10QSB 1 p0839-10qsb.htm FORM 10-QSB FOR QUARTER ENDED JUNE 30, 2005 Unassociated Document
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-QSB

 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2005
 
000-28745
(Commission File No.)
______________

NATIONAL SCIENTIFIC CORPORATION
(Name of Small Business Issuer in its Charter)
______________
 
Texas
 
86-0837077
(State of Incorporation) 
 
(I.R.S. Employer Identification No.)
 
 
 
 14505 North Hayden Road, Suite 305
   
 Scottsdale, AZ
 
85260-6951 
 (Address of Principal Executive Offices)
 
(Zip Code) 
 
(480) 948-8324
(Issuers Telephone Number, Including Area Code)

Securities registered under Section 12(b) of the Exchange Act:
Preferred Stock, $0.10 par value
 
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.01 par value
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o

There were 91,536,459 shares of Common Stock, par value $.01 per share, outstanding at August 9, 2005.
 
Transitional Small Business Disclosure Format (Check One):  Yes o No x

 
FORM 10-QSB
INDEX
 
   
 Page
     
Part I Financial Information
 3
     
Item 1. Financial Statements (unaudited)
 3
     
 
 3
 
 4
 
 5
 
 6
 
 7
     
Item 2.
 13
Item 3. Controls and Procedures
 18
     
Part II Other Information
 20
     
Item 1. Legal Proceedings
 20
Item 2.
 20
Item 3. Defaults Upon Senior Securities
 20
Item 4.
 20
Item 5. Other Information
 20
Item 6. Exhibits
 20
     
Signatures
 21
   
Exhibit 31 - Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
Exhibit 32 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act  
 
2

 
 
Item 1.
Financial Statements

(A Development Stage Company)

Unaudited Condensed Balance Sheet
June 30, 2005

ASSETS
Current Assets:
       
Cash and cash equivalents
 
$
15,384
 
Trade receivables, net
   
21,328
 
Inventory, net of obsolescence reserve of $32,282
   
32,282
 
Other assets
   
2,790
 
Total current assets
   
71,784
 
 
       
Property and equipment, net
   
10,860
 
Deposits
   
2,000
 
Investment in common stock
   
289,100
 
 
 
$
373,744
 
 
       
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
       
Accounts payable
 
$
194,920
 
Accrued expenses
   
476,216
 
Note payable, related party
   
159,000
 
Other notes payable and advance
   
73,750
 
Total current liabilities
   
903,886
 
 
       
Note payable
   
 
Total liabilities
   
903,886
 
 
       
Commitments and contingencies
   
 
 
       
Shareholders’ equity (deficit):
       
Preferred stock, par value $0.10; 4,000,000 shares authorized, and no shares issued and outstanding
   
 
Common stock, par value $0.01; 187,000,000 shares authorized, and 91,536,459 shares issued and outstanding
   
915,365
 
Additional paid-in capital
   
22,068,801
 
Accumulated deficit
   
(23,514,308
)
Total shareholders’ equity (deficit)
   
(530,142
)
 
       
 
 
$
373,744
 
 
       
See accompanying notes to financial statements, which are an integral part of the financial statements.
3


(A Development Stage Company)

Unaudited Condensed Statements of Operations
For the Three and Nine Months Ended June 30, 2005, 2004, and Development Stage

   
Three Months
Ended
June 30, 2005
 
 Three Months
Ended
June 30, 2004
 
Nine Months
Ended
June 30, 2005
 
 Nine Months
Ended
June 30, 2004
 
 Development
Stage
 
                                 
Revenues
 
$
24,157
 
$
4,031
 
$
29,629
 
$
78,569
 
$
1,056,831
 
Cost of Sales
   
14,680
   
2,719
   
17,911
   
58,717
   
970,995
 
Gross profit
   
9,477
   
1,312
   
11,718
   
19,852
   
85,836
 
 
         
 
         
 
       
Costs and expenses
         
 
         
 
       
Salaries and benefits
   
86,847
   
183,290
   
251,761
   
440,685
   
2,821,865
 
Research and development
   
96,795
   
8,652
   
294,329
   
18,050
   
4,260,721
 
Stock compensation
   
4,668
   
22,178
   
9,105
   
50,471
   
3,135,220
 
Consulting fees, related party
   
   
   
   
   
8,175,973
 
Other
   
97,497
   
78,774
   
214,179
   
209,944
   
2,882,131
 
Inventory obsolescence charge
   
32,282
   
   
32,282
   
   
32,282
 
Total costs and expenses
   
318,089
   
292,894
   
801,656
   
719,150
   
21,308,192
 
 
   
 
   
 
   
 
   
 
   
 
 
Loss from operations
   
(308,612
)
 
(291,582
)
 
(789,938
)
 
(699,298
)
 
(21,222,356
)
 
         
 
         
 
       
Other income (expense)
         
 
         
 
       
Interest and other income
   
   
   
   
   
178,972
 
Gain on settlement
   
   
   
   
   
89,403
 
Interest expense
   
(6,720
)
 
(8,178
)
 
(14,690
)
 
(18,652
)
 
(70,500
)
Loss on disposal of assets
   
   
   
   
   
(30,960
)
Loss on impairment of equipment
   
   
   
   
   
(64,187
)
 
   
(6,720
)
 
(8,178
)
 
(14,690
)
 
(18,652
)
 
102,728
 
 
   
 
   
 
   
 
   
 
   
 
 
Loss before income taxes
   
(315,332
)
 
(299,760
)
 
(804,628
)
 
(717,950
)
 
