a net loss of $672,567 for the six months ended June 30, 2005. This represents an increase in the net loss of $599,004 or 89%. 13 Liquidity and Capital Resources The primary source of financing for the Company since its inception has been through the issuance of common and preferred stock and debt. The Company had cash on hand of $646,280 at June 30, 2006 and $1,094,061 at December 31, 2005. Our primary needs for cash are to fund our ongoing operations until such time as they begin to generate sufficient cash to fund operations and to have cash available to make additional acquisitions of businesses that provide homeland security products and services. While we believe that we have sufficient cash on hand to satisfy our current operating commitments, we will require significant additional funding in order to make additional acquisitions. While we currently do not have any commitments in place for additional funding, on August 29, 2005, the Company entered into term sheet agreement with Cornell Capital Partners to enter into a $50 million standby equity distribution agreement (the "SEDA Financing"). Based on the SEDA term sheet, Cornell Capital Partners shall commit to purchase up to $50 million of Common Stock of the Company over the course of 24 months after an effective registration of the Company's common stock, par value $.001 per share (the "Common Stock"). The Company shall have the right, but not the obligation, to sell Common Stock to Cornell Capital Partners, in advances up to $1,000,000 each. Upon closing, the Company shall issue to Cornell restricted shares and/or warrants of the Company's Common Stock in an amount equal to 2% of the commitment amount based on a share price of $0.001 per share. The number of restricted shares issued shall be limited to less than 4.9% of the total outstanding shares of the Company at closing. Upon each advance, Cornell Capital Partners shall receive directly from escrow cash compensation equal to 5% of the gross proceeds of such advance. The Company shall sell to Cornell Capital Partners the Common Stock at a purchase price equal to 98% of the market price, which is defined as the lowest closing bid price of the Common Stock during the five consecutive trading days after the date an advance notice is given to Cornell Capital Partners. As of August 14, 2006, the Company has not received any definitive documents in connection with the SEDA Financing. The final terms and conditions of the SEDA Financing may be subject to modification as mutually agreed upon by the Company and Cornell Capital Partners at the time of entering into definitive agreements. The Company entered into a Securities Purchase Agreement with Cornell Capital Partners, dated as of February 6, 2006, which provided for the purchase by Cornell Capital Partners of a Convertible Debenture (the "Debenture") in the amount of $4,000,000, which debenture is convertible into Common Stock. The conversion price of the Debenture shall be equal to the lesser of (1) $0.01 or (2) a ten percent discount to the lowest daily volume weighted average price of the Common Stock for the thirty days preceding conversion. Cornell Capital Partners will be entitled to convert the Debenture at a conversion price into Common Stock, provided that Cornell Capital Partners cannot convert into shares of Common Stock that would cause Cornell Capital to own more than 4.9% of the issued and outstanding Common Stock. The Debenture will bear interest at 5% per annum and the principal amount will be payable on the third anniversary of the effective date of the Debenture. If the Common Stock is trading below the conversion price, the Company may redeem the Debenture at any time upon the payment of a redemption premium equal to twenty percent of the amounts redeemed. On February 6, 2006, the Company entered into an Investment Agreement with Cornell Capital Partners, pursuant to which the Company exchanged with Cornell Capital Partners 1,000,000 shares of Series G Convertible Preferred Stock (the "Series G Preferred Shares") for 450,000,000 shares of the Company's Common Stock owned by Cornell Capital Partners. Each share of Series G Preferred Shares may be converted, at Cornell Capital Partners' discretion, into 450 shares of the Common Stock. The Series G Preferred Shares are senior to all Common Stock and all series of preferred stock of the Company. Each share of Series G Preferred Share has a liquidation preference of $0.10 plus any accrued and unpaid dividends. The holders of Series G Preferred Shares are not entitled to receive any dividends. The Company paid a $10,000 structuring fee to Yorkville Advisors Management, LLC in connection with the transaction. During the six months ended June 