10QSB 1 p0588-10qsb.htm FORM 10-QSB FOR THE QUARTER ENDED MARCH 31, 2006 FORM 10-QSB

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 March 31, 2006
 
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
 
Check 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 þ     No o
 
Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o No þ
 
There were 96,725,459 shares of Common Stock, par value $.01 per share, outstanding at May 15, 2006.
 
Transitional Small Business Disclosure Format (Check One):  Yes o     No þ
 
FORM 10-QSB
INDEX
 
   
 Page
     
Part I Financial Information
 3
     
Item 1. Financial Statements (unaudited)
 3
     
 
 3
 
 4
 
 5
 
 7
 
 8
     
Item 2.
 17
Item 3. Controls and Procedures
 21
     
Part II Other Information
 22
     
Item 1. Legal Proceedings
 22
Item 2.
 22
Item 3. Defaults Upon Senior Securities
 22
Item 4.
 22
Item 5. Other Information
 22
Item 6. Exhibits and Reports on Form 8-K
 22
     
Signatures
 23
   
Exhibit 31 - Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
Exhibit 32 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act  
 

 
Item 1.
Financial Statements
 
(A Development Stage Company)
 
Unaudited Condensed Balance Sheets
March 31, 2006 and September 30, 2005
 
 
 
March 31, 2006
 
September 30, 2005
 
ASSETS
 
(Unaudited)
 
(Audited)
 
Current Assets:
 
 
      
Cash and cash equivalents
 
$
218
 
$
1,616
 
Trade receivables, net
   
1,266
   
9,968
 
Inventory, net
   
17,827
   
23,735
 
Other assets
   
19,296
   
68
 
Total current assets
   
38,607
   
35,387
 
 
           
Property and equipment, net
   
4,359
   
7,680
 
Deposits
   
2,000
   
2,000
 
Deferred offering costs, net
   
22,000
   
 
Investment
   
289,100
   
289,100
 
 
 
$
356,066
 
$
334,167
 
 
         
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
           
Current Liabilities:
           
Accounts payable - related parties
 
$
89,442
 
$
72,914
 
Accounts payable - other
   
172,569
   
183,664
 
Accrued expenses
   
696,267
   
519,132
 
Notes payable - related party
   
159,000
   
159,000
 
Notes payable - other
   
45,750
   
60,150
 
Total current liabilities
   
1,163,028
   
994,860
 
 
           
Notes payable, net of current portion
   
118,595
   
 
Total liabilities
   
1,281,623
   
994,860
 
 
           
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 shares issued and outstanding 96,225,459 and 94,095,459 at March 31, 2006 and September 30, 2005, respectively
   
962,255
   
940,955
 
Additional paid-in capital
   
22,322,097
   
22,248,814
 
Accumulated deficit prior to the development stage
   
(2,394,680
)
 
(2,394,680
)
Accumulated deficit during the development stage
   
(21,815,229
)
 
(21,455,782
)
Total shareholders’ equity (deficit)
   
(925,557
)
 
(660,693
)
 
         
 
 
$
356,066
 
$
334,167
 
 
         
See accompanying notes to financial statements, which are an integral part of the financial statements.

(A Development Stage Company)
 
Unaudited Condensed Statements of Operations
For the Three and Six Months Ended March 31, 2006, 2005, and Development Stage
 

 
 
Three Months
Ended
March 31, 2006
 
Three Months
Ended
March 31, 2005
 
Six Months
Ended
March 31, 2006
 
Six Months
Ended
March 31, 2005
 
 Development
Stage
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
10,152
 
$
3,609
 
$
87,831
 
$
5,472
 
$
1,188,259
 
 
                     
Cost of Sales
   
4,120
   
2,118
   
56,959
   
3,231
   
1,058,823
 
                                 
Gross profit
   
6,032
   
1,491
   
30,872
   
2,241
   
129,436
 
 
                             
Costs and expenses
                             
Salaries and benefits
   
46,562
   
61,113
   
129,689
   
164,914
   
3,037,501
 
Research and development
   
46,465
   
124,051
   
134,543
   
197,534
   
4,492,526
 
Stock compensation
   
   
   
   
4,437
   
3,142,288
 
Consulting fees, related party
   
   
   
   
   
8,175,973
 
Other
   
44,369
   
60,694
   
87,187
   
116,682
   
3,010,829
 
Inventory obsolescence charge
   
   
   
   
   
46,775
 
Total costs and expenses
   
137,396
   
245,858
   
351,419
   
483,567
   
21,905,892
 
 
                     
Loss from operations
   
(131,364
)
 
(244,367
)
 
(320,547
)
 
(481,326
)
 
(21,776,456
)
 
                     
Other income (expense)
                     
Interest and other income
   
   
   
   
   
178,972
 
Gain on settlement
   
   
   
   
   
89,403
 
Interest expense
   
(20,491
)
 
(4,253
)
 