(21,119,628
)
Income tax expense
   
   
   
   
   
 
 
         
 
         
 
       
Net loss
 
$
(315,332
)
$
(299,760
)
$
(804,628
)
$
(717,950
)
$
(21,119,628
)
 
   
 
   
 
   
 
   
 
   
 
 
Net loss per common share, basic and diluted
 
$
(0.00
)
$
(0.00
)
$
(0.01
)
$
(0.01
)
     
 
   
 
   
 
   
 
   
 
       
Weighted average number of shares outstanding
   
91,518,361
   
83,921,036
   
88,283,373
   
76,149,638
       
                                 

See accompanying notes to financial statements, which are an integral part of the financial statements.
4

(A Development Stage Company)

Unaudited Condensed Statements of Cash Flows
For the Nine Months Ended June 30, 2005, 2004, and Development Stage
 
 
 
2005
 
 2004
 
 Development Stage
 
Cash flows from operating activities:
 
 
 
 
 
 
 
Net loss
 
$
(804,628
)
$
(717,950
)
$
(21,119,628
)
Adjustments to reconcile net loss to net cash used in operating activities:
         
 
       
Non cash transactions
         
 
       
Depreciation
   
10,161
   
9,789
   
88,491
 
Loss on disposal of assets
   
   
   
30,960
 
Impairment loss on equipment
   
   
   
64,187
 
Stock and options issued for services, net
   
9,105
   
50,471
   
11,637,238
 
Other adjustments for non-cash items
   
(25,000
)
 
   
(25,000
)
Decrease (increase) in inventory
   
33,868
   
(55,524
)
 
(32,282
)
(Increase) decrease in deferred offering costs
   
   
   
(85,171
)
Decrease (increase) in trade and other receivables
   
4,469
   
13,200
   
110,303
 
Decrease (increase) in other assets
   
15,730
   
14,029
   
4,150
 
Increase (decrease) in accounts payable and accrued expenses
   
181,965
   
67,050
   
920,592
 
Net cash (used in) operating activities
   
(574,330
)
 
(618,935
)
 
(8,406,160
)
 
                   
Cash flows from investing activities:
   
 
   
 
   
 
 
Acquisition of property and equipment
   
   
(2,074
)
 
(155,766
)
Repayment of loans
   
   
   
200,000
 
Proceeds from the sale of furniture and equipment
   
   
   
6,050
 
Loans issued
   
   
   
(400,000
)
Net cash (used in) provided by investing activities
   
   
(2,074
)
 
(349,716
)
 
                   
Cash flows from financing activities:
   
 
   
 
   
 
 
Increase in notes payable
   
30,500
   
   
30,500
 
Draws on the line of credit
   
   
   
430,000
 
Loan from (to) officer, related party, net
   
159,000
   
   
224,079
 
Repayment of notes payable
   
   
(7,500
)
 
(120,000
)
Repayment of line of credit
   
   
   
(430,000
)
Repayment of capital lease obligations
   
   
   
(1,819
)
Proceeds from the exercise of options
   
   
9,675
   
208,265
 
Proceeds from the exercise of warrants
   
   
   
92,460
 
Proceeds from equity line of credit
   
   
   
414,824
 
Proceeds from the issuance of preferred stock
   
   
   
482,500
 
Deposits from private placement
   
   
(20,000
)
 
 
Proceeds from securities exchange agreement
   
240,000
   
   
240,000
 
Proceeds from issuance of common stock
   
   
1,045,044
   
7,196,833
 
Net cash provided by financing activities
   
429,500
   
1,027,219
   
8,767,642
 
 
                   
Net (decrease) increase in cash and cash equivalents
   
(144,830
)
 
406,210
   
11,766
 
Cash and cash equivalents, beginning of period
   
160,214
   
17,903
   
3,618
 
 
                   
Cash and cash equivalents, end of period
 
$
15,384
 
$
424,113
 
$
15,384
 
 
                   
Supplementary Disclosure of Cash Flow Information:
   
 
   
 
   
 
 
Cash paid for interest
 
$
145
 
$
10,493
 
$
36,112
 
 
                   
Cash paid for income taxes
 
$
 
$
 
$
50
 
 
                   
See accompanying notes to financial statements, which are an integral part of the financial statements.
5

 
(A Development Stage Company)

 Unaudited Condensed Statement of Changes in Shareholders' Equity (Deficit)
For the Nine Months Ended June 30, 2005

 
 
Common Stock 
 
Preferred Stock 
 
 
 
 
 
 
 
 
 
Number
 
 
 
Number
 
 
 
Additional
 
 
 
 
 
 
 
of
 
Par
 
of
 
Par
 
Paid-In
 
Accumulated
 
 
 
 
 
Shares
 
Value
 
Shares
 
Value
 
Capital
 
Deficit
 
Total
 
 
                             
Balance, September 30, 2004
   
84,330,669
 
$
843,307
   
 
$
 
$
21,627,654
 
$
(22,709,680
)
$
(238,719
)
                                             
Stock Issued for services
                                           
Price per share ranged
                                           
$0.1608
   
6,218
   
62
   
   
   
838
   
   
900
 
$0.145
   
13,770
   
138
   
   
   
1,659
   
   
1,797
 
$0.0711
   
10,373
   
104
               
560
         
664
 
$0.088
   
25,429
   
254
               
1,760
         
2,014
 
                                             
Common stock options granted, net
   
   
   
   
   
3,730
   
   
3,730
 
                                           
Securities exchange agreement of common stock shares for $0.074
   
7,150,000
   
71,500
   
   
   
432,600
   
   
504,100
 
                                             
Net loss
   
   
   
   
   
   
(804,628
)
 
(804,628
)
                                             
Balance, June 30, 2005
   
91,536,459
 
$
915,365
   
 
$
 
$
22,068,801
 
$
(23,514,308
)
$
(530,142
)
 
                                           
See accompanying notes to financial statements, which are an integral part of the financial statements.