30, 2006, we had a net decrease in cash of $(447,781). Our sources and uses of funds were as follows: Cash Flows from Operating Activities We used net cash of $(3,788,018) in our operating activities during the six month period ended June 30, 2006. Our net cash used in operating activities resulted primarily from the Company's net loss of $(1,271,571) for the six months ended June 30, 2006, a use of $(2,547,690) from net changes in operating assets and liabilities for the six months ended June 30, 2006 and the net change in derivative and debt discounts of $321,744. These uses have been offset by $271,216 from the use of stock issued as compensation and for payment of expenses, $21,065 in depreciation and amortization and $72,220 in amortization of debt offering costs for the six months ended June 30, 2006. Cash Flows from Investing Activities 14 We used net cash of $(237,492) in our investing activities during the six month period ended June 30, 2006, consisting primarily $202,991 in purchases of fixed assets and an increase of $240,000 in other assets, offset by an increase of $205,499 in minority interest in consolidated subsidiaries. Cash Flows from Financing Activities We provided cash of $3,577,729 from financing activities during the six month period ended June 30, 2006, consisting of $4,000,000 in proceeds from convertible debentures issued less $430,000 in costs associated with the issuance of those debentures. We also converted debentures and received net proceeds of $7,729 in cash. As of June 30, 2006, we had positive net working capital of $176,914. ITEM 3. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures: As of the end of the period covered by this Report, the Company carried out an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer/Principal Accounting Officer (which is one person), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. The Company's disclosure controls and procedures are designed to produce a reasonable level of assurance of achieving the Company's disclosure control objectives. The Company's Chief Executive Officer/Principal Accounting Officer have concluded that the Company's disclosure controls and procedures were, in fact, adequate and effective to ensure that material information relating to the Company that is required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in rules of the U. S. Securities and Exchange Commission (the "Commission") and accumulated and communicated to the Company's management, including its Chief Executive Officer/ Principal Accounting Officer, to allow timely decisions regarding required disclosure. (b) Changes In Internal Controls Over Financial Reporting In connection with the evaluation of the Company's internal controls during the Company's last fiscal quarter, the Company`s Chief Executive Officer/Principal Accounting Officer has determined that there are no changes to the Company's internal controls over financial reporting that has materially affected, or is reasonably likely to materially effect, the Company's internal controls over financial reporting. 15 PART II ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of this filing:
Exhibit No Description Location ---------- ---------------------------------------- ---------------------------------------- 3.1 Certificate of Amendment to Certificate Incorporated by reference as Exhibit 3.1 of Incorporation to Form 8-K filed with the Commission on February 6, 2006 3.2 Certificate of Designation for the Incorporated by reference as Exhibit 3.1 Series G Convertible Preferred Stock to Form 8-K filed with the Commission on February 14, 2006 4.1 Form of Convertible Debenture due Incorporated by reference as Exhibit 4.1 February 2009 to Form 8-K filed with the Commission on February 14, 06 10.1 Securities Purchase Agreement dated Incorporated by reference as Exhibit February 6, 2006, by and between 10.1 to Form 8-K filed with the Homeland Security Capital Corporation Commission on February 14, 2006 and Cornell Capital Partners LP 10.2 Investment Agreement dated February 6, Incorporated by reference as Exhibit 2006, by and between Homeland Security 10.2 to Form 8-K filed with the Capital Corporation and Cornell Capital Commission on February 14, 2006 Partners LP 10.3 Investor Registration Rights Agreement Incorporated by reference as Exhibit dated February 6, 2006, by and between 10.3 to Form 8-K filed with the Homeland Security Capital Corporation Commission on February 14, 2006 and Cornell Capital Partners LP 10.4 Investor Registration Rights Agreement Incorporated by reference as Exhibit dated February 14, 2006, by and between 10.4 to Form 8-K filed with the Homeland Security Capital Corporation Commission on February 14, 2006 and Cornell Capital Partners LP