(36,900
)
 
(7,970
)
 
(118,657
)
Amortization of deferred offering costs
   
(1,200
)
 
   
(2,000
)
 
   
(2,000
)
Loss on disposal of assets
   
   
   
   
   
(30,960
)
Loss on impairment of investment
   
   
   
   
   
(91,344
)
Loss on impairment of equipment
   
   
   
   
   
(64,187
)
 
   
(21,691
)
 
(4,253
)
 
(38,900
)
 
(7,970
)
 
(38,773
)
 
                     
Loss before income taxes
   
(153,055
)
 
(248,620
)
 
(359,447
)
 
(489,296
)
 
(21,815,229
)
Income tax expense
   
   
   
   
   
 
Net los Net loss
 
$
(153,055
)
$
(248,620
)
$
(359,447
)
$
(489,296
)
$
(21,815,229
)
 
See accompanying notes to financial statements, which are an integral part of the financial statements.
 
(A Development Stage Company)
 
Unaudited Condensed Statements of Cash Flows
For the Six Months Ended March 31, 2006, 2005, and Development Stage

 
 
 Six Months
Ended
March 31,
2006
 
 Six Months
Ended
March 31,
2005
 
 Development
 Stage
 
Cash flows from operating activities:
                
Net loss
 
$
(359,447
)
$
(489,296
)
$
(21,815,229
)
Adjustments to reconcile net loss to net cash used in operating activities:
             
Depreciation
   
3,321
   
6,671
   
94,992
 
Loss on disposal of assets
   
   
   
30,960
 
Impairment loss on equipment
   
   
   
64,187
 
Stock and options issued for services, net
   
   
4,437
   
11,639,616
 
Impairment of inventory
   
   
   
46,775
 
Impairment of investment
   
   
   
91,344
 
Warrant expense
   
   
   
4,691
 
Amortization of deferred offering costs
   
2,000
   
   
2,000
 
Amortization of debt discount
   
4,300
   
   
4,300
 
Amortization of beneficial conversion feature
   
828
   
   
828
 
Changes in assets and liabilities:
             
Decrease (increase) in inventory
   
5,908
   
78
   
(64,602
)
(Increase) decrease in deferred offering costs
   
   
   
(85,171
)
Decrease (increase) in receivables
   
8,702
   
(31,115
)
 
130,365
 
Decrease (increase) in other assets
   
(19,228
)
 
11,647
   
(12,356)
)
Increase (decrease) in accounts payable and accrued expenses
   
215,618
   
22,774
   
1,297,974
 
Net cash (used in) operating activities
   
(137,998
)
 
(474,804
)
 
(8,569,326
)
 
             
Cash flows from investing activities:
                   
Acquisition of property and equipment
   
   
   
(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
   
   
   
(349,716
)
 
             
Cash flows from financing activities:
                   
Proceeds from notes payable
   
177,500
   
   
442,000
 
Loan from (to) officer , related party
   
   
100,000
   
65,079
 
Draws on the line of credit
   
   
   
430,000
 
 
             
(Continued)
 
See accompanying notes to financial statements, which are an integral part of the financial statements.
 
NATIONAL SCIENTIFIC CORPORATION
(A Development Stage Company)
 
Unaudited Condensed Statements of Cash Flows
For the Six Months Ended March 31, 2006, 2005, and Development Stage
(Continued)

 
 
 Six Months
Ended
March 31,
2006
 
 Six Months
Ended
March 31,
2005
 
 Development
 Stage
 
               
Repayment of notes payable
   
(16,900
)
 
   
(225,500
)
Repayment of line of credit
   
   
   
(430,000
)
Repayment of capital lease obligations
   
   
   
(1,819
)
Proceeds from the exercise of options
   
   
   
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
 
Payment of financing costs
   
(24,000
)
 
   
(24,000
)
Proceeds from securities exchange agreement
   
   
240,000
   
240,000
 
Proceeds from issuance of common stock
   
   
   
7,221,833
 
Net cash provided by financing activities
   
136,600
   
340,000
   
8,915,642
 
 
 
 
 
 
 
 
 
Net (decrease) increase in cash and cash equivalents
   
(1,398
)
 
(134,804
)
 
(3,400
)
Cash and cash equivalents, beginning of period
   
1,616
   
160,214
   
3,618
 
 
             
Cash and cash equivalents, end of period
 
$
218
 
$
25,410
 
$
218
 
 
             
Supplementary Disclosure of Cash Flow Information
                   
Cash paid for interest
 
$
625
 
$
11
 
$
37,338
 
Cash paid for income taxes
 
$
   
 
$
50
 
Conversion of accounts payable and accrued expenses to equity
 
$
33,050
 
$
 
$
115,240
 
Common stock exchanged for investment
   
   
   
289,100
 
Debt discount and beneficial conversion feature
 
$
61,533
 
$
 
$
61,533
 
 
             
 
See accompanying notes to financial statements, which are an integral part of the financial statements.
 