6


(A Development Stage Company)
 
NOTES TO FINANCIAL STATEMENTS
 
1.
Basis of Presentation

The accompanying financial statements have been prepared by National Scientific Corporation (“NSC” or the “Company” or “We”), without audit, and reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods. The statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations.

In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) that are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the nine months ended June 30, 2005 are not necessarily indicative of the results to be expected for the entire fiscal year. 

These 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 the fiscal year ended September 30, 2004 and the Company’s quarterly report on Form 10-QSB for the fiscal periods ended December 31, 2004 and March 31, 2005.

2.
Issuance of Common Stock

During the three months ended June 30, 2005, the Company issued an aggregate of 35,802 shares of common stock, to Gregory Szabo, a director, for board services during the period from October 1, 2004 to April 27, 2005. The stock issuances were recorded using the prior quarter’s average closing market price of the Company’s common stock. Stock-based compensation of $2,678 was recognized in the financial statements for the three months ended June 30, 2005. 

On April 27, 2005, at our Annual Meeting of Shareholders, we obtained the approval of our shareholders to amend our Articles of Incorporation to increase the number of authorized shares of common stock from 120,000,000 to 187,000,000. On May 26, 2005, the Office of the Secretary of State of the State of Texas issued a Certificate of Amendment recording the change to our Articles of Incorporation.

On January 28, 2005, the Company entered into a securities exchange agreement with TurboWorx, Inc., a Delaware corporation (“Turbo”) that provided for the exchange of 360,000 shares of the common stock of Turbo plus $240,000 in cash in exchange for 7,150,000 shares of NSC Common Stock (the “Exchange”). NSC and Turbo consummated the Exchange on February 1, 2005, and we filed an 8-K report with the Commission regarding this Agreement on February 2, 2005, which included the full text of the Agreement. We recorded the cash of $240,000 and the 7,150,000 shares at an average market price of $.074 less the placement agent’s fee of $25,000. The agreement provides the Company to receive reimbursement from Turbo for all our legal and accounting expenses associated with this transaction, up to a maximum of $150,000. Our claims to date for reimbursement of expenses totaling approximately $38,200 were paid in May 2005.
7

 
3.
Development Stage Operations

Although we have been in operation since 1996, management considers NSC to be in the development stage. From September 30, 1997 through the year ended September 30, 2001, we engaged our efforts in the research and development of semiconductor proprietary technology and processes and in raising capital to fund its operations and research. Beginning calendar 2002, we focused our efforts toward the development, acquisition, enhancement, and marketing of location device technologies. Since its initiation of operations in 1996, we have not realized significant revenue, except for approximately $882,000 generated through the export of electronic equipment, an isolated event, which occurred in fiscal 2001.
 
We experienced significant operating losses during fiscal 2004 and 2003, of $951,780 and $952,564, respectively, which raise substantial doubt about the Company’s ability to continue as a going concern. Of the total net operating losses, approximately $45,000 and $292,000 are related to stock issued for services and compensation in fiscal 2004 and 2003, respectively. Management believes that our current cash position including cash funds arising from the exercise of outstanding options, equity private placement, loans from officers, product sales, and continued aggressive expense management to be sufficient to continue operations for the next twelve months. We also believe that we may be able to reduce outstanding liabilities through negotiations with our creditors, or possibly negotiate to extend the payment schedule for these debts, or swap some debt for equity. In the event these approaches do not provide us with adequate working capital, we may be required to further curtail or reduce our development activities, seek alternative funding sources, or seek protection under reorganization laws.

The accompanying financial statements do not include any adjustments relating to the recoverability and classification of the recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.
 
4.
Stock Options and Warrants
 
Stock Options

As of June 30, 2005, we have a stock-based compensation plan initially adopted in 2000 wherein officers and employees were granted stock options. We apply APB 25 and related interpretations in accounting for the plan. Accordingly, compensation expense is equal to the difference between the exercise price of the options granted and the fair value of the common stock at the date of the grant.

Under the above-mentioned 2000 Stock Option Plan, the purchase price must be at least 100% of the fair market value of our common stock (if the option is an incentive stock option), or at least 25% of the fair market value of our common stock at the time the option is granted (if the option is a nonqualified grant), or such higher price as may be determined by the Board of Directors at the time of grant. If however, an incentive stock option is granted to an individual who would, immediately before the grant, directly or indirectly own more than 10% of the total combined voting power of all our classes of stock, the purchase price of the shares of common stock covered by such incentive stock option may not be less than 110% of the fair market value of such shares on the day the incentive stock option is granted. As the price of the Company’s common stock is currently quoted on the OTC Bulletin Board, the fair market value of the common stock underlying options granted under the 2000 Stock Option Plan shall be the last closing sale price of the common stock on the day the options are granted. If there is no market price for the common stock, then our Board of Directors may, after taking all relevant facts into consideration, determine the fair market value of our common stock.
8

 
The following is a summary of the total number of outstanding stock options and related transactions for the nine months ended June 30, 2005:
 
 
 
Weighted
Weighted
 
 
 
Number
 
Average
 
Average
 
 
 
of
 
Exercise
 
Fair
 
 
 
Shares 
 
Price
 
Value
 
 
             
Options Outstanding, September 30, 2004
   
3,709,257
 
$
0.82
 
$
0.02
 
Granted 
   
80,000
   
0.10
   
0.03
 
Exercised
   
   
   
 
Canceled
   
   
   
 
Expired
   
   
   
 
Options Outstanding, June 30, 2005
   
3,789,257
 
$
0.81
 
$
0.01
 
                     
 
40,000 stock options were granted to Gregory Szabo, a director, for board services on October 25, 2004. The weighted average grant date fair value of these options was $0.044. Stock based compensation of $1,740 was recognized in the financial statements for the three months ended March 31, 2005 using the Black-Scholes option pricing model value on the grant date. The options have a life of ten years. 