16
Exhibit No Description Location ---------- ---------------------------------------- ---------------------------------------- 10.5 Security Agreement dated February 6, Incorporated by reference as Exhibit 2006, by and between Homeland Security 10.5 to Form 8-K filed with the Capital Corporation and Cornell Capital Commission on February 14, 2006 Partners, LP. 10.6 Agreement and Plan of Merger, dated Incorporated by reference as Exhibit February 14, 2006, by and among Nexus 10.1 to Form 8-K filed with the Technologies Group, Inc., Corporate Commission on February 14, 2006 Security Solutions, Inc., CSS Acquisitions, Inc. and certain other persons named therein. 10.7 Series A Convertible Preferred Stock Incorporated by reference as Exhibit Purchase Agreement, dated February 14, 10.2 to Form 8-K filed with the 2006, by and between Homeland Security Commission on February 14, 2006 Capital Corporation and Nexus Technologies Group, Inc. 31.1 Certification by Chief Executive Officer Provided herewith and Principal Accounting Officer pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification by Chief Executive Officer Provided herewith and Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports of Form 8-K: On January 5, 2006, the Company filed a Current Report on Form 8-K reporting the results of the Special Meeting of its stockholders held on December 30, 2005, whereby, among other actions, the stockholders (i) approved amendments to the Company's Certificate of Incorporation to change the name of the Company to `Homeland Security Capital Corporation'; and to increase the number of authorized shares of Common Stock of the Company from 5,000,000,000 to 20,000,000,000. On January 6, 2006, the Company filed a Current Report on Form 8-K to correct a typographical mistake in its Form 8-K filed on January 5, 2006. On February 6, 2006, the Company filed a Current Report on Form 8-K to disclose the filing of its amended Certificate of Incorporation and the Company's new ticker symbol. On February 14, 2006, the Company filed a Current Report on Form 8-K to disclose the entry into an Investment Agreement, dated February 6, 2006, with Cornell Capital Partners, and related ancillary documents, pursuant to which the Company exchanged with Cornell Capital 1,000,000 shares of Series G Preferred Shares for 450,000,000 shares of the Company's Common Stock owned by Cornell Capital. The Form 8-K also disclosed the entry into a Securities Purchase Agreement, dated February 6, 2006, with Cornell Capital Partners, whereby Cornell Capital Partners purchased a Debenture in the amount of $4,000,000, which debenture is convertible into Common Stock. On February 14, 2006, the Company filed a Current Report on Form 8-K to disclose the entry into a Series A Convertible Preferred Stock Purchase Agreement (the "Purchase Agreement") with Nexus, pursuant to which, the Company purchased 3,400,000 shares of Nexus Series A Convertible Preferred Stock (the "Preferred Shares") for an aggregate purchase price of $3,400,000 (the "Offering"). The Company also committed to purchase an additional 6,400,000 Preferred Shares, in one or more transactions, at a purchase price of $1.00 per share at any time prior to February 14, 2008, subject to certain conditions. Additionally, on February 14, 2006, Nexus completed its acquisition of Corporate Security Solutions, Inc., a Pennsylvania corporation ("CSS") pursuant to the terms of an Agreement and Plan of Merger, dated February 14, 2006, by and among Nexus, Corporate Security Solutions, Inc., CSS Acquisition, Inc. and certain other persons named therein. Immediately following the Merger and the Offering, the Company will control 82.1% of the voting power of Nexus. 17 On March 15, 2006, the Company filed a Current Report on Form 8-K to disclose the entry into two Letters of Intent. On March 8, 2006, the Company and SecurityInc., a single-source manufacturer of active radio frequency identification (RFID) enabled security solutions for commercial and government sectors, entered into a non-binding letter of intent for a business combination between a subsidiary of the Company and SecurityInc. On March 9, 2006, the Company and Viscom Systems, Inc., a security integrator based in Cambridge, Massachusetts, entered into a non-binding letter of intent for a business combination between a subsidiary of the Company and Viscom Systems, Inc. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed in its behalf by the undersigned, thereunto duly authorized. HOMELAND SECURITY CAPITAL CORPORATION /s/ C. Thomas McMillen ------------------------------- C. Thomas McMillen President, Chief Executive Officer and Interim Chief Financial Officer August 14, 2006