(A Development Stage Company)
 
Unaudited Condensed Statement of Changes in Shareholders' Equity (Deficit)
For the Six Months Ended March 31, 2006 and Development Stage

 
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Number of Shares
 
Par Value
 
Number of Shares
 
Par Value
 
Additional
Paid-In
Capital
 
Accumulated Deficit
Prior to Development Stage
 
Accumulated Deficit
During the Development Stage
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2005
   
94,095,459
 
$
940,955
   
 
$
 
$
22,248,814
 
$
(2,394,680
)
$
(21,455,782
)
$
(660,693
)
 
                                 
Issuance of common stock as part of financing program
   
1,200,000
   
12,000
   
   
   
49,533
   
   
   
61,533
 
 
                                 
Issuance of common stock in exchange for accounts payable and accrued expenses. Shares issued for:
                                                 
$0.036
   
500,000
   
5,000
   
   
   
13,000
   
   
   
18,000
 
$0.035
   
430,000
   
4,300
   
   
   
10,750
   
   
   
15,050
 
 
                                 
Net loss
   
   
   
   
   
   
   
(359,447
)
 
(359,447
)
 
                                 
Balance, March 31, 2006
   
96,225,459
 
$
962,255
   
 
$
 
$
22,322,097
 
$
(2,394,680
)
$
(21,815,229
)
$
(925,557
)
 
                                 
 
See accompanying notes to financial statements, which are an integral part of the financial statements.
 
 
(A Development Stage Company)
 
NOTES TO FINANCIAL STATEMENTS
December 31, 2005
(Unaudited)

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 statements have been prepared on the basis that the Company will continue as a going concern. The results of operations for the six months ended March 31, 2006 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, 2005 and the Company’s quarterly report on Form 10-QSB for the fiscal period ended December 31, 2005.
 
2.
Issuance of Common Stock
 
On November 1, 2005, as an important phase in the current years financing plan, we entered into a financing program with a U.S. investment fund. The terms of this program include a five-year Note payable at maturity in November 2010 for $175,000, at a stated annual interest rate of 8%. Interest is due and payable semi-annually on May 1st and November 1st for each year in which the note is outstanding. The transaction also included 1,200,000 restricted common shares and a conversion/exchange option to convert the principal amount and any unpaid interest of the Note into common shares at a per share conversion price of $0.0525. These shares include weighted average anti-dilution provisions, as well as piggyback registration rights. Additionally, the Note has various put and call rights. The 1,200,000 restricted common shares were recorded at $0.043, which was the five-day average market closing price of our stock. The note and common stock were issued with a debt discount of $51,600 and a beneficial conversion feature of $9,933. The discount and beneficial conversion feature are being amortized to interest expense over the term of the note, which is approximately 60 months. The issuance of the shares resulted in deferred financing costs of $24,000. The deferred financing costs are being amortized over term of the note, which is approximately 60 months, and are included in the statement of operations as offering costs.
 
On March 15, 2006, we issued 430,000 of the Company’s restricted common shares, to Mr. Graham Clark, at the closing price of $0.035 in lieu of his partial forgiveness of the Company’s back pay indebtedness to him.
 
3.
Development Stage Operations
 
Although the Company has 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, the Company engaged its 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, the Company focused its efforts toward the development, acquisition, enhancement and marketing of location device technologies. Since its initiation of operations in 1996, the Company has not realized significant revenue, except for approximately $882,000 generated through the export of electronic equipment, an isolated event, which occurred in fiscal 2001.
 
The Company experienced significant operating losses during fiscal years 2005 and 2004, of $1,140,782 and $951,780 respectively, which raise substantial doubt about the Company’s ability to continue as a going concern. Of the total net operating losses, approximately $11,482 and $45,000 are related to stock issued for services and compensation in fiscal years 2005 and 2004, respectively. Additionally, $4,691 relates to compensation expense recorded for warrants granted in fiscal 2005. The Company also recorded an impairment in its investment in TurboWorx Inc. of $91,344 and wrote down its inventory by $46,775 in fiscal year 2005. Management believes that its current cash position including cash funds arising from the exercise of outstanding options, equity private placement, mergers and acquisition activities, 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. 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 March 31, 2006, 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.

 
 
 
 
Weighted
 
Weighted
 
 
 
Number
 
Average
 
Average
 
 
 
of
 
Exercise
 
Fair
 
 
 
Shares
 
Price
 
Value
 
 
 
 
 
 
 
 
 
Options Outstanding, September 30, 2005
   
3,789,257
 
$
0.81
 
$
0.02
 
Granted
   
   
   
 
Exercised
   
   
   
 
Canceled
   
   
   
 
Options Outstanding, March 31, 2006
   
3,789,257
 
$
0.81
 
$
0.02
 
 
9

 
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.
 