40,000 stock options were granted to Gregory Szabo, a director, for board services on May 17, 2005. The weighted average grant date fair value of these options was $0.05. Stock based compensation of $1,990 was recognized in the accompanying financial statements for the three months ended June 30, 2005 using the Black-Scholes option pricing model value on the grant date. The options have a life of ten years. 
 
During the nine months ended June 30, 2005, no stock options were exercised or canceled and no stock options expired.

The weighted average fair value of our options was calculated using the Black-Scholes option-pricing model.

Our board of directors adopted the 2000 Stock Option Plan effective January 1, 2001. Our stockholders formally approved the 2000 Stock Option Plan on February 14, 2001. We have reserved the right to issue a total of 7,000,000 shares of our common stock for issuance under the 2000 Stock Option Plan, although our Board currently plans to limit issuances of options to 4,000,000 for the immediate future.
9

 
The following table summarizes the status of stock options outstanding at June 30, 2005:
 
   
Stock Options Outstanding
 
Stock Options Exercisable
 
       
Weighted
             
       
Average
             
       
Remaining
 
Weighted
     
Weighted
 
       
Contractual
 
Average
     
Average
 
   
Number
 
Life
 
Exercise
 
Number
 
Exercise
 
Range of Exercise Prices
 
Outstanding
 
(In Years)
 
Price
 
Outstanding
 
Price
 
                       
$0.05 to $0.46
   
2,479,257
   
7.8
 
$
0.18
   
2,479,257
 
$
0.18
 
$0.47 to $1.84
   
1,000,000
   
5.4
 
$
1.84
   
1,000,000
 
$
1.84
 
$1.85 to $3.00
   
310,000
   
5.6
 
$
2.49
   
310,000
 
$
2.49
 
Total
   
3,789,257
   
6.6
 
$
0.81
   
3,789,257
 
$
0.81
 
                                 
Stock Based Compensation
 
The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations as permitted by SFAS 123 “Accounting for Stock-Based Compensation” as amended in accounting for its employee stock options. Under APB 25, compensation expense is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of grant over the exercise price.

During the quarters ended June 30, 2005 and June 30, 2004, the Company had no employee stock-based compensation awards.

Warrants

The warrants outstanding as of June 30, 2005 were as follows:
 
       
Weighted
Number
     
Average
of
 
Exercise
 
Grant Date
Shares
 
Price
 
Fair Value
         
1,000,000
 
$
0.35
 
$
24,000
1,000,000
   
0.50
   
13,100
275,000
   
0.50
   
5,590
275,000
   
0.75
   
2,690
640,000
   
0.13
   
41,600
500,000
   
0.10
   
50,650
4,414,739
   
0.11
   
463,106
3,335,961
   
0.11
   
349,942
1,808,497
   
0.10
   
215,573
800,000
   
0.10
   
46,080
135,000
   
0.062
   
3,051
14,184,197
       
$
1,215,382
             
10

 
On June 24, 2005, the Company granted warrants to purchase 135,000 shares of the Company’s common stock at an exercise price of $0.062 in conjunction with a financing program (See Borrowings below). The weighted average grant date fair value of these warrants was $3,051.

On June 30, 2005 there were 14,184,197 outstanding warrants. The weighted average grant date fair value of the warrants was $1,215,382.

5.
Net Loss Per Share
 
Basic and diluted loss per common share is calculated by dividing net loss by the weighted average number of outstanding common shares. The following table reconciles weighted average shares outstanding to amounts used to calculate basic and diluted earnings per share for the nine months ended June 30, 2005 and June 30, 2004.
 
   
2005
 
2004
 
 
         
Net (loss)
 
$
(804,628
)
$
(717,950
)
Weighted average shares:
             
Average shares outstanding
   
88,283,373
   
76,149,638
 
Effect of diluted shares
   
   
 
 
             
Average Shares outstanding, adjusted for dilutive effect
   
88,283,373
   
76,149,638
 
 
             
(Loss) per share - basic
 
$
(0.01
)
$
(0.01
)
 
             
(Loss) per share - diluted
 
$
(0.01
)
$
(0.01
)
 
             
The following are incremental common shares (not included in denominator of diluted earnings per share because of their anti-dilutive nature):

 
 
2005
 
2004
 
 
         
Stock options
   
3,789,257
   
3,312,257
 
Warrants
   
14,049,197
   
18,249,197
 
 
             
Potential common equivalents
   
17,838,454
   
21,561,454
 
 
             
11

 
6.
Borrowings
 
On June 11, 2003, the Company issued a three-year interest free convertible note of $43,250, with no payments required of the Company until the end of the three-year period, to its then-Director Mr. Lou Ross for past services rendered (See 10-KSB report for the year ended September 30, 2003). The Company can pay this note at any time before the three-year period elapses with either cash or its common restricted stock or a combination of cash and stock, at its sole discretion. Mr. Ross retired from the Company’s board on September 30, 2003. Based on the maturity date of the note, this note was classified as non-current liabilities at March 31, 2005 and as current liabilities at June 30, 2005.

On February 24, 2005, March 28, 2005, May 2, 2005, and May 27, 2005 our Chairman Michael Grollman made new personal loans to the Company totaling $159,000 to assist us with working capital needs. The loans are evidenced by a demand note that provides for repayment within five business days of a demand notice from Mr. Grollman, with interest of 6% compounded annually from June 1, 2005.

In June 2005 the Company entered into a financing program with an unrelated party to assist us with working capital needs. The program, evidenced by a promissory note, allows the Company to borrow in two traunches, each of $22,500 payable in seventy-five days. The transaction provides the note holder with a security interest prior to delivery in any assets purchased for the fulfillment of Auto Safety House (ASH) and Scottsdale Unified School District orders and a security interest in any receivable from the fulfillment of such orders. The program also required support from Mr. Grollman. Interest at 13% APR is payable if payment is extended past maturity. The agreement also required the Company to grant the note holder a warrant to purchase 135,000 shares of the Company’s common stock at an exercise price of $0.062. The Company received the first traunch on June 24, 2005.

On June 24, 2005, an Officer of the Company raised approximately $3,000 using his personal credit from a shareholder to assist the Company with short-term cash requirements in consideration of a verbal promise to repay.
 
On June 25, 2005, Officers of the Company raised approximately $5,000 using their personal credit from a shareholder in consideration of short-term personal promissory notes to assist the Company with very short-term cash requirements. The note carried effective annual interest rates of less than 6% and is payable in 90 days.
 
7.
Subsequent Events
 
On July 7, 2005, our Chairman Michael Grollman made an additional personal loan to the Company in the amount of $45,000 to assist us with working capital needs. The loan is evidenced by an unsecured promissory note that provides for repayment within 90 days or less, at no interest. The promissory note also provides that if repayment takes longer than 90 days, then interest accrues at a rate of 6 percent per year until paid in full. This brings total indebtedness of the Company to Mr. Grollman of approximately $358,000 including miscellaneous expenses, as of the date of this report. Collateral to support this debt will likely be provided by the Company in the form of equity, such as common or preferred stock or both, at some future date.

As of the date of this report, the Company is negotiating a financing program with a U.S. investment fund entity that wants to remain confidential. The draft terms of this program include a one-year Note for approximately $190,000, payable at maturity. The transaction will include warrants to purchase the Company’s restricted stock during the warrants lifetime. The warrants will include anti-dilution provisions, as well as registration rights in the event that the Company was to file an appropriate registration statement with the SEC during the next five years. Collateral to support this Note will be provided by the Company in the form of equity and an officer of the company will provide personal collateral, which would be forfeited in the event of non-payment of the Note.

12

 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Safe Harbor Statement

Statements contained herein that are not historical fact may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words and phrases such as “should be,”“will be,”“believes,”“expects,”“anticipates,”“plans,”“intends,”“may,” and similar expressions to identify forward-looking statements. Forward-looking statements are made based upon our belief as of the date that such statements are made. These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties, many of which are beyond our control. You should not place undue reliance on these forward-looking statements, which apply only as of the date of such documents. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described above and elsewhere in this report.

Three Months Ended June 30, 2005 Compared to the Three Months Ended June 30, 2004

We incurred a net loss of $315,332 for the three months ended June 30, 2005, as compared to a net loss of $299,760 for the three months ended June 30, 2004, as explained below.

Revenue was $24,157 for the three months ended June 30, 2005 compared to $4,031 for the quarter ended June 30, 2004. This revenue increase is attributable to the delivery in June, 2005, of 18 Travado IBUS™ video recorders, to Auto Safety House, Inc. (ASH) a leading distributor of Thomas Built Buses for use by the Scottsdale Unified School District. These 18 units were part of an overall shipment of 47 Travado IBUS™ units due to ASH, which are scheduled for delivery in August 2005. This shift in product sales follows the Company’s increased focus on its newer business-oriented products, which entered the market in March 2005 combined with a small decrease in focus on its consumer products such as Gotcha!®, which had revenues for the three months ended June 30, 2005 of $2,941 compared to $4,031 for the three months ended June 30, 2004.

We marked down our inventory of Gotcha!® products at June 30, 2005 by $32,282 or fifty percent of its original cost, for estimated obsolescence based on assumptions about age of the inventory and future demand.

NSC has recently initiated product-marketing efforts after several years of research and development and has negative operational cash flow and has never been profitable.

Our operating expenses for the three months ended June 30, 2005 were approximately $285,807 compared to $292,894 for the same period ended June 30, 2004. Explanations for this are below.

Salaries and benefits were approximately $86,847 for the three months ended June 30, 2005 compared to approximately $183,290 for the three months ended June 30, 2004. Salaries of engineers totaling approximately $86,100 were classified as research and development in the three months ended June 30, 2005. In the three months ended June 30, 2004 engineers’ salaries of approximately $76,405 were classified as salaries and benefits.
13


Stock-based compensation for the three months ended June 30, 2005 was $4,668 compared to $22,178 for the three months ended June 30, 2004. The decrease in fiscal 2005 was mainly because we did not pay any contractors with stock grants during the three months ended June 30, 2005.
 