As of March 31, 2006, we have issued options to purchase an aggregate of 3,789,257 shares of our common stock leaving a balance of 3,210,743 available for grant. Also as of March 31, 2006, 3,789,257 options are exercisable and 3,789,257 are vested. No options have been exercised or have expired during the six months ended March 31, 2006.
 
Stock Based Compensation
 
The Company has elected to follow 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.
 
The following table summarizes the status of stock options outstanding at March 31, 2006:

 
 
Stock Options Outstanding
 
Stock Options Exercisable
 
 
 
 
 
Weighted
 
 
 
 
 
 
 
 
 
 
 
Average
 
 
 
 
 
 
 
 
 
 
 
Remaining
 
Weighted
 
 
 
Weighted
 
 
 
 
 
Contractual
 
Average
 
 
 
Average
 
 
 
Number
 
Life
 
Exercise
 
Number
 
Exercise
 
Range of Exercise Prices
 
of Shares
 
(In Years)
 
Price
 
of Shares
 
Price
 
 
 
 
 
 
 
 
 
 
 
 
 
$0.05 to $0.46
   
2,479,257
   
7.04
 
$
0.18
   
2,479,257
 
$
0.18
 
$0.47 to $1.84
   
1,000,000
   
4.67
 
$
1.84
   
1,000,000
 
$
1.84
 
$1.85 to $3.00
   
310,000
   
4.81
 
$
2.49
   
310,000
 
$
2.49
 
Total
   
3,789,257
   
5.92
 
$
0.81
   
3,789,257
 
$
0.81
 
 
The following table illustrates the effect on net loss and loss per share for the six months ended March 31, 2006 and March 31, 2005 if the Company applied the fair value recognition provisions of SFAS 123 to stock-based compensation:

     
Six Months Ended
   
Six Months Ended
 
     
March 31, 2006
   
March 31, 2005
 
               
Net loss as reported
 
$
(359,447
)
$
(489,296
)
Deduct: Total stock based compensation expense as determined under the fair value method
   
   
(5,637
)
Add: Total stock based compensation recorded in the statement of operations
   
   
4,437
 
 
         
Pro forma net loss
 
$
(359,447
)
$
(490,496
)
 
         
Loss per share as reported
   
(0.00
)
 
(0.01
)
 
         
Loss per share, pro forma
   
(0.00
)
 
(0.01
)
 
As required by SFAS 123, as amended, the fair value of each grant is estimated on the date of grant using the Black-Scholes option pricing method for pro forma footnote disclosure. During the six months ended March 31, 2006 the Company did not grant any options under the 2000 Stock Option Plan. The following assumptions were made for the six months ended March 31, 2005; dividend yield of 0% and expected option life of 10 years, expected volatility 50% and risk free interest rate 5.0%.
 
Warrants
 
The warrants outstanding as of March 31, 2006 are as follows:

 
 
Warrants Outstanding
 
 Warrants Exercisable
 
 
 
Range of Exercise Prices
 
 
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Life (Years)
 
 
 
Number of Shares
 
Weighted Average Exercise Price
 
 
 
 
 
 
 
 
 
 
 
 
 
$0.062 to $0.062
   
135,000
 
$
0.062
   
2.24
   
135,000
 
$
0.062
 
$0.090 to $0.090
   
1,250,000
 
$
0.090
   
2.47
   
1,250,000
 
$
0.090
 
$0.100 to $0.100
   
3,108,497
 
$
0.100
   
4.60
   
3,108,497
 
$
0.100
 
$0.110 to $0.110
   
7,750,700
 
$
0.110
   
3.02
   
7,750,700
 
$
0.110
 
$0.130 to $0.130
   
640,000
 
$
0.130
   
0.77
   
640,000
 
$
0.130
 
$0.350 to $0.350
   
1,000,000
 
$
0.350
   
0.25
   
1,000,000
 
$
0.350
 
$0.500 to $0.500
   
1,275,000
 
$
0.500
   
0.25
   
1,275,000
 
$
0.500
 
$0.750 to $0.750
   
275,000
 
$
0.075
   
0.25
   
275,000
 
$
0.075
 
 
   
15,434,197
               
15,434,197
       
 
                               
 
11

 
During the six months ended March 31, 2006, the Company did not issue any share purchase warrants. During the six ended March 31, 2006, no share purchase warrants were exercised or have expired.
 
5.
Notes payable and Long Term debt
 
All long-term debt consisted of the following notes payable:
 
 
 
March 31, 2006
 
September 30, 2005
 
 
 
(Unaudited)
 
(Audited)
 
 
 
 
 
 
 
Note payable to shareholder; unsecured; non-interest
         
bearing; matures in June 2006; repayment may be made by the
         
Company with either cash or its restricted common stock
         
or a combination of cash and stock.
 
$
43,250
 
$
43,250
 
Note payable to an Officer of the Company; interest
         
at 6%; principal and interest payable on demand; unsecured.
   