Research and development expenditures increased to $96,795 for the three months ended June 30, 2005, compared to approximately $8,652 for the three months ended June 30, 2004. The increases in research and development expenditures are primarily because the Company continued to engineer and develop new location tools such as Travado. The Company has also spent and plans to spend resources on the development of strategic partnerships with other technology firms to assist in taking its products to market. The Company will continue to explore innovative ways to take its technology expertise and products to market, across its entire portfolio of semiconductor and location electronics related devices. All expenses incurred during the research and development stage are expensed as incurred.

Other costs and expenses were approximately $97,497 during the three months ended June 30, 2005 compared to $78,774 during the three months ended June 30, 2004. Expenses increased in the three months ended June 30, 2005 because costs related to the annual shareholders’ meeting held in April 2005 were reflected in the quarter ended June 30, 2005 whereas the meeting in 2004 was held in March, the 2004 software expense was lower due to a credit for an old accrued expense, and the bad debt reserve charge in 2005 was higher than the reserve in 2004. The increased expenses were partially offset by lower rental expense for the Scottsdale office, and lower marketing and selling expenses compared to the 2004-quarter which included the costs of a radio commercial. Other costs and expenses consist primarily of office related costs, insurance, legal and accounting fees, investor relations and shareholders meeting expenses, selling and marketing costs, and occupancy costs.

In September of 2004, we signed a contract with KidMapper Inc. of Elmhurst, IL. KidMapper is a privately owned company and concentrates on marketing and distribution of a full array of child safety products into schools, youth groups, and parent-teacher associations (PTAs). The material terms of the contract include a two year term, exclusive marketing rights of Gotcha!® into schools and PTAs using KidMapper’s national sales representatives. The Company is concerned with the lack of sales by KidMapper since we signed the contract, and is renegotiating the terms of the agreement. During the quarter ended June 30, 2005, the Company has fully reserved for the balance of $25,200 owed by KidMapper.

Nine Months Ended June 30, 2005 Compared to the Nine Months Ended June 30, 2004

We incurred a net loss of $804,628 for the nine months ended June 30, 2005, as compared to a net loss of $717,950 for the nine months ended June 30, 2004, as explained below.

Revenue was $29,629 for the nine months ended June 30, 2005 compared to $78,569 for the nine months ended June 30, 2004. This decrease in revenue was partly attributable to a consignment shipment of our Gotcha!® product sent to Canada in November, with a planned selling price of $34,200, that had been expected to invoice out of consignment before the end of June 2005, but did not. This inventory remains on consignment in Canada and is available for sale as needed. An additional factor has been the increase in the Company’s focus on its newer business-oriented products, which entered the market in March 2005, such as Travado IBUS™, and a small decrease in focus on its consumer products, such as Gotcha!®, which had revenues for the nine months ended June 30, 2005 of $6,913 compared to $75,801 for the nine months ended June 30, 2004. Revenues from our Travado IBUS™ products in the four months to June 30, 2005 totaled $22,716 and are projected to increase as we deliver our open orders during the remainder of this calendar year.
14

 
We marked down our inventory of Gotcha!® products at June 30, 2005 by $32,282 or fifty percent of its original cost, for estimated obsolescence based on assumptions about age of the inventory and current demand.

Our operating expenses for the nine months ended June 30, 2005, were $769,374 compared to $719,150 in the comparable period ended June 30, 2004. The increase in the nine months ended June 30, 2005 compared to the corresponding period ended June 30, 2004 was primarily attributable to our focus on research and development as explained below.
 
Salaries and benefits were $251,761 compared to $440,685 for the nine months ended June 30, 2004. Salaries of engineers totaling approximately $262,000 were classified as research and development in the nine months ended June 30, 2005. In the nine months ended June 30, 2004 engineers’ salaries of approximately $211,000 were classified as salaries and benefits.

Stock based compensation decreased to $9,105 for the nine months ended June 30, 2005 compared to $50,471 for the nine months ended June 30, 2004. The decrease in fiscal 2005 is mainly because we did not pay any contractors with stock grants during the nine months ended June 30, 2005.

Research and development expenditures were $294,329 for the nine months ended June 30, 2005, compared to $18,050 for the nine months ended June 30, 2004. The increases in research and development expenditures are primarily because the Company continued to engineer and develop new location tools. The Company has also spent and plans to spend resources on the development of strategic partnerships with other technology firms to assist in taking its products to market. The Company will continue to explore innovative ways to take its technology expertise and products to market, across its entire portfolio of semiconductor and location electronics related devices. All expenses incurred during the research and development stage are expensed as incurred.

Other costs and expenses were $214,179 during the nine months ended June 30, 2005 compared to $209,944 during the nine months ended June 30, 2005. Business liability insurance premiums for Gotcha!® were slightly higher in 2005, the 2004 software expense was lower due to a credit for an old accrued expense, and the bad debt reserve charge in 2005 was higher than the reserve in 2004. The increased expenses in fiscal 2005 were offset by lower rental expenses for the Scottsdale office and lower marketing costs as the radio spots of 2004 were not repeated in 2005. Other costs and expenses consist primarily of office related costs, insurance, legal and accounting fees, investor relations and shareholders meeting expenses, selling and marketing costs, and occupancy costs.

As of June 30, 2005, the Company had a note payable of $43,250 to Mr. Lou Ross, a former director, a note payable of $159,000 to our Chairman Michael Grollman, and other notes and an advance totaling $30,500 (See Borrowings above).

Total liabilities at June 30, 2005 of $903,886 included accounts payable of $194,920, accrued expenses of $476,216, and notes payable and an advance of $232,750. Accrued expenses included approximately $396,000 for accruals of salaries, vacation pay, and interest on deferred wages.
15

 
The Company expects to continue to increase its focus on sales and marketing of its Location Tools™ products for the foreseeable future. This includes significantly increased attendance at trade shows and other product marketing events, as well as recent additional investment in product promotion through outreach programs with the trade press, using public relations resources. Partly as a result of these efforts and others, revenues have begun to be generated from operations. It is thus possible that the Company may emerge from its development stage status at sometime during the coming year.

Liquidity and Capital Resources

At June 30, 2005, we had cash and cash equivalents of $15,384. Our total cash used in operating activities from developmental stage inception in 1997 through June 30, 2005 was $8,406,160. We have an accumulated deficit of $23,514,308 and expect operating losses in the foreseeable future as we continue our efforts to develop and market commercial products. We expect to generate future revenues by entering into strategic joint venture licensing relationships, manufacturing agreements, development agreements, and other relationships with manufacturing firms and/or entities that will incorporate our technologies into their products and overall solutions. We have financed our operations primarily through the sale of common stock, through personal loans from officers and directors, and to a very limited extent and only just recently, through the sale of our products.

During the nine months ended June 30, 2005, cash used in operations was approximately $574,330 compared to approximately $618,935 for the nine months ended June 30, 2004. The decrease in cash used in operations in the 2005 period resulted from salary deferrals, and shorter hours worked by part-time employees.

During the nine months ended June 30, 2005, cash provided by financing activities of $429,500 resulted from personal loans of $159,000 from our Chairman, Michael Grollman, other loans of $30,500 (See Borrowings above), and $240,000 from the securities exchange agreement with TurboWorx, Inc. that was consummated on February 1, 2005.
 
During the nine months ended June 30, 2004, financing activities generated $1,054,719 in cash. Private offerings of our restricted common stock units raised $1,045,044 and proceeds from the exercise of stock options generated $9,675.

We believe that our current cash position as of June 30, 2005, including cash funds arising from the exercise of outstanding options, and secured plant assets from legal settlements, from equity placement sales, preferred stock sales, debt to equity swaps, and other capital raising efforts, loans from officers, product sales, and aggressive expense management to be sufficient to continue operations for the next twelve months. We also believe that we may be able to reduce outstanding liabilities through negotiations with our creditors, or possibly negotiate to extend the payment schedule for these debts. In the event these approaches do not provide us with adequate working capital, we may be required to further curtail or reduce our development activities, seek alternative funding sources, or seek protection under reorganization laws.

Other Results of Operations

April 13-14, 2005, we exhibited our Travado IBUS™ product at the Colorado Association of School Business Officials (CASBO) / Colorado School Pupil Transportation Association (CSPTA) Vendor Show held in Colorado Springs, CO. More than 200 Colorado school business and transportation officials were in attendance. From this show we identified a number of potential distributors and customers with whom the sales group is following up.
16

 
On April 26, 2005, we were granted U.S. Patent number 6,885,853 by the U.S. Patent and Trademark Office for a communications receiver with integrated IF filter and method therefor. The application for this patent was submitted in April of 2001 in conjunction with our Bluetooth research and development conducted by our former San Jose, CA office.

In May 2005, in conjunction with technology firms SAP, Intel, and Ekahau, we began a successful series of tests on a new NSC product dubbed the Mini-Travado or the “Mini-T100.” The units were designed to provide real time location and telemetry data of government and first responder vehicles. Testing was undertaken in Corpus Christi, Texas, on a citywide WiFi-mesh network developed by a team from Tropos with support from Intel. Our Mini-T unit successfully completed the evaluation stage and representatives from SAP and Intel made a presentation about the project at SAP’s Sapphire Boston event on May 17, 2005. The Mini-T100 provides GPS location and sends this information in real-time over a WiFi network. The target market for this new product, which we expect to formally launch later this year, includes fire, police and ambulance, as well as the education market.
 
On May 18, 2005, we received a purchase order from Auto Safety House (ASH) for 22 units of our Travado IBUS™ Digital Video Recording (DVR) and location aware system in response to an order ASH received from the Scottsdale Unified School District for 22 school buses equipped with NSC’s IBUS™ system. The specification for these new buses includes the requirement that each be equipped with an NSC Travado IBUS™ system. We delivered 18 Travado IBUS™ units to ASH in June 2005.  Labor to install the units is provided by ASH. We expect to gain additional orders for this technology throughout the coming year. ASH is a leading distributor of Thomas Built Buses. We are working on a further strategic relationship with ASH for the development of channel sales for our Travado IBUS™ product.
 
NSC has agreed to distribute at least 180,000 of the shares of TurboWorx stock it received in the Exchange to NSC shareholders of record on a pro rata basis as soon as practicable after the effective date of a registration statement on Form SB-2 registering the TurboWorx shares to be distributed to NSC shareholders. TurboWorx has agreed to file such registration statement, and has agreed to use its best efforts to have such filed registration statement declared effective no later than 90 days following the filing date. TurboWorx filed a registration statement or Form SB-2 with the SEC on June 6, 2005. The parties have also granted each other certain "piggyback" registration rights regarding the exchanged shares. The registration rights terminate on December 31, 2007. The foregoing summary of the Agreement is qualified in its entirety by the securities exchange agreement previously filed. The Exchange is a further development resulting from the Memorandum of Understanding entered into between NSC and Turbo on October 29, 2004 regarding the joint development of technology and joint marketing.

On June 22, 2005 we exhibited our Travado IBUS™ product at the Transportation Administrators of Arizona’s Annual Summer Conference held in Flagstaff, AZ, where we demonstrated the product on a school bus configured for Scottsdale Unified School District and provided by our partner, ASH. The conference was attended by more than 250 buyers of school bus and transportation products and services.