159,000
   
159,000
 
Note payable to shareholder; unsecured; non-interest bearing
   
   
3,000
 
Note payable to shareholder; unsecured; interest at 6%
   
   
5,000
 
Note payable to an employee; interest at 6%; principal and interest
         
at 6%; principal and interest payable on demand; unsecured.
   
   
8,900
 
Note payable to shareholder; unsecured; non-interest bearing
   
1,000
   
 
Note payable to shareholder; unsecured; non-interest bearing
   
1,500
   
 
Note payable to an investment fund; payable in full in
         
November 2010; interest at 8% payable semi-annually in May
         
and November; unsecured.
   
175,000
   
 
 
   
379,750
   
219,150
 
Less:
         
Current portion of long term debt
   
(204,750
)
 
(219,150
)
Discount
   
(47,300
)
 
 
Beneficial conversion feature
   
(9,105
)
 
 
Long-term debt, net of current portion
 
$
118,595
 
$
 
 
         
 
 
12

 
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.
 
On February 24, 2005, March 28, 2005, May 2, 2005, and May 27, 2005 our Chairman, Michael Grollman, made 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. As of March 31, 2006, these loans were outstanding.
 
On November 1, 2005, as an important phase in the current years financing plan, we entered into a financing program with a U.S. investment fund. The terms of this program include a five-year Note payable at maturity in November 2010 for $175,000, at an effective annual interest rate of 8%. Interest is due and payable semi-annually on May 1st and November 1st for each year in which the note is outstanding The transaction also included 1,200,000 restricted common shares and a conversion/exchange option to convert the principal amount and any unpaid interest of the Note into common shares at a per share conversion price of $0.0525. These shares include weighted average anti-dilution provisions, as well as piggyback registration rights. Additionally, the Note has various put and call rights. The 1,200,000 restricted common shares were recorded at $0.043, which was the five-day average market closing price of our stock. The note and common stock were issued with a debt discount of $51,600 and a beneficial conversion feature of $9,933. The discount and beneficial conversion feature are being amortized to interest expense over the term of the note, which is approximately 60 months. The issuance of the shares resulted in deferred financing costs of $24,000. The deferred financing costs are being amortized over term of the note, which is approximately 60 months, and are included in the statement of operations as offering costs.
 
In March 2006 we secured short-term loans in the aggregate principal amount of $2,500. The loans are unsecured and non-interest bearing.
 
The aggregate maturities of long-term debt were as follows:

2006
 
$
204,750
 
2007
   
 
2008
   
 
2009
   
 
2010
   
175,000
 
   
$
379,750
 

6.
Investment
 
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. The total value of the transaction of $620,444 was determined by the $240,000 cash paid to the Company, plus the then current market price of the Company’s common stock of $.074, plus the total fee of $91,344 charged by Casimir Capital, L.P. (“Casimir”) the placement agent. Casimir’s fee consisted of cash consideration of $25,000 and $66,344, which was determined to be the value of the 800,000 warrants, issued to the placement agent, with an exercise price of $0.11 at date of issue. Since Turbo’s common stock was not listed on any stock exchange or the Over the Counter Bulletin Board, the Company recorded the Investment of 360,000 Turbo shares at its net cost, the average market price of the 7,150,000 shares issued to Turbo less the cash received from Turbo. The consideration paid to Casimir did not increase the fair value of the investment and therefore, resulted in an impairment write-down of $91,344. The Company’s investment in these equity securities is carried at its original cost at March 31, 2006. Management does not believe that there is any material change in the value of these securities since acquisition. The Company will regularly monitor this investment for impairment in the carrying value. The securities are considered available for sale.
 
The Company intends to distribute at least 180,000 of the shares of Turbo 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 Turbo shares to be distributed to NSC shareholders. Turbo 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. Turbo has filed the SB-2 registration statement with the Securities and Exchange Commission on June 6, 2005. Turbo filed an amendment to the SB-2 registration statement with the Securities and Exchange Commission on October 12, 2005. When the registration becomes effective, NSC will announce the distribution. The parties have also granted each other certain “piggyback” registration rights regarding the exchanged shares. The registration rights terminate on December 31, 2007. 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.
 
During the quarter ended March 31, 2006, NSC continued discussions with Turbo concerning their delinquency in obtaining an effective registration. NSC still believes that TurboWorx will honor its contractual obligations and will file an amended SB2 to the comments received from their October 12, 2005 filing, and that Turbo would still expect NSC to distribute up to 180,000 shares to our existing shareholders. However, we have not received any specific new assurances regarding timing of such an amended filing, as of the date of this report, and the continued failure of Turbo to execute on their obligations under the Securities Exchange agreement is considered a serious matter by us, and may result in legal action by us against TurboWorx if reasonable remedy is not achieved soon.
 
7.
Inventory, net
 
Inventories, primarily finished goods, are stated at the lower of cost or market values. Cost is primarily determined on a FIFO (first-in, first-out) basis.
 
 
Inventory, net consisted of the following at March 31, 2006 and September 30, 2005:
 
 
 
 
March 31, 2006 
   
September 30, 2005 
 
     
(Unaudited) 
 
 
(Audited) 
 
               
Inventory, gross
 
$
64,602
 
$
70,510
 
Less: reserve for obsolescence
   
(46,775
)
 
(46,775
)
Inventory, net
 
$
17,827
 
$
23,735
 
 
We marked down our inventory of Gotcha!® products during the fiscal year ended September 30, 2005 by $46,775 for estimated obsolescence, based on assumptions about age of the inventory and current demand. We did not dispose of any significant amount of Gotcha!® inventory during the quarter ended March 31, 2006. We have no specific timeline to dispose of the Gotcha inventory, and intend to sell this inventory from time to time as market conditions allow.
 

8.
Accrued Expenses
 
Accrued Expenses consisted of the following at March 31, 2006 and September 30, 2005:
 
     
March 31, 2006 
   
September 30, 2005 
 
     
(Unaudited) 
   
(Audited) 
 
               
Salaries & vacation pay - current management and staff
 
$
478,726
 
$
332,391
 
Salaries & vacation pay - former employee
   
29,375
   
29,375
 
Payroll taxes for back pay
   
29,634
   
27,952
 
Interest
   
78,887
   
48,189
 
Employee stock retainage pool
   
50,250
   
50,250
 
Other liabilities
   
29,395
   
30,975
 
   
$
696,267
 
$
519,132
 
 
9.
Earnings Per Share
 
The following table reconciles weighted average shares outstanding to amounts used to calculate basic and diluted earnings per share for the six months ended March 31, 2006 and March 31, 2005.
 
 
 
March 31,
2006
 
March 31,
2005
 
 
 
 
 
 
 
Net (loss)
 
$
(359,447
)
$
(489,296
)
Weighted average shares:
             
Average shares outstanding
   
95,479,030
   
86,665,878
 
Effect of diluted shares
   
   
 
 
         
Average shares outstanding, adjusted for dilutive effect
   
95,479,030
   
86,665,878
 
 
         
(Loss) per share - basic
 
$
(0.00
)
$
(0.01
)
 
         
(Loss) per share - diluted
 
$
(0.00
)
$
(0.01
)
 
         
 
Incremental common shares (not included in denominator of diluted earnings per share because of their anti-dilutive nature):

 
March 31,
2006
 
March 31,
2005
 
 
 
 
 
 
 
Options
   
3,789,257
   
3,749,257
 
Warrants
   
15,434,197
   
14,049,197
 
Potential common equivalents
   
19,223,454
   
17,798,454
 
 
         
 
 
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 March 31, 2006 Compared to Three Months Ended March 31, 2005
 
Our business focuses on the research, development, manufacture, and sale of mobile computer related hardware and software products and devices that span a range of markets. The majority of our products are electronic location-determining devices and digital video recording devices. These devices typically use small, portable radios, in conjunction with Global Positioning System (GPS) technology and small powerful mobile computers, to help establish and report the physical location of people and objects to which these devices are attached. Some of our location technologies are used in conjunction with video cameras and other sensors to record incidents on school buses. We also own devices and designs that are used in the semiconductor and electronics industries.
 
From 1996 to 2002, we engaged primarily in developing devices and designs used in the semiconductor and electronics industries. This resulted in a number of U.S. patents, but did not produce any significant amount of revenue. Additionally, during the period from 2000 to 2001 we engaged in the business of distributing electronic and other semiconductor-related products to customers in Asia and the United States in order to generate revenue. In 2001, we discontinued those activities because they did not produce the originally expected profit margins.
 
In 2002, we began to focus on applications of electronic devices in the location tools market. We also began to decrease our focus on semiconductor designs and devices, due primarily to difficult market conditions in the semiconductor industry. We plan to continue our focus on location tools for the foreseeable future. Our focus from 2002 has been on development and sales of our location tools products. Our current sales are generated primarily from our Travado™ line of mobile video systems, introduced in 2005, which include GPS and student tracking functionality. We believe this technology is more advanced than other solutions available today in the market, and can serve various mobile fleet markets, such as school, police, and fire, with a great deal of effectiveness.
 
We generated $10,152 of revenue during the three months ended March 31, 2006 compared to $3,609 during the three months ended March 31, 2005. During the three months ended March 31, 2006, all of the revenue of $10,152 was generated by our newer business-oriented products, such as Travado IBUS™, which entered the market in March 2005. During the three months ended March 31, 2005, our Gotcha!® products generated sales of $2,109 and our Travado IBUS™ products had revenues of $1,500.
 
Gross profit increased to $6,032 in the three months ended March 31, 2006 from $1,491 in the three months ended March 31, 2005.
 