Throughout the quarter ended June 30, 2005 our sales and marketing staff spent many hours following up the leads obtained at tradeshows with sales calls, marketing materials, product demonstrations, and product proposals. This sales cycle activity continues as of the date of this report and is expected to continue the remainder of the current fiscal and calendar years.
 
17

 
Other Subsequent Events

On July 7, 2005, TurboWorx received a comments letter from the U.S. Securities and Exchange Commission in response to its first filing of Form SB-2 on June 6, 2005. To the best of our knowledge, TurboWorx plans to address the SEC’s comments fully and file an amended registration statement or Form SB-2/A likely during the month of August.

On July 29, 2005 we received a purchase order from the City of Corpus Christi, Texas for Mini-Travado's for delivery in August 2005. This order is a result of the successful testing program with select Corpus Christi First Responders conducted in May 2005. We believe these new units will be used to further the Intel Digital Cities and Communities Initiative that includes Intel, SAP, and others. Upon successfully completing this phase we would expect an opportunity for additional orders as the town integrates these units into their significant fleet of vehicles.

On August 1-2, 2005, we exhibited our Travado IBUS™ product at the School Transportation News 12th Annual North American School Bus Expo in Reno, NV. More than 450 school transportation officials and school district buyers from all over the country were in attendance. Prior to and during the exhibition we ran a number of promotional events that generated a significant number of leads from qualified school districts.
 
Additional Travado IBUS(tm) units were delivered to ASH in August 2005.

As of the date of this report, we have ongoing discussions with potential distributors in California, New York, Colorado, New Mexico, and Texas. Our product is listed in now listed on the Mohave Educational Services Co-operative through our Arizona and Nevada distribution partner, Auto Safety House (ASH). This Co-operative allows us to sell our products directly to the school districts in Arizona without going through a formal bid process. We also have a number of quotations for our IBUS™ system pending at various school districts throughout the Southwest that we expect to convert to purchase orders during the coming weeks. Our primary focus as a Company this year is to develop and sell this product into the education and related markets.
 
Item 3.
Controls and Procedures
 
Our management has responsibility for establishing and maintaining adequate internal control over financial reporting for us. Our management uses a framework for establishing these internal controls. This framework includes review of accounting detailed records on at least a quarterly basis by multiple senior officers of National Scientific, at least one of whom operates outside of the corporate finance and accounting area, and one of whom operates within the area of corporate finance and accounting. This review process includes review of significant accounting records and source documents, such as general journal entry records, accounts payable records, and monthly bank statement reconciliations. Documentary records are kept of this review process.

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Acting Chief Financial Officer and its President, of the effectiveness, as of June 30, 2005, of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Acting Chief Financial Officer and its President concluded that the Company’s disclosure controls and procedures are effective.
18

 
There have been no significant changes in our internal control over financial reporting during the quarter ended June 30, 2005 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The controls and procedures for our disclosure as well as our internal controls over financial reporting are processes designed by, or under the supervision of, the principal executive and principal financial officers, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. However, our Chief Executive Officer and Acting Chief Financial Officer and its President have concluded that the Company’s disclosure controls and procedures and its internal controls and procedures are effective at providing that reasonable level of assurance.

Our management believes that upon significant future growth in the number of accounting transactions we process, perhaps within the next year, additional review and enhancement of internal controls will be required. Our management is planning to assign additional staff resources to assist with support for growth in the internal controls area when the increase in transaction velocity dictates this as a prudent step in order to maintain our effective level of internal controls.

Our external auditors, for the fiscal year ended September 30, 2004, Hurley and Company, have not issued an attestation report on management’s assessment of the Company’s internal control over financial reporting, as it is not yet required since the Company has less than $75 million in “public float.”
19

 

Item 1.
Legal Proceedings.

The Company is involved in legal actions in the ordinary course of its business, including those outlined in the Company's annual report on Form 10-KSB for the fiscal year ended September 30, 2004. Although the outcome of any such legal actions cannot be predicted, in the opinion of management, there are no legal proceedings pending or asserted against or involving the Company the net outcome of which are likely to have a material adverse effect upon the financial position or results of operations of the Company.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.

On October 25, 2004, the Company issued 19,988 restricted common shares to Gregory Szabo, a director, for board services at average market prices ranging from $0.145 to $0.1608 per share.

On May 17, 2005, the Company issued 35,802 restricted common shares to Gregory Szabo, a director, for board services at average market prices ranging from $0.711 to $0.088 per share.

Item 3.
Defaults Upon Senior Securities.

Not applicable.
 
Item 4.
Submission of Matters to a Vote of Security Holders.

Not applicable.
 
Item 5.
Other Information.

Not applicable.
 
Item 6.
Exhibits.
 
Exhibit Number
 
 Description
     
 31
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
 32
  Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
 
20

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
  NATIONAL SCIENTIFIC CORPORATION
 
 
 
 
 
 
Date:  August 12, 2005 By:   /s/  Michael A. Grollman
 
 
Michael A. Grollman
Director, Chairman, Chief Executive Officer, and
Acting Chief Financial Officer
 
     
   
 
 
 
 
 
 
Date:  August 12, 2005 By:   /s/  Graham L. Clark
 
 
Graham L. Clark
Director, President, and Secretary
 
     
   
 
 
 
 
 
 
Date:  August 12, 2005 By:   /s/  Gregory Szabo
 
 
Gregory Szabo
Director

21