Costs and expenses were $137,396 in the three months ended March 31, 2006 compared to $245,858 in the three months ended March 31, 2005.
 
Salaries and benefits, of administration and marketing personnel decreased to $46,562 in the three months ended March 31, 2006 from $61,113 in the three months ended March 31, 2005. The decrease is mainly attributable to the reduction in accrued payroll taxes resulting from a recalculation of the estimate of taxes required for outstanding back pay, the departure of one part-time employee in January and the reduction of hours worked by other part-time employees.
 
Research and development expenditures decreased to $46,465 for the three months ended March 31, 2006 from $124,051 for the three months ended March 31, 2005. This trend is expected to reverse during the second half of fiscal 2006, as research funding is planned to increase in the near term. The Company has focused an increasingly significant amount of its time and energy on development of new sources of revenue through the building of new customer relationships. The Company has also spent and plans to spend resources on the development of strategic partnerships with other technology firms to assists it 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.
 
There was no stock compensation in the three months ended March 31, 2006 and March 31, 2005.
 
Other expenses decreased in the three months ended March 31, 2006 to $44,369 from $60,694 in the three months ended March 31, 2006 as a result of reductions in depreciation, marketing, selling, telephone, insurance, shareholder’s meeting expenses and office costs. The expense reductions were somewhat offset by increases in expenses such as accountant’s fees and statutory filing fees.
 
Interest expenses increased to $20,491 during the three months ended March 31, 2006 from $4,253 in the three months ended March 31, 2005 due to the provision in the quarter ended March 31, 2006 of interest for the interest bearing Notes Payable and the amortization to interest of debt discount and the beneficial conversion feature (See Issuance of Common Stock above). None of these costs were incurred in the quarter ended March 31, 2005.
 
During the three months ended March 31, 2006, amortization of deferred offering costs, amounting to $1,200 have been charged to operations as compared to no amortization of deferred offering costs in the same period in 2005.
 
We have focused an increasingly significant amount of our time and energy on development of new sources of revenue through the building of new distributor and customer relationships. This has included increased attendance at trade shows, increased expenditures on promotional literature, Internet advertising and promotion through website listings, on-site customer product demonstrations, and other marketing related activities intended to foster customer acquisition. We have also developed plan to continue to grow strategic partnerships with other technology firms to assist our marketing efforts. We will continue to research and implement innovative ways to take our technology expertise and products to market, across our entire portfolio of semiconductor and electronics-related devices.
 
Six Months Ended March 31, 2006 Compared to Six Months Ended March 31, 2005
 
We generated $87,831 of revenue during the six months ended March 31, 2006 compared to $5,472 during the six months ended March 31, 2005. During the six months ended March 31, 2006, $86,832 or 99% of the revenue of $87,831 was generated by our newer business-oriented products, such as Travado IBUS™, which entered the market in March 2005, while the consumer-oriented products such as Gotcha!® generated $999 in sales or 1% of the revenue. During the six months ended March 31, 2005, our Gotcha!® products generated sales of $ 3,972 or 73% of the revenue of $5,472 and our Travado IBUS™ products had revenues of $1,500.
 
Gross profit increased to $30,872 in the six months ended March 31, 2006 from $2,241 in the six months ended March 31, 2005.
 
Costs and expenses were $351,419 in the six months ended March 31, 2006 compared to $483,567 in the six months ended March 31, 2005.
 
Salaries and benefits, of administration and marketing personnel decreased to $129,689 in the six months ended March 31, 2006 from $164,914 in the six months ended March 31, 2005. The decrease is mainly attributable to the reduction in accrued payroll taxes resulting from a recalculation of the estimate of taxes required for outstanding back pay, the departure of one part-time employee in January and the reduction of hours worked by other part-time employees.
 
Research and development expenditures decreased to $134,543 for the six months ended March 31, 2006 from $197,534 for the six months ended March 31, 2005. This trend is expected to reverse during the second half of fiscal 2006, as research funding is planned to increase in the near term. The Company has focused an increasingly significant amount of its time and energy on development of new sources of revenue through the building of new customer relationships. The Company has also spent and plans to spend resources on the development of strategic partnerships with other technology firms to assist us in taking its products to market faster. 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.
 
There was no stock compensation in the six months ended March 31, 2006 compared to $4,437 in the six months ended March 31, 2005.
 
Other expenses decreased in the six months ended March 31, 2006 to $87,187 from $116,682 in the six months ended March 31, 2005 as a result of reductions in depreciation, marketing, selling, telephone, insurance, shareholder’s meeting expenses and office costs. The expense reductions were somewhat offset by increases in expenses such as insurance, rent, accountant’s fees and statutory filing fees.
 
Interest expenses increased to $36,900 during the six months ended March 31, 2006 from $7,970 in the six months ended March 31, 2005 due to the provision in the half year ended March 31, 2006 of interest for the interest bearing Notes Payable and the amortization to interest of debt discount and the beneficial conversion feature (See Issuance of Common Stock above). None of these costs were incurred in the half-year ended March 31, 2005.
 
During the six months ended March 31, 2006, amortization of deferred offering costs, amounting to $2,000 have been charged to operations as compared to no amortization of deferred offering costs in the same period in 2005.
 
Liquidity and Capital Resources
 
At March 31, 2006, we had cash and cash equivalents of $218 compared to $1,616 at September 30, 2005. Our total cash used in operating activities from developmental stage inception in 1997 through March 31, 2006 was $8,569,326. We have an accumulated deficit of $24,209,909 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 and warrants in the public and private market, and to a very limited extent and only just recently, through the sale of our products.
 
On November 1, 2005, as an important phase in the current years financing plan, we entered into a financing program with a U.S. investment fund (See Issuance of Common Stock and Notes Payable above). Funding from this program amounted to $175,000 before financing costs of $24,000.
 
On September 7, 2005, we entered into a one-year factoring agreement with United Capital Funding of Florida. The agreement provides for a maximum amount of funding of $100,000. The initial and periodic factoring fee is .45%. The factoring period is five days and the purchase price is 80% of the face amount. United Capital Funding is a specialized financial services firm offering Accounts Receivable Management and working capital funding via factoring. We expect to increase our cash flow with this arrangement.
 
During the month of January 2006, we began a program of temporarily reducing staff hours in areas outside of sales, marketing, customer support and accounting. The objective of this program was conservation of cash without affecting our revenue growth rate, and it is expected to end in May 2006. We also have a number of non-disclosure agreements with new prospective partners to help finance our growth, which has now seen four consecutive quarters of revenue growth.
 
Cash used in operations was approximately $137,998 for the six months ended March 31, 2006 compared with approximately $474,804 for the six months ended March 31, 2005.
 
We believe that our current cash position as of March 31, 2006, including cash funds arising from the exercise of outstanding options, from equity placement sales and other capital raising efforts, short-term loans from officers, directors, and significant shareholders, 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. 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 Subsequent Events
 
We have invested significant management, engineering, and sales resources in customer demonstrations of the latest versions of our Travado product line during the last six months. This has resulted in a number of invitations to bid for mobile video projects. We have started work on, and in some cases completed, pilot projects using this technology with the Gilbert Public School District in Arizona, the Palo Alto Fire Department (in partnership with SAP), the US Department of Homeland Security (in partnership with SYS), and the Clover Park School District in Washington, and others. We have completed or expanded installations of this technology in the Scottsdale School District in Arizona, the Sunnyside School District in Arizona, and the Amphitheatre School District in Arizona. As a result of these efforts, we had a $15,000 order backlog at the end of March 2006.
 
We have further initiated formal presentations with a number of school districts located throughout the USA, that have resulted in requests for proposal (RFP). To further aid our sales efforts we are in discussion with a number of Regional and National distributors. In order to build on this momentum, we have taken advertising space in a Trade Journal, and will attend a number of Regional and National exhibitions during June and July.
 
We have also initiated a significant effort towards combining our resources and technologies with those of complimentary firms, using a mergers and acquisitions approach to achieve more efficient operation through increased scale. This new program has been titled MDEF, or Market Defined Earn-out Framework. We have entered into preliminary negotiations with a number of firms in this regard, and we believe that these negotiations may result in significant new business combinations for us during the next several quarters. However, no firm offers have been made by us or accepted by us in this regard as of the date of this report.
 
As a part of our MDEF program, we engaged the services of Alaron Financial Services to assist us in identifying and structuring appropriate transactions in this regard. We also engaged the services of a new outside public relations firm, and have launched a new corporate website at www.nsct.info to support our efforts in this area.
 
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 March 31, 2006, 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.
 
There have been no significant negative changes in the our internal control over financial reporting during the six months ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
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 year ended September 30, 2005, Epstein Weber & Conover, PLC 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.”
 
 
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, 2005. 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.
Changes in Securities and Use of Proceeds
 
On March 15, 2006, we issued 430,000 of the Company’s restricted common shares, to Mr. Graham Clark, at the closing price of $0.035 in lieu of his partial forgiveness of the Company’s back pay indebtedness to him.
 
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 and Reports on Form 8-K.

(a)
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

(b)
Reports on Form 8-K
 
None.
 
 

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:  May 22, 2006 By:   /s/  Michael A. Grollman
 
 
Michael A. Grollman
Director, Chief Executive Officer, Acting Chief
Financial Officer and Chairman
 
     
 
 
 
 
 
 
Date:  May 22, 2006 By:   /s/  Graham L. Clark
 
 
Graham L. Clark
Director, President, and Secretary
 
     
 
 
 
 
 
 
Date:  May 22, 2006 By:   /s/  Gregory Szabo
 
 
Gregory Szabo
Director
 